Just as a picture tells a thousand words, a single statistic portrays the current mood among investors: the IA Targeted Absolute Return sector saw more inflows than any other sector in 2016, as money poured from equity funds in 10 of the 12 months. But as the average monthly return of absolute return funds was 0.2 per cent compared with 2.4 per cent for global equities, many investors managed to create their own bear market.
Popularity among these funds highlights the continuation of a complete aversion to bonds. It also demonstrates the impact pessimistic reports on the health of the global economy have on investors. Yet commentators have been proven wrong; the world has not fallen to pieces and every single IA sector, in sterling terms, posted a positive return last year. In fact, targeted absolute return funds were the worst-performing of the lot.
Active mixed-asset fund managers have the ability to reduce equity or bond exposure if they feel concern over the wider economic environment. However, the equity/bond split of passive funds is often fixed. Funds in the Vanguard Lifestyle range, for example, do not have the option to move into cash and, as a result, have performed well over the past year as equities and bonds have been strong. Clearly this will not always be the case but active managers now have some catching up to do.
The biggest question is what will happen next? Will the bond bubble burst or will equities fall sharply from grace? Of course, no one knows.
In the UK it is hard to see an interest rate rise this year, although the Bank of England could reverse the cut made after the European Union referendum. Inflation is on the rise but it has been as high as 5 per cent in the past. In that case the BoE made no move to interest rates, so it is no guarantee of a hike.
The future is slightly easier to predict in the US. There, I would expect to see an interest rate rise as soon as June. With low unemployment and relatively low inflation, the Federal Reserve has a window of opportunity. Raising rates now gives it the ammunition to start cutting them againif the economy takes a turn for the worse.
While economics is difficult to gauge, politics is near impossible. Nothing can be ruled out when it comes to President Trump. This is, therefore, the most difficult period I can remember for asset allocation – although, contrary to what many passive investing fans believe, it has never been easy. Asset allocation is far harder than stockpicking and there are far fewer people any good at it.
Take the past six months. It appeared we had reached an inflection point: defensives are dead, cyclicals are back. Yet in an era of low growth and low interest rates, quality companies have not lost their magic. As evidenced by the recent bid for Unilever, defensive companies have simply looked to mergers and acquisitions to replace the lack of organic growth opportunities. Whether cyclical companies return to favour with investors or defensive businesses remain in vogue is anyone’s guess.
As such, the most sensible approach is to have a foot in most areas of the market. A period of strong economic growth could boost the performance of funds biased to more cyclical areas of the market. However, a turn for the worse could continue the reign of defensive large caps.
It is a fascinating, if somewhat worrisome, time to be invested. I take solace from the high degree of pessimism from investors. It means much cash is on the side- lines, so any dip in the market is likely to be short-lived as investors flock back to purchase at reduced prices. This is the time we can show our real value to clients. Many suffer from severe information overload. Our role is to rise above it, stay cool and hold our course.
Mark Dampier is head of research at Hargreaves Lansdown