What should we focus on in our private wealth portfolios for H2 2024 and beyond?

The second half of the year is set to be dominated by the upcoming US presidential election. With Kamala Harris now almost certain to be the Democratic nominee, it currently appears to be a very tight race - but the outcome is likely to have major geopolitical and investment market impacts.

For our private wealth clients, investors will be expecting portfolios that consider the risks and opportunities inherent in the numerous global themes they will be exposed to. In the short term, as well as the US election, markets will also contend with continued global political tensions and (it feels like we have been saying it for a while) potential rate cuts in both the US and the rest of the developed world.

We have our regular review of our 13 private wealth model portfolios coming up at the end of the July. I’ve set out some of the themes (both strategic and tactical) that I think we should be discussing.

Tactical

Currency exposure

We are currently unhedged in our developed market equity allocation. I feel comfortable with this position - given the potential risks outlined above. Exposure to some strong currencies, like the dollar, provides a natural hedge if there is market volatility and growth assets struggle. However, I see three areas of consideration we should debate that could impact the relative strength of the dollar versus other major currencies. These are:

1. Markets expect an imminent cut to US (and broader developed market) rates. If this and subsequent cuts are more aggressive than markets anticipate, then the dollar could weaken. The Fed has clearly indicated that they are looking for more consistency in inflation data (a couple of good months need to become a trend) before deciding on whether and how frequently to cut rates, but market expectations is it is only a matter of time. The impact this will have on the dollar versus other economies (many of which are also looking to cut rates) will be an area of scrutiny.
2. To date, the US presidential elections have been something of a soap opera. We have had an assassination attempt, the fumbling, forgetful performance of Biden in the TV debate and now a change in the democratic candidate. Whilst Kamala Harris seems to have got off to a strong start, with tight polling and seemingly very binary outcomes based on who is elected, there could be volatility in currency markets over the next three months as the battle ebbs and flows.
3. Linked to the above two points, a key input into longer-term (post 2024!) currency markets could be the election of Donald Trump for a second term. Trump’s key policies seem to me to be more tax cuts, more immigration controls and more tariffs. These could have a mixed impact on the economy and also the dollar. Whilst it is clear tax cuts would be good for growth this could also increase inflation and put pressure on further rate cuts. Supply side issues such as the tariffs and immigration controls could also have a knock-on impact of higher inflation, impacting the potential for rate cuts and by extension dollar strength.

Emerging market allocation

Emerging markets (EM) continue to trade at a material discount to developed market equities after 10 years of relative underperformance. However, I think there are some indications that this could be a good time to consider EM more closely both from a short-term tactical and a longer strategic perspective:

1. The prospect of the Fed joining its EU counterparts in cutting rates in the coming months could be attractive for EM economies where a weaker dollar is usually a tailwind.
2. The economic fundamentals of EM markets are much better than they have been in the past. Current account balances have improved, USD foreign reserves reduced, and political instability (especially in Latin America) seems more settled. In essence, the foundations of EM economies (ex China?) are more robust to respond to any market catalysts, such as a weakening US dollar.
3. From a strategic perspective, 90% of the world’s working age population and two thirds of its high-consuming middle class (according to Fidelity), are also expected to be living in emerging markets in the next couple of years. As such, EM economies have more labour resourcing relative to developed counterparts than they have ever had.

We currently are slightly overweight EM (15% of our equity allocation), but I am sure we will discuss whether the tailwind potential merits a further allocation in our more adventurous portfolios.

Cash v bonds

We currently hold a tactical allocation to cash in some of our more conservative private wealth portfolios and why wouldn’t you? A return of c.5% with no volatility is a strong positive in my view. However, if the Fed follows their EU counterparts in rate cuts, this could be a catalyst to consider locking into ‘current market rates’ for longer. As such, I can see us reviewing the allocation to cash in favour of bonds. In the past, rate cuts and strong fundamentals have been an accommodative environment for credit. However, current credit spreads are near to, or at, their lowest point in several prior market cycles.

A key question will therefore be is there any space for credit to deliver returns going forward? The cash allocation, as well as delivering great current returns, also provides us with the secondary benefit of supplying some ‘dry powder’ to be nimble if opportunities do arise and valuations do become attractive. The discussion about if and when to reduce the cash allocation, as well as what bond allocation to choose, will be an interesting one as we get further clarity on what rate cuts will look like across the globe.

Property v infrastructure

We currently hold a slight overweight in our real assets building block to global infrastructure (60%) v global property (40%). A discussion on whether to move this position to be equal may be interesting, as well as a specific focus on sector and regional allocations within both.

In relation to property, many global property markets (with the exception being some pockets of Asia) have seen a material correction in capital values over the last couple of years as a result of the global high interest rate environment. UK property valuations were hit hardest where the added dynamic of the Liz Truss ‘mini Budget’ and associated impact on the number of DB pension schemes being forced sellers of property meant a much bigger valuation correction than other global regions. As such, looking forward, I believe UK property to be better positioned to benefit from any rate cut rally purely from the perspective that the likely improvement in valuations will be starting from a lower base. From a regional perspective, logistics and residential sectors continue to perform well post-Covid and with strong future projections compared to retail.

Infrastructure has been a topical asset class recently and I expect this to remain the case going forward. The long-term nature of the asset class meant they did not see the write downs to valuations in the same way we saw in property - so returns delivered were stronger. The case for maintaining an allocation going forward also looks good. In a world where so many developed market economies are challenged for finance due to their fiscal positions, many of the large infrastructure projects will need to be privately financed. However, a diverse exposure to the sector remains prudent. In recent times we have seen political risk impacting some projects (water companies, windfall tax implications), some infrastructure projects being economically sensitive (airports, toll roads, etc), and many projects focused on the energy transition returning well. So, with infrastructure, the focus will be on the right ‘kind’ of infrastructure and the relative weighting of our holding compared to property.

Strategic

Whilst our meetings often focus on more recent market activity and expectations, we try to take a step back and ask ourselves ‘is there anything we are missing’? I believe the below topics could also be strong strategic considerations for our portfolios.

Illiquid allocations

The UK Government’s focus on productive finance has been extended from institutional pension schemes to retail with the approval of the Long-Term Asset Fund (LTAF) structure for retail use. Whilst less liquid allocations have been commonplace in a private wealth setting for a long time, they have either been direct holdings or there have been question marks about the fund structure used to access this exposure. The LTAF framework means illiquid assets are much more easily accessible, with much lower initial financial commitments required and often in a pre-packed multi-asset solution, that has been commonplace with many LTAF funds recently launched.

Climate-aware investing

If Trump returns to the White House in November, there are strong indications that he is likely to reduce environmental spending and climate support. As such, there could be a five year headwind to climate awareness in the US. This could add to a broader sentiment, largely but not exclusively driven by populist pressure, of a weakening of climate change impetus at a government level. For example, closer to home, we have recently had the delaying of the elimination of fossil fuel powered cars from 2030 to 2035. However, I think the investing community will continue to champion the importance of reducing the impacts of climate change as well as broader responsible investment themes as being an important risk management consideration and return opportunity. As a result, in our private wealth portfolios we may wish to consider more explicit allocations such as impact funds as well as better incorporation of climate change into our fixed income allocations.

There is only one certainty in investing, that what is predicted won’t be fully borne out in practice. The number of variables and market-changing events remaining in 2024 make this statement a racing certainty, but it also makes it a fascinating time to be reviewing and developing our portfolios.