Quarterly Investment Update

Market Review

When we sat here a year ago writing this update, markets were expecting an imminent recession with the expectation that interest rates would come down quickly to compensate. At the time we didn’t think that the outlook for the UK economy was quite that bad, though we were positioned for a more controlled reduction in interest rates as growth slowed manageably.

A year on and we can now say for sure that second pathway is really what played out. It isn’t that growth hasn’t been poor… it has. It just hasn’t pushed the UK into a recession just yet. This time around our view is that (especially in the UK and Europe) economies are stagnating as we haven’t yet seen a significant rise in unemployment or a rise in company defaults that would suggest a recession is pending. The US economy, in contrast to Europe and the UK, has been the main driver of global growth and market confidence, and has also been remarkably resilient even despite higher interest rates.

So 2024 was a year of resilience albeit with pretty low growth numbers for the global economy. This allowed policymakers time to take a considered approach to reducing interest rates, and as a result, rates reduced by 0.5% – 0.75% across 2024, compared to the 1.5% that was expected a year ago. Bond markets have largely struggled given that backdrop, especially those that were more closely linked to interest rate movements, with US equities and the riskier areas of the investment universe performing better as recession risks faded into the background.

The two biggest single events of the year were concentrated less than a week apart in the final quarter. The US election and the UK budget were both expected to cause volatility, and they didn’t disappoint, with big moves in equity and bond markets in the aftermath. Both were negative for bonds, as they indicated a higher likelihood of increased government borrowing and inflation. That’s about where the similarities stopped though, the US election seen as a positive for business and growth, and therefore equity markets, given Trump’s light tax policies, and the UK budget the exact opposite.

The outcomes of those events twinned with ‘ok’ economic data meant it was once again a good quarter for US equity markets in particular. The pound weakened considerably against the dollar, doubling the advantage. From an equity perspective that was the trend across the year really, with the ‘Trump Bump’ adding to the strong returns already delivered on the back of the AI investment craze. Although the US market is big and broad, the majority of the gains haven’t just been concentrated in a single market, but also in a small number of large US stocks such as Nvidia, Meta (Facebook) and Google. To put it in perspective, the US market added 25% in 2024 in pound terms, compared with the main UK index at 9% and 5% from the European index.

Bond markets had a tough quarter to cap off a tough year. The income yields came through to support weak capital values, and there were pockets of positivity, with corporate bonds benefiting from a flat economic environment and low company defaults. Again, to share the divergence, UK government bonds returned -3% on the quarter and -4% on the year, compared to UK Sterling Corporate Bonds at -1% for the quarter and +3% for the year respectively. Happily, our fixed income exposure performed rather better than the market, though the difficult backdrop means that overall there is more value in fixed income at the start of 2025, than since Gordon Brown was chancellor.

Overall, a combination of better economic growth than expected, higher interest rates, and the end of year policy changes, meant it was one to suit higher risk portfolios over lower risk ones. Depending on where you were invested, that doesn’t necessarily mean it was a bad year for low risk portfolios, in fact far from it, just that if you owned US equities to a larger degree, you tended to get a better outcome.

Portfolio Review

Our portfolios delivered returns ahead of their individual targets for the year, and significantly ahead of their respective industry benchmarks.  Overall, our portfolio’s returned 4.62% to 16.11% depending on the risk profile.

Although the returns in 2024 were strong across the board, it should be noted there is a divergence between the lower risk and higher risk portfolios. To add context, these hold a greater degree of equity exposure (and within that US equity exposure), which as discussed before, performed extremely well last year. Naturally that exposure carries more volatility; for example, the market fell 7.5% in a single week in August; so it is important investors have the time horizon and risk tolerance to absorb this type of move. In addition (as we will argue in our outlook) this market now looks expensively priced on a forward basis, and therefore whilst previously benefiting those portfolios more, they carry significantly more risk. Consequently, we are always striving to find diversification and balance, even within our higher risk portfolios.

2024’s outcomes also build on positive returns in 2023, which was on the back of a very difficult 2022. Although many equity markets have recovered, in many ways, the lower risk portfolios are still to benefit to the full extent from some of the excellent opportunities we were able to secure back then. Those opportunities are in fact now bigger than at any time in recent history, with income yields remaining comfortably above 5% per annum, and room for significant capital growth on top.

The key factor for lower risk assets is interest rates falling, which didn’t happen in 2024 to the degree markets were expecting. In the end, the UK budget was viewed as being inflationary, and at the same time, unlikely to deliver the growth required to improve the economy and support that inflation. This is not an ideal scenario and will mean that unless the growth comes through (its not happening anytime soon looking at the data), then more tax rises or less spending is likely. Politically it is hard to see the Chancellor coming back cap in hand in 2025, and therefore markets took a very dim view of the UK’s longer-term ability to meet its obligations. Consequently, yields moved up in Q4 to levels well above those of Liz Truss in 2022. The end of 2024 was therefore a challenging period for fixed income, and this detracted from our lower risk portfolios. The flip side is now that we have a very attractive yield to roll into 2025. It might of course get worse before it gets better, and we wait with interest to see if Rachel Reeves has a Plan B.

