"Engaged asset management is the next generation of active management" – Piers Hillier, CIO
2021 was another extraordinary year for investors. It began with the hope that vaccine roll-outs would ensure a return to ‘normality’. And it ended with the emergence of the Omicron variant, demonstrating that increased confidence and activity remains fragile.
In our Outlook 2022, RLAM's investment managers consider the key risks and rewards that may be encountered in the year ahead. CIO Piers Hillier puts forward three issues he believes we should all be looking at over the next 12 months, and explains why RLAM’s diverse investment processes should help to navigate a very different investment landscape.
Discover the focus for RLAM in 2022
In our Outlook, RLAM’s fund managers assess the impact of rising inflationary pressures on their respective asset classes for 2022.
With rising energy costs and supply chain disruption, we ask: are current inflationary pressures transitory or more structural? Will the recovery continue? And what are the opportunities and areas of potential growth within this environment?
Extracts from our Outlook 2022
Peter Rutter, Head of Equities at Royal London Asset Management, discusses his market views for the year ahead, what themes we can expect to emerge and assesses the market performance of 2021.
What worked well in european and global equities in 2021?
Semiconductors, consumer cyclicals, energy and software companies have been particularly strong areas of the market. Weaker areas were those particularly reliant on resumption in international travel as well as the temporary beneficiaries of Covid-19 disruption/lockdowns in 2020 where that boost is not filtering through to 2021, such as auto insurance.
Richard Marwood, Senior Fund Manager at Royal London Asset Management, discusses the prospects for UK equities in 2022, reflects on an eventful 2021 and shares his longer-term views on dividends.
What important lessons did you learn from 2021?
Each year the markets teach us something new and while this equips us for the future to some extent, every year finds something entirely unique to throw at us. It very much feels like ‘known unknowns’ and then ‘unknown unknowns’.
One theme I would take from this year is about just how interconnected the global economy has become and how small glitches in one area can give rise to unexpected impacts. For example, car production in Europe is suffering because of production issues surrounding semiconductors in the Far East while people were sitting in long queues outside UK petrol stations, not because there was a shortage of petrol, but because there was a lack of lorry drivers to get that fuel to the right places.
While retaining a very positive longer-term view on sustainable investing, we expected 2021 to be a challenging year – as presaged by the performance of our sustainable funds during November 2020 as the ‘Covid-19 reopening’ trade played out. However, as of early December, the funds have had a strong 2021, although this masks periods of strong out and underperformance, rather than a consistent trend.
There are several reasons for this, but in summary we tend to favour more growth-oriented sectors and stocks (such as technology, healthcare and high-end engineering); and the long-term prospects for those companies and industries badged as ‘growth’ have accelerated due to the pandemic. Conversely, many companies and sectors regarded as value (leisure, retail, oil, etc.) have seen their prospects worsen.
Two years have passed since Covid-19 emerged on the world scene. The appearance of the more transmissible Omicron variant reminds us that the pandemic is, sadly, not over. High vaccination rates make a return to a deep and prolonged lockdown unlikely, though, and global activity measures have made the round trip back to their pre-pandemic levels. What’s different are policy settings and inflation dynamics. Our base case is that loose policy keeps global growth strong in 2022, while inflation drops from its highs as supply chain disruption eases. This backdrop should be positive for stocks, despite a gradual tightening of policy. We see clear two-way risks to growth and to financial markets, however. Broad diversification across asset classes and active management, both between them and within them, will be key to navigating the challenges ahead.
The longest US business expansion on record was followed by its shortest and most unexpected recession as the pandemic hit, with global activity plummeting and stocks suffering their worst crash since 1929. Massive policy support and the rapid development of vaccines have turned things around remarkably quickly, with economies broadly back to pre-pandemic levels and global stock market indices significantly higher.
Last year, sterling investment grade credit spreads hit their lowest levels since 2007. With a quantitative easing (QE) programme in place that included the purchase of corporate bonds, and with fiscal programmes including the furlough scheme and bounce-back loans, corporates garnered extremely strong support from policy makers, quelling the likelihood of default. Although we saw sterling investment grade markets trade at the upper limit of the price range we might usually expect, they continued to pay investors incrementally over the levels we believe are required to be fairly compensated for the risk of default. With this in mind, we do not expect overall returns in 2022 to be driven by improvements in corporate pricing. With support for markets rolling back – the Bank of England drew its QE programme to an end in December – we expect bond yields to rise (and prices to fall) in the sterling market this year.
Risk in the absence of traditional credit drivers
We still believe the risk of default is low and will remain low through the year – corporates in the UK have built strong balance sheets with the help of monetary and fiscal policy makers, and many have large cash balances. However, this support has restricted the risks which traditionally drive markets, leading their prices to be more closely tied at present to the underlying gilts of the same maturity. This led to significant volatility into the end of 2021, as investors in UK markets mistakenly priced in a high certainty of a November Bank of England rate rise, and reacted to the emergence of the new Omicron variant of Covid-19 in the same month. We expect sterling markets will continue to take their lead from gilts through 2022.
We’ve been very positive on global high yield since central banks stepped in so promptly to support markets on an unprecedented scale following the initial impact of Covid-19 in March 2020. It was hard to be anything else, particularly once the Federal Reserve (Fed) committed to buying corporate bonds as well as government debt, and that position has served our clients well over most of the period since then.
While it may not be a surprise that we remain bullish on global high yield going into 2022, a lot has changed under the surface for us to retain this positive view. I would certainly have given a very different answer if I’d been asked at the beginning of August 2021. At that time, the yield on the global high yield market was down at around 3.8%, having started the year at 4.2% – at that level, it was difficult to see significant upside for the market as a whole, although particular credits still had potential.
The recovery and inflation trades were the dominant themes of 2021 – a tough environment for global government bonds which provided negative absolute returns for the year, as yields trended upwards from low levels. However, with inflation expectations growing and nominal yields on the rise, real yields reached all-time lows. This saw global index-linked government bond funds perform very strongly and significantly outperform traditional government bonds last year. Looking into 2022, we expect nominal yields to continue creeping higher, as central banks begin to remove support from markets. We also expect buoyant global inflation markets to cool somewhat, pulling real yields higher from their all-time lows.
Waning monetary policy support will see yields trend upwards
Nominal yields are likely to rise in 2022 as central banks begin to remove monetary support, including rolling back vast quantitative easing (QE) programmes that have been in place since the beginning of the pandemic, and rising interest rates from record low levels. Most global government bond markets are well priced for rate rises at the short end at present – i.e. bonds between 0 and 10-years in maturity – so we expect the most significant yield rises to come from longer-maturity bonds, causing curves to steepen globally.