Review of 2023, and how cash was not king

As we enter a new year, it is normal for us to review the previous one, if only to see what we can learn from what happened. With world events in 2023 being pretty bleak generally, it would be easy to believe that investment markets were similarly bad, especially if you were not paying attention as the year came to an end. However, I am pleased to say that a very strong ‘Santa rally’ means that there is good news to report when looking at 2023 in the rear view mirror.

The dominant issue during the year remained inflation and interest rates, as investors looked for signs that the former was rolling over, and that the later would follow. Markets tried to gain upward momentum several times, only for conflicting data to cause them to fall back again each time. However, clarity emerged late in the year, with November and December seeing a strong rally in both equity and bond markets.

The result was positive performance across the year from all of our portfolios. Taking additional risk paid off, so the more aggressive portfolios, with higher equity content, performed better, as would be expected in a period of improving sentiment. Returns ranged from 5.3% to 9.3% across our Core and Gaia ranges, with Gaia outperforming after lagging in a difficult 2022. Compared to history, such returns represent a solid year. However, there is a particularly pleasing aspect to the numbers, namely how they compare to cash.

As interest rates rose from the extraordinarily low levels seen for over a decade after the Global Financial Crisis of 2008/9, we were asked by a number of clients why we did not hold higher levels of cash in the portfolios. The question was totally understandable, with rates for one year personal deposits going north of 5% at one point during the year. Why would we not take a ‘risk free’ return of that level when there was so much uncertainty in the world? Indeed, we considered exactly such a move, but decided against it, and it is worth reiterating why.

Our core case throughout 2023 was that inflation would be brought under control, and that the US, the largest economy in the world and the driver of so much economically, could avoid a recession. In the event that inflation did indeed moderate, interest rates would be expected to fall. In such circumstances, the interest rate on deposits would reduce, whilst returns on bonds would increase. Furthermore, in the event that we were wrong, and we fell into recession, central banks would be expected to cut interest rates aggressively. This act would cut returns on cash sharply, whilst boosting the value of bonds. Therefore, we saw Fixed Interest as an option that provided a good outcome in a wider range of scenarios. Of course, the outcome that would have caused cash to perform very well was a second wave of inflation, but we saw that as unlikely in the short-term, and had other assets in the portfolios that would have protected against such an event, at least to some degree.

It is very pleasing that our decision played out, with every portfolio outperforming the return achieved on Royal London Short-Term Money Market, our preferred Money Market fund (or cash proxy), of 4.8%. It is worth noting that the return is lower than the over 5% returns available mid-year, as those rates declined later in the year as inflation started to fall. I am not writing this to blow our own trumpet, as whenever we make an investment decision, we can never be certain that it will prove beneficial. Instead, I wanted to communicate two things. Firstly, even when it is difficult in the market (and world) volatility of 2023 to ignore the temptation of such cash rates, it is important to keep a calm head and consider all scenarios and opportunities (and “thank you” to our clients for having trust in what we do, and allowing us to generate a better outcome for them). Secondly, with so much of the positive returns having come late in the year, unless they have been watching your investments very carefully, many people will be unware that 2023 was a decent year. Therefore, with good news seemingly in short supply everywhere, I wanted to take the opportunity to start the year on a positive note. To quote Joe Abercrombie, “A man lost in the desert must take such water as he is offered”.

Andrew Shaw, Chief Investment Officer

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