The year began negatively with many commentators predicting poor returns. This was mainly because 2018 was a particularly poor year for assets. Deutsche Bank said 93% of assets were down in 2018 - worse than during the Great Depression - and December 2018 was the lowest performing month since the 2008 financial crisis for global equities. In Q4 2018, Brent crude oil fell by 35% due to rising crude inventories and increased production, in addition to fears that global growth may be slowing.
The main causes of the large declines in 2018 were: US central bank increasing interest rates, a slowdown in Eurozone business confidence, tightening global liquidity due to the withdrawal of quantitative easing, and weaker Chinese growth. There were also rising geopolitical concerns including Brexit, Italian politics, US political gridlock, and the ongoing trade conflict between the US and China.
Key features from 2019 were the liquidity issues affecting Neil Woodford’s flagship fund, the Woodford Equity Income Fund, H2O Asset Management and the M&G property fund. As investors continue to hunt in riskier, illiquid parts of the investment universe (due to the decreasing yields available), I would not be surprised if similar events occurred this year.
Environmental, social and governance issues (ESG) became more important in 2019 as trustees faced new requirements to document the way in which they take account of ESG issues in their Statement of Investment Principles (SIPs). This resulted in a frantic push from asset managers to make their funds meet the relevant standards. Suddenly every fund became an ESG focused fund, which going forward is likely to result in a degree of ‘greenwashing’. There will be additional ESG requirements in place from October 2020 so trustees should prepare to spend more time on this area.
2020 has certainly begun differently to 2019, mainly because 2019 was a fantastic year for assets. It would have been hard to lose money with equities and bonds both going up. Global equities increased by 22% - even a 60:40 equity bond fund would have increased by 20%. Commentators have been claiming that 2020 will be a good year, but I wonder how influenced they are by the joy of 2019.
Nevertheless, there are reasons to be optimistic about 2020. Due to the large Conservative majority in the House of Commons, progress on Brexit will hopefully be made and years of uncertainly should come to an end. There has also been progress on the US/China trade war. In the USA strong real wage growth, low debt levels and rising house prices means the US consumer, the key driver of the economy, is more likely to keep spending, which could prolong the economic cycle and be supportive for assets.
However, bonds and some equity markets do appear expensive by historical standards. There is a high level of global debt and the increased tension between the USA and Iran could very quickly escalate. This means that asset values are susceptible to any type of global shock.
To reduce the effects of such a shock, investors should aim to be highly diversified, allocating not only to the traditional asset classes of bonds and equities, but also alternative asset classes such as infrastructure, commodities, emerging market debt, structured finance, and currency.