Monthly Investment Letter: New Year’s portfolio resolutions

As we approach the end of 2021, many of us are thinking about New Year’s resolutions to help us live better lives. In this letter, I’ve taken some of the more popular resolutions, and considered how they might help keep your portfolio on track in the year ahead:

1. Focus on the future – keep a longer-term perspective amid shorter-term fears
2. Get more organized – review your financial plan at the start of a Year of Discovery
3. Lose some weight – put excess cash holdings to work
4. Widen your horizons – into the oft-neglected Eurozone and Japan equity markets
5. Get healthy – and a healthcare portfolio
6. Try something new – diversify some exposure into alternatives
7. Be unconventional – boost your portfolio’s yield
8. Save a few more dollars – favor the US dollar over the euro, yen, and Swiss franc
9. Learn a new language – the ABCs of technology
10. Be more green – align your portfolio with the drive toward net-zero carbon

While mindful of risks around COVID-19 variants and inflation, we keep a positive outlook on stocks for the start of 2022. Global economic growth is likely to remain above trend for the first half of 2022, monetary policy is still accommodative, even if emergency support measures are being scaled back, and we expect 10% growth in global corporate earnings in the year ahead. We particularly like the Eurozone, Japan, and the global energy and financials sectors.

In fixed income, amid low yields and tight spreads, we think the opportunity set is limited. We do, however, see opportunities for investors to boost yield in US senior loans, Asia high yield, and in private credit.

We expect the US dollar to strengthen further in the year ahead as the Fed withdraws monetary accommodation faster than some other major central banks. We also hold a positive view on oil as demand hits new highs, and a negative view on gold against a backdrop of rising rates and a belief that inflation will fall.

New Year’s resolutions

1. Focus on the future – keep a longer-term perspective amid shorter-term fears

The emergence of the omicron variant has heightened volatility in recent weeks. But early indications that the variant is relatively mild have helped global markets rebound toward all-time highs. It’s another demonstration of the importance of keeping a longer-term perspective amid shorter-term fears.

The spread of the new omicron variant sparked fears about restrictions on economic activity and prompted a 3.5% sell-off in global equities between 25 November and 3 December.

Early indications suggest that omicron does appear to be more transmissible than delta: a study from Kyoto University using mathematical modelling found that omicron was 4.2 times more transmissible than delta in its early stage, while a study by Pfizer shows that protection from two doses of the Pfizer/BioNTech vaccine is lower for omicron than for prior variants.

However, initial indications also suggest that the virus is relatively mild. Data presented by South Africa’s National Institute for Communicable Diseases on the severity of omicron pointed to no “dramatic increases” in the number of people who need oxygen, ventilators, or needed to be moved to intensive care units. Nor has the mortality rate increased. The share of hospitalized patients in South Africa’s Gauteng province who were in ICU has been no more than 10% since the emergence of omicron, while the proportion was more than 20% in the first stages of the delta wave.

Meanwhile, GlaxoSmithKline has said that its COVID-19 antibody treatment is effective. Pfizer’s study suggests that a third booster dose neutralizes the new variant and that existing vaccines will still help defend against severe disease.

Taken together, we think developments are consistent with our base case that, from a market perspective, the variant will broadly ‘merge’ into the existing delta wave, with governments only imposing partial and short-term restrictions on economic activity. In this environment, we would expect markets to shift their focus beyond omicron and onto the underlying trajectory for the economy.

Against this backdrop, investors should keep a longer-term focus. As the recent equity market rebound has proven, shifting portfolio strategies in response to short-term fears has the potential to damage longer-term returns.

2. Get more organized – review your financial plan at the start of a Year of

Discovery

The start of a new year is often a time for reflection. After two years marked by significant change, investors should use this time to take a fresh look at their goals and how they align with their portfolios.

We believe a good starting point to financial planning is to divide wealth into three distinct strategies: Liquidity. Longevity. Legacy.1:

Liquidity

First, we recommend that investors set aside enough resources—in cash, bonds, and borrowing capacity—to cover the cash flow that they’re planning to pull from their portfolio over the next two to five years. This allows most assets to stay focused on growth and longer-term goals. Many clients have told us how important this strategy, and specifically their Liquidity strategy, has been to their peace of mind as they cope with the pandemic. As we contemplate the changed circumstances of a post-COVID-19 world, everyone should review their liquidity needs.

Longevity

By keeping a Longevity strategy focused on the medium to long term, investors can avoid the potential risk of overtrading, and allow their portfolio to compound growth over the longer term. It can be psychologically difficult to re-enter the market quickly after exiting, and investors who sold out during market pullbacks this year, such as in September and late November, may have missed subsequent equity gains. Keeping a Longevity strategy well-diversified by region and asset class can also help reduce the temptation to trade in-and-out of individual markets.

