TRANSCRIPT: EPISODE 233
5 January 2023 (pre-recorded 21 December 2022)
Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.
[INTRO]
Staci West (SW):
Welcome back to the ‘Investing on the go’ podcast. I’m Staci West, and today we’re joined by Darius McDermott and Juliet Schooling Latter. And as we sit today in December 2022, we’re looking back at the year and also forward as best as we can to 2023. So, let’s get started. For you both, what were the key moments of 2022 and what did you learn as investors?
[INTERVIEW]
Juliet Schooling Latter (JSL):
Well, Staci, there’s a lot of things you could say about 2022, but it hasn’t been uneventful. So, where to start? Well, we had Putin’s invasion of Ukraine in February, which blindsided a world just recovering from Covid and sent energy prices skyrocketing. We celebrated our Queen’s Platinum Jubilee in June, and then of course, sadly she died in September.
Meanwhile, on the political front, we finally got rid of Boris Johnson only to have him replaced by our shortest-lived Prime Minister in Liz Truss, who managed to wreak havoc with our economy and ruined the UK’s reputation for stability. On top of all this, China has continued to have lockdowns, which has hurt its economy and interrupted supply chains, forcing companies to rethink their offshoring policies. So, all in all, it’s been rather a tumultuous year.
Darius McDermott (DM):
Yes, it really has. And you’ve highlighted some of the sort of milestones. For investors’ purposes, it’s been a very difficult year. We’ve seen the vast majority of equity markets go down and bonds have also lost money – sort of good double-digit losses in most asset classes. And if I think, as we maybe recorded something similar to this last year, the word ‘inflation’ had really reentered the vocabulary having been absent for a decade. And this time last year, central banks certainly were using the word ‘transitory,’ … “It’s only here for a while”. Well, boy, did they get that wrong. And to be fair, mostly everybody did. Inflation has, in fact, continued to dominate and go up in 2022, and that has had a pronounced effect on investment.
So, if we go back to our simple bond economics, when rates go up, bond prices go down. So, you know, we’ve seen most central banks, certainly in the UK and the US and more latterly, the ECB [European Central Bank] raising interest rates throughout 2022. And whenever the rhetoric from the central banks is that they’re going to continue to raise rates maybe further than was expected, then bonds just fall even more. And who knew that an inflation-linked bond, given that inflation has been so high – and inflation-linked bonds have lost more than 25% this year, because of the long-term nature of that type of debt instrument. So, inflation, you think inflation-linked bonds have got to have gone up, but inflation-linked bonds have very long duration – that’s their time to maturity – and with that, they’ve had incredible losses this year, so it’s been a really tough year up for investors in pretty much every asset class. So, it’s been a really tough year for investors, I mean, so much so that in Q1, every single asset class fell; it’s the first time that that had happened in over 30 years. So, it’s been a tough year and it’s not nice to say this, but trying to lose less money than everybody else has been the name of the game this year. And it’s been a very tough year for investors in 2022.
SW: And you mentioned there, of course, inflation; obviously a very popular topic over the last few months, year, etc. But in these quarterly kind of updates that we have, there’s been a few other similar themes. The only asset classes doing well were commodities and Latin American equities, while the worst performers were UK index-linked gilts and UK smaller companies. Did any of this surprise you over the last year?
DM: Well I’m sorry, I maybe slightly ruined your question by answering a bit of it in the last rant. Index-linked gilts, as I touched on briefly, you know, the returns are linked to inflation, yet they still lost money when we’ve had much higher than expected [inflation].
From my perspective, I think we have to come back on all of these chats to, what is in the price, what are the valuations of these assets? And if there’s one thing that has surprised me this year, it’s how resilient India has been. So, as we turned into the start of 2022, India was on an approximately 40% premium to other emerging markets. Now, it normally trades at a premium to other emerging markets, but this was at the upper end of the scale. And certainly, India had been a real winner for us as a team in 2021, and we sort of cut some of our exposure to try and buy some other assets that had already started to underperform. With hindsight, that was probably wrong. Not that ever taking profit is necessarily a bad thing, [but] India’s resilience has surprised me, given that it was expensive on valuation. I think the other thing is equity markets had had a very good run, you know, multiple years of double-digit returns. And as we all know, sometimes, things do go down as well as up.
