He elaborates: “It’s a bit like what has happened with quantitative easing. We’ve done so much but none of it has hit main street. Individual investors have behaved like that as well. As they have seen potential incomes decline due to incredibly low interest rates, they have chosen to save more.
“If you see interest rates are more likely to go up because inflation is going up, you’re more likely to put your capital into higher risk-seeking assets.”
The waiting game
The year-long wait for the transition from the ‘lower for longer’ trade into a more inflationary environment has been painful at times for the team. Brookes says he has been hurt by not owning enough dollar-based assets, for instance.
Similarly, he has had to refrain from adding investments such as Neil Woodford’s Equity Income fund to his portfolio. During Woodford’s Invesco Perpetual days, Brookes says he invested heavily in funds spearheaded by the superstar manager, who he rates as “one of the very best.”
Following the launch of Woodford’s own outfit in 2014, however, the market conditions did not support investing in Woodford’s products, from Brookes’ point of view.
“We wondered how the ‘lower for longer’ environment was going to evolve and decided Woodford wasn’t for us. But there is an environment where his portfolio will absolutely sing, and as soon as we enter that, his fund will be one of the first places we go.”
Nonetheless, he is starting to see the strength of his convictions shine through. From a UK equity perspective, the value stocks in Alastair Mundy’s Investec Special Situations portfolio and the Andrew Green-led GAM UK Diversified fund are starting to yield in the rising inflationary setting.
Majedie Asset Management’s Tortoise Fund, which is long value and inflation beneficiaries and short high-quality, expensive companies, is another favourite of Brookes in the current climate.
“For bonds, all we can do is sidestep the problem,” he says. Manoeuvring around bonds means Brookes avoids long-duration products at all costs, including inflation-protected bonds and investing in fund managers who short bonds in their portfolios, such as William Littlewood’s Artemis Strategic Assets Fund. Littlewood’s short book is made up of predominantly government bonds and some corporate bonds.
About face
Another consequence of the changing inflationary environment is the reversal in the performance of defensives versus cyclicals.
One of the main reasons investors have been throwing their money at classic defensive stocks such as pharmaceuticals, utilities and consumer goods is because of the uncertain economic growth outlook that has weighed heavy on 2016, says Brookes.
However, many of these stocks have been underperforming since August, and this has been accelerated further in the US by Trump’s election success.
The emerging markets equities (and commodities) narrative is also compelling, according to Brookes. Though he has had to hold off on adding to his emerging markets position because of the recent strong dollar bounce, he intends to add to this holding in the first quarter of next year.
“Emerging market equities should not be a ‘sell for the sake of it’ type of story, though most people have defaulted to that. On one end of the spectrum in emerging markets you have companies that grow consistently; on the other end you have the super cheap stocks, such as Russian banks, energy companies and Chinese financials, which are in themselves worrisome.
“You want to be in the middle, with a relatively value, long emerging markets portfolio like Artemis Global Emerging Markets, run by Peter Saacke and Raheel Altaf.”
He also thinks emerging market equities will benefit from the bottoming out and stabilisation of commodities prices and improving fundamentals locally.
“Emerging countries are by far the biggest producers of commodities so that is likely to be a boon for the region. Also, if fundamentals start to pick up, you have to think supplies into the US are going to do well and emerging markets should do well off the back of it.”
Populist positions
The isolationist policies taking root in the US, UK and Europe have also given Brookes food for thought. “Politics is something we’ve always been worried about, but it’s amazing the extent to which everyone is talking about it at the moment.