Legacy

Finally, a Legacy strategy holds the assets that may exceed those needed to fulfill an investor’s lifetime goals. Here, given a long time-horizon, investors can potentially take on more aggressive and less liquid investment strategies to enhance their growth potential, allowing for even more meaningful gifts to philanthropy or to future generations.

1 Timeframes may vary. Strategies are subject to individual client goals, objectives and suitability. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved.

3. Lose some weight – put excess cash holdings to work

Trimming some excess is something many people aim to do in a new year, and considering a trim to excess cash could have benefits too. While holding cash can be comforting in the short term, it can be bad for your portfolio’s long-term health, particularly when nominal interest rates are lower than inflation, like they are today.

Currently elevated levels of inflation, and near-zero interest rates, mean that the real value of cash is eroding fast. US consumer prices rose 6.8% in the 12 months to November, the fastest pace since 1982. But even more moderate rates of inflation can lead to significant real wealth erosion over time. Take the example of an investor with a USD 5mn portfolio earning 0% interest, and annual expenses of USD 250,000 that are rising by 2% each year due to inflation: keeping the portfolio in cash would halve its value in just 10 years.

4. Widen your horizons – a home bias hurts many portfolios

Many investors have too much exposure to local markets, industries, or companies. Currently, we think many investors could improve their risk/reward by diversifying into the Eurozone and Japan.

Weaker longer-term performance has led many investors to reduce exposure to Eurozone and Japanese equities. But we think an environment of strong economic growth suits their cyclical characteristics, and now is a good time for investors to re-engage.

We expect Eurozone equities to be supported by accommodative monetary and fiscal policy; above trend GDP growth; higher earnings growth than most regions; and undemanding valuations. MSCI EMU is currently trading at 15x forward consensus P/E, a 16% discount to global equities, represented by MSCI All Country World.

Japanese stocks, represented by MSCI Japan, have underperformed global equities by 12% (in US dollar terms) since the beginning of the year. But with 79% of the Japanese population now fully vaccinated, economic recovery is underway, supported by new fiscal stimulus equivalent to around 10% of GDP. We expect a 10% rise in earnings in fiscal year 2022. Japanese stocks also tend to be more resilient than other regions to rising US real yields.

5. Get healthy (and a healthcare portfolio)

Getting healthy is one of the most popular New Year’s resolutions. But when it comes to portfolios, we think investors should also think about boosting their allocation to healthcare. The sector is cheap compared to its long-term average, while also offering structural growth.

Over the past 20 years, the global healthcare sector has traded at an average 10% premium to global equities, but today this premium is just 2%. Pharma stocks appear particularly cheap, with the MSCI All Country Pharma index trading at a 16% discount to the MSCI All Country World Index on a 12-month forward price-to-earnings basis, close to 20-year lows.

Pharma stocks’ relative insensitivity to economic performance should be beneficial as growth normalizes in the second half of the year. We think increased clarity on US policy should remove a key overhang. The drug pricing proposals in the US Build Back Better bill would have only a limited impact on the sector, in our view.

Medtech stocks account for around a third of healthcare market capitalization. Mature medical device companies share many of the defensive characteristics expected of the healthcare sector, such as high returns on equity fueled by sustainable revenue growth and relatively high margins. We expect revenue growth to pick up in 2022 as hospital access recovers from the winter COVID-19 wave and the backlog of procedures is dealt with.

6. Try something new – diversify some of your investments into alternatives

Alternative asset classes, such as hedge funds, can help improve portfolio diversification, yet 83% of GWM investors (ex-US) don’t have any exposure to alternatives.

More positive correlations reduce the ability of bonds to act as a portfolio diversifier, and with monetary policy likely to remain a key market driver in the year ahead, equities and bonds could continue to move up and down together. Currently, the correlation between the S&P 500 total return and US Treasuries total return (Bloomberg Barclays US Treasury Index) has moved from negative 0.3 at the end of August to positive 0.35 at the end of November, and was as high as 0.75 in September.

Hedge funds offer an alternative diversifier with a low correlation to other asset classes, the potential for attractive risk-adjusted returns, and historically less downside sensitivity than equities. They delivered solid returns in 2021, gaining 11.4% from January to end-October, as measured by the HFRI Fund Weighted Index.

We think hedge fund managers should be well positioned to generate alpha against a backdrop of monetary policy shifts, desynchronized growth, and inflationary dynamics. Hedge funds can also be a defensive way to attain market exposure. They typically exhibit a lower beta to global markets and include a focus on risk management and downside mitigation.

7. Be unconventional – boost your portfolio yield

We expect yields and rates to remain near historical lows, and see limited opportunity in traditional fixed income. Investors looking to boost income will therefore need to look for ‘unconventional’ yield sources, including US senior loans, private credit, synthetic credit, active strategies, and dividend-paying stocks.

