A fragmenting world: A Multi-Asset update

Simon [00:00:12] Welcome to our first Multi-Asset update of 2025. I'm Simon Hildrey and with me is James Klempster. James, if we just look towards the end of last year, the AI frenzy continued, domination of a few stocks, Donald Trump came in which reinforced that. Where did that kind of leave you as an investor at the start this year?

James [00:00:36] Well Simon, we had loads thrown at us last year. Markets reacted generally pretty positively to it, if you take a over-the-year view. A lot of the political changes that we had last year were actually sort of material in the sense of incumbents got replaced. Most notably you mentioned Donald Trump returning in the US. A lot of that uncertainty is perhaps behind us, but we're now greeted with new uncertainty of course of what happens next? And perhaps less well telegraphed policies and the rest of it. So, I think we've come into 2025 in pretty good shape. The global economy sort of rumbling along and markets seem fairly well supported. We've seen actually even so far this year, and clearly it's early days, but we've seen when challenges have been thrown at markets, whether it be surprises with respect to the AI story, whether it be tariffs out of the US, the markets have largely taken it in their stride. There's been a period of sort of surprise and markets perhaps sold off in the immediate aftermath, but after that they maintained their composure or regained their composure quite quickly and we saw decent returns so far year to date. And then on that particular point in terms of the AI and DeepSeek, which we saw earlier this year, what was reassuring about that was the impact in markets was pretty localised in the sense it was focused on the stocks that were obviously, potentially at least, at risk from that story rather than being a broad based market sell-off. So the market seems to be broadening out a bit. It's reasonably well supported and so far year to date, reacting relatively calmly to the newsflow it's being dealt.

Simon [00:02:12] And within that market support, you've got the UK's actually done relatively well, Europe's done better, NASDAQ's kind of, I think, one per cent as we records this. What's driven that differentiation and a divergence really from what we've seen last year?

James [00:02:27] Well, over the short term it's always very difficult to make very confident statements about those sorts of differentials. But I think clearly as we went through last year, as you mentioned already, the AI related stocks did very well and then had a sort of final 'Trump bounce' in the final third of the year. And they've come into this year at pretty high valuations frankly. Now, it might be with the benefit of hindsight, if we come back in a decade's time, we'll say those valuations are justified. But if history is a guide, the sorts of valuations you're seeing in those tech names are looking stretched. They're almost priced to perfection. And when you think about the amount of profitability that's sitting behind that, you think about how much has been spent on AI, billions and billions of dollars, to have high multiples on revenues and profitability based on those very big numbers, you know, it is a reason to be a little bit careful. Or certainly cautious in terms of those valuations. So we think when you look at what's done better this year, it's really been the stuff that started the year at a valuation discount. You mentioned Europe, you mentioned the UK, emerging markets as well. Areas of global stock markets that we have maintained for the last couple of years have been undervalued, underappreciated. And, you know, they're still actually looking pretty cheap from a valuation perspective, despite a small amount of relative outperformance this year. So there's no one catalyst you can kind of point to, no one single signal you can say, well, that's the reason why. But ultimately, they have found more buying demand so far this year, and therefore they've driven their prices up.

Simon [00:03:52] And you've talked before about fragmentation and globalisation. We've seen Donald Trump beginning to impose tariffs. We've also seen inflation higher, we've seen growth low. All these factors that you've talked about for a while, is this cementing this kind of differential in terms of interest rate policy, in terms of economic cycles? Are you seeing that now cement?

James [00:04:15] I think that's a very clear indication at the moment. What we've moved from is this sort of almost 'one size fits all' monetary policy approach. Certainly in that period between the Financial Crisis and COVID, that sort of 15 year period where we had very unusually low interest rates, everyone moving in lockstep really. As of today, though, it's very much not the case. You've got the UK interest rate decision. There were two members of the Monetary Policy Committee debating whether to do a bumper 50 basis point cut. You've got the ECB, certainly firmly in cutting territory. Bank of Japan is still putting interest rates up. And the US now sitting somewhere in the middle, it's sort of on pause watching what's going on. And there's an argument in favour of, you know, rather than cutting rates this year, on the balance of probabilities, we're heading towards increasing interest rates in the US this year. So it is very much the opposite of a 'one size fits all' era. We're also in that sort of inflationary paradigm. We think secular inflation is likely for the reasons you've already mentioned, not least the green transition, but also, the potential for tariffs and globalisation to not sort of disappear, but be less powerfully a disinflationary force. And on the basis of that, we can see an argument for having higher, but not necessarily high inflation. So where it's sitting and settling today in the sort of twos to fours in most major economies, seems much more likely to be the sort of level we'll see for the foreseeable future. And by historical context, it's perfectly normal, perfectly reasonable inflationary levels.

