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MPS Investment Committee: LGT Vestra on where the risks lay in 2018

MPS Investment Committee:  LGT Vestra on where the risks lay in 2018

LGT Vestra's model portfolio service team expolore four risks to markets in 2018 and how they may affect their MPS.

'We have identified four risks to markets for the next 12 months which we will be monitoring for our Model Portfolio Service.

Central banks act unexpectedly

The heads of central banks across the world have clearly signposted the anticipated rate of change of their respective monetary policies. If central bank actions play out entirely as expected, things tick on, but if the central banks act outside what they have led the markets to believe is going to happen, we are likely to see fairly unexpected shifts in markets and increasing levels of equity volatility.

It’s all about the (Phillips) curve

One of the reasons central banks have been fairly relaxed about increases in inflation in the developed economies is the absence of wage inflation. Economists represent this as a ‘flat’ Phillips curve. If we did start to see wage inflation come through, it could cause inflation to move even further up from here (don’t forget in the UK the inflation rate is already 3%) which would force the hand of central banks to likely increase interest rates faster than the expected rate (refer back to point one). Markets may become jittery if inflation starts to really take off.

The US dollar reverses its 2017 weakness

Over 2017, the US dollar fell 8% on a trade-weighted basis versus major currencies as investors became more sceptical both of president Trump’s effectiveness and the Federal Reserve’s ability to normalise the interest rate cycle. If we see a rebound in the value of the US dollar during 2018 it may have an impact on emerging market economies. In a strengthening US dollar environment as the value of the debt in the domestic currency increases, an effect compounded by rising US interest rates.

Sterling rebounds

Following the result of the Brexit vote, sterling is a depreciated currency versus recent history, and one of the risks to investors is that sterling strengthens considerably from here. We view this as unlikely because of the downward pressure Brexit uncertainty has on sterling. However, if we did see a strong rebound it could be to the detriment of both FTSE 100 companies for which 75 to 80% of the revenues are generated abroad and companies held in portfolios that are overseas on an unhedged basis.

Key changes were implemented in portfolios during October and November 2017 partly in response to these concerns and challenges.

During October, we decided to increase exposure to the Artemis Global Income fund in the Balanced portfolio and introduce exposure to the same fund in the Adventurous portfolio. The Artemis fund has an overweight position to financials (40%) and Europe which were two areas we specifically wanted additional exposure to across the portfolios.

During November, we sold our holding of Woodford Equity Income in the Cautious and Balanced portfolios on concerns over the unquoted element of the fund. The L&G FTSE 100 Index Tracker was added to portfolios to replace the allocation to Woodford.

As we have become more positive on the outlook for European equities, we increased allocation to the geography in portfolios and switched into BlackRock European Dynamic, which is a strategy that has a higher exposure to growth-orientated companies in Europe.'

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