We think central banks are likely to scale back monetary accommodation in 2022, but remain cautious about the risk of overtightening. As a result, we expect only a gradual rise in rates and yields, and expect US 10-year yields to rise from 1.5% today to 2% by June 2022.

Meanwhile, we expect inflation to average 2.7% in Asia, 2.2% in the Eurozone, and 4.2% in the US, meaning investors holding excess cash or high-quality bonds are likely to experience real wealth destruction.

With developed market credit spreads still tight, investors looking to boost income will need to look for ‘unconventional’ yield sources. We like US senior loans, which currently offer an average yield of 4.4% with a floating rate structure that offers insulation against the risk of higher interest rates. For investors willing to lock up capital and accept higher risk, private credit can provide income opportunities more than public market returns. Finally, dividend yields in some regions, such as the Eurozone, are already well above government bond yields, and dividend-focused strategies can enhance income further.

8. Save a few more dollars – favor the US dollar over the euro, yen, and

Swiss franc

Despite high US debt levels, we expect dollar appreciation to continue in 2022, as investors focus on divergent central bank policies. We prefer the US dollar over other currencies such as the euro, yen, and Swiss franc.

The US dollar index (DXY) has gained 7% year to date, but news of the emergence of the omicron variant halted the dollar’s appreciation, after many short-term investors unwound speculative currency positions.

In our base case, we expect the dollar’s appreciation to resume as investors refocus on divergences in central bank policy. The Fed has accelerated the tapering of its USD 120bn per month asset purchases, and we expect the central bank to continue its gradual tightening of policy in 2022, which should support further upside for the USD.

In contrast, the Bank of Japan, Swiss National Bank, and European Central Bank look likely to remain more accommodative. For example, ECB President Christine Lagarde has said that premature policy tightening would be an “unwarranted headwind” for the region’s recovery, and we think the ECB will keep policy loose. We think this should lead to deprecation of the negative-yielding EUR, CHF, and JPY, which are likely to increasingly be used to finance carry trades.

9. Learn a new language – the ABCs of technology

After years of talk of the FAANG stocks, we think tech investors in 2022 and beyond will need to learn a new language: the “ABCs of technology.” We expect growth in Artificial intelligence, Big data, and Cybersecurity to outpace the broader tech sector, and we think investors should look to the small- and mid-cap tech space—as well as private markets—to capture the opportunities they present.

Our “ABCs of tech” theme is driven by powerful secular trends in automation, analytics, and security—key strategic focus areas for many businesses. We expect the market for AI services and hardware to grow 20% a year to reach USD 90 billion by 2025. We expect the global data universe to expand by a factor of more than 10 from 2020 to 2030, reaching 660 zettabytes—equivalent to 610 128GB iPhones for every person on the planet—and presenting opportunities for big data analytics. Digital lifestyles require greater investment in protecting against cybercrime: the average cost of a data breach rose from USD 3.9mn in 2020 to USD 4.2mn in 2021, according to the Ponemon Institute.

To tap into the “ABCs of tech” trends, we think investors need to look beyond the mega-caps, and into small- and mid-cap companies. As well as providing exposure to key tech disruption themes, we think small- and mid-cap tech stocks offer faster earnings growth than their larger peers, lower regulatory or tax risks, and greater opportunity to benefit from consolidation. We expect companies exposed to the ABCs of technology to generate earnings per share growth averaging 16% between now and 2025.

Investors should also consider private equity as a way of accessing earlier stage growth opportunities. Around 437,000 tech companies globally are privately held, according to PitchBook, compared with just 8,100 listed on public exchanges.

10. Be more green – align your portfolio with the drive toward net-zero carbon

The drive to net-zero carbon has emerged as a key theme for many individuals, as well as governments, businesses, and investors. We believe it will generate some of the best growth opportunities in the coming decade, from clean energy and carbon reduction solutions to digitalization and electrification.

With 136 countries, responsible for 88% of global emissions having pledged to reach net zero (source: net zero tracker), the energy transition has become a critical investment theme.

We expect that most of the reductions in global CO2 emissions through 2030 will be driven by deployment of renewable energy. The International Energy Agency projects that global renewables capacity will rise to more than 4,800 gigawatts by 2026, an increase of over 60% from 2020 levels. Renewables should account for nearly 95% of the expansion in global power capacity over that period.

The combination of government regulation, incentives, spending, and investment aimed at driving the transition should create some of the most compelling growth opportunities of the coming decade. Across greentech, we see opportunities ranging from clean energy and carbon reduction solutions to digitalization and electrification. Longer term, we also expect new investment opportunities to become more prominent in areas such as hydrogen.

Best wishes

Whatever your hopes and resolutions for 2022, I hope we’ve provided some inspiration to help you build a better portfolio for the future. Thank you for being on this investment journey with us in 2021. We wish you a happy and prosperous year ahead.

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