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Cirilium Active monthly commentary - May 2022

Date: 30 June 2022

UK: Suitable for retail and professional clients.

Market review

In May, signs of a shift in investor focus, away from worries about inflation and the rising interest rates needed to combat it and toward the weaker outlook for economic growth, led to a pause in the sustained equity and bond market sell-off that has so far characterised 2022.

Among equity markets, UK large cap stocks were again strong performers. The energy sector led the way, as oil prices rose, despite a 25% windfall tax on oil and gas company profits announced by the UK government, which subsequently impacted the shares of energy generators such as Drax and Centrica.

While the FTSE 100 Index gained 1.1%, the UK’s smaller companies didn’t fare so well, with the FTSE 250 Index declining by an identical amount.

Elsewhere, the MSCI Japan Index gained 1.3%, thanks partly to a recovery in the yen after two months of heavy losses.

The portfolios suffered muted losses that were much in line with their IA comparators

Meanwhile, emerging market equities were helped by the easing of pandemic restrictions in China. The country has pursued a ‘zero covid’ strategy this year resulting in much of Shanghai being placed in lockdown. Consequently, the MSCI Emerging Market Index was up 0.1% while the MSCI China Index gained 0.8%.

The MSCI USA Index finished the period down 0.6% with the consumer staples sector being a notable casualty. This was largely driven by corporate earnings releases from some major US retailers, some of which announced reduced profit margins.

In Europe, much stronger-than-expected eurozone inflation data at the end of the month re-ignited the bond market sell-off, although European equities mostly held their ground with the MSCI Europe ex UK Index down just 0.3%.

At its May meeting, the US Federal Reserve (Fed) confirmed that in June it will begin to sell the assets it purchased under its pandemic-era quantitative easing (QE) programme, meaning that quantitative tightening (QT) will get underway. It also raised its policy rate by 0.5%, double the usual 0.25% increment.

April’s consumer price index report (released in May) showed tentative signs that US inflation may be peaking with the headline rate dipping from 8.5% to 8.3%.

Signs that inflation may be peaking, and that the subsequent rate of interest-rate increases might slow, helped US Treasury yields to fall (meaning their prices rose), while global equity markets regained their poise and rallied in the closing weeks of the month with the MSCI World Index down just 0.2%.

The Bank of England (BoE) raised UK interest rates by another 0.25%, at its May meeting, to 1%. Having been among the first of the developed market central banks to increase interest rates, the BoE has so far been unwilling to ramp up the pace of tightening, despite increasingly rampant inflation, due to a particularly weak growth outlook. Monthly UK GDP growth for March was down 0.1%.

Over the month, the ICE BofA UK Gilt Index declined 3.1%, while the ICE BofA Sterling Corporate Index also fell, down 1.6%. However, US Treasuries posted a small gain, with the ICE BofA US Treasury (sterling hedged) index nudging up 0.1%.

Note:Currency hedging of foreign investments dampens the effect of currency fluctuations on returns and reduces the volatility of your investment. Under most circumstances, we currency hedge foreign currency bond holdings except in cases where the foreign currency exposure is an explicit return-driver (eg emerging market local-currency debt exposures).

Performance review

The Cirilium Portfolios delivered muted losses in May. With global equity and bond markets broadly flat, the lower-risk Cirilium portfolios were much in line with their respective Investment Association (IA) sector comparators while losses were slightly greater for the Cirilium Dynamic and Adventurous Portfolios due to their greater equity ‘growth’ exposure.

In May, the Cirilium Conservative Portfolio declined 0.7% while its IA Mixed Investment 0-35% Shares sector comparator fell 0.8%; the Cirilium Balanced Portfolio fell 0.7% while its IA Mixed Investment 20-60% Shares sector comparator fell 0.6%; the Cirilium Moderate Portfolio declined 0.7% against its IA Mixed Investment 40-85% Shares sector comparator, which fell 0.9%; the Cirilium Dynamic Portfolio declined 1.1% while its IA Flexible Investment sector comparator fell 0.9%; and the Cirilium Adventurous Portfolio declined 1.3% against its IA Flexible Investment sector comparator, which fell 0.9%.

The best-performing holdings were ‘value’ strategies

Within our equity allocation, our Japanese and UK holdings performed well. The Liontrust Japan Opportunities and the JO Hambro UK Dynamic funds were the two largest positive contributors over the month. Elsewhere, our exposure to smaller UK companies, through funds like Premier Miton UK Value Opportunities and Montanaro UK Income, continued to struggle as small-cap stocks remained out of favour.

While the FTSE All-Share remains the only major regional index to be in positive territory this year (up 1.5% to the end of May), the fortunes of the UK’s largest companies have been quite different from those of its smaller stocks. So far this year, the FTSE 100 Index is up 4.8% while the FTSE 250 Index is nursing a loss of 12.1%.

Elsewhere, the Pantheon International and Monks investment trusts both succumbed to declining share prices, while the Sands Capital Global Leaders Fund (like Monks) continued to languish due to the soured investor sentiment towards ‘growth’ stocks. This negative sentiment hit valuations in a number of underlying holdings, despite the absence of poor corporate results.

After a long hiatus, our Asian equity holdings contributed positively in May, with the Fidelity Asia Opportunities Fund still providing our core exposure to the region.

Meanwhile, a rising energy market continued to support Riverstone Energy Limited, which is held in the higher-risk portfolios.

We recently met with the managers of some of our holdings that have struggled this year. These meetings strengthened our conviction in the managers and their strategies, so we opted to trim some of this year’s top performers and added to the Fidelity China Consumer, Jupiter Global Emerging Equity, SGA US Large Cap and Eurazeo funds (Cirilium Dynamic Portfolio only).

In the fixed-income portfolios, we added government bond exposure at attractive prices. This was done using US bond futures contracts and by the reduction or disposal of the Allianz Fixed Income Macro, BlackRock Ultra Short Duration and Janus Henderson Absolute Fixed Income funds, among others.

Outlook

Despite some uncertainty, May failed to provide the catalyst for which investors were hoping. The Ukraine war continued and central banks continued to grapple with high levels of inflation. Meanwhile, corporate margins started to come under pressure, particularly in consumer-facing companies.

Against this backdrop, we believe it should provide opportunities for active managers, which is why we continue to focus on ‘quality’ companies and good-quality portfolio managers, rather than speculating on whether ‘growth’ or ‘value’ investment styles will outperform in the coming weeks.

The worst-performing holding were ‘growth’ strategies

Such managers look to generate robust long-term returns and, in doing so, they generally have a bias towards those ‘quality growth’ companies that have been in the crosshairs most recently. But, so far, our underlying managers report that their portfolio companies have been performing well operationally, with results and guidance (in the main) in-line with their expectations.

We recognise that the environment is challenging, which is why we believe that ‘quality’ will, over the longer term, triumph.

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Paul Craig

Portfolio Manager

Hinesh Patel

Portfolio Manager

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