2022 reflections – Looking backwards and forwards
2022 served as a reminder that investing is not an easy game. Despite a global pandemic, recession, and political polarisation, investors had enjoyed around a decade of relatively strong – and fairly consistent – market returns. Now rampant inflation and the resulting climb in interest rates seem to be ushering in a new market era. It seems strong year-on-year returns can no longer be taken for granted. So, what lessons can investors learn from 2022?
Looking backwards
Investing can very much be a game of ‘three steps forward, one step back’. If there was no risk of market downside, it would be unreasonable to expect any return at all above cash. For most investors, 2022 was a relatively tough year. Returns ranged from benign to poor across most major asset classes – global developed value companies being an exception.
Rising prices make returns significantly worse on an after-inflation basis. Year-on-year inflation in the UK having reached levels not seen for decades. The year was particularly challenging for investors in bonds, as yields have risen (and thus prices have fallen) across much of the world. Bondholders with longer and lower quality debt suffered greater capital falls – shorter dated, high-quality bonds continue to be preferred.
Figure 1: Global investment returns – sensible assets 2022 returns
With few places to hide, most investors will have finished the year in negative territory. This is to be expected from time to time. These losses, however, should lie well within the tolerances of their financial plan. Put into context, the scale of the losses hasn’t been too severe (global equities fell by over 40% during the Credit Crisis, for example).
At BpH, our model portfolios are systematic, comprising a diversified basket of equities (with tilts to value and smaller companies) paired with shorter-dated higher-quality bonds – from low risk to high risk. Portfolios like these will have provided better results than most. Such solutions outperformed over 70%[1] of professionally managed multi-asset funds in 2022. Major US firms like Tesla and Meta may have hit headlines with share price falls of over 70% and 60% respectively in the past year. However, they only represent a small allocation – and thus have a small impact – in a well-diversified portfolio.
Investors with portfolios denominated in GBP have benefited from the strong performance of the US dollar, which has meant overseas assets translate back to more in GBP terms. In 2022, Global equities fell around 18% in USD terms, around 10% more than when viewed in GBP terms.
The asset class that – uncharacteristically – stole the headlines was fixed income. Many bond indices experienced their worst calendar year on record. This was chiefly due to persistent high inflation and corresponding rising policy rates from central banks. In turn this led to a swift increase in the compensation bondholders demanded for lending their capital. Rising borrowing costs, and little yield buffer to begin with, have meant absolute falls for fixed income investors. This is something that few investors will have seen in a year when equities fell too. The last time was 1994.
The reality is, however, that higher yields are a good thing for investors with time horizons longer than the maturity of their bonds. Bondholders start 2023 in far better shape – from an expected return perspective – than 12 months prior. Over time, the new bonds being invested in have been at a higher yield, providing a larger yield cushion going forward and reducing the chance of absolute falls on an interim basis. Today, 5-year gilt yields stand at 3.5%, as opposed to -0.1% at the start of 2022.
Looking forwards
Uncertainty abounds – it always does. Basing investment decisions on forecasts or judgments is best avoided. For instance, using forecasts to try to profit when oil prices fell in 2014 would have ended in severe disappointment. As would speculating on US 10-year bonds.
After stating his column’s 2023 predictions Robert Armstrong, of the Financial Times, questions: ‘Do I have high confidence in any of this? Heck no.’.2 There is no shortage of seemingly sensible predictions on market performance and global developments. Nor any effective method to separate those that will be more or less accurate.
As always, Investors should look to the future anticipating that new information will arise, and markets will react quickly to take it into account. Without the ability to profit directly from superior information a diversified portfolio built to weather all storms, guided by an ever-growing body of academic literature, gives the best chance of success. If, for example, inflation or growth comes in higher or lower than expected, some parts of the portfolio will – by design – be helping, and others detracting from, performance.
With the reasonable belief that risk and reward go hand in hand, it should be expected that incremental risk taking in a portfolio will be rewarded. However, on a daily (or even multi-year) basis – which in the context of a true investment time horizon is miniscule – the expected daily reward is dominated by unexpected noise. This can be positive or negative.
From an investing perspective, perhaps our philosophy of ‘hope for the best but prepare for the worst’ has never been more relevant.
And finally…
Outside of investors’ portfolios, Putin continues to wage his illegal war in Ukraine, with much of the world feeling the repercussions of the supply chain impacts. The NHS is under considerable strain. Increasing borrowing costs and a higher cost of living place pressure on many of us. These challenges provide a stark reminder that we should be grateful for what we can be. News outlets have a bias towards reporting bad news, which is hardly surprising. Bad news sells.
Nicholas Kristof of the New York Times plainly states that journalists ‘report on planes that crash, not planes that land’. He writes a column[2] on some significant achievements made by the human race in 2022. For example, solar power is now on track to overtake coal as the world’s leading power source in the next five years.
Time away from day-to-day news can help one feel more positive. For example, reading information from news outlets such as Good News Network®[3] can be a refreshing exercise. We particularly enjoyed this article: The Top 10 Acts of Kindness in 2022. We hope you enjoy a fulfilled 2023 and all the better news it may bring.
1 Source: Albion Strategic Consulting. More information is available on request.
[2] https://www.nytimes.com/2022/12/31/opinion/2022-good-news.html
[3] https://www.goodnewsnetwork.org/
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