Simon [00:05:43] So in all these factors that we've talked about, are you seeing a broadening of winners across markets?

James [00:05:48] Perhaps the way to answer that is it's dangerous to presume that what's done very well in a particularly unique set of circumstances will continue to do well in perpetuity. If you look at the period, actually, we'll to go back to the Financial Crisis and roll forward to today. In 15 years of market returns, if you list the major markets, the US wins about 10 times out of 15 calendar years. US Treasury did very well, US dollar did very well. It really was a period where if you look at this belief system around US exceptionalism, you can make a very clear case for it. But again, history as a guide suggests that these periods of outperformance don't exist in perpetuity. You've got Nifty 50, you've got the Japanese stock market, you've got the BRICs. You know, people that have their day in the sun have a really sort of strong period. But at some point, you know, capital moves elsewhere and you see that broadening out when we see other markets come to the fore. So whether it be in fixed income, whether it be in equity markets, we think generally it's sensible to remain diversified and be meaningfully diversified rather than naively diversified when building portfolios.

Simon [00:06:50] And what does that mean for you as portfolio managers? What does it mean for investors?

James [00:06:54] What you've got to make sure you think about when you're building your portfolios is having a diverse range of drivers in the portfolios within equity markets. Don't just be beholden to the US, for example, which is now 70% of the global stock market by market cap. Now, we've talked before about the marginal price insensitive buyer, which in that period between the Financial Crisis and Covid, certainly even post-Covid perhaps, was central banks and quantitative easing and that liquidity sort of washing around. In this era of quantitative tightening, the buyer of last resort is unlikely to be governments and central banks. But it might be another source of naive price insensitive buyers. And you can argue perhaps over the last few years, the flows into passive investments, which are a very useful investment tool in many ways. But that flow into passive investments has created a new, significant price insensitive buyer that will just top up as the flows come in and buy whatever's gone up. Looking at the US as a case in point, you've got mega cap names that have done well because of their business being in the zeitgeist. On top of that, you've arguably got a catalyst from passive flows as well. So, you know, again, when you're think about building a portfolio, you want lots of different returns drivers, not just reliant on what's done well on the back of that price insensitive buyer, staying away from momentum perhaps and looking for areas of the market that look cheaper, looking for valuation. And then, of course, outside of just your equity allocation, you want your fixed income to be working for you as a meaningful diversifier as well. We've seen periods in the past where correlation between equities and bonds periodically increases, but over the long run, you expect your bonds to do something materially different from equities. It's a meaningful diversifier. And so you want to have that as a means to dilute the impact of your stock market volatility. Over the long run, you expect stock markets to beat inflation meaningfully. It's your main return driver, your real return driver. But fixed income is very useful as a diversification tool.

Simon [00:08:42] So what you're talking about is active management, not of the underlying securities, which could be active and passive, or passive, but really you're talking about active management of portfolios?

James [00:08:52] Exactly right. So we like to think of building portfolios that are actively different. The activity is a key part of it, but also differentiation as well. If you just look the same as all the other portfolios out there, you're not going to provide a meaningful portfolio diversification for your underlying clients. So we look, based on first principles, we look at markets based on their attractiveness, and we allocate that way, not to be different for the sake of it, but also we don't want to follow and just lead in with the same allocation as everybody else. So active management, the more we see these flows naively chasing on a price insensitive basis, arguably the greater the opportunity set for active management becomes. And sometimes it's hard to argue, you know, passive investments have done very well over the last decade or so for lots of different reasons. But we think that opens up an ever growing space for active managers to exploit. So as you rightly say, we're not directly active in terms of the stocks that we choose. We use third party managers for that, or indeed passive vehicles. But from a top-down perspective, managing your portfolios very actively, we think is key where we're going from here.

Simon [00:09:52] And just final question, coming back to the start with Donald Trump. As an investor, is Donald Trump noise that you need to ignore? Is he a real kind of changemaker for markets? Or is there somewhere in between?

James [00:10:04] You could be all three of those things. All politicians are a potential source of noise. Now, clearly, if you are a noisy politician in the largest economy in the world, you're a meaningful source of noise. So we can't  dismiss that as a source of potential volatility. But I think in some ways, as long term investors, it gives us an opportunity to look through the short term kind of aberrations that get caused as a result of that and identify long term fundamental value to invest in. So we would expect the current president in the US to create more volatility in markets in some ways, but a patient, long term, disciplined approach can, we believe, be meaningfully rewarding and take advantage of those in time.

Simon [00:10:44] Great. Thank you, James. Thank you for watching and we'll see you next time.