RLAM Market outlook

Read the latest update from Royal London Asset Management (RLAM)

Piers Hillier, Chief Investment Officer and Mike Fox, Head of Sustainable Investments at Royal London Asset Management provide a market outlook for 2021 and share their thoughts on what's to come. 

Piers Hillier, Chief Investment Officer

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Mike Fox, Head of Sustainable Investments

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Multi Asset Webinar - December 2020

Watch the latest quarterly webinar from Trevor Greetham, Head Multi Asset, RLAM where he discusses the latest tactical positions across the Governed Range and his views on what’s to come in 2021. Trevor emphasises why there continues to be a need for diversification in what he believes will be an inflationary post-Brexit world. 

Adam Vaites:       
Hello and welcome to this latest webinar from Royal London Asset Management. To introduce myself, I'm Adam Vaites, part of the wholesale team here, and I'm here with my colleague from Multi Asset, Trevor Greetham. Trevor has got over 20 years' experience in the market in asset allocation and managing multi-asset funds.

I suppose what we're going to talk about today is market outlook, talk about the latest on the economy and talk about our new strategic asset allocations that we're implementing. We'll then end with a Q&A of what clients have been asking us over the past few weeks. So, Trevor, I look forward to hearing from you on the market. Over to you.

Trevor Greetham:   

Great, thanks Adam, thanks everybody. We’re going to cover various things today, so there will be a quick overview of the portfolios and how they’ve been doing in 2020. We know that they’ve not kept up with some of the balance funds that are in the same peer groups as us, so we'll address that directly. We'll talk about the tactical outlook, which we see as quite positive because there is an economic upturn coming with a high degree of certainty now in 2021. But we'll also talk about some short-term risk factors.

We'll talk about the more inflationary feel to the recovery that we see, and then we'll come back to our asset mix, our broader asset mix, that we think will put us in good stead in a more inflationary recovery relative to some of the global balance funds that have done really well this year, and in doing so, we’ll touch on the new strategic mix that we're moving to. We’re still committed to broad diversification and trying to maximise returns after UK inflation, different investors, according to their risk tolerance.

So, moving on to the portfolio overview, I won't spend too much time on this. But just to describe what we have on offer. You'll be familiar with the governed portfolio. These are nine risk-rated, multi-asset portfolios within the insurance company used for the pensions, unit-linked pensions. They launched in January 2009, have a good long-term track record. The governed range now has almost £40 billion of assets under management, one-and-a-half million policyholders invested in them. So, a lot of your customers will know them very well, and a return per annum since they launched being in the range of five to eight per cent, depending on risk level.

Back in 2016, we launched the GMAP fund, so the ones that are shaded in, four of the most popular governed portfolios we launched on platform as the GMAP range. There are six funds in total starting with a pure fixed income fund, the conservative fund, moving through these four progressively positioned multi-asset funds which map up to particular governed portfolios, and then we have the pure equity fund, the dynamic fund, to complete the range.

 Inside each doughnut there, you can probably just about see a number and that number is the long-term volatility target of those particular funds.

We also have a retirement income portfolio, again back within the insurance wrapper, so we have the GRIPs the governed retirement income portfolios and they launched in 2012. All of these different funds have in common one thing which is they have a broad diversification and they're trying to maximise returns either versus inflation or in the case of the GRIPs, maximise sustainable retirement income.

The performance of the governed portfolios and the GMAPs have been very consistent with each other. This is the long-term track record of governed portfolio six, which maps up to the GMAP balance fund, and you can see the strong long-term performance trend and you can see, I hope, the red line which is the GMAP fund from the date that it launched. It's tracking very closely to the equivalent GP. So, although the GMAP was launched in 2016, and has that track record now of four years, they share the same proposition if you like of the governed portfolios that launched all the way back in 2009. So, they're talking about an 11-year track record for this proposition.

But you'll also notice that those governed portfolios and GMAPs, although they've been doing rather better in the last month or two, are still slightly below the level they were at before the pandemic hit. You'll be aware that a lot of balance funds relying on global equities and UK government bonds primarily for their returns have had a better year than that. You can see then if we look at this patchwork quilt which looks at different asset classes and the returns they generated for sterling based investors over different calendar years, and lots of numbers on the screen, here but just to highlight the dark, black square there is the benchmark of the GMAP growth fund, slightly different fund from the one we saw in the previous page. You can see that the return there is in the middle of the pack.

