Rather than 'bet' on specific market outcomes, writes Simon Evan-Cook, a large part of the multi-manager's job is to find excellent fund managers, then allocate capital to those with the healthiest opportunity set
Back in October, before the whole ‘reflation' brouhaha kicked off, we had been warning that a whole ‘reflation' brouhaha might be about to kick off. Having spotted the nascent trend - and been fairly fortunate with our timing - it is fair to ask: should we have bet the house on the reflation trade?
We don't think so. We were happy to tilt towards reflationary assets, as that is where the risk-reward trade-off was more attractive. But there was no guarantee reflationary forces were going to win. So we thought our stance - best described as a ‘best of either deflation or reflation, but with a bias towards reflation' - was the most appropriate.
When we were setting out that position six months ago, we acknowledged its somewhat fence-straddling nature - largely because, in respect of the fence that separates deflation and reflation, that is exactly what it was.
We could forgive you for suspecting that such a wishy-washy, lily-livered attitude could ever lead to anything but mediocrity, but it is gratifying to report that our funds have performed well since, regardless of whether the reflation trade has been winning or losing.
If there is a point to make here, it is ‘pick your battles'. We had no way of knowing whether Brexit would happen, or if Trump would be elected, let alone how markets would react to those unexpected outcomes.
So we did not try to ‘bet' on them. A large part of our job is to find excellent fund managers, then allocate our investors' capital to those with the healthiest opportunity set. As last year kicked off, that meant allocating more - but not all - to our ‘value' managers (who tend to benefit from reflation), and less to our ‘growth' managers (who have fared better in deflationary phases).
Both are excellent long-term investment methods, but they tend to work at different parts of the cycle - as the chart below illustrates. Timing the pendulum swings is nigh on impossible, however, so we only ever ‘lean' one way or the other, remembering it is our responsibility to provide a well-balanced portfolio for our investors.
Source: FE Analytics
Now, six months on, the ‘reflationary trade' has become familiar in the financial media, with many declaring it the end of the deflationary era. Is it though?
It is back to the fence for us, although we are still inclined to lean more to the reflationary side. It may have felt as if reflation landed a knock-out blow after Trump's victory, but it is important to recognise the deflationary trends we have been seeing are no glass-jawed weaklings.
Indeed, as the chart above implies, for much of 2017 the deflation trade has been back off the ropes and swinging hard again. And when you consider that many of the drivers of deflation - such as technological change, high debt, ageing demographics and rising inequality - have not gone away, you will understand why it may be a little previous to declare the death of deflation just yet.
All in all, the pendulum swings we have seen between reflation and deflation remind us of the ‘risk-on, risk-off' conditions we saw during the euro crisis of 2011. Back then, the general feeling was Europe was sliding towards a serious meltdown, but this was punctuated by occasional bursts of hope as markets sensed politicians had ‘got the message' that they needed to take action.
Markets would then rally, which allowed politicians to think they did not need to act after all, at which point the declines resumed. This cycle repeated three or four times before politicians genuinely did get the message - as symbolised by Mario Draghi's ‘whatever it takes' speech in July 2012. Markets have been rising ever since.
Today we have a different problem, but with similar results. Markets appear to be signalling that reflationary policies are needed. But, being politically difficult, politicians are resisting.
Whenever the world does step towards reflationary policies - recently through populations forcing the issue through regime change: see Brexit or Trump - reflationary assets rally. But when the reflationary momentum wanes, as we saw with the Dutch election or Trump's recent healthcare defeat, the deflation trade ascends once more.
We suspect the right investment call through this period will be the same one we made back in 2011 - find good-quality, attractively valued assets, then stick with them through the noise. The alternative - trying to second-guess how or when politicians will act - is speculation, not investment, and risks losing on red when it comes up black instead.
Simon Evan-Cook is senior investment manager, multi-asset funds at Premier Asset Management
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