Is there still room for progress in US equity markets?
There are a number of core tenets in our strategy that we believe differentiate the Janus Henderson Balanced Fund from its peers: dynamic asset allocation, collaboration between the equity and fixed income teams, transparency and consistency.
We believe that a dynamic approach to asset allocation that leverages the breadth of our bottom-up, fundamental equity and fixed income research can help us to outperform our peers over time. We strive to provide smooth returns for our clients over varying market cycles, in good times and bad, so that they have the confidence to stay invested. In fact, since inception (to 28 February 2018), the Janus Henderson Balanced Fund has provided similar returns to the S&P 500 Index, with a little over half of the volatility. We focus on equities and bonds, without complicating the strategy with derivatives, commodities or property. Our flexible, diversified approach means that we can shift the portfolio, either to preserve capital in more volatile markets, or position for capital growth when the opportunities arise.
Why a balanced approach?
No single asset class outperforms every year. We can position the strategy for where we think the market is heading at any particular time, either by adjusting exposure between the different asset classes, or diversifying within each asset class sleeve. Over time, we have the ability to move the equity weighting between 35% and 65%. These are never dramatic movements, but the shift can be quite significant over time.
Chart 1: Asset allocation reflects our views on market conditions[caption id=”attachment_63381″ align=”alignnone” width=”680″] Source: Janus Henderson Investors, as at 31 December 2018. Proportion of the total portfolio expressed as a percentage.[/caption]
Within asset classes, we have a lot of flexibility. While we currently hold a 60:40 split between equities and bonds (what we would consider a ‘neutral’ position), we could increase our exposure to US Treasuries in the fixed income portfolio to increase downside protection, or take advantage of better market conditions via higher-yielding issuances. Our fixed income sleeve is actively managed in tandem with the entire portfolio, which is unusual for multi-asset funds. The more risk we take on within the equity portfolio, we try to counterbalance this by reducing risk within the fixed income sleeve.
Overall, decisions on asset allocation are a competition for capital, based on different types of yield, growth prospects, fundamental in-house research, risks that we see in the market and a host of other factors. We look to optimise equity and fixed income portfolio weightings based on the most attractive risk-adjusted return opportunities across the capital structure.
So what are our current views on asset classes?
We continue to favour equities over bonds, although we have seen some opportunities at the high yield end of the fixed income market. We still feel that there are still a lot of growth opportunities out there and this is reflected in our current balance. We are optimistic about free cash flow yields and dividend yields. The current dividend yield for the S&P500 is about 2%, which is attractive to shareholders. We think the normalised free cash flow yield is much higher than that, giving companies the flexibility to reinvest in their businesses, or think about rewarding investors. We are also seeing a very active level of buybacks, which we believe create value for shareholders.
Thematically, we believe that there are some really interesting stories within the equities arena. We talk a lot about the growth in global travel, which we see as an attractive area of opportunity, particularly in Asia. Global travel is increasing 6% year-over-year. We also believe the transition to cloud technology is a very economical move for enterprise applications. Only a fraction of total enterprise spending is currently within the cloud, so we believe that this area has real potential – not just for companies that are providing cloud services, but also a lot of the equipment makers providing the infrastructure and equipment that helps to facilitate the growth of the cloud. Software as a service (SaaS) is another area of interest, where we see continued expansion of the total market size for companies that are offering subscription services.
The semi-conductor industry had a very difficult year in 2018. The supply chain struggled and orders were falling, with a lot of weakness in the second half of the year. But we believe that the long-term fundamentals for the semi-conductor industry remain extremely favourable, in terms of the increasing interconnectivity of devices and machines, and the use of AI to make networks more efficient, improving safety and productivity.
How late is ‘late’?
It is worth considering how we expect our long-term disruptive or technological themes to evolve, given the length of the current business cycle. We believe that there are some fundamental drivers that can continue to drive growth in the economy over the next couple of years, partially helped by tax reform and capital spending, which remains robust across a range of sectors. The economic backdrop and current policy is still very favourable for companies, and we expect interest rates to remain range-bound between reasonably tight margins of 2.5% and 2.8%. High employment levels are feeding through to wage inflation at a moderate level, which is supportive for consumer spending, and helping drive economic growth.
There are risks to this view, namely geopolitical uncertainty and concerns over trade wars, some of which we saw in 2018. We would like to see progress on trade negotiations and favourable resolutions that can instil companies with confidence, instead of uncertainty, which could really disrupt the capital spending cycle. Any indication that fears are overstated would be a supportive factor for valuations.