The things doing better have been the things that you find in a lot of our less diversified competitors, so global equities, emerging markets and gilts had a really good year, for one reason or another, because it's been a deflationary shock. Below the black square you'll find property, commodities, which we have a relatively small exposure to, and UK equities which have hurt the funds this year. So, I will come back and describe why we include those asset classes the way we do.

Quick comment on tactical asset allocation, it's adding value again. We did have a setback in March this year, so we were reducing our exposure as the pandemic started to hit outside of China, but we were still overweight equities and we maintained an overweight position in global high yield bonds as well. So, if you look at our tactical asset allocation models, you can see here the long-term simulation going back to 1992. If you see at the top right-hand corner of the screen there's that drop down. But what we're seeing since then is the tactical models are adding value again.

So, we've been outperforming our benchmark since the April low through tactical asset allocation strategies as well, and that's added value from the cross asset strategy, the credit strategy, the regional strategy and the sector strategy, everything outside of currencies in fact has been adding value since then. So, we're very much still a believer in our approach to tactical asset allocation using things like the investment clock and we are seeing it back on track again.

Let's talk a bit about the positive outlook we see for markets. Well, the main thing to say is we've had a tremendous amount of stimulus and we think a lot of that stimulus will be left in the system for quite some time to come. So, on the left hand side of the page here you can see the fiscal stimulus coming through in various parts of the world. On the right hand side, you can see the monetary stimulus. This shows the expansion in the size of central bank balance sheets.

What's different about this crisis when compared to the crisis 10 years ago that I was also managing asset funds in, I suppose it's 12 years ago now, the great financial crisis, the difference primarily is that when central banks printed money back in 2009 - you can just about see it on the graph there, it's tiny in comparison to what’s happening now - the commercial banks are pulling in their loans. There was a collapse in the money supply being caused by the credit crunch and the money printing helped to offset it. This time around the banks haven't filled in their loads partly because of the chart on the left-hand side of your screen that says partly government guarantees of bank loans. So, they haven’t needed to pull in their loans.

So, the money supply was not contracting and then the central banks did QE, and you've seen this big increase in money. So, there's lots of money sloshing around, loads of government support, and that's likely to remain in place, we think, for quite a long period of time. The Bank of England is not likely to raise interest rates for years, the US federal reserve has said it won't start raising interest rates until unemployment gets to its maximum employment level, and that suggests a very strong tailwind for financial markets, when you add in of course the fact that we've got the vaccine starting to come through.

The investment clock is meant to pick up the turning points and business cycles which, on average, last about five years between the recessions. There are faster cycles, the ebb and flow of industrial production which lasts about two years. Obviously, in 2020, we've had a whole business cycle in about six months. We had the collapse, we had the rebound. If you look at the trail on the diagram, it went from the top right-hand corner to the bottom left-hand corner when the lockdown hit in March-April and it's retraced its steps. We're back where we started. That red dot shows that growth is starting to pick up and inflation is also starting to pick up and that's suggesting things like commodities should be doing better than bonds. We reflect that in our positioning.

Some concern over the very near term because we've got lockdowns still happening in the world and we've got relatively new lockdowns in Europe and the US. So, we could see some weakness over the winter. Looking into 2021, gradually the vaccine gets rolled out, and not immediately, but gradually, social distancing gets reduced. That suggests it's going to be quite a strong economic recovery year.

You can see the relationship between the economy and stock markets on this slightly noisy looking picture. What this does is it plots the six month return you're getting out of stocks, so a return on a rolling six month basis in red, against the Citibank economic surprise index, and this measures whether economic data is coming in better or worse than expected. We're expecting that surprise index to remain fairly strong in the reopening phase and we think stocks will also be making progress.

High yield bonds we think have been a really great place to be this year and we've remained overweight high yield bonds throughout. In fact, we have a maximum overweight position in high yield bonds. You can see on this graph the spread of the high yield bonds over government bonds in purple, and against it in red is a measure of bank lending appetite and the senor officer loan survey of the federal reserve in America. In a way, high yield bonds have been the favoured asset class of central bankers in this crisis.

So, way back in April, the Fed, when it first announced its easing program, earmarked a trillion US dollars if necessary to keep spreads low in the US corporate bond market. This is because all of the bank lending in the leveraged balanced sheets of 2008 have migrated through the financial markets by 2020. So, most companies in America weren't borrowing from banks, they were borrowing from investors through high yield bonds or through investment grade bonds and debt levels have risen dramatically over this period with interest rates so low.

