In a large organisation filled with experienced people, it can be difficult for less senior members of the team to make their voices and opinions heard. But that’s what Abrdn seeks to ensure during its monthly asset allocation meetings, says multi-asset strategist Karolina Noculak.
The investment director chairs the equity steering group, having joined Abrdn in 2014 following its acquisition of Scottish Widows Investment Partnership. “There are seven asset class steering groups, including equities, fixed income, currencies, emerging market assets, commodities, ESG and private markets. Each with eight to 10 individuals,” she says.
The research-heavy tactical asset allocation process starts on the first Wednesday of each month. Noculak describes it as “an evidence-based approach that uses both qualitative and quantitative methods”.
During the initial two-hour session research is presented that is based around six drivers of performance: macro profits, micro profits, valuation, monetary, behavioural and ESG. These are the same across all seven asset classes, albeit with different weightings and interpretations.
At this stage “facts and figures are at the centre of the conversations rather than opinions”, she explains.
It’s how the team aggregates those views that sets Abrdn apart, according to Noculak. “It is done via a secret ballot by the voting members of each of the steering groups”. It means every member “has an equal voice”.
“The seniority or position of a person in the firm, or their length of service, does not play a role. A team head or a specialist in a particular area does not have a bigger say than someone who is a young analyst but is involved in producing the evidence and looking at the facts and figures.”
The more conventional way of running a research team involves evidence being presented by junior members but the ultimate decisions being made by the CIO or head of research/multiasset, she says. But Abrdn’s experience is that “being senior doesn’t necessarily deliver better results”.
“It’s the proximity to research that matters. Being more involved on the research side allows you to make better decisions,” she says. “It’s a process that has diversity of opinions at its heart. Because it is secret by nature, it is not influenced by the loudest person or the one who speaks first on the topic. It is very much evidence-based and links back to fundamental research.”
A culture of sharing research, combined with the diversity of backgrounds of the people involved and different research methods “allows for better decision making”, she says.
The team subscribes to the ‘wisdom of the crowd’ principle, “with academic research showing that a group of diverse, well-informed people make better decisions than a committee with directorship bias or a very dominant personality”, explains Noculak.
The steering committee will meet a couple of days after the secret ballot to discuss, debate and distil those views into recommendations, which are subsequently shared with the broader multi-asset team and inform any changes to portfolios.
Geopolitical variables
The scoring is done looking roughly 12 months down the line, which undoubtedly has made for some interesting discussions given the wider macroeconomic backdrop.
“What a few months it has been,” she says. “Since the bottom of the pandemic, when policy was supportive, growth was picking up and profit cycles were strong, we’ve moved to an environment with many more uncertainties – Covid, inflation, Fed reaction and Russian geopolitics.
“In the past three months we have seen this enormous amount of volatility and headlines that can go either way and are very hard to predict.”
Noculak’s interview with Portfolio Adviser took place after Russia invaded Ukraine in the early hours of 24 February and a week before the team met for the start of its March asset allocation cycle.
She says the invasion really brings to the fore the importance of the team’s framework. Rather than focusing on the market reaction or headlines, they have looked to the six performance drivers.
“None of us has more insights into geopolitics than the best commentators that we read and, quite frankly, a lot depends on what Putin decides and how the west applies sanctions.”
Instead, the team looked at other variables, she explains. “For growth, what do the sanctions mean? What do they mean for corporate profits? What could the exposure to Russia be?
“There is also the important angle of commodities prices, not only energy but natural gas and agricultural commodities. How it can exacerbate already-out-of-control inflation in the western world. What about monetary policy becoming tighter?
“We focused on macro profits, micro profits and monetary. The last element we looked at is what is priced in. Valuation and behaviour tell us what is priced in by the market. So, we looked at the extent of derating and of the price reaction, but also things like investor sentiment and positioning.”
She says while there is some noticeable capitulation in sentiment, the same cannot be said for positioning.
“Positioning has been coming down this year because of some of those risks, and geopolitics obviously plays a role, but it has not been a fear scenario. Those elements of the framework help us to assess where we are, what is the likely path for the base case and what is priced in.”
‘Perfect storm’
When it comes to inflation, Noculak says the Covid recovery was a “perfect storm” as the acute supply bottleneck emerged following the rapid reopening of economies.
“We think some of it is transitory, with some of the elements that led to the headline inflation being so much higher now likely to fade. Unless, of course, energy prices double from here, but I don’t think that is in anyone’s forecast.
“There are also signs of some of the supply bottlenecks reopening. The Omicron variant delayed that in Q1 but the response from key governments has been more along the lines of endemic rather than pandemic.”
The lifting of social distancing and other restrictions should further help those supply chain issues, she says, pointing to Danish shipping giant Maersk recently predicting the situation should ease in the second half of the year.
“I would say inflation is probably what is causing sleepless nights for us. Bull markets typically don’t die of old age or valuation alone, it tends to be because of a policy error or overtightening. It’s not our baseline case by any means, but there is no question that policymakers are walking a tightrope. And the balance of risks for both growth and inflation is tilted to the downside.”
She adds: “The wild card now is Russia and Ukraine. That’s particularly important for the UK and Europe, especially eastern Europe given its reliance on natural gas, energy and wheat exports from that region. That is concerning.”
The big rotation
While geopolitical tensions are the dominant topic of conversation at the moment, the invasion of Ukraine has not been the only hit to global markets in 2022.
“We had such a violent, rapid rotation at the start of the year away from the darlings of Wall Street, those big-cap tech stocks, and towards under-loved and under-owned UK equities. We know the reason for that: the backup in yields has massively penalised growth stocks.”
There was a “misperception” that growth stocks in the US are long-duration assets, therefore their sensitivity to the discount rate was much higher.
“They were also expensive,” she adds. “So, the sensitivity to the discount rate is exacerbated by that. The other side of it is the cheapness of UK equities that have commanded a big discount for a long time.”
But valuation is just one element, she says. “The returns in the market this year have been very much driven by the monetary side, the rate side and not so much by the profit side. But when we look at the profitability forecasts for the US, they are much better than the UK.”
We entered the recent earnings season with “the big scare that valuations were rich and at risk in the US, and that technology stocks maybe pulled forward a lot of revenues during the pandemic”.
“We started the season with two spectacular misses: Netflix and Peleton.” Those results exacerbated fears, but what actually occurred was the remaining big tech stocks, with the exception of Facebook, “delivered further positive surprises”.
“The biggest constituents in the S&P 500 actually surprised to the upside and the earnings surprise within growth stocks was bigger than within value stocks, which is quite interesting.”
But Noculak is unsure whether that was enough to appease investors. “That focus on rates and valuation is still quite dominant. Last year was very good for FTSE 100 profits, not because they reached some sort of exceptional profitability or ROE [return on equity] or margins, but because they had such steep declines in 2020.”
The question is how sustainable the growth is, she says. “To me, that’s really centred in two sectors. One is commodities, which led the recovery and the declines in the recovery. The second is banks. In 2021, the banking sector rolled back a lot of provisions that were made in the bad times, which boosted profits.
“I can see that some of the valuation gap closed. In an environment where growth has been quite abundant coming into this recovery there was no need to place a premium on growth stocks, therefore the gap converged with valuation.
“But I would be slightly wary of completely capitulating out of those stable, high-quality growth stocks in the US.
“When we think about the S&P 500, we’re not thinking about unprofitable tech; we’re talking about highly profitable, cashflow-generative, well-managed companies with great balance sheets and great market positions that are expected to grow high single digits and probably deliver a lot of upside surprise as they have over the years.”
This article first appeared in the March edition of Portfolio Adviser magazine