JSL: I mean, I think the index-linked gilts probably took us by surprise as well, it’s fair to say, isn’t it, Darius? I mean, the extent of the selloff you know, but I mean that was down to the sort of the Truss [Liz Truss, former UK Prime Minister] government policy, trying to boost growth whilst the Bank of England was tackling inflation. And that had quite a considerable impact. At the same time, you know, the UK’s been quite unloved. You mentioned UK smaller companies and these smaller companies are obviously at the riskier end of the UK market. So, that has been damaged too.
DM: Yeah, the UK’s been a very interesting market because the larger companies, the FTSE 100, is broadly flat, if not slightly positive this year. So, it’s one of the few equity markets that is up, and that is primarily driven by the UK’s concentration in energy companies. We also have, you know, listed … are home to nearly all the European listed miners. So, commodities had a good first half of the year. Oil has had a very strong, and energy companies had a very strong year, yet mid and smaller companies in the UK have had a horrendous time and there’s been lots of really good companies that have fallen 30, 40, 50% in the UK this year, just on the back of sentiment, and that liquidity premium that one gets with smaller companies. So, I think we are experienced enough to know that when markets go bad, smaller companies go very bad.
But this year, has been an odd year in UK equities. So, you know, the FTSE 100 is actually up and small cap in some cases are down 30 or 40%. So, it really has been a year where large cap has outperformed in the UK specifically, but smaller companies globally have also had a much tougher year. And as listeners to our podcast or readers of any of the literature [that] we generally put out, is we like smaller companies because of their ability to grow. And it’s been a tough year for smaller companies in 2022 for sure.
SW: Now, switching gears slightly, looking forward to 2023, what is your outlook? Will the current state of affairs continue? Do you expect other asset classes to do better? Perhaps starting with the UK.
DM: I mean for me, whenever we look at these things, we have to start with valuations. What looks good value, and just following on from the last question, UK smaller companies look good value because they’ve had such a torrid time in 2022.
The broad outlook from an economist point of view – and I’m not an economist, but I get to listen to lots of intelligent people and borrow some of their thinking – but both the central banks in UK and US have stated that they are going to continue to raise rates, even if they do so at a slower pace. The one asset class which has now actually become quite interesting, which we’ve not been invested in much at all, is of course fixed income. Because once I think we are getting nearer to the end of the rate rising cycle, you are now getting paid a decent yield to hold bonds. You know, two years ago holding a US or UK government bond, you got paid a half a percent, now you get paid 4%. In fact, we looked this morning and the US two-year Treasury [a short-term U.S. government debt instrument] was paying four and a quarter [per cent]. So, it’s got no interest rate risk, or very little interest rate risk, and four and a quarter [per cent], that’s a handsome return for a short duration asset. So, I think bonds potentially look good value here.
And if you can stomach the volatility, things like UK smaller companies.
A very interesting market, which we haven’t really touched on yet is China. It’s one that causes a lot of debate in the team, but China is definitely cheap on all of its metrics. It’s been derating steadily for the last three or four years, and their continued covid lockdown has really hurt China, as obviously a lot of the fallout from covid, so some people find it or are talking about China being uninvestable now. That’s not my personal view, and it’s one market that I do think looks cheap. I thought that 12 months ago. And there’s nothing you know, when you’re in the investor game, if you are wrong, you’d say you are early. And I think I’ve definitely probably been 12 months early on China. But I’d probably be looking to add to that position as China’s actually got cheaper and cheaper again. And there is some light with respect to their covid reopening policies shift in only the last two or three weeks. So, you know, sometimes valuation is all you need, but I think the outlook broadly for 2023 is quite mixed and quite challenged. It could be a tough year again.
JSL: I mean, I think on the sort of macro side, we’re rather at the mercy of geopolitics, aren’t we? Which makes it a very difficult call. You know, if the Ukraine war comes to an end, we’ll certainly see a relief rally in markets, you know, particularly in Europe, which has been hardest hit by the impact of rising energy costs. And this will obviously help to bring inflation down too. With central banks sort of trying to combat inflation almost everywhere, recession is certainly, it seems to be on the cards so quite simply as interest rates go up, consumers’ debt and mortgage payments increase and the less they have to spend on other items. So, demand declines and so does inflation. But obviously this also hits companies’ margins. But on the flip side of that, this recession has been very, very well flagged. It’s sort of the most expected recession ever. So, it’s a question as to how much is already in the price, as it were, on expecting companies’ earnings to decline. You know, consumer confidence in the UK and Europe is extremely low at the moment. So, it remains to be seen how deep and how hard the recessions are.
