From a credit investment perspective, that’s a sign to me that we should be getting cautious about consumer cyclical businesses that rely on discretionary spending. The property market too could have leaner times ahead, as the combination of a higher cost of living and higher mortgage rates starts to feed through the system. In other parts of the economy there may be more of a lag, as people still flock overseas on holiday to make up for two years of Covid disruption, although what the new bookings picture may look like after this summer season is more questionable given squeezed discretionary spending.
In the broadest terms, as bond investors we always need to think about risk, and whether we’re being appropriately compensated for that in the form of the yield we receive. It is at inflection points in the economic cycle, like we appear to be in now, when we need to be especially wary of any businesses that have perhaps been too aggressive with the capital structure and/or have few defensive ‘moats’ when it comes to protecting their earnings during a downturn.
Of course, the sectors making the headlines right now for delivering bumper profits are related to energy, or commodities more generally. Here too, however, it’s a question of whether or not you’re being paid for the fundamental risk as an investor. I was very bullish on energy a couple of years ago because the market was so bearish and you could pick up bonds very cheap, but now – although the fundamentals are undoubtedly stronger – investors are getting paid a lot less to own the bonds, as the risk premium has eroded and, along with it, the return potential.
We may well be in a bear market, but my view is that this is the best time to be an active fund manager, providing one is willing and able to change one’s mind (and strategy positioning) as the world evolves. Across Jupiter’s fixed income desk, we look to be active, to be contrarian when it seems the right thing to do, and in particular focus on downside risk because in bond markets you can add the most value over time by not losing money.
Firstly, the constituents of the different indices go a long way in explaining the discrepancy. There are many oil and commodity names in the FTSE 100 Index, which have obviously performed particularly well recently, and there are fewer in the mid- and smaller-company space.
Secondly, we tend to see investors taking less risk during phases of high market stress, which has also put pressure on UK smaller companies year to date, which are always going to be considered a higher-risk part of the market and will therefore sell off harder when the market falls – this is something we saw with Brexit, and the Covid pandemic, for example. However, this is a relatively transient feature, while commodity stocks are always led by moves in commodity prices.
Smaller-company oil and commodity stocks tend to be exploration companies, which means that investors must consider asset risks as well as commodity price risks, so there’s a structural element there too. Smaller-company commodity stocks tend to not only be more difficult to invest in, but there are lots of environmental, social and governance issues to consider when investing as well. For these reasons, we tend to avoid investing in names in the oil and commodity sectors in our strategy, which has contributed to a difficult period for us year to date.
Whenever you get a very dramatic change in market direction like we saw with Russia’s invasion of Ukraine, it’s obviously difficult to be positioned for that in advance. Uncertainty about how the situation there will develop means it is particularly difficult right now to make clear-cut judgements on the outlook for the UK economy, and for the global economy more broadly. Furthermore, while a squeeze on UK consumers has been dominating headlines recently, it wasn’t long ago that we were hearing about the significant savings build-up by UK households, so the pattern there is quite difficult to predict too.
While top-down considerations are very much part of our team’s investment process, it’s not necessarily about making big bets in one direction or another. A lot of what we’ve been trying to do over the past year or so is to take some of the risk off the table and try not to take any large calls until the picture becomes clearer. When it does, we will then look to align our portfolios with what is leading the market.
Over the longer term, studies from the London Business School show that UK smaller company stocks have consistently produced returns above the market. History shows it’s really an asset class for contrarian investors. While UK smaller companies are generally perceived as risky and unglamorous, we think the investment universe is a melting pot of well-run, disruptive businesses, with many fantastic business leaders and managers who have a proven ability to generate value.
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
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