Another year of flux

2023 felt like an especially uncertain year as the world started to cope with the consequences of the pandemic and inflation. Despite the sombre mood, most equity markets performed relatively well and rewarded the more adventurous investor for the pain of 2022. It was a mixed year for those slightly more cautious investors, who allocated more to fixed income in the hope that interest rates had peaked and 2023 would prove to be the ‘year of the bond’. To combat inflation, interest rates were marched even higher by central banks, and doing so weighed on bond prices, albeit with some respite as the end of the year approached.

Looking ahead to 2024

Heading into 2024 there’s plenty to look forward to, even though the global economy appears to be weakening further. Savers are now earning the highest rates of interest for over a decade, inflation is abating and wages are finally growing faster than prices. Our annual Strategic Asset Allocation (SAA) project began in late 2023, as government bond yields started to turn a corner after a tricky third quarter that brought many yields back to levels not seen since prior to the financial crisis. As with late 2022, a possible juncture in markets provides an interesting time to reposition the portfolios for the markets we now face. As ever we have let the mechanical nature of our SAA process dictate the direction of travel for portfolios, however we have intervened in three areas with Tactical Asset Allocation (TAA) calls to course-correct where we see risks not accounted for in the Mean Variance Optimiser (MVO)-led SAA.

Strategic asset allocation

To address a hot topic: cash is indeed an interesting asset given where interest rates are. The lower-risk portfolios had a relatively high weighting to cash in 2023 and we have increased this slightly for 2024, albeit not quite as aggressively as called for in an MVO setting. We opted to temper the increase in cash for 2024 with a TAA, as there is no telling how long these interest rates on cash will be available, and missing out on the duration of fixed income in a falling interest rate environment is a risk worth considering. We do however acknowledge that cash is currently paying us to be patient.

In 2023, the portfolios benefitted from an allocation to global high-yield bonds, as investors were attracted to the asset class following the increase in yields in the prior year. Within the portfolios that allocate broadly to fixed income, we have trimmed the exposure to high yield via a TAA for 2024 because we feel the additional return for holding high yield relative to government bonds is not reflective of the risks involved going forward (such as company defaults). Instead, we prefer higher-quality bonds such as UK and US government bonds, and investment grade corporates. If the economic environment worsens to a greater degree than suggested by current high yield credit spreads, government and investment grade should perform better than high yield.

The final TAA also sits within the fixed income book; we prefer the credit risk and higher yield of US Treasuries relative to the global government bond index, which includes Europe, China and Japan (the latter still has bond yields held artificially low by policy at the Bank of Japan and presents an asymmetry akin to that in other developed bond markets in 2022). In times of market stress, which we are not explicitly predicting, US Treasuries often benefit from a ‘flight to safety’ – this TAA instinctively feels like a good protection mechanism for the bad times.

The allocation to equity within the portfolios remains broadly unchanged going into 2024 and we have allowed the SAA process to rotate towards what look to be pockets of better value in Europe and Japan. This in turn reduces the weighting to US stocks and those ‘magnificent seven’ that performed so well for much of 2023 (Apple, Amazon, Tesla, Nvidia, Microsoft, Meta and Alphabet). Although we hold no specific negative view regarding these large US stocks, our long-term approach to valuing asset classes is forcing us to reappraise the positioning in the US after such a good year.

Finally, the small weighting towards the alternative investments, currently UK commercial property, has been tempered as bond yields and cash are offering a comparatively better prospective return for the level of risk taken.

Overall, this SAA has seen relatively low turnover at an asset class level. This reflects the deliberate focus on long-term asset allocation and that the portfolios of last year remain largely appropriate for the current environment. From a TAA perspective, we constantly monitor risks and opportunities for the portfolios, however, we only commit to intervening when asymmetry presents itself; a discipline that is often overlooked.

Want to hear more?

Our full strategic asset allocation brochure is now available to download, alongside the latest AJ Bell Funds and Managed Portfolio Service portfolios.

If that’s not enough, why not watch the Q&A session with AJ Bell Investments’ Managing Director, Ryan Hughes, and Director of Personal Finance, Laura Suter?

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