But the Fed very quickly realised a health crisis would become a financial crisis if they didn’t step in and, as a result, we saw a very quick move back in spreads even though bank lending practices are still pretty cautious on new loans, and we think that given the amount of refinancing that's been done over the last six months as the economies recover in 2021, we'll continue to see good returns from high yield debt.

Commodities, I mentioned, the investment clock suggests commodities should be doing better than bonds. We have seen commodities begin to pick up. This graph looks at commodity returns shown in purple, against a China activity indicator in red. This is the so-called LKQ index which looks at things like industrial production and bank loans in China, the harder data. You can see the Chinese recovery that we've seen has helped commodity prices to pick up, and if the rest of the world recovers in 2021, we think there will be a further leg up in commodity prices.

So positive on equities and on high yield debt and on commodities. What's the catch? Well, there might be a couple of catches. One of them may be short-term risk. If you look at investor sentiment, we track it every day. Investor sentiment is quite euphoric at the moment. We're not the only people that noticed that there is a vaccine being rolled out. The red line here is our composite investor sentiment indicator and its reading of above plus one means people are a bit greedy and trying to chase markets higher.

Quite often, when you've got this level of greed, you can see markets carry on rising and fundamentals keep improving. But it also means they're vulnerable to bad news surprises. One bad news surprise we think could come through is on the virus data in America. If we look at that on the next chart, you can see on the left-hand side new cases in different parts of the world and America is the red line which is now going up quite rapidly because of the Thanksgiving Holiday. So, in the next couple of weeks, we're expecting to see really very bad data on new virus infections and unfortunately, hospitalisations and deaths are likely to follow.

Now, there is a vaccine coming but it will take some time to roll out. It's not really going to help things over this winter and the risk, I think, is of a more broad lockdown across America which could hurt economic expectations and therefore hurt stock markets in the near term.

I'd also mention here of further risk of geopolitical problems, President Trump is still President Trump until 20 January next year and isn’t getting much attention from the world at the moment. He still does have the nuclear codes and not wanting to overstate the risk, I think there is a risk that between now and January, there are some military misadventures launched which could also hurt stock markets. So, I'd watch him quite closely. And there's the Brexit ongoing saga as well which has the ability to cause a fall back in global markets.

So, a little bit cautious and that's represented in our funds by us being not fully overweight equities.

If you look at our sliders, you can see we have a lot of risk in high yield; that's a 10 out of 10 if you like overweight in high yield bonds and that's been our main exposure this year. It's dipped in and out of equities. It's always been either overweight or neutral. But equities you'll see there on the top slider is only halfway up the scale. If we get a dip in the next few weeks, we're probably going to buy it. I wouldn’t be surprised to see us being more aggressively overweight at that stage rather than selling a lot at the moment. Commodities also we've got scope to buy dips and cash is the main thing that we've been underweighting in funds and also government bonds.

We’re also slightly underweight UK property. In fact, some funds are quite are big underweight in UK property, and that's because as we've had inflows over the year, we've actually invested in the other asset classes and have allowed property to move more underweight. Sometime next year, I think property will be something we'll want to build up and move to a more overweight position. Regional equities look really dull here, don’t they, so the sliders are very close to neutral in most areas, and that's because - that's something I'll come back to in a second - there's a big rotation potentially going at the moment between value and growth within the stock market, and that also impacts regional equity exposures.

So, markets like the US is a very growthy market. Emerging markets have been quite growthy as well, whereas US and Europe have been value markets. What we've been doing is closing some of those positions to wait and see what happens next on growth versus value. Similarly in our sector positions, they’re quite close to neutral at the moment. We’re still overweight technology but we're also overweight financials which is a value sector.

So, risk being taken at the cross asset level, quite a lot of risk actually being taken at that cross asset level with our constructive view on what happens next. But the nature of the recovery, how inflationary it is, and whether that's a growthy or a value-driven recovery, that's still something to figure out.

So, why would this recovery be more inflationary? Well, we’ve lived through a very disinflationary period. Let's be clear about that. This graph looks at the inflation score card. This is our inflation indicator, the global inflation that we use to help position where we are on the investment clock. On the investment clock, inflation is the left to right to direction on the clock with growth being up-down.

