2023 has been a frustrating year for global financial markets thus far as expectations have continued to reset in response to global inflation and interest rate shocks. After a tumultuous 2022, investors understandably hoped and expected to see a stronger rebound this year. But every wave of optimism has thus far been swiftly stamped out by the sober warnings from central bankers, with ‘higher-for-longer’ interest rates being their default policy response until inflation is well and truly tamed.
Against this backdrop, PRISM has performed in line with its peer group, with PRISM H5 posting modest gains of +1.65% year-to-date in GBP terms (+3.7% in USD). The longer-term performance history of PRISM H5 remains strong relative to peers as illustrated below.
The unique structure of PRISM, where the returns of all profiles are driven from a single highly diversified master strategy, has resulted in lower risk PRISM profiles significantly outperforming their respective peers, while higher risk PRISM profiles have lagged pure equity only and growth strategies in the short term. This is due to the very unusual behavior of markets this year and longer term we believe the diversified nature of the PRISM master strategy will outperform less diversified strategies as markets normalise.
The scale and speed of the inflation shock and the interest rate response is unprecedented in recent history, with inflation reaching double digits in much of Europe and interest rates rising by over 5% in the US and UK in little more than a year.
Most of the hit to markets came in 2022, with all asset classes falling significantly but with fixed income and real estate being the biggest fallers. Extraordinarily, 10-year government bonds (traditionally viewed as a ‘safe haven’) fell in value by nearly 40% in a matter of months.
In the face of persistent inflation, we added to assets we believed would be able to maintain their real value over time, including real assets like commodities and precious metals, and trimmed our property and infrastructure holdings. Over the medium term only equity has the ability to respond to high inflation with higher earnings and despite short term volatility we largely held onto our high quality equity weightings throughout.
This strategy proved largely correct, with equities, commodities and alternatives holding up relatively well.
We were very underweight in bonds at the start of 2022, and in hindsight we were too quick to add to bonds as yields rose. Like many others, our initial view was that the inflationary spike was likely to be short lived and that the rapid rise in interest rates was an opportunity to lock in bonds yields that were starting to look attractive for the first time in many years.
While we were too early, we strongly believe this strategy will prove to be correct. UK and US treasury bonds are yielding 4.5% and 4.25% respectively, levels we’ve not seen for 15 years or more. The balance of risks is now firmly skewed to the upside for these bonds in our view. Similarly, high quality corporate bonds are yielding 6% or more and high yield bonds giving over 8%.
For the first time in well over a decade, bonds are expected make a substantial contribution toward PRISM’s annualised return target of 7.75% with relatively low risk, providing the perfect counterbalance to our equity exposures. We expect to continue to increase our bond exposures over the coming months as opportunities arise.
Equity valuations are more nuanced. The US market in particular has held up well this year with the S&P500 only 10% below its all time high, but there is a stark contrast in the distribution of those returns, with technology and in particular AI exposed tech companies driving the majority of the market performance.
On average, the earnings yield of US equities is just 4.75%, only 50bp above treasury yields of 4.25% - hardly, representative of deep value. Nonetheless, when we look past the averages and take out technology companies, we quickly find quality companies at much more reasonable valuations. Europe and particularly UK equities are awash with value. The earnings yield of the UK market is in excess of 9% with dividend yields exceeding 4% making the UK one of the most attractive markets from a relative valuation perspective.
Looking forward, investors are increasingly attracted to high cash yields, with fixed deposit rates close to or exceeding 5%, and asking why bother with volatile and risky markets when they have delivered little over the past couple of years when you can now achieve 5% in the bank? Tempting as this sounds, we believe it’s a classic liquidity trap. Real cash deposit rates, after inflation, are extremely low or negative and are likely to remain so.
A fixed deposit is at best a holding position providing relative protection in a falling market, but with bond yields now back up to attractive levels and the interest rate cycle nearing its peak, we expect the balance of risk to shift firmly to the upside over the next couple of years. Timing your entry is fraught with danger and impossible if you are locked into a fixed deposit.
History has demonstrated that the best strategy is to build up positions in quality assets during times of volatility, like now, and enjoy the ride when the market turns bullish again. We are certainly not out of the woods yet and further set backs are entirely possible if not likely over the coming months; however, we believe this is a good time for investors to top up holdings or begin re-entering markets in advance of the start of the next cycle.
Please do not hesitate to contact us if you have any questions or require further information in relation to this Prism Performance Update; our Business Development team can be contacted by email businessdevelopment@capital-iom.com or by telephone on +44 (0) 1624 654200.
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Disclaimer: The views, thoughts and opinions expressed within this article are those of the authors and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article has been prepared for information purposes only and does not constitute an offer or an invitation, by or on behalf of any company within the Capital International Group of companies or any associated company, to buy or sell any product or security or to make a bank deposit. Nor does it form a constituent part of any contract that may be entered into between us. Opinions constitute our judgement as of this date and are subject to change. The information contained herein is believed to be correct, but its accuracy cannot be guaranteed. Any reference to past performance is not necessarily a guide to the future. The price of a security may go down as well as up and its value may be adversely affected by currency fluctuations. The company, its clients and officers may have a position in, or engage in transactions in any of the securities mentioned. PRISM GBP, USD and EUR Strategies were launched in June 2014, April 2018 and September 2018 respectively. Historical performance is calculated by reference to the actual investment performance of Fusion Alpha modelled into the PRISM product structure. Full details of PRISM are contained in the PRISM Brochure, Terms of Business and associated literature which is available upon request.
Regulated investment activities are carried out on behalf of Capital International Group by its licensed member companies. Capital International Limited and Capital Financial Markets Limited are licensed by the Isle of Man Financial Services Authority. Capital International Limited is a member of the London Stock Exchange. CILSA Investments (PTY) Ltd (FSP No. 44894) and CILSA Solutions (PTY) Ltd (FSP No. 6650), t/a Capital International SA are licensed by the Financial Sector Conduct Authority in South Africa. All subsidiary companies across both jurisdictions are represented under the Capital International Group brand.
