Whitechurch Investment Update: Nothing Lasts Forever

11th December 2020

At the end of every year it is customary for investors to take stock, review recent events and consider what the future might hold. Of course, 2020 was dominated by a global pandemic that no strategist could have predicted. However, that does not mean that it was a genuine Black Swan event, rather it was, to quote Donald Rumsfeld, a known unknown, in the sense that its possibility had previously been identified but the timing of an outbreak was impossible to determine. Clearly governments could and should have done more to prepare healthcare systems and societies to meet this risk. Another known unknown is a future Tokyo earthquake. The last great quake to hit Tokyo was in 1923. Experts estimate these happen roughly every eighty years based on the theory of plate tectonics. The next one is now ‘overdue’, but no one knows exactly when it will occur. Looking to 2021 and beyond, it can be argued that investors should spend more time analysing big ‘tectonic’ risks to their portfolios and less time on trying to make finely tuned predictions that are invariably inaccurate. As John Maynard Keynes remarked, “it is better to be roughly right than precisely wrong.” We see three key risks that investors should bear in mind when constructing their portfolios.

The first risk is overextrapolation. As everyone knows, the last ten years have witnessed a huge divergence in returns between different asset classes. US equities have hugely outperformed the rest of the world and in particular UK equities. Growth stocks have massively outperformed value stocks. Within the former grouping, the so-called ‘Super Seven’ (Microsoft, Google, Amazon, Facebook, Tesla, Alibaba and Tencent) have dominated returns. There are, of course, reasonable arguments to explain these outcomes based on technological change, highly scalable business models and differential rates of profit growth. Yet, as the writer Sidney Sheldon once wrote, “nothing lasts forever”. It is important to remember that at the end of the previous decade (2001-10), during which emerging market equities had hugely outperformed developed market equities, analysts waxed lyrical over the merits of investing in developing economies. Over the following ten years, emerging market equities were a significant laggard. In fact, reversion to the mean remains the norm, and not the exception, in the investment world.

The second risk area concerns the twin threats of deflation and inflation. In the short term, the pandemic has had a clear deflationary impact as economic activity has contracted during the various lockdowns. In this case, short-term higher-quality debt is attractive, offering as it does a limited time frame and a high probability of repayment. However, state intervention quickly offset that dynamic. On the monetary side, the scale of the stimulus, under the mantra of doing ‘whatever it takes’, from central banks has been unprecedented. Not only has this bailed out holders of riskier assets such as high yield bonds but it has had a significant impact on money supply. Optimists argue that this merely offsets a fall in the velocity of circulation of money, something that has been going on for a while. What is different this time is that central banks are now talking up the virtues of inflation. The Federal Reserve recently introduced average inflation targeting and implied that it would let the economy run ‘hot’ if it could. The ECB has indicated it will consider following suit. Concurrently, governments worldwide are grappling with increased debt burdens and record fiscal deficits. To politicians, inflation might well seem the least bad choice, to erode the real value of debt, given the public’s appetite for ‘austerity’ appears extremely slim.

The third risk is around correlations. Investors have long sought to construct portfolios with a mixture of assets, in the expectation that different assets would perform better or worse at different points in the economic cycle. The most famous example is the simple 60% equity 40% bond portfolio. The bond element was anticipated to deliver its strongest returns in a recession when interest rates would be cut, pushing up bond prices, at the exact moment when corporate profits and share prices would be under most pressure. However, in recent years correlations between asset classes seem to have increased. This may be partly due to monetary policy with some pointing to the impact QE has had – ‘a rising tide lifts all boats’. In addition, the low level of bond yields (in some cases already negative) may make bonds less defensive than previously as there is simply less scope for prices to rise and yields to fall. There is no easy answer to this problem except that, in constructing portfolios, investors would do well to rely less on long-term historic correlations and more on thinking about how things may develop in future.

The Whitechurch investment strategy is designed to meet the risks outlined above. To begin with we have maintained our overweight position in UK equities. Following the double whammy of Brexit and the COVID pandemic, UK valuations versus the rest of the world are pretty much at their lowest ebb ever. On the macro side, as noted above, we see inflationary risks in the longer-term. To this end we have increased the inflation hedge across the portfolios by bolstering our position in index-linked bonds. With regard to fund selection, we think the managers who will perform best in 2021 and beyond will be those with a nuanced, possibly contrarian, approach. It will not be enough, as it has in the recent past, to simply follow the trend. Nothing lasts forever.

Simon Jaffé



This publication is issued and approved by Whitechurch Securities Limited which is authorised and regulated by the Financial Conduct Authority. The views and opinions expressed in this publication are those of the Whitechurch Securities Investment Managers. Opinions are based upon information Whitechurch consider correct and reliable but are subject to change without notice. This publication is intended to provide information of a general nature and you should not treat any opinion expressed as a specific recommendation to make a particular investment or follow a particular strategy. We have made great efforts to ensure contents of the publication are correct at the date of printing and do not accept any responsibility for errors or omissions. Past performance is not a guide to future performance. Value of investments can fall and investors may get back less than they invested. All investments can incur losses of capital whilst income may fluctuate and cannot be guaranteed.