You can see for the most decade, most of these purple bars have been pointing resolutely downwards and that means inflation is likely to drop rather than rise. There have been a few areas where actually inflation was looking like it was picking up, and those kinds of things like commodities did quite well. The 2016-17 commodities did quite well, for example.

The red line which explains these global inflation trends is the consensus forecast of Chinese growth. You can see that was 10 per cent back in 2010 and then it's dropped down to about five per cent at the moment. We think the slow down in China though has probably run its course. They've had a very good pandemic, if you can have a good pandemic. So, they've managed to use very effective track and trace to clampdown on the virus in Wuhan. It didn’t really spread anywhere else as it has done elsewhere around the world. I do believe that; I don’t think that's a made-up fact, because if there were over-run hospitals, we would know quite a lot about it by now, or a wave of people dying in their homes, we would know about it.

But China has had quite an effective way of dealing with the pandemic and the president of China, President Xi, has committed to double the size of the economy by 2035, and that means growth probably of at least five per cent per annum. So, there's some stabilisation in China. Maybe it's changing its disinflationary backdrop.

More importantly, debt levels are due to rise really very dramatically across the Western world, because of COVID, yes, but also because of demographics, the ageing society and all of the commitments we've made to people in terms of pensions and care and the health service.

This graph looks at the UK level of debt to GDP going all the way back to 1900 and you can see in the middle there that after World War Two, we got up to 250 per cent debt to GDP, and under John Major, we were down to 30 or 40 per cent debt to GDP. We're just going through the 100 mark again now. You can see the leg up caused by the financial crisis and then you can see another notch up caused by COVID and there may be more to come on that.

But the future projection shown in grey from the Office of Budget Responsibilities is all about demographics and either you’ve got to cut benefits for people as they get older, which seems unlikely because a lot of them are very keen voters, or you've got to do something else.

What else can you do? If you look at the sorts of things that are typically used to try and deal with debt ratios rising, you can either try to grow very strongly. Now, in the case of the UK, I think that's very much challenged by Brexit. Didn’t really matter whether if we got a free trade deal or no deal, you're talking about a hit to GDP on a 15-year time horizon. According to the Treasury, they're numbers of six and nine per cent. In other words, Brexit is another financial crisis that saps growth over a long period of time. So, growth isn’t that likely to boom in the UK

Austerity is something I think the government will try. We’re already talking about Rishi Sunak talking about tax rises and spending cuts. But I think it's going to be very hard politically to sustain that given the commitments.

I think we're going to end up with a combination on this list of number two, which is inflation being allowed to overshoot, and number six, which I have to explain, is financial repression. Financial repression is where interest rates are kept below the rates of inflation. That shouldn’t be a new thing for us because we've actually had interest rate base rates below the rates of inflation on average in the UK since about 2010, and if you look at the loss you've made in real terms by keeping cash in the bank over that period, it's almost as bad as keeping cash in the bank over the 1970s, already, and there's more of it to come.

So, if government and central banks keep interest rates below inflation, it means they're borrowing at a negative real cost, and you can see that in the index linked gilt market; the UK's borrowing, minus three per cent. Basically the government is being paid three per cent a year in real terms to borrow money. This is why you don’t see governments hurrying to do massive austerity or massive tax rises, because they're being paid to borrow. So, I think ultimately, when they see the markets don't really care when they borrow, they're going to carry on doing it.

So, I think you're going to see higher inflation over the next five or 10 years and you're going to see interest rates staying low. That has big implications for financial markets. It really plays towards having a much broader diversification, because very low interest rates and pick-up in inflation would be very good for commodities, it would be very good for commercial property, which is obviously very much out of favour at the moment. It would be good for equities as well. Pretty bad for gilts, and potentially a big set for rotation within equities.

If you look at what's going on within the equities market here, this graph looks at the performance of value versus growth. So, the purple line is the performance globally of value stocks relative to growth stocks. This graph goes all the way back to the early 1980s, so that's why it looks so noisy. The big spike you can see in the middle where value is outperforming is the dotcom crash in 2001-02-03. The other spike you can see, the downward spike is now. The downward spike is a massive outperformance by growth stocks. That's partly because bond yields are dropping. The red line shows you which direction government bond yields are going. Part of the outperformance of growth has been falling bond yields, but also obviously it's been COVID. Many of the value industries have been COVID losers.

