Square Mile’s team of analysts conducts regular meetings with fund managers running portfolios across a broad spectrum of assets. As well as informing Square Mile’s conviction in a fund manager’s process and repeatability of performance, these meetings also offer invaluable insight into the wider market sentiment among asset managers.
While the bulk of these conversations were held before two widely anticipated events – the first Autumn Budget delivered by a Labour government in 14 years and Trump’s victory in the fiercely contested US presidential elections – overall sentiment among fund managers across asset classes, if not buoyant, was cautiously optimistic. Key points include:
- The UK: Labour’s decisive victory in July’s General Election should usher in a period of political stability making the UK a more attractive proposition for overseas investors; inflation is easing and interest rates falling; small and mid-caps stocks remain undervalued relative to large caps.
- Europe: Some evidence of a two-tier economy, with ‘old’ economy sectors lagging those linked to AI build-out and energy transition. European valuations look cheap relative to US peers; household balances look strong and inflation and interest rate headwinds easing.
- Emerging markets: Chinese stimulus package provided a fillip to Chinese equities which have recently comfortably outperformed other EM markets. Sectors and economies linked to AI/tech suffered; allocations to EM remain low and these markets should benefit from any reversal in investor sentiment.
- Fixed income: These assets are more appealing against a backdrop of political/economic uncertainty; corporate spreads at historically tight levels; from a duration perspective, overweighting US and European interest rates remains a popular strategy; high yield (in particular European HY), emerging market debt and securitised assets are favoured assets.
- Multi-asset: Sentiment split between risk on/risk off; views on the US polarised between those confident in continued economic growth and those seeing greater opportunity in UK/Europe; alternatives seen as attractive by many, albeit with the need to be selective; renewed interest in property.
- Property: Ongoing rate cutting cycle should reduce concerns of REIT debt burden; expectation that discounts should narrow; sectors performing well include datacentres, e-commerce logistics, warehouses and assets associated with the digitisation of the economy; regional UK offices out of favour.
UK equities
The UK general election in July was seen as a non-event for markets, but most managers agreed that the Labour Party’s comfortable majority should provide political stability, hopefully making the UK more appealing to overseas investors. Nonetheless, and despite the relative attractiveness of UK equities relative to other developed markets, primarily the US, the UK remains in outflow, though this is slowing.
In general, managers consider the UK economy to be in reasonably good health. Inflation is seemingly under control and interest rates are expected to fall further. Savings rates remain elevated and so there is some scope for consumers to start spending again.
However, views on consumer confidence are mixed given uncertainty surrounding the impact of the Autumn Budget. Some managers commented that data on the sales of bigger ticket items had slowed during the summer. For example, kitchen maker Howden Joinery has been trimmed from some portfolios reflecting this.
Meanwhile, small and mid-caps remain undervalued relative to their larger peers. It is within the small cap sector where fears were most elevated; concerns over changes to the IHT status of AIM-listed stocks led to managers trimming holdings that are widely owned by AIM IHT vehicles. Most consider the Budget as a clearing event for the AIM market, which has subsequently experienced a modest rally.
There has been some general frustration around operational performance of smaller companies as many managers had anticipated a recovery in earnings, which should have helped drive the market higher. However, this has not generally materialised and the earnings of a number of companies remain at trough levels.
Europe
One portfolio manager we spoke with noted that positive real income growth persists in Europe, something which is not typically evident in a recessionary environment. Furthermore, consumer and household balance sheets remain in good shape.
European equities do tend to be cheap relative to the US, but they look very cheap at present with relative valuations now at levels last seen during the Eurozone crisis. Nonetheless, Europe appears to be a two-speed economy. Areas with good investment spend linked to energy transition, digitalisation, and AI build-out are performing well. However, “old” economy sectors have been softer, although this appears to be stabilising. The standout pocket of weakness in Europe at present is in Autos.
A further manager noted that the starting point for monetary policy is supportive; Europe is more sensitive to short rates falling, and the headwinds caused by inflation and the energy crisis are now abating.
Emerging markets equities
On the 24th of September, the Chinese government announced a stimulus package which included supportive measures for the property market, rate cuts and other measures to prop up the economy and instil market confidence. This caught investors by surprise and led to a sharp rally in Chinese equities into the month end. The MSCI China index was up by some 21% over September compared to a 5% increase in the MSCI EM index, in GBP terms. In contrast, the MSCI India index was flat. Over the third quarter as a whole, these indices were up +16%, +3%, and +1% respectively.
In India, domestic institutional investors remain net buyers of the market for the 14th consecutive month (ending September) driven by a positive outlook for the economy with GDP growth expected to remain around 7%.
At the sector level, worries over AI demand and the memory chip cycle compounded by disappointing earnings guidance from NVIDIA led to global investors reassessing tech given the valuation premiums in general in the sector. This volatility also impacted the market performance for Korea and Taiwan, two tech heavy markets. MSCI Taiwan fell c.5% whilst MSCI Korea fell even further, -11%.
