Whatever about inflation eating into the value of cash, investors in life company funds had a bumper outcome in 2021. In the managed funds sector, Zurich reports pre-charges annual growth of 11.5% for its Cautiously Managed fund, 18.0% for its Balanced fund, and 23.0% for its Dynamic managed fund.
These outcomes were propelled by an extraordinary bull market in equities last year. In euro terms, the indices gains were way above historic norms: S&P 500 (38%), FTSE 100 (26%), Eurostoxx 50 (23%), Nasdaq (31%), and Ireland’s ISEQ (14%).
Unfortunately, what goes up must come down, and the start of 2022 heralded a significant sell-off in global equities. The plunge bottomed out in the middle of January, and there was a meaningful bounce-back before more weakness in February.
The view from Richard Temperley, Head of Investment Development at Zurich, is that continued strong economic growth in 2022 and reasonable earnings expectations underpin equities, although increased volatility is likely due to monetary stimulus being tapered and higher interest rates in the US.
“Our outlook for equities remains positive,” says Temperley. “This positive bias is mainly based on the relative value argument that equities remain more attractively valued against fixed income investments. As the medium-term growth dynamics are still positive, we expect government bond yields to gradually move higher.”
In Association with
With annual consumer price inflation in America currently at 7.5%, its highest level in 40 years, there’s little doubt that the US Federal Reserve will increase interest rates through 2022. Most commentators believe that US interest rates will increase four or five times this year.
As interest hikes are not good for equities, increased volatility is not surprising. The question is whether the market really has priced in what’s coming from the Fed, or whether a 0.5% instead of expected 0.25% rates increase in March would prompt large-scale equity disposals.
The risk to bond values from inflation
At New Ireland, Kevin Quinn, Chief Investment Strategist, notes that rising rates impact negatively on lower risk assets such as bonds, which can feature in a many low-risk investment funds, and is something for investors to be mindful of.
This caution is echoed by Paul O’Brien, Head of Investments at Goodbody Asset Management. In O’Brien’s opinion, bonds are yet to meaningfully incorporate the growing risk of higher and stickier inflation. “This is very important because bonds and cash are often viewed as casualties of rising inflation. The role of bonds in multi-asset funds is something that warrants increased scrutiny,” says O’Brien.
In the make-up of multi-asset funds, bonds are the low-risk anchor that protect capital. As interest rates have been pushed lower and lower by central banks, bonds with fixed income coupons attached have soared in value, supporting the strong returns of multi-asset funds.
In a note to clients, O’Brien points out that bonds now face a very different outlook, given that starting yields are very low or negative, while the largely fixed nature of their coupons is exposed to rising inflation.
According to O’Brien: “Our analysis suggests that the average allocation to bonds within ESMA 3 funds available via the life platforms is around 50%. The average allocation within ESMA 4 is 30%. Therefore, the future performance of bonds - linked to what happens to inflation - is likely to have a significant impact on overall fund performances.”