If there's a big reopening going on as the vaccine comes through and we start to use physical economy rather than technology for all of our business, and travel starts to pick up again and tourism starts to pick up again and retail sales in bricks and mortar starts to pick up again, you could see really quite a big rotation back to value stocks, and that's what we were referring to earlier. So, you could get a more inflationary ceiling where you want a broader asset allocation and you don’t want to be too exposed to growth sectors.

Looking at the longer-term horizon here, again, I relate back to China and the different phases of Chinese growth. The shaded areas represent areas where China has been slowing down economically, and the black line on the graph, the lowest line you can see on the picture there, is again the thing we saw earlier on when we were talking about the inflation scorecard; it's consensus growth in China.

You can see the slowdown in China in the 1990s. That was a period in which the technology sector, which is in purple, outperformed massively, but the energy sector, in red, struggled. Then you had a period when China was building its cities from 2000 to 2007 or '08, and there you had suddenly technology underperforming and a more commodity-rich, value-driven market with the energy sector outperforming, and UK equities, by the way, at that time, outperforming the world.

Then we had this period we're in now where China has been slowing down, tech has been doing well and energy has been doing badly. I'm asking the question here is this changing again? And beginning to appear where Chinese growth starts to be underpinned and starts to pick up and, as a result, we've got more inflation in the world and people are not going to be so willing to pay up for growth stocks. That's the really critical question for the next couple of years.

It matters for the UK more than anything really. So, if you look at the valuation of different markets, the UK is the cheapest of the major markets. This graph looks at the long-term valuation of equities based on the Robert Shiller approach which is cyclically adjusted price earnings ratio - try saying that quickly. What that means is looking at the market price and then dividing it between the very smooth long-run average of earnings over about 10 years or so, and it strips out the funnies you get with price earnings ratio and you've got companies going into profit and loss.

What it shows you is that the most expensive market globally on this basis and this comparison is the US in red, and the US market is the most expensive it's actually been outside of the dotcom bubble. You can take that graph back to the 1920s. As of now, the US is as expensive as it was at the peak, just before the 1939 crash.

The UK is the bottom of the three lines. The middle one in dark purple is Europe and the UK is the light purple. On the same basis, the UK is the cheapest it's been in 30 years. That says to me potential for a big regional rotation if the there's a big sector rotation.

This takes me to our new strategic mix. Every few years we do a formal review of the governed portfolios and the GMAP portfolios to check that the asset mix remains consistent with our risk targets and is properly diversified and is seeking growth in all the ways it can do. The review we've just completed and we're going to implement in the early part of next year, what we're trying to do is improve diversification. We're doing that by reducing property slightly and increasing global high yield, which is an asset class we introduced in 2016, and then we're going to also make some changes with equities which will reduce the exposure to the UK and increase exposure to faster growing countries in the emerging markets and faster growing sectors.

But bear in mind we have tactical allocation leeway, that if the UK is outperforming next year, we can use our TAA budget to keep UK exposure pretty close to where it would have been before this change anyway, and then we can reduce it further on if we feel that it’s had its run. So, all changes are in line with tactical positioning and we have the flexibility to use our tactical positioning to find the right time to reduce UK equities.

Let's look at the changes. Quite small numbers on the screen here, but this shows you the asset mix for the GMAPs and the governed portfolios where we're making changes. I'm not showing on here the GMAP conservative fund which isn't seeing any changes this time; that's the pure fixed income fund. What you see are changes within the equity mix reducing in the UK and increasing in overseas emerging markets. You also see a reduction in property, three of the funds that had the highest property ratings to raise high yield.

I want to come back to what this mix looks like still versus a lot of the funds in our peer groups. We're trying to beat UK inflation over the long run with a mix of assets, which we think offers us resilience and diversification and some kind of connection to the UK inflation process. We know that a lot of people out there are offering funds like a 60-40 balance fund. We looked at the 60-40 mix, the 60 per cent global equities, the 40 per cent UK aggregate investment grade fixed income. It has the same sort of long-term risk level on our metrics for GMAP growth which is one of the higher risk funds in our suite.

On the left-hand side of the screen, you can see what are called tile maps, and what this does is it looks at the strategic mix of the different funds by asset class, and it shows you by the area of each tile on the screen how much you've got in those areas. What you find with a 60-40 balance fund, there's more than 30 per cent of it in North America, and with a quarter of that in technology, mostly four or five stocks. Then you've got another 30 per cent or long dated UK gilts.