In general, valuations within emerging markets remain very attractive relative to developed markets. In addition, the consensus points to earnings growth for full year 2024 and 2025 to be much higher than that in the US and Europe.
With investor allocation to emerging markets at historical lows, there is the potential for them to benefit should sentiment reverse.
Fixed income
In a climate of economic and political unpredictability, investors are increasingly turning to fixed-income funds as a strategic play for a more stable return profile. The coming months are likely to see market fluctuations as pivotal events, such as the U.S. presidential election, shape market sentiment and influence short-term volatility. With corporate credit spreads at historically tight levels, cautious optimism remains the dominant view among fixed income investors.
The consensus at present is one of a “soft landing”, where growth slows without triggering a significant recession, although some managers commented that a “hard landing” remains within the realm of possibility. This creates both risks and opportunities for fixed-income assets.
Trump’s victory may have profound implications for fiscal policy given his rhetoric around aggressive tariffs and immigration restrictions. Such policies may complicate the Fed’s ability to meet anticipated rate cuts, potentially leading to higher yields. Investors should consider that, while monetary policy is used to stimulate the economy, in developed markets the rate hikes resulted in relatively benign impacts as shown by the resilience in the US. This raises the question of whether the reaction to rate cuts may also be more muted than expected.
Looking at the outlook from a duration perspective, overweight positions in US and European interest rates remains a popular strategy. As the global trend toward rate cuts continues, holding longer-duration assets such as sovereign bonds could offer a valuable hedge against declining interest rates. The increased sentiment for holding higher duration is ongoing in a bid to capture the potential upside as rate cuts support sovereign bond valuations across developed markets.
Asset classes in favour are high yield, particularly in Europe due to cheaper valuations over the US, as well as emerging market debt and securitised assets. These asset classes are providing incremental and attractive levels of yield despite the tight credit spread environment.
In the coming months, excess returns are more likely to come from carry rather than additional narrowing of credit spreads, i.e. capital appreciation. With spreads already compressed, focusing on yield seems to be the path most travelled in an attempt to offer a sustainable return profile.
Multi-asset
Our recent discussions with multi-asset managers suggest a broad range of macro and market views. This has resulted in a split in attitude to risk, with those who feeling sanguine on the growth outlook comfortable maintaining, or adding to, their risk asset exposure, predominantly via equities or credit. Those who are more cautious, are typically allocating more towards more defensive assets.
As the largest economy in the world, and the largest market in terms of global equity index representation, the US often occupies the bulk of our managers’ thoughts, regardless of whether they are positive or negative on the market. Some believe the US economy has the potential to continue to grow through 2025 and beyond, with inflation under control and corporate earnings driving returns. Others believe that not enough negative news has been priced into markets, with inflation only just impacting a weakening consumer, the uncertainty surrounding the election impact and US market valuations at or near historic highs in absolute and relative terms. This has led to a preference among some for UK and European markets, which appear cheaper after many years of being unloved. The UK in particular is an area of interest to several managers, who believe that Labour’s large mandate and focus on growth create some certainty.
Within their fixed income allocations, some managers believe that credit offers ample compensation for the risk assumed. Others believe that spreads are now too tight, after what has been a strong period for the asset class. Some have shifted their attention to government bonds, which have lagged this year, and continue to offer relatively high yields compared to the decade following the GFC.
Approaches to building in downside protection are also varied. Some managers have increased their duration (interest rate sensitivity) believing that long-dated government bonds will act as a hedge to equities. The opposing view is that they remain positively correlated, leading to a preference for shorter dated issuance which offers attractive yields and low term risk.
Many managers are seeing some good opportunities within alternatives; however, they stress the need to be selective with regards to the asset class and sub-asset class. After a torrid period of returns for the asset class, property in particular is increasingly viewed with interest by several managers.
Property
Recent discussions with managers running funds of REITs (and therefore less applicable to direct property portfolios) suggest overall optimism, with the ongoing rate cutting cycle reducing debt burden concerns for REITs.
While rate cuts are not materialising as quickly as anticipated, there is the expectation that discounts should narrow further. Once further into rate cutting cycle, it is hoped that banks will become more competitive on debt pricing, leading to a good potential for expansion in the UK & European property sectors.
In general, managers feel that UK investors remain cautious of any significant exposure to property. Nonetheless, there is optimism that this will abate, given property’s potential for delivering a good yield and diversification to other risk asset classes.
In terms of sectors, datacentres, e-commerce logistics, warehouses and assets associated with the digitisation of the economy continue to perform strongly. In contrast, managers remain pessimistic around regional UK offices. The retail space, which has long been out of favour, has been positive more recently and, as an often lower quality, higher LTV asset class in the sector, it has benefited from the start of rate cuts. Despite this, managers remain cautious on retail assets.
A key theme this year has been the continuation of M&A activity among REITs. Private equity and peers/competitors are still willing to bid at prices well above current discounts to NAV. That is likely to continue if discounts remain at their current wide levels by historical average standards.
