In this latest Cirilium update, portfolio managers Ian Jensen-Humphreys, Sacha Chorley, and CJ Cowan explain how they’re delivering returns from volatile bond markets, why downside risks are rising, and the latest changes to their tactical positioning.
How do your recent moves in global bonds illustrate your approach to the asset class?
“It’s been a painful couple of years for bond markets which explains why we’ve remained underweight relative to our strategic asset allocation (SAA).
“However, the pain of rising bond yields (and falling bond prices) has created opportunities for nimble investors, which is why we took the decision to halve our previous underweight to government bonds from around 7% to closer to 3.5% in mid-October.
“We came into 2023 around 3.5% underweight to government bonds relative to our SAA, which was helpful against a backdrop of easing bond prices in the first two months of the year. However, the sudden run on three US regional banks and the hastily arranged ‘shotgun’ merger of Credit Suisse into UBS in March delivered a boost for bond markets as investors took fright and sought safe havens.
“We chose to sell into this rising market. This enabled us to book profits on some of our holdings and to extend our underweight to government bonds to just under 7%, which was in line with our outlook for the asset class at a time when we thought that global interest rates still had further to rise.
“Bonds subsequently sold off again, with government bond yields rising steadily from April through to October (meaning their prices fell).
“Following the scheduled review of this tactical tilt, we decided to increase our allocation to government bonds in October. This reduced our underweight back to around 3.5% relative to our SAA.
“Our activity in this area illustrates our opportunistic approach – by trading in and out, we can still book profits even in an asset class where we’re less than enamoured with the outlook.
“That said, the outlook for government bonds has become slightly more balanced than it was even a few months ago. From here, we’ll look to further increase our allocation if we see bond yields rise by, say, 0.5% to 0.75%. Conversely, if bonds rally back again (meaning their yields fall) we’ll look to reduce our position once more and stay underweight until we see data that supports position building once more.”
How has Cirilium’s positioning changed since the summer?
“At the September review of our overall risk appetite, we concluded there was little benefit in changing the exposures from those we had at the start of the summer as these were in line with our core view of a ‘soft landing’ for the global economy. Economic data released over the summer had generally been slightly better than anticipated, although at the same time, with evidence of only modest improvements in company earnings, and the absence of any obvious catalysts for what might drive them higher once more, it’s difficult to justify extending our equity exposure.
“Despite some notable performances, the latest earnings season was a tough one for equity markets. There were scant rewards for those companies that beat earnings estimates and historically severe price declines for those that missed. Indeed, the progress of the US tech stocks known as the ‘Magnificent Seven’, which have cumulatively gained around 75% since the start of the year, has masked the fact that, absent the performance of these mega-caps, the US equity market has declined in broad terms this year.
“Even so, the economic backdrop remains relatively sound with employment levels in the US, UK, and elsewhere still robust, which points to the need to stay invested in equities.
“Although the economic backdrop hasn’t changed greatly since the start of the summer, geopolitical risks have been steadily rising. The war in Ukraine continues and a second bitter conflict has broken out in the Middle East, which could also escalate into greater potential sanctions or the weaponization of energy supplies if neighbouring states are drawn further into the conflict.
“So while our central scenario remains the same, the potential downside risks have grown.”
What adjustments have you made to the tactical asset allocation (TAA) in the Cirilium Portfolios?
“In October, we increased our tactical overweight to the healthcare sector by increasing our position in the AllianceBernstein International Health Care Portfolio by 1%, taking it back to around 3% overall.
“Since late 2022, healthcare has underperformed global equity markets, presenting us with the opportunity to buy back in at a lower price to a sector that delivers high-quality, defensive earnings and which enjoys long-term structural tailwinds.
“The defensive characteristics of healthcare investment mean this increased position should provide an added buffer to the portfolios by outperforming in the event that broader markets suffer a decline.
“Meanwhile, in the alternatives space we introduced a new position in the L&G Multi-Strategy Enhanced Commodities ETF, a ‘smart-beta’ strategy that tracks the performance of the Barclays Backwardation Tilt Multi-Strategy Capped Total Return Index. This presents us with a more cost-efficient way to capture physical commodity exposure.”
What does your VTEC analysis framework suggest about how markets are positioned?
“Our valuations, technicals, economic, and companies (VTEC) framework provides confirmation for many of the most recent adjustments we’ve made within the Cirilium Portfolios.
“Our VTEC analysis shows that sentiment has worsened. This was confirmed by the latest earnings season where there were few rewards for those beating their earnings estimates and notable downgrades for those that fell short (both relative to one another and to long-running historical averages). In simple terms, positive sentiment is clearly lacking when good news for leading companies fails to move the needle.
“More broadly, there was little evidence of future earnings growth from this earnings season while corporate leaders generally adopted a more cautious tone toward the outlook. Similarly, geopolitical risks are rising, especially those emanating from the Middle East.
”This all advocates for a more tempered, cautious approach to risk markets.”
What progress have you made on equalising the headline risk exposures across the portfolios?
“We’ve made excellent progress here. This month we announced the moves we’re making to align the strategic asset allocation (SAA) across all of the Cirilium Portfolios. This harmonisation will provide greater consistency across the Cirilium, Cirilium Blend, and Cirilium Passive Portfolios and brings with it some important enhancements to how we manage the portfolios.
“We’re in the process of increasing the number of individual asset classes and sectors we use to construct the SAA for each of the 15 portfolios. In particular, we’ll be using more granular fixed-income building blocks, which will allow us to better refine each portfolio’s risk and return characteristics, improving their diversification.
“We’re also aligning the SAAs for the Cirilium Passive Portfolios by equalising their regional equity market exposures with those of the Cirilium and Cirilium Blend Portfolios and enabling them to invest in alternatives. For the Cirilium Passive Portfolios, this means introducing a fund that tracks a diversified hedge fund index.
“These changes and others will provide an over-arching asset allocation for the Cirilium, Cirilium Blend, and Cirilium Passive Portfolios. This will streamline decision-making for advisers and their clients while helping to improve risk-adjusted returns over time.”