Asset allocation update

In this feature we attempt to lift the lid on the process and our views by interviewing one of the decision-makers:
Andrew Fleming: Chairman of Saltus Asset Management and Asset Allocation Committee

It feels like a risky time to be invested, what are the major risks at the moment?

Reflecting on the last few decades it always seems to be a ‘risky’ environment as there is always something to really worry about. War particularly involving a nuclear power is always going to be risky but the really big issue for investors to be worried about is the potential for a major change to the investment regime. We covered some of this in our last update but to elaborate: the last 35 years has been characterised by falling nominal and real interest rates, and falling inflation, largely as a result of China’s integration into the world economy, independent central banks and demographics. In our view this is changing. The investments that have performed well in the last few decades, and investors have become conditioned to ‘buy and hold’, are unlikely to be those that perform well in the future.

How are Saltus managing those risks?

As we have been highlighting for some time the biggest risks lie in fixed income. We have been running very low weightings in fixed income and have again reduced our positions in credit as we also think the risk of recession is rising. This is a key difference between Saltus-managed portfolios and those of many of our competitors who still have significant weightings in fixed income in many cases. We also have good allocations to alternative strategies which are generally positioned to add value in a more volatile environment.

Has our approach been working?

In short yes. We have been able to protect our lower/middle-risk portfolios in particular as fixed income has recently sold off sharply giving many investors big negative surprises, and our commodities investments have been strong. If I have learnt anything, though, in some 40 years of investing, is that it is an extraordinarily humbling business and it is really important to challenge one’s own conventional wisdom particularly when things are going well.

How do you see the Ukrainian conflict playing out?

This conflict was clearly a major surprise to almost everyone except the US/UK intelligence services. Our key conclusion is that this is likely to be a long drawn out conflict. Putin cannot ‘lose’ and will do everything to demonstrate some sort of ‘victory’ and the Ukrainians have shown themselves to be extraordinarily brave and resourceful in fighting, with strong western support, for their homeland and a western-orientated future as an independent nation. If this is the case then it appears inconceivable that the ‘West’ will be able significantly to reduce sanctions while Putin remains in power particularly given the recent evidence of likely war crimes. Longer term this conflict is very likely to accelerate the emergence of a bifurcated world that divides supply chains and technology between a US-centred ‘West’ and a China-centred trading area that was beginning to emerge anyway as a result of the Covid-related disruptions.

How do you think that will affect capital markets? Is this already priced in?

This is all part of the deglobalizing regime change above. It is likely to be inflationary and also accelerate the transition to a much less carbon intensive future to reduce dependence particularly in Europe on Russian energy. We have good weightings in commodities, which have recently performed well but there is still plenty of potential.

What’s the committee’s view on inflation? How has that influenced their asset allocation decisions?

Inflation remains the key risk. We think it is likely to be generally higher than has been the case for the last few decades. This is why we have very low weightings in fixed income and high allocations to commodities. The emerging risk of an extended Ukraine war is to agricultural commodity prices. This will add to already evident rising metals prices which is likely to continue as the ‘green’ energy transition is going to be commodity-intensive in the infrastructure build phase.

Are you worried about stagflation in developed markets?

Yes, it’s a big risk if our strategic concerns about rising and persistent inflation is paralleled by rising recession risk. Equity valuations are particularly vulnerable to stagflation or a deep recession.

We have been increasing our exposure to ‘quality’ companies, what are they and why do we like them?

We still like equities in general as they have strong inflation protection characteristics. Given our rising concerns about the risk of a recession we are particularly emphasising ‘quality’ companies which generally have strong balance sheets, strong management teams, strong brands, high returns on capital and crucially have better ‘pricing power’ which allows them to pass on high input prices in an inflationary environment to final consumers. These companies are generally more expensive but we believe in the next phase of investing it is a price worth paying.

We have reduced our exposure to domestically focussed UK companies – are you worried about the UK economy?

Yes, we are worried about inflation and recession risk. UK wages are lagging inflation which will squeeze consumption which is by far the largest part of the economy hitting corporate profits. There is also evidence UK companies are losing world trade market share post- Brexit and in some areas are finding it difficult to pass on high input costs onto final selling prices eroding margins. Small and mid-capitalization equities in the UK are generally very exposed to the domestic UK economy while larger FTSE companies generally have more global revenue exposure.