Now, technology has had a brilliant 2020 because of the COVID lockdowns and because of the drop in bond yields. I'm not so sure it will keep outperforming in a COVID recovery, especially if bond yields are allowed to rise. I'm not saying it won't do well next year. It's possible bond yields will stay low for a while and it's possible we'll see another blow off in technology like we did in the late 1990s. Tactically, we're attuned to that, and that's why tactically we still have a technology overweight.

But we think on a strategic time horizon you really can't guarantee that the value growth relationship, which has become so strained, is not going to snap back. In that more inflationary recovery, you're onto a loser with gilts. It's either yields stay low and you're getting a return less than inflation, or yields rise and you lose money.

If you look at the GMAP growth asset mix, you can see much more resilience and diversity. So, exposure to North America is actually about the same size in our mix as the exposure to the UK. You've also got exposure to commercial property there in pale pink colour on the right-hand side, you've got global high yield in red. The black rectangle is commodities. This is a very inflationary pick up. Commodities will probably do very well, and then we've got less exposure to duration that's generally if interest rates are rising, because we've got an ultra-short duration category as well, and we've also got index linked gilts to give us some inflation protection.

So, apples and oranges here really. We know that we've underperformed balance funds in 2020, but we also know that we've got a much more resilient, we think, mix of assets to try and deal with some of the challenges ahead.

Another way of looking at this, and this is quite old-fashioned, actually, when I started in the early '90s, and Adam by the way, makes me younger than I am, I've got almost 30 years investment experience - more than 20, but almost 30. In the early '90s and late 1980s, we valued pension funds off their income, not off their market income. We looked at the income. Where is all the income coming from? What kind of income is it? What value does that add to us over the long run?

The pie charts look at these two different asset mixes through that lens. The purple slice in each case is UK real income. By that, I mean things like dividends, rents from property, index-linked gilt coupons. In your global balance fund, with it's very heavily reliance on tech and gilts, you've got [only seven] per cent of your income coming from UK dividends, and the bulk of your income is coming from global dividends where the link with UK inflation is a little bit more tenuous.

If you look at the bottom pie chart, two-thirds of our income and GMAP growth, two-thirds, is coming from UK related real income, UK dividends, UK rents, UK index-linked gilt coupons. In most cases, that is an undervalued asset class. So, property we think is undervalued at the moment, and UK equities we think are undervalued.

Wrapping up with this bit on the strategic mix, we think we get a similar long run return but with greater diversification through the GMAP or governed portfolio approach. So, a final comparison here just looking at the benchmarks, the before and after graph if you like, the dark purple line of the GMAP growth benchmark before and after this most recent strategic shift. The light purple line is the 60-40 global balance fund. In both cases, you'll find the balance fund will have done better in 2020 and we're not really surprised about that. If you're comparing funds, bear in mind, you're wanting to compare apples with apples and oranges with oranges. We think the changes we've made can improve long-term returns and we're very much sticking to our conviction that board diversification is what really matters over the longer run.

Happy to stop there and take some questions, Adam.

Adam Vaites:           

Perfect, thanks Trevor. Yes, almost 30 years' experience…

[Over speaking]

Indeed. We've had a lot of questions over the past few weeks from clients. We're just trying to summarise a few of them. I suppose we'll kick off with UK equities on the patchwork quilt there. Let's talk about UK equities going forward. It's been a good few weeks for the asset class. Any more thoughts on it?

Trevor Greetham:   

Yeah, if you look at some work that Peter Rutter on our global equity team did, but if you look at the UK market and you look at the sector mix, and you equalise the sector mix to global equities, you find it's got a similar valuation to global equities. In other words, the reason it's cheap is because there are lots of cheap sectors in the UK.

Now, the UK itself has had a bad coronavirus experience. Unlike China, our track and trace really wasn’t effective and so we've had these big lockdowns and we've had lots of infections and lots of deaths compared to other countries. We've also got the Brexit risk hanging over the market throughout 2020. But actually the main cause of the UK's underperformance, and it's been shocking underperformance this year, the worst in many years, has been because it's got a one per cent exposure to tech and it's got a big exposure to banks and resources and consumer discretionary leisure and hotels and all this kind of thing.

So, the mix of the UK was really badly hit by COVID and what's happened in the financial market. So, the UK has been doing better, not because people are suddenly much more optimistic about the UK economy. It's actually because people are now thinking that those COVID losers are very cheap and they could end up being COVID winners in the recovery play way.

