As investors, we are often asked what long-term trends we are trying to gain exposure to across our multi-asset portfolios and, at Canada Life Investments, a long-term approach is central to what we do. However, there are subtleties to this that are often not talked about. Our annuities business funds pensions for thousands of people, liabilities that we must match with the right assets. Therefore, we have to be certain that the businesses we lend money to have sustainable business models that will stand the test of time. When you are buying a 30 year bond to match a 30 year liability, you have to be confident in the quality and viability of the underlying business.
However, it is undeniable that in the modern world, today’s business model is not necessarily the business model of tomorrow. This makes it very difficult to commit to, or make bets on particular long-term trends at the correct time, particularly as the market tends towards exuberance. For example, whilst blockchain is likely to become revolutionary technology at some point in the future, no one knows when, nor which businesses – which may not yet exist – will be the primary beneficiaries.
So how do we make investments when the long-term outlook is, by its very nature, uncertain?
A pragmatic focus on quality & value
Our approach to fixed income investment is built on our long experience in annuities. Therefore, when we analyse potential corporate credit opportunities, we want to make sure the business is strong, stable and capable of repaying us our money over the long-term. We recently took part in Oxford University’s 100 year bond issue. This is an institution that has been around for nearly a thousand years and remains a high quality seat of learning. We are therefore confident in its ability to repay its debts over the next 100 years.
However, in the short-term, we are prepared to be more pragmatic. We are much more prepared to lend money to a BBB-rated corporate, when the bond is only three years in duration. This is because we get a greater return from a lower-rated security, but we are protected by its short duration profile. It removes the big ‘business model’ risk that will undoubtedly impact some parts of the market. It is also important in protecting capital. For example, short duration supranational bonds have a current yield of c. 0.9%. It would not take a big move in interest rates for that to turn into a real loss for investors. In contrast, short duration insurance bonds currently have a c. 2.0% yield, offering significantly more capital protection.
The same approach is utilised across the equity allocation of our multi-asset portfolios. For example, we have a particular bias towards high-quality, income-generating UK equities that we believe offer a more defensive approach within a more uncertain environment. However, with valuations stretched across many areas of the global equity space, we have adopted a more value stance overseas, particularly in the US. For example, the big US banks are trading at attractive valuations, and paying decent dividends, whilst some of the more crowded tech stocks are at stratospheric multiples.
Most importantly, we are believers that diversification is key across the cycle and that investors should have exposure to the major asset classes at all times. Despite interest rate rises making bonds more unattractive, they have generally held up better than equities amidst the recent sell-off. Whilst we believe that equities will significantly outperform over the long-run, this highlights the importance of asset class diversification.
Despite rising yields, bonds can outperform when markets are volatile
Source: Morningstar Direct, as at 28/02/17. Past performance is not a guide to future performance.
Property is another area that is typically uncorrelated with equities and fixed income. The UK commercial property market surprised on the upside last year, largely due to improved investor sentiment as the market returned to normal conditions. Performance has also been relatively robust in 2018 so far. As interest rates rise, performance is likely to be driven by income rather than capital appreciation as we move through 2018, but attractive yields are still available, providing investors with a strong and stable income stream.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com. Some Canada Life Investments funds may invest in property funds that may be illiquid and subject to wide price spreads, both of which can impact the value of the fund. The value of the property is based on the opinion of a valuer and is therefore subjective.
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CLI01135 Expiry 19 March 2019