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PruFund Strategic Asset Allocation Update: Evidence of a changing economic regime

7 min read 23 Aug 23

  • Builds on the events of 2022 where we’ve seen evidence of a changing economic regime
  • A review of the inflation and interest rate environment
  • Increases to the fixed income allocation with change in the yield environment over the past 12 months
  • Incremental additions to real asset allocations focusing on quality, building infrastructure in particular land & forestry 

In this article

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Strategic Asset Allocation Review

This year’s annual review of the long-term positioning of PruFund builds on the events of 2022 where we’ve seen evidence of a changing economic regime. After three decades of benign economic conditions, with falling interest rates and low inflation underpinned by globalisation, advances in technology and a much deeper labour pool due to China becoming more open and the break-up of the Soviet Union, the world has changed.

US, Europe and UK inflation

Inflation is no longer a dormant risk. Aside from Covid-related supply chain issues and stresses caused by the conflict in Ukraine, there are potentially inflationary forces, like the transition to renewable energy and onshoring of supply chains that suggest inflation may remain persistent even after short-term disruptions fade.

UK Inflation outlook over the next five years  

Source: Datastream, Bank of England, LTIS calculation, as at 26th July 2023 

The shift in the interest rate regime has been a challenge for all asset classes but it has reset the valuation environment, particularly in fixed income, improving the potential returns from assets such as investment grade corporate bonds and developed market government bonds.

Recent key changes

Asset allocation of PruFund Growth and PruFund Cautious 

PruFund Cautious

PruFund Growth

Source: M&G Treasury and Investment Office – July 2023

Fixed Income – increased allocation with change in yield environment

Yields available in assets like government bonds and investment grade corporate bonds are now at levels we have not witnessed for well over a decade. This changed yield environment has warranted a rebalance in the portfolio and an increased allocation to fixed income. Positions in Asia, Emerging Markets, High Yield and Private Credit also had small increases.

For context, around 2 years ago the yield on a 10-year UK Gilt was less than 1%, based on recent data the yield on the same asset is over 3.5%. Similarly in the corporate bond space, the increase in yields and credit spreads mean that high quality developed market investment grade bonds yield over 5% now as opposed to around 2%, two years ago.

With this in mind, the Long-Term Investment Strategy team, recommended that the bulk of the increased allocation is to European and US investment grade corporate bonds. 

Property, Infrastructure and Alternatives – Maintained

Our meaningful holdings in real assets have been maintained and we aim to marginally increase quality and quantity as opportunities arise. These assets generally offer cash flows with good inflation linkages and this remains important in the current environment. The quality and diversification of real assets is also key.

We have invested in food infrastructure and continue to seek opportunities in land/forestry where there has been the greatest disruption and need for new long-term capital.

Equities – small reductions

The reduction of around 4% does not necessarily reflect an overly negative view on equities, simply that fixed income is more attractive currently. Much of the increased allocation to fixed income will come from UK equities, which have been resilient over the last year such that relative valuations are less compelling, although the UK remains the largest equity position.

Only small adjustments have been made to other equity allocations, so in aggregate the exposure to Asia, Africa and other Emerging Markets has only reduced by a very small amount, due to factors like demographics and favourable valuations. 

Portfolio performance overview

We continue to see value in pursuing a portfolio that is well diversified across different asses classes and regions, with positive exposure to factors such as a inflation risk and tilted toward the solutions to the problems of the coming decade.

In recent years, we have done a lot of work to build diversified exposure to real assets, like global property, infrastructure and private credit, a good proportion of which provide linkages to inflation. Significant effort has also gone in to sourcing sustainable and impact investments that will be key as the global economy transitions to a cleaner future.

Whilst we have been busy implementing these changes to portfolios the team continue to monitor closely what is happening in economies globally. Economist forecasts for growth have been upwardly revised since the turn of the year, however, we remain cautious at this stage of the economic cycle, and are conscious that the full impact of tightening monetary conditions may only come through with a lag.

The value of an investment can go down as well as up and your clients may get back less than they have paid in. Past performance is not a reliable indicator of future performance.

The views and opinions expressed in this should not be taken as a recommendation, advice or forecast.

Information provided has been obtained from sources that M&G Treasury and Investment Office (T&IO) believes to be reliable and accurate at the time of issue but no representation or warranty is made as to its fairness, accuracy, or completeness.. Neither T&IO, nor any of its associates, nor any director, or employee accepts any liability for any loss arising directly or indirectly from any use of this video. Reference to the names of each asset class/company mentioned in this communication is merely for explaining the investment strategy, and should not be construed as investment advice or investment recommendation of those companies.

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