Very rarely do you get everything right when investing, and it is not unusual for the benefits of certain decisions to take a long time to play out. In some ways, delivering great outcomes when things haven’t worked perfectly is more pleasing than when they do. There are always areas to improve as well, though overall, our ability to add value and improve returns in a diversified way is probably the most pleasing outcome of recent years.  Our passive portfolios have performed well, showing that our asset allocation (how we split the portfolios between equity markets, fixed income, cash, property etc) has been on point in 2024. Our main portfolio range improved further on that, thanks to our active fund picks over which provided outperformance vs their main index. Examples here include our active US position which produced 37.49% in 2024, compared to the US index at 27.22%, and our active UK position, which produced 24.42% versus the index at 9.57%. The excellent work of our investment team is highlighted here.

Overall, it was good to see value added across the two main investment levers (asset allocation and fund selection), with our main portfolio range outperforming our passive range, which also incidentally outperformed the main industry benchmarks.

Q4 Investment Returns Main Portfolio Range

Q4 Investment Returns Passive Portfolio Range

Disclaimer *Following our Passive range passing its 5-year anniversary, we will now also be displaying its historical return data in these updates*

Market Outlook

Global inflation has slowed sharply in the last two years, and is now within touching distance of the classic 2% target. However, the path to lower inflation has been uneven across countries, with most developed economies enduring policy induced slowdowns, with the US bucking the trend and running at close to full capacity. The question that has dominated the market narrative over the last two years is; has the US achieved a soft landing, or will the impact of higher interest rates eventually lead to a harder one (recession)? This remains unanswered, though the progress towards one of those outcomes will continue to determine portfolio returns.

Our base case is that US growth will continue to slow, even despite Trump’s re-election and more spend / growth policies. Although his second campaign is likely to be stimulatory, we don’t think it is as much of a shift from the status quo as is being made out. Lower tax policies and higher tariffs are likely to mean higher growth and inflation at the margin, though that means interest rates will stay higher for longer, which squeezes the consumer and makes it less attractive for businesses to invest. US equities are likely to grow more slowly in the next 12 months.

The UK and Europe have the same spending and investment problem but without the positive policy stimulus. Inflation is likely to tick-up here across the next 6 months or so towards 3% driven by public sector wage rises and energy price base effects. It is important not to get too carried away and see this as a return to 2022, though it does mean that the Bank of England will also remain cautious. Interest rates and taxes will both stay higher than at any point in the last decade, which means we feel it is unlikely we see the UK economy improve. The consumer should stay relatively resilient, though businesses are low on confidence and that will feed through to the consumer over time. We feel that this should play out to be very positive for our fixed income exposure, though until we see that positivity come through into performance we will have to be content with picking up the income yield.

In Europe there are big political and economical challenges, albeit we see the potential for improvements in sentiment on the back of a potential peace deal in Ukraine once Trump takes office. This of course remains a highly uncertain event, though we do feel a ceasefire and an agreement of sorts is a realistic outcome, which is better than where we were 12 months ago and would be seen as a good thing if it materialises.

At this point it is worth highlighting that equity market valuations are reasonably reflective of these realities. The US market is trading on expensive multiples but has momentum and a higher chance of continued growth if the US economy can sustain its path. We see some of the steam coming off here, so care is required. European and UK markets are much cheaper, offering higher income returns, but with more challenging backdrops. Each has their pros and cons though they look well priced on a 3-to-5-year view.

Comparatively where we continue to see the largest mispricing is in bond markets, which continue to expect very steady interest rate policy, higher inflation for longer and an almost negligible chance of a recession. However, although not our base case it is completely plausible in our view that UK growth, which is trending at close to 0%, could fall further, and that alternatively the US slowdown may gather momentum. Markets aren’t worried, and at present we are looking to add assets at excellent entry points which should benefit returns over the years ahead. Moreover, we will continue to receive 6% per annum in income whilst holding this insurance, so it is a little like getting paid to insure your house (that would be nice right!).

All put together, our view from here is that the majority of equity markets are now priced appropriately for their 2025 outlook, but that bonds continue to offer a profitable hedge against a bad outcome. Absent of a worsening growth outlook, returns should continue to be underpinned by high income yields and the underlying profit growth of businesses. That said we remain focused on a number of forward scenarios, and the opportunities that each will provide. If we can continue to add value in addition to what markets offer us, the portfolios should remain in a good place. Active diversification in our view will be very important in 2025 and our team are looking forward to the challenge.