Asset Allocation
By way of a summary, the Fund is currently positioned neutrally across most of the asset classes compared to the neutral allocation which is Fund is managed against. At a time when markets are particularly volatile, we do not believe its is the best time to be aggressive in our investment policy. Instead, we prefer to be diversified across asset classes, regions and investment styles. When looking at asset allocation, we think it is better to try and prepare rather than time.

Equities
There is a marginal overweight position in equities. The reasoning for this is that equities are a ‘real asset’. By this, we mean that equities can provide protection during periods of higher inflation, with underlying companies hopefully able to pass on higher input costs to the end consumer, thereby protecting profit margins.

There are a number of reasons and concerns which stop us from going more overweight this asset class at present.

1. Valuations. Although there has been some retracement over weeks given the falls in the market seen, many regions continue to see their markets trade at high valuations relative to their own history and relative to others.
2. Economic activity. The cost of living is clearly starting to have a negative impact on economic growth. A slowdown is at least expected, with the potential that some economies could move into recession should central banks be too aggressive with their rising of interest rate and removal of liquidity in the market through quantitative tightening. Whilst a global recession is not predicted, regional/country recessions could certainly be seen.

This overweight to equities has been protected during market falls, with exposure added when necessary. We are however, at this time, of the mindset that it is too early to buy the dips, particularly as the US Federal Reserve remain on a tightening cycle. Should their rhetoric become more dovish, perhaps because they feel policy is too aggressive given economic conditions, then we may be encouraged to add more risk back to the portfolio. For now however, this does not appear to be forthcoming as they are remaining focussed on fighting inflation.

Within the equity allocation the Fund maintains a large weighting to the UK. The sector and stock weighting within the main UK index, the FTSE 100, has previously been something of a headwind. Since circa October last year however it has worked in its favour. The return of inflation and higher interest rates and bond yields has brought value as an investment style back to the fore, and we have seen something of a rotation from valuation to growth. The favours sectors such as oil and energy, commodities/mining and financials, all of which are sectors which account for a significant proportion of the UK market. This is particularly the case relative to the US. The UK has strongly outperformed the S&P 500 since the turn of the year in local currency terms. The UK has also performed well thanks to its high allocation to miners and oil companies, where supply issues caused by COVID and the Ukraine conflict have sent commodity prices soaring.

Within the equity allocation it is our preference at present to favour those which are cheaper from a valuation perspective relative to both their own history and to other markets, which leads us to regions such as Japan. Here we are attracted by the valuation and the outlook for corporates, given the significant change which we have seen in governance, dividend growth, strong cashflow on balance sheets and smaller levels of leverage compared to their other developed market counterparts.

Chinese stock market valuations also look attractive and fund research has been conducted here. We had refrained from investing in a direct Chinese equity fund until we saw further clarity on the outlook for the economy given the current slowdown due to lockdown restrictions, in particular Shanghai. With the lockdown due to end at the beginning of June, we have tentatively added a small position, which we may continue to add to as conditions show more improvement.

With regard to fund allocation, there remains a balance between those funds which follow a quality growth bias and those which follow a value driven style approach. The latter have been the stronger performers in the year to date, with value performing well during periods of rising interest rates and bond yields. An allocation to a value fund is maintained in each region, such as Lazard Emerging Markets, River & Mercantile European, Man Japan Core Alpha, Dodge & Cox US Stock and Schroder Recovery.

This exposure is balanced with fund investing with a stronger quality growth bias. Should we see a marked slowdown in the economy and central banks do pivot away from their current hawkish stance, that could see a rotation back into stocks which would typically be invested in by these funds. In particular, companies which can pass on higher costs they are suffering to the end user.

In terms of recent activity, we removed the exposure to Baillie Gifford Japanese Smaller Companies. If there were to be a marked economic slowdown, historically smaller companies suffer greater than their larger cap counterparts. The proceeds were reinvested back into Japanese equities via a current holding which indeed invests in large, quality companies.

