Perpetual : Volatility and value – NFP investors and the turning of the tide

With war in Eastern Europe, inflation and interest rates on the rise and Covid surging in China, investment markets faced a rising tide of volatility during the past quarter.

The March 2022 Perpetual Private Quarterly Market Update looks at what happened and what that might tell us about the future. You can download the full report - or read our concise review of what it means for NFP portfolios below.

Download the report

March Quarter 2022: asset class summary

• Australian shares performed solidly with the S&P ASX 300 up 2.1%. By global standards inflation and interest rates are still low in Australia and as a resource economy we benefited from commodity price rises.
• International Equities were impacted by war in Ukraine, with European shares particularly hard-hit.
• Australian listed real estate retreated as the threat of rising rates proved to be negative for property stocks. However, performance over the past year has been robust.
• Local and global bonds suffered from the rising rate environment. Both were down close to 6% over the quarter.

^{Indices referenced: Bloomberg AusBond Composite, Bloomberg Global Aggregate (hedged). All performance number for March quarter unless otherwise stated.}

The big influences

Ukraine and China

The cruelty of Russia's 'special military operation' has shaken the world but history tells us war does not always derail investment markets. However, there are specific Ukraine-related forces at play that are influencing markets. Higher energy prices as a result of sanctions on Russia (a major energy producer) provide an economic headwind as they drag on consumers' pockets. The loss of Ukraine's harvests will add to food costs.

Somewhat lost in the fog of war is another Chinese Covid crisis - as we write there are over 20 million people locked down in Shanghai as Chinese rulers stick to a futile zero-Covid policy. That has implications for industrial production, keeps the pressure on global supply chains and curtails Chinese consumer confidence and spending.

Inflation and interest rates

For investors today, inflation and interest rates are the terrible twins: inseparable and inexorably influencing investment assets. Hopes that supply chain pressures would ease as the world recovered from Covid have been dashed by the invasion of Ukraine and China's new lockdowns. Inflation is now at rates unthinkable a year ago - 7.9% in the US, 6.2% in the UK, 7.5% in the Euro area. And around the world - except Australia - rates have started to rise in response. There are more rises to come, with the US response stretching to a potential seven rate hikes.

Hometown bias works for NFP investors

The benefits of franking credits mean many NFP portfolios are tilted towards Australian shares. That worked well for NFP investors in the first quarter of Calendar 2022. As a resource based economy, Australia is benefiting from higher demand for our commodities and higher prices for those exports - especially coal, oil and gas but also lithium, nickel and copper. According to the Federal Minister for Resources and Water, our resource and energy exports could hit a record $425 billion this year.

Andrew Garrett, Investment Director at Perpetual Private, says "An overweight to Australian shares was the right place to be in early 2022. However, we're always keen to remind NFP clients of the diversification that global shares bring to their portfolios. As always, it's a question of balance."

Fixed income shifts

Each year Perpetual Private's investment team reassess the longer-term assumptions that govern the allocation ranges for each asset class with a portfolio (for example, given the longer term market outlook and past experience, is an allocation range of 20 - 45% in Australian equities optimal?). While they see no need to change these overarching portfolio structures at this point, they have been finessing portfolios within those limits to manage changing market dynamics. One significant move was a lower allocation to fixed-rate government bonds at the end of 2021 as rates started to edge up. In a rising rate cycle, bonds lose value (because their fixed rates become less attractive). By switching into floating-rate credit securities, Perpetual Private was able to capture the upside of higher income flows - without the downside of capital losses.

A switch to value

According to Andrew Garrett, markets are now dealing with geopolitical risks and inflation pressures they haven't experienced for over a decade. Yet while Perpetual Private do expect higher volatility and lower overall returns, that doesn't mean well-diversified portfolios can't deliver solid results for NFP portfolios. Indeed, the evolving market environment is well suited to traditional value investors - like Perpetual.

"The long-running, low-rate environment was great for growth assets and particularly, for growth equities like emerging tech stocks - companies that promise growing returns long into the future," says Andrew.

But a rising-rate environment is one where active investors with a nose for quality typically do well. We're likely to see better results from value stocks (ie profitable companies with predictable earnings whose full potential is not built into their ticker price).

Recent results in Australia may be a sign of things to come in this growth/value shift. Value shares were up 11.7%. Growth shares lost 4%.

Perpetual Private's quarterly investment update for January to March 2022 covers these issues in greater depth, with detailed analysis of individual asset classes including equities, fixed income, real estate, currency and alternatives.

Download the report

^{[1] https://tradingeconomics.com/country-list/inflation-rate
[2] https://www.minister.industry.gov.au/ministers/pitt/media-releases/resources-energy-export-earnings-set-record-425bn}