Positive returns
Lewis notes that two of the group’s positions have attracted attention. He adds: “We have been investing in gold since October, on the basis that global currency devaluation could drive gold higher.”
This has worked well, and the group has gained more than 30% from the trade, helped by the weakness of sterling. Also, the opportunity cost of holding gold (which doesn’t pay an income) versus sovereign bonds is not material, given that yields are so low.
The other notable position is to be short the Chinese yuan and long the US dollar. Given Lewis’ gloomy position on the outlook for China, he believes currency devaluation looks likely.
Brexit is among the thorniest issues with which he has to contend on behalf of his clients at the moment. He says: “No one knows what the economic impact will be. Predictions have been made using a set of assumptions that have yet to be negotiated. This is creating headwinds. Whatever the outcome, it would certainly be naive to think the impact will be benign. The UK will take a short-term hit but there will also be damage for the EU. The same issues fester within Spain and France.”
The group’s portfolios held up relatively well in the wake of Brexit. Diversification proved very important. Positions such as short-dated US treasuries, gold and the short yuan/long dollar positions proved useful. However, small and mid-cap weightings in UK equity, and the group’s holdings in commercial property were less successful.
Perhaps, more importantly, Lewis believes that Brexit is symptomatic of wider international issues and highlights growing division. He says: “The way it shapes the future is unlikely to be beneficial for risk assets. Brexit is the manifestation of a much deeper problem.”
He believes investment returns have to start to reflect economic reality. “We have lost the relationship between risk and reward; it’s been all reward.”
Quantitative easing brings forward tomorrow’s consumption and will act as a drag on growth for some time into the future. The biggest driver of asset prices has been liquidity, which has left many assets looking highly correlated. This is a real challenge for investment managers struggling to protect client returns.
The outcome of easy credit, capital misallocation and excessive debt could well be secular stagnation. In fact, many countries are already showing signs. The absence of a true credit cycle has prevented the destruction of excess capacity, and monetary easing has distorted asset pricing, creating significant social imbalances.
In short, Lewis suggests, it is a mess, which is likely to constrain growth for some time. It is an environment that calls for defensive positioning.