We continue to favour the UK and we also recently added a new structured note. This was an at-the-money autocall, with the FTSE CSDI index as its underlying, issued by Citi. With a maximum 8 year duration, it has the ability to mature at its annual observation, from year one onwards, should the underlying index be at or above its initial strike level. This note is paying an annual coupon of 11.55%.

Fixed Income
The Fund has a neutral weighting to fixed income, having reduced the exposure recently in favour of alternative asset classes. This saw the exposure to the Janus Henderson Strategic Bond fund reduced.
Regarding those which are allocated to, these have been carefully selected to provide a range of different investment styles and propositions, despite all bar one being in the IA Sterling Strategic Bond sector. Each of the strategic bond funds in has a different process and method for investing, which adds a level of diversification within the same asset class. For example, the Nomura Dynamic Bond Fund manager is very much macro driven and therefore asset allocation within this fund is driven by top down, macro news. GAM Star Credit Opportunities meanwhile invests in subordinated, non-investment grade issues, predominantly financials. Whilst the issues are non-investment grade, the issuers are typically investment grade. Therefore you are picking up an additional yield from what ultimately is an investment grade company. One commonality across these fixed income funds is that they are running a duration which is shorter than they normally would. This is to reduce their sensitivity to any interest rate increases which central banks may impose.

The largest fund exposure within fixed income is to Artemis Target Return Bond. This fund has a great deal of flexibility in terms of managing its credit exposure and its duration so that, in market conditions like we have recently seen, it can position itself accordingly to try to minimise drawdown. For example, the duration on the fund can range between -2 years to +4 years. The upper limit is not as high as a more traditional fixed income fund and therefore if central banks were to become more hawkish, we would most likely reduce the position in this fund. For now however we believe it adds a good defensive element to the Fund overall.

Alternatives
Within this allocation the Fund is overweight relative to the neutral allocation. Here the majority of the portfolio is allocated to long/short equity funds. The Tellworth UK Select fund is market neutral, whereby it is looking to carry zero market risk. Instead performance is expected to be driven by the long and short positions within the portfolio. In positive bull markets the investment process can mean that it would lag funds which take long only positions in stocks. In more volatile, negative markets however the fund has provided strong levels of protection.

The Carmignac Portfolio European long Short fund is very similar except the fund manager has a greater degree of flexibility in terms of not having to be market neutral. Instead, he can have, for example, a greater weighting to long positions compared to short, which will be driven by his interpretation of opportunities and market conditions. We envisage that we will maintain these exposures for now whilst market volatility looks to be staying with us. Should equity markets show signs of improvement however then we would most likely remove exposure here.

Diversifiers
Within the Equity and Alternatives allocations the Fund has exposure to funds which it is hoped can provide further diversification whilst also potentially benefit from the underlying market and economic conditions. Within the alternatives section their continues to be an allocation to physical silver via an exchange traded fund (ETF). Real assets and precious metals typically perform well in inflationary environments. Silver also has an industrial use within the greener energy revolution which should also support demand. We also hold this metal in case of a central bank policy mistake.

Within the Equity allocation there is an allocation to a Gold & Silver fund. This fund holds a combination of physical silver and gold, along with gold and silver miners. The reasoning for this holding is very similar to the silver position discussed above.

We have also recently added the TB Amati Strategic Metals fund. This fund invests purely in miners but covers not just gold and silver but also industrial and strategic metals. Commodities have enjoyed a sharp rally of late given the supply issues which have been seen. There could however also be a tailwind behind commodities driven by demand as the world moves to achieving carbon neutral etc. This potentially leads to a large increase in demand at a time when capital expenditure in the mining space over the last 10 years has been very little compared to previous periods of time. History shows that commodity cycles tend to be long in duration and therefore it possible that this could be the start of the next one. Commodities are also, despite the recent rally, still cheap relative to equities.

These latter two investments are recognised and allocated to the Equity bucket, but we believe that given conditions in which they could perform that they potentially offer a different return dynamic.