So, I think the UK is a recovery play for 2021. It could do really well and beyond that, I think you end up back in more normal markets, and a lot will depend on how inflationary the world is going to be if the UK ends up being a gradual outperformer or gradual underperformer. But I think the opportunity is more tactical than strategic. It does sound a bit inconsistent that we're saying the UK has got a great outlook and we're cutting its weighting strategically in the funds, but we have the tactical risk budget there.

So, I think we can maintain a similar level of UK exposure if we're really bullish on the UK. That will still be more UK exposure than almost all of our competitors, but then as that big catch-up [trade] goes through, we can trim down to a lower level. In a pure equity sense, we're going from a 50-50 mix of UK versus overseas to the UK dropping a bit below 40 strategically and then we're adding emerging markets at an extra 10, and then we're moving to global equities at 55. The numbers don't quite add up because some of them are lucrative and some aren’t. But anyway, it's going to be just short of 40 in the UK from 50. It’s still quite a big chunk and if we've still got our tactical allocation in play, we can be quite close to 50 still.

Adam Vaites:           

Thanks Trevor. I think Brexit, I know every webinar we've done I think for the last few years has mentioned this. I can’t not ask you, but what do you now think is the most likely Brexit outcome considering the past few weeks, and how have you been positioning for it?

Trevor Greetham:   

I think the most likely outcome is this continued difficulties in trade over the next year or so, and that was always going to be the case whether we got a deal or didn’t get a deal. Some of that is quite well-known by now. What we've been doing in the last few months is trying to reduce our exposure to one outcome or another. So, we've taken the UK from underweight up to neutral. Most of the last five years, we've been very underweight in the UK, by the way, tactically. So, we took it up to neutral in September-October mainly because of concern over which way the UK market would jump if there was a jump in the pound from the Brexit outcome. So, it's more luck than judgement really that we were already up at neutral when the UK had its big out-performance in November. But we're now seeing the sector rotation as something that could give that legs.

So, you're going to get some gyrations. It's going to be tough over the next year or so. The pound could still move around a little bit. But I do think Brexit uncertainty, one way or another, is going to be lower in 2021 and then we can start focusing on the other fundamentals.

Adam Vaites:           

Excellent, thanks Trevor. Just your views on property going forward. There was obviously a lot of empty office space and things like that. What are your thoughts?

Trevor Greetham:   

For property, if you think about it sector by sector, the thing that's got most attention this year, for obvious reasons, is high street retail because of the lockdowns and there will be a lot of business failures coming through in high street retail. But high street retail outside of central London is less than four per cent of the UK property benchmark. So, you've got more industrial warehousing which is actually benefiting from online shopping. General retail parks, which are a bit more [intonated] than the high street, especially when people physically start shopping again, which they certainly will, and you've also got the offices.

The offices, I think it's temporary that you're seeing so much vacancy. People will go back towards offices. Maybe not as much as before, maybe they'll use the offices differently. But we're expecting rent to continue to be paid. Tactically, as I mentioned, we think there's possibly a bit more difficulty to work through and we're underweight in the fund, and we're likely to move up to neutral and then go overweight I think, some time towards the second half of next year. That's our current thinking. But do bear in mind, if we're right about financial repression, that interest rates stay below inflation, they stay very low, and if inflation starts to build up, properties and asset class, people will really want to move towards. I know there are some question marks over the way you enter and exit property because of the FCA review, but large balance funds and multi-asset funds like ourselves have better ways of managing that liquidity.

You're looking at an asset class that's yielding five per cent in a world of zero interest rates, and that rent is likely to rise with inflation. So, I think if you get that scenario I'm talking about with financial repression plus inflation, I think property can get a big valuation shift in its favour. I'm actually quite optimistic about commercial property on a five to 10 year view. I just think now is just not quite the time to charge in.

Adam Vaites:           

Sure, sure, thank you very much. Just a couple of questions on Biden really. Your views on Boris working with Biden and how do you envisage the relationship between China and the US and the knock-on effect in terms of global growth really? What are your thoughts there?

Trevor Greetham:   

I think the Biden election is a watershed moment because it's a move back to internationalism from protectionism. Trump is all about America first and creating these big trade spats with all and sundry, loads of threats. I think there has been a lot of deglobalisation because of the Trump administration. Obviously, it's got a big further move because of COVID, less people moving around.

