Intro

In 2022, the world witnessed the conclusion of a 40-year cycle of reducing interest rates, as central banks sought to counter inflationary pressures resulting from the Covid-19 stimulus and global supply chain disruptions. With this pivotal turning point behind us, we must now focus on identifying the crucial factors that could influence our investment portfolios in the upcoming year. Additionally, it is crucial to re-evaluate old adages that may not apply in this more volatile environment.

While the new year brings with it fresh opportunities, we cannot ignore familiar themes that continue to affect the global economy. The economic recovery and Covid-19 response in China, the ongoing conflict in Ukraine, and above-target inflation rates are just some of the critical issues that demand our attention. As investors, we must navigate these challenges and identify the opportunities that arise from them.

Our key findings are as follows;

• Inflation is likely to persist, although it may have peaked or be close to peaking.
• Geopolitical tensions have led to a global reassessment of supply chains, which may impede production in the medium term.
• The focus on net zero carbon emissions limits investment in expedient but less environmentally friendly options, resulting in an energy demand-supply mismatch that supports inflation.
• Understanding wage inflation is crucial to understanding central banks.
• Central banks cannot resolve supply-side constraints and may resort to a manufactured recession.
• Central banks may slow their interest rate hikes, but we expect some overtightening and reluctance to cut rates, even in a likely recession.
• Some countries, such as Canada, are making progress on inflation, suggesting that some central banks may achieve their inflation targets without significant rate hikes or inducing a recession.
• Bond markets are pricing in interest rate cuts in 2024, which may not occur if a recession is avoided, hurting longer-dated bonds.

Considering the assumptions and dynamics, we have conducted a thorough review of our portfolio exposures and made adjustments to safeguard capital and achieve satisfactory returns. For clients who are interested, we have provided an explanation of our strategy on an asset sector-specific level below.

Asset Allocation

DEVELOPED MARKET EQUITIES – UNDERWEIGHT WITH A SKEW TO QUALITY.

In 2022, global equity prices suffered significant losses, but BlackRock believes that equities have not fully priced in the impact of even a mild recession on earnings. As a result, we have taken an underweight position in global equities in the short term, unless there is an improvement in valuations or a reduction in risk compared to other asset options.

We have also adjusted our portfolio exposure by avoiding growth-style companies that generate little or no profits, and instead, we focus on companies with solid balance sheets and robust, defensible earnings. These types of companies have a strong financial foundation, with cash on hand and low debt levels, which enables them to weather a recession and continue operating as interest rates rise and production costs increase.

In addition, companies with robust, defensible earnings have a sustainable competitive advantage, making them less susceptible to economic downturns. By investing in companies with these attributes, we aim to protect your portfolio during times of economic uncertainty, such as a recession, by mitigating risk and preserving the value of your investments.

In summary, by investing in companies with solid balance sheets and robust, defensible earnings, we aim to protect your portfolio during times of economic uncertainty, such as a recession. Investing in companies with solid balance sheets and robust, defensible earnings is a superior strategy in a recessionary environment, as these companies are better equipped to weather economic downturns and sustain their operations.

EMERGING MARKETS AND ASIA – UNDERWEIGHT WITH A SKEW TO COMMODITY-BASED COUNTRIES.

The performance of most emerging market indices is likely to be influenced by outcomes in

China. Unfortunately, China’s handling of the Covid situation has resulted in a significant increase in severe cases across the country, with an estimated 72,000 fatalities reported since December 8, 2022. This rise in cases has led to unexpected changes in Chinese travel behaviour, with citizens tending to avoid travel due to the pandemic.

It will be interesting to see how economic activity is affected after as we progress through the year, given this behavioural trend. Despite these headwinds, there is still an expectation that spending in residential property and infrastructure will increase, which may be the reason for the support in industrial ore prices.

