PruFund Growth & PruFund Cautious Investment Update from the M&G Treasury & Investment Office (T&IO)
- Strategic asset allocation review completed with some small adjustments to portfolios
- Most equity mandates rebalanced – a lot of performance captured since last summer, so the small reduction does not reflect a negative view
- Diversification within fixed income continues with increased allocation to emerging market bonds and small increase to US treasuries and private credit
- Property exposure will slowly evolve as exposure to Asia increases but UK still a core holding
- Scenario analysis suggest ‘real assets’ still have a key role to play particularly if inflation does pick up
- A good year so far for equity holdings, more challenging for corporate bonds
- Commercial property continues to recover although uncertainty remains for areas of retail
Q2 Market Overview
The majority of world stockmarkets registered solid gains in the quarter, buoyed by the widespread rollout of vaccination programmes which aided the reopening of economies. Investment returns among European shares were particularly strong as vaccination take-up in the region accelerated following a slow start. Global commodity markets continued to reflect rebounding demand for raw materials – the price of oil advanced by more than 20% during the quarter, for example.
Fixed income markets were also higher in Q2 as central banks dampened speculation they would be withdrawing stimulus measures soon, and many investors seemed to shrug off global inflation fears. There was little overall movement in currency markets.
Strategic asset allocation review
The annual review of the long-term positioning of PruFunds was recently completed with relatively small changes recommended by the T&IO Long Term Investment Strategy team (LTIS) for 2021.
Whilst much uncertainty still exists, with concerns over inflation and US/China relations for example, a large part of the work LTIS do is to understand how various scenarios will affect overall portfolio performance.
ESG has also been a factor that has been considered when setting the strategic asset allocation. Environmental, social and governance is all factored in when thinking about the risk premium/volatility assumptions for different regions.
Research also suggests that there is a lot of scope to differentiate at a stock level, due to the huge ESG score differentials between the best and worst companies in any given index, so each underlying manager is expected to follow the Prudential UK ESG policy and report on ESG aspects.
The current portfolio positions as at end June 2021 are;
30 June 2021
30 June 2021
|Europe ex. UK||6.55||Infrastructure||2.43|
|North America||6.16||Total Alternatives||8.14|
|Japan||3.33||UK (Investment Grade)||6.38|
|Asia ex. Japan||7.47||Europe (Investment Grade)||1.89|
|China||1.79||UK & Euro (High Yield)||1.18|
|Global Emerging Markets||2.14||US (Investment Grade & High Yield)||6.00|
|Middle East and Africa||2.14||US Treasury||0.74|
|Europe||1.51||Private High Yield||1.59|
|North America||1.01||Lower Risk Private Credit||0.37|
|Asia||1.62||Global High Yield||0.25|
|Total Property||13.76||South African Debt||0.60|
|Cash||2.00||Emerging Market Debt||1.25|
|TAA Mandate||3.00||Total Fixed Income||24.75|
30 June 2021
30 June 2021
|Europe ex. UK||4.77||Infrastructure||1.84|
|North America||3.98||Total Alternatives||5.28|
|Japan||1.85||UK (Investment Grade)||14.25|
|Asia ex. Japan||5.02||Europe (Investment Grade)||4.22|
|China||0.99||UK & Euro (High Yield)||2.64|
|Global Emerging Markets||1.19||US (Investment Grade & High Yield)||13.78|
|Middle East and Africa||1.19||US Treasury||1.70|
|Europe||1.03||Private High Yield||1.23|
|North America||0.48||Lower Risk Private Credit||0.64|
|Asia||0.66||Global High Yield||0.54|
|Total Property||7.47||South African Debt||1.07|
|Cash||2.00||Emerging Market Debt||3.35|
|TAA Mandate||2.00||Total Fixed Income||53.33|
So, to summarise, the recent changes made are;
- Equities – small reduction
To give some context the UK equity exposure reduced by 1.05% in PruFund Growth and 0.44% from end Q1 to end Q2.
We believe the decision to increase UK equities last year was well timed and beneficial to portfolios. A lot of positive UK equity performance has been captured so we believe it is prudent to rebalance and allocate elsewhere.
These decisions do not reflect a negative view on equities; indeed, equity exposure is still higher now than this time last year.
- Fixed income – small increase
Diversification has never been more important in fixed income, with inflation concerns and very low real yields from develop market government bonds.
The main change for 2021 is to increase exposure to the Emerging Market Debt allocation, by 0.52% in PruFund Growth and 1.66% in PruFund Cautious. This brings the benefit of higher real yields.