I think we may be in a period where there's a bit of reglobalisation. As COVID fades away, people start travelling again and you've got a more engaged partner in the US.

So, I think the UK government will have to engage with the US. I think China will find Biden isn’t a total pushover. Because people felt that there were some things that needed resetting in the relationship with China anyway. You could argue that the use that Trump has served is by getting that underway. Hopefully, there can be a slightly less chaotic relationship with China, but I think the things like pressurising China on protection of intellectual property and all those sorts of things, I think will actually intensify with Biden.

So, we're in a retreat from globalisation, but I think actually things could get a bit more globalised over the next year or two because of the Biden administration and the reopening. That could be quite good for stock market earnings.

Adam Vaites:           

Okay, that's good. In terms of then moving it to the vaccine effect on markets in 2021, we've obviously seen that come in over the past month or so. Outwith your side, thinking about the vaccine.

Trevor Greetham:   

Well, it's light at the end of the tunnel, and that's really very welcome. There's not just one vaccine but several. There will be challenges. It’s not just flick a switch and everything is okay. There will be challenges in getting the vaccine out to people. I was listening to an interview last night with Fauci, the virologist in the US, and he was saying you need to get 75 per cent vaccinated for herd immunity to mean that COVID dies out. The most recent Gallup poll in America said something like 58 per cent would take the vaccine, not 75.

So, you've got to get through the anti-vaxxers, you've got the distribution challenges. There isn’t a National Health Service to distribute the vaccine in America. So, you're going to have a patch delivery of the vaccine. But it will happen. I think what that means is that we go into the next flu season, next winter, when you’d expect COVID to start picking up again, there will be a bit less social distancing than now. It's not going to be a total flip of the switch back to the old normal, but over 2021, I think gradually you'll see this improvement in economic activity because you start to cope with COVID a lot better.

Adam Vaites:           

Thanks, Trevor. Let's talk about diversification. How do you think that is going to benefit you in 2021 versus some of your peers?

Trevor Greetham:   

Well, the recent period really reminds me of the very late period before the dotcom crash, and I made a bit of a name for myself at the time by predicting the dotcom crash. I used to run the Merrill Lynch fund manager survey. In March 2000, we published a report, and it said the TMT phenomenon, that's technology, media, telecom, known as TMT, the TMT phenomenon, overvalued, overweighted and over soon, and that was 13 March 2000 which I think was the day the NASDAQ peaked. So, I've got a bit of a history of analysing technology and understanding its trends.

In the period before the dotcom crash, if you ever talked to people about asset allocation and diversification, and bear in mind I was dealing with a lot of American clients, they'd say ha, diversification, diworsification. This is because they thought what's the point having bonds in the portfolio or other stuff in the portfolio? Tech is making us so much money, that's all we want. It does feel like we're in a similar situation where 2020 has been diversification diworsification.

But diversification is all about long run risk. We saw that slide comparing a more diversified mix - I flipped back to it on the screen - to the balance funds. We had a very similar long run return with these adjustments we've made to waiting. It would be almost an identical long run return. But I think we've got more resilient if there is a more inflationary period ahead.

I should say we don’t know for sure there will be and that's the whole point about diversification. You're spreading your bets. You don’t know what the future will be. Next year, maybe bond yields stay low and technology keeps doing well. But value stocks and technology could both be doing well and the market could go a lot higher. Or it could be a year like 1994. I am starting to age myself. In 1994, the markets did all the running the year before and when the economy really recovered, interest rates went up, bond yields went up, technology did badly, commodities went through the roof, and it was a much more choppy market, but with a massive rotation.

In that environment, I think the bigger diversification that we're running would work better. So, we don't know what the future brings, but we do know that 2020, on every account, hasn’t been a normal year.

Adam Vaites:           

Thanks, Trevor. I really appreciate your time and thank you everyone for listening today. We appreciate you've got busy schedules over this period. So, thank you for that. I was just going to say, if anyone does have any further questions on the governed range, GMAPs or GRIPs, please do get in contact with your usual Royal London business development manager. But also feel free to get in contact with Scott, Oliver, Christian and Charlotte. So, yeah, thank you for listening and thank you Trevor, and enjoy the festive period everyone.

Trevor Greetham:   

Yeah, it won't be a normal Christmas but I hope it's a happy Christmas.

Adam Vaites:           

Thanks, Trevor.


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