Looking more broadly, there is potential for commodity-focused emerging countries to outperform their peers and some developed markets in 2023, thanks to a declining USD, recovery in China, and energy commodity supply mismatch. We are actively seeking tactical entry points to take advantage of this trend.

FIXED INCOME – SHORT DURATION SKEW

The bond markets continue to view inflation with positivity, despite fluctuations surrounding announcements by central banks and inflation. To account for this, we plan on maintaining our stance of less sensitivity to interest rates by holding onto short-term, low-duration bonds.. Currently, these low-duration positions are still providing acceptable yields to maturity so have limited opportunity cost. B At present, these bonds offer acceptable yields until maturity, with limited opportunity cost. However, venturing further out on the bond risk spectrum does not offer much in terms of reward. As we approach the end of the identified inflationary supply side themes and reach a terminal rate, we may look into adding alpha through longer-duration government bonds. Our short-term exposure will also include private debt, and we may gradually increase corporate credit.

Commodities and Gold

The investment committee will continue to maintain an overweight position to Commodities, which can be attractive in a rising interest rate environment, and during recessions, for several reasons:

Inflation hedge: Commodities are often seen as a hedge against inflation, as the prices of commodities tend to rise as the cost-of-living increases. This makes them a good investment option during periods of rising interest rates, when inflationary pressures are typically higher.

Diversification: Commodities provide diversification benefits to an investment portfolio, as they tend to have low correlations with other assets such as stocks and bonds. This makes them a good option during periods of rising interest rates, when other investments may become less attractive.

Supply and demand dynamics: The prices of commodities are often driven by supply and demand dynamics, rather than interest rates. For example, the price of oil may rise due to a shortage of supply, regardless of what is happening with interest rates.

Real rate of return: When interest rates rise, the real rate of return on bonds and other fixedincome securities can decline. This can make commodities a more attractive investment option, as they provide the opportunity for a positive real rate of return.

Demand for essential goods: Some commodities, such as food and energy, are considered essential goods that are in constant demand, regardless of economic conditions. This means that the demand for these commodities can remain stable during a recession, providing a stable source of revenue for the companies that produce them.

Economic stimulus: Governments may engage in economic stimulus measures during a recession, such as infrastructure spending, which can increase demand for commodities such as steel and copper.

Overall, the unique characteristics of commodities make them an attractive investment option during periods of rising interest rates or recessions, as they provide diversification benefits, act as an inflation hedge, and are driven by supply and demand dynamics rather than interest rates. However, it is important to keep in mind that commodities can be volatile and subject to price swings, so they will be used as only a part of client’s investment portfolio.

Moving to gold, we maintain a ‘far weight’ position as Gold is often considered a haven asset during times of economic uncertainty and volatility. This is because gold has a long history of holding its value and serving as a store of wealth, even during periods of economic stress. Gold is seen as a more stable investment that is less likely to be affected by the ups and downs of the economy.

Additionally, during a recession, central banks may engage in monetary stimulus measures, such as increasing the money supply, which can lead to concerns about inflation and a weaker currency. This can make gold an attractive alternative, as it is not tied to a specific currency or government and has a finite supply.

ALTERNATIVES

Assets that don’t perform in line with broader markets, such as private equity and quantitative hedge strategies, remain viable options and will continue to feature in portfolios. It is important to identify alternative managers who have ridden the “Cheap money” wave or rely heavily on algorithmic patterns which may not hold true to the future and remove them from the potential investment universe. Instead, we focus on strong alternative macroeconomic style managers whose investment style and risk mitigation strategy have demonstrated the ability to avoid correlation in market downturns.

We expect broad market indexes to achieve historically restrained returns for 2023 and so actively managing exposures to specific sectors will be a requirement for outperformance. Companies that can sustainably disrupt industries or benefit from proven thematic such as

Energy, Electric Vehicles and shifting global supply lines will always be able to cut through the noise and grow wealth. Our focus will be on discovering and prudently allocating to these exposures while retaining a conservative and diversified core to portfolios.