DM: Yeah, I mean the one thing I would say is even though equities have had a very tough year, it doesn’t quite feel as if we’ve had that sort of ‘last-ditch recessionary equity selloff’ where everybody sells everything and runs to cash.
As I say, I do think certain parts of the small cap market, small cap managers we talk to, they very much feel as if that has happened already. It clearly hasn’t happened in UK large cap, but the sort of the main stock market in the world – the US – is down quite a lot this year. But again, it doesn’t feel – even though I think with rates going up, all that geopolitical uncertainty and the fact that the US was expensive at the start of the year, so we’ve had a sort of a bit of a valuation derating, I never like to sound too miserable and depressing – but I think, I don’t feel we’ve seen that sort of recessionary-based, everybody sells [scenario] and you see that liquidity squeeze. So, hopefully that doesn’t happen in 2023.
But with recession very well forecast, as Juliet has pointed out, you know, we may well … the one thing I’m absolutely sure of is, we will continue to see substantial volatility in equity markets and having the confidence to try and buy the dips and look for markets that really have been hit, I always think is a reasonable strategy when trying to invest.
SW: Well, speaking of strategy, if you had 10,000 pounds today to invest, where would you put it and how would you invest it?
JSL: I think, given the uncertain sort of geopolitical outlook, I would invest it on a sort of regular savings basis rather than as a lump sum because you never know when you’re going to hit the bottom, whether it’s got further to go or not.
Being a contrarian, I might be tempted to put some into Europe and perhaps even UK smaller companies, which over the long-term, I think this has got to be a good entry point.
DM: Yeah, I mean I totally agree with you. I think regular savings would be the way; they always say it’s time in market rather than timing market. And if there’s one thing I’ve learned over 20 plus years in investing, that actually timing markets is very, very difficult. And I, as I do expect markets to continue to be volatile, I think doing a regular saving would be the best probably course of action for long-term.
I would definitely put 50% in UK smaller companies. I would also probably put 25% in China because I think China is cheap and there’s good opportunity to make money in China. And the other markets, I mean the emerging markets have had a very difficult year. The dollar has been strong against most currencies for most of the year. And at some stage when that dollar strength stops, that’s generally a good sign for emerging markets, again using valuation as our core for thinking about investing in those areas. So, that’s a pretty high-risk portfolio from me. But those would be the assets that I would be drawn to for the years ahead. If we had to make that sort of choice of investing in a lump sum or regular, I’d be looking at a regular saving.
SW: And would your choices for both of you, change if you were investing on behalf of say, an elderly relevant or into a junior ISA for your children? And if you would change your choices, where would you change them to and why?
JSL: Yes, definitely. I think you have to take into account people’s attitude to risk and obviously if you’re investing for children, which I do for mine, hopefully it’s for quite a long time period so, you can afford to take more risk; generally taking more risk over the long term gives greater returns.
So, for them I might do something like put something into tech, which, you know, I like technology over the long term. It’s been one of the worst hit sectors in 2022. So, that might be something. And then for someone older, I think generally you are looking at income, aren’t you? And as Darius mentioned earlier, bond funds now look quite interesting. So, that might be a pick for someone older.
DM: Yeah, I totally agree – annoyingly! Bonds are much better value; I can get paid a decent yield for holding them in a short-dated – and by that, that means bonds that have less time, they mature on a risk adjusted basis – you can get 6 or 7% without much interest rate risk. I think that’s a fabulous opportunity for anybody wanting income or some defensiveness in their portfolio. Like Juliet, I also invest for my children and I’m afraid they get the VT Chelsea Managed Aggressive funds, whether they like it or not. We like to eat our own cooking and that’s where their Junior ISAs go.
SW: Well, on such an agreeable note, which is unusual let’s say, thank you both for joining us today and thank you everyone for listening. We hope that you had a lovely holiday period with your families and friends and wishing you a very, very happy new year.
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Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.
