There has been little movement in the US market over the month as long-term expectations of interest rate moves have remained subdued despite an acceleration in US CPI inflation to 2.1% in December 2016, the highest reading since 2014. Whilst inflation is rising rapidly in the short-term, we believe that much of this is down to year on year gains in the oil price which bottomed out in early 2016. Once this theme plays out, we expect the inflation growth rate to start dropping back in the second half of this year. Without a clear impetus for longer term inflation, we expect that bond yields will remain low, although investors are likely to see better opportunities to buy in the short term as inflation continues to rise.
Outside the US, yields moved modestly higher with Switzerland remaining the only significant country with negative yields. In the UK, the yield curve rose across all maturities. 10 year gilt yields increased from 1.33% to 1.52% over the month, reflecting modestly higher interest rate expectations.
Against this backdrop, the M&G Corporate Bond Fund fell 0.9% over the month, although the Royal London Corporate Bond Fund fell only 0.5%, outperforming the benchmark which was down 0.8%.
We continue to see value with property allocation within mandates. Our focus is primarily on UK commercial property with the use of the M&G Property Fund which rose 0.6% over the month and the F&C Commercial Property Trust which was flat over the month. Both holdings offer attractive long term income streams. Over the month, the FTSE All UK Property indices was slightly positive with a 0.14% return. With Brexit discussions remaining ‘front and centre’ and Theresa May’s hard strategy, the enactment of Article 50 is taking time. It is clear that uncertainty remains with regards to the UK’s long term future prospects which will be very reliant on our trade agreements with Europe. At this time we are seeing some strong data figures from the UK which could bode well for property alongside stock shortages in some regions, however as a house we remain cautious, and as a result, underweight with our allocation.
Gold was back in favour and has been one of the best performing asset classes, gaining 5.2% on the month and closing the month above $1,200/ounce. The yellow metal benefited as rate expectations eased and some volatility returned to equity markets. It also exhibited strength due to dollar weakness and increasing political risk. We believe it remains an important diversifier within client portfolios. Total return funds currently on our buy list continue to find the environment challenging. The Newton Real Return fund fell by 0.2%. It is likely to perform better in a falling market. The JP Morgan Global Macro Opportunities fund lost 1.1%, hit by its long positions in the US dollar against a range of currencies. Troy Trojan gained 0.7%, benefiting from gold exposure. Exposure to alternatives, primarily total return funds, helps to reduce overall risk within equity portfolios and this remains very important as markets are subject to increasing levels of volatility given the current macroeconomic backdrop.
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