There is also a small increase in Private Credit some of which reflects investments through ‘Catalyst’. Private Credit can benefit portfolios through offering an origination and illiquidity premia. Private credit deals are often ‘floating rate’ which can offer protection against inflation and ‘asset backed’ such that creditors have a claim on physical assets in the event of a default. The Private Credit exposure will continue to grow over time.
To further diversify, a small increase in US treasuries was recommended. LTIS believe yields are more attractive and the asset class offers liquidity and some downside protection.
- Property & alternatives - maintained
Part of the work carried out by LTIS this year was to ensure portfolios maintained a diversified basket of assets with positive, medium to longer-term inflation hedging characteristics. Tangible real assets such as infrastructure, property and private credit can benefit from either higher real yields (property) or long-term inflation-linked cashflows (infrastructure) whilst also generating extra returns via risk, illiquidity, or origination premia.
The constant evolution of portfolios in recent years means this basket of real assets is already largely in place for PruFund Growth. Some further phased increases are planned for PruFund Cautious. Portfolios will continue to evolve though as exposure to Asian property likely grows and investments through ‘Catalyst’ increase exposure to areas like private credit and infrastructure.
The two pie charts below neatly encapsulate some of this messaging around real assets and why we believe they differentiate PruFund Growth, in this example from other multi asset funds that are available to UK retail investors.
Portfolio performance overview
The key drivers of returns for the underlying PruFund portfolios to end May* were the regional equity allocations and good performance from some of the underlying active equity managers.
Several continued to benefit from owning ‘value’ stocks that have performed well due to vaccine rollouts and economies re-opening. The UK, US, European, Japan, Emerging Market and Asian equity holdings all produced strong positive returns.
The China mandate has been the only equity position to post a negative return so far this year.
Another overall positive during the first part of 2021 was property.
Gains made in the UK and Asia offset losses in Europe and the US. The industrial/logistics and office exposure within PruFunds have been resilient and as the UK economy continues to reopen this should provide more support to the hard-hit retail sector and shopping centres, which also form part of portfolios.
Finally, in fixed income, the uncertainty around inflation and change in investor sentiment has meant that most of the larger corporate bond mandates have produced negative returns in 2021 so far, although the second quarter was better. Pleasingly, some of the more specialist, diversifying assets like Private High Yield, Global High Yield and African Bonds have produced positive returns.
*Due to a small lag in gathering data for private assets, performance comments are based on numbers as at end of May.
T&IO and teams across M&G had another busy quarter implementing the new strategic asset allocation and adding new investments.
Some recent examples;
The M&G Alternatives team have been able to provide capital to develop the world’s largest carbon capture and storage project. This will sequester carbon from a number of biofuel refineries in the Mid-western US and when fully developed, the company projects having an infrastructure network capable of capturing and permanently storing more than 10 million tons of CO2 annually, which is equivalent to taking 2 million cars off the road per year.
The M&G Alternatives team have also made a commitment to a large European based partnership that is creating large-scale infrastructure projects across the developed world and is responsible for some of the first offshore-wind projects in the US, Taiwan and Australia.
Whilst the changes to portfolios were relatively modest in percentage terms a huge amount of thought and work goes into the research and analysis that informs these investment decisions.
This scenario work LTIS carry out is not a ‘crystal ball’ but helps the team understand how resilient portfolios will likely be across a range of outcomes. Therefore, it is good news to see that they still see areas like property, alternatives and other private market assets as key diversifiers. As we know property had a challenging 2020.
We hope this emphasises our belief that genuine long-term investors running diverse portfolios across regions, asset classes and public and private markets, don’t always need to make significant changes to portfolios.
The aim is to produce steady risk adjusted returns over 5-10 years and not be too influenced by short-term performance, both positive and negative.
ARTICLE by Parit Jakhria
Inflation and Real Assets – PruFund spotlight article
M&G’s Treasury and Investment Office (T&IO)’s Long Term Investment Strategy team continue to expect inflation to be contained over the long-term but acknowledge that the shorter term risks of inflation have increased.
2021 strategic asset allocation review for the PruFund range of funds
T&IO provide an update on the PruFund range of funds following the 2021 strategic asset allocation review and where the team see upcoming opportunities.
ARTICLE by Adrian Gaspar
Asset class performance update: A spotlight on Asian Bonds
Within this article we provide an in depth look at our approach to investing in Asian bonds within our PruFund funds.