PruFund Q2 update from the M&G Treasury & Investment Office (T&IO)

Fears of an imminent recession in the US and Europe, brought on by months of rising inflationary pressure which dented consumer and business confidence, gathered steam during the quarter. Business surveys for the month of June pointed to a sharp deceleration in the health of the global economy, as manufacturing and services sector activity slowed among the world's leading economies. Economic damage from the war in Ukraine has been a significant factor in the slowdown in global growth in 2022 and has greatly exacerbated the global inflation problem. Fuel and food prices have increased rapidly, hitting vulnerable populations in low-income countries hardest. The worsening inflationary picture necessitated a more aggressive pace of interest rate hikes from many of the world's central banks.

Against this backdrop, bond yields rose sharply, the US dollar rallied and equity markets fell. The increases in oil and gas prices added to investor concerns over global growth as the war in Ukraine rumbled on. However, fears of a global recession knocked industrial metals prices, with many registering their first quarterly fall since the onset of the pandemic in Q1 2020.

The rising interest rate environment and recession fears had a negative impact on both bond and equity allocations. Our strategy over the past year has been to pivot the portfolios to a more defensive stance in terms of inflation risk. We have done this by increasing the allocation to asset classes that offer both some protection against inflation as well as additional risk and return characteristics that offer further diversification benefits.

These diversifying strategies including property, infrastructure, private equity and private credit all made positive contributions to performance and thereby helped to limit losses from the bond and equity allocations.

The higher allocation to fixed income and lower exposure to property and alternatives in PruFund Cautious meant that it received less of the diversification benefits.

During the quarter the portfolios formal annual review of the long-term positioning took place. This year’s Strategic Asset Allocation builds on the risk reduction exercise we carried out in the spring.  Further details of some of the changes are provided below.

After 12 months of strong relative outperformance we are trimming some UK equity exposure. We are also making small increases to the portfolios allocations to emerging markets, which continue to see positive trade flows. Corporate reforms in Japan as well as valuation considerations favour a small increase in the portfolios Japan allocation. Finally, we are building on the portfolios allocation to India, which we believe will continue to benefit from the globalisation of services.

Given the low level of bond yields in developed markets and the challenge of inflation we continue to transition the portfolios fixed income exposure away from developed markets and toward emerging markets. This includes issuers in Asia, Africa and Latin America where we are able to source higher levels of yield compensation.

We are tilting the portfolio’s alternatives exposure away from hedge funds and towards infrastructure, particularly food infrastructure. Within real estate, we are seeking to increase residential exposure outside of Europe. This is an area of the market that is deemed to have stronger links to future inflation and so will in our view provide further inflation protection for the portfolio. 

The first half of 2022 has been a difficult period for financial markets. Unfortunately, as we begin the second half of year the economic backdrop remains extremely challenging.

Policy makers confronted with decade high levels of inflation have started to accelerate the speed at which they tighten policy. It is now becoming clear that with high inflation eroding real spending power and financial conditions tightening, an economic slowdown is underway.

In this environment the broad diversification of PruFund portfolios should continue to help shelter investors from some of the negativity. In addition, the uncertainty could well provide the opportunity to add exposure at more attractive levels both at an asset class and security level.