- Inflation concerns in US the major theme in the first quarter
- Despite renewed national lockdowns, the global economic recovery does not appear to have been blown off course
- Commercial property continues to recover
- A good quarter for equity holdings, more challenging for corporate bonds
- Significant progress made on further embedding ESG considerations across PruFund portfolios
- ‘Catalyst’ will see £5bn invested in exciting sustainable investments on behalf of the Prudential With-Profits Fund and PruFunds over the next 5 years
The major story of the quarter was the activity in fixed income markets. This was driven by inflation concerns causing many mainstream government bonds to sell off, led by US Treasuries.
President Biden’s US$1.9 trillion COVID-19 relief bill was passed in early March. This raised short-term growth expectations for the US economy, but also the prospect of higher inflation.
Investors worried that the US Federal Reserve may have to act a lot earlier than anticipated to stifle inflation following the third stimulus package in the US since the pandemic. Consequently, the yields on US 10-year Treasuries rose.
The Long Term Investment Strategy (LTIS) team in T&IO believe the widespread vaccinations programme and rising commodity prices alongside the US stimulus package could cause short-term increases to inflation.
There are also logistical challenges caused by the pandemic, with planes and containers in the wrong places and some borders being closed. This could cause prices to spike in certain goods, although over time, as capacity builds up and supply chains are re-adjusted, these challenges should fade.
Looking longer-term there are several factors that LTIS believe have kept inflation low.
Independent, inflation-targeting central banks
Technology has weakened the pricing power of firms and undermined the bargaining power of employees
Globalisation and competition in global markets, particularly the introduction of China to the world economy, has limited wage and price increases. The pandemic and more nationalistic economic policies could start to reverse this
Demographics, an increasing share of populations able to work, particularly the 30-64 age range, often means greater productive capacity relative to demand, hence lower inflation
The base case is we believe inflation will be contained over the medium-term although the possibility of higher inflation is greater than it has been for several years as factors like globalisation and demographics may become less influential in keeping inflation low.
Despite renewed national lockdowns, the global economic recovery does not appear to have been blown off course. There were signs that the rollout of national vaccination programmes had begun to raise optimism among businesses and consumers. This has boosted underlying economic activity.
Portfolio performance overview
PruFunds hold relatively little in US Treasuries or other mainstream government bonds but the sell-off did have a knock-on effect on other assets held, like corporate bonds.
The key drivers of returns for the underlying PruFund portfolios in the first quarter was the regional equity allocations and good performance from some of the active equity manager. Several benefitted from owning many stocks that markets feel will do much better now with economies re-opening. The UK, US, European, Japan, Emerging Market and Asian equity holdings all produced strong positive returns. This was pleasing to see after some challenging periods in recent years for mandates that have held a number of ‘value’ stocks. The China mandate was the only equity vehicle to have a negative return in the first quarter, following a strong 2020.
Another overall positive during the first part of 2021 was property. Gains made in the UK and Asia offset losses in Europe and the US. The industrial/logistics and office exposure within PruFunds have been resilient and as the UK economy continues to reopen this should provide more support to the hard-hit retail sector and shopping centres, which also form part of portfolios.
Finally, in fixed income, the change in investor sentiment meant that most corporate bond mandates across both portfolios produced negative returns apart from the Private High Yield and Global High Yield mandates.
T&IO and teams across M&G had another busy quarter.
- Two new managers were onboarded to run US Small Cap money – Ernest Partners and Granahan Investment Management
- An interesting sale from the PruFund Growth property portfolio was a former Debenhams department store in Guildford. The site will likely be converted to primarily residential property subject to planning permission. This theme is becoming increasingly prevalent as the high street continues to evolve
Environmental, Social and Governance
An important aspect of how Prudential manages its investments has been the integration of ESG factors into investment decisions. We believe this can help manage risks and generate sustainable, long-term returns.
T&IO have worked hard to more formally embed ESG considerations into the strategic asset allocation (SAA) process, manager selection and oversight and mandate design.
T&IO will look to the asset managers they select to:
- engage with companies as active owners that help foster a more sustainable economy
- participate in voting on key issues such as climate
- manage assets in accordance with the M&G Plc Asset Owner ESG Policy
- ensure that ESG is integrated into their investment process
The majority of PruFund assets are managed by M&G Investments. Their experienced Stewardship and Sustainability team provide detailed analysis on specific companies or sectors to help inform teams across T&IO.
A fuller Q&A on PruFunds and ESG is available here;
The first quarter saw the launch of an internal mandate known as 'Catalyst', which will invest £5 billion over the next 4/5 years into privately-owned businesses working to create a more sustainable world. This investment will be made on behalf of the Prudential With Profits Fund and PruFunds.
Drawing on M&G’s heritage and track record in private assets and ESG, the Catalyst team will seek opportunities across the globe to invest in unlisted businesses which might otherwise struggle to access capital to develop and grow.
The full press release can be viewed here;
The first part of 2021 has been very busy and productive from a PruFund perspective, with the work on ESG and the launch of Catalyst.
Capital markets have reminded us that bouts of investor uncertainty and volatility will continue to present challenges. It has also reminded us of the importance of diversification and maintaining a long-term view. The gradual improvement in sentiment towards commercial property being a good example.
As we noted in the previous update, there are several themes that the strategists and portfolio managers are currently assessing as they start thinking about what adjustments are made to portfolios and what new asset classes are added in the 2021 SAA review. The outcome of this is likely towards the end of the second quarter so we hope to provide a full update in the next note.
The value of any investment can go down as well as up so your customer might not get back the amount they put in.