Rather than the economic recovery many were hoping for, 2022 has brought war, runaway inflation and the prospect of a global recession. Times of Malta discusses active management and preserving capital during volatile times with Jesmond Mizzi Financial Advisors’ executive director Mark Azzopardi.

TOM: How have financial markets been affected by inflation and the resulting cost-of-living crisis?

MA: We started the year with inflation continuing to rise due to economies reopening after COVID-19. This was arguably a healthy type of inflation because it was related to growth. What we’re seeing now, with the Ukraine war, is inflation driven by crises in sectors like energy and food. Both are primary raw inputs that are crucial to everything we do, which is why the effects have been fully transmitted to the real economy. Markets were then dealt another blow when central banks started increasing interest rates to rein in inflation.

TOM: How has your strategy changed as a result?

MA: We’ve had to turn everything on its head and shift to a more defensive approach that minimises risk wherever possible. Inflation was always going to be important in 2022, so we were looking at cyclical stocks, like companies with a strategic advantage that can push inflationary costs onto consumers. We were also looking at companies with potential, and which stood to gain from the resumption of normal life after COVID-19. But the war and subsequent interest rate hikes forced us to rethink our strategy to one aimed at preserving capital. That said, opportunities exist, and we’ve managed to lock in some very attractive yields. For example, there was a time when you could not find a five-year bond with a positive yield, but they have now become very appealing because they can be bought below par and generate a decent income. What we have done with the bond component of our portfolio is improve the credit quality – shifting to investment grade bonds with a high yield – as well as add more short-term bonds, without selling any long-term bonds.

TOM: And what if interest rates continue to go up?

MA: If that happens, then bonds maturing in the immediate term will simply be reinvested at a higher interest rate in a couple of months’ time. The bottom line is that if you do not invest your money, inflation is going to constantly eat away at it. You lose more by doing nothing than you risk investing in the short term, because an investment will give you an income. All you risk is the fair value movement, which is only really a concern if you need the cash and decide to sell it before it reaches maturity. Bond fair value movement is currently the largest contributor to lower valuations in our strategy because bonds are trading below par. So yes, you are losing if you sell today, but if you hold it to maturity, it will recover, leaving you with an annual yield; not a huge income but enough to cushion against inflation. It’s like owning a shop. The value of the property might go up or down, but it is of little concern if you are making a yearly profit and not thinking of selling. In our portfolio, although we are not currently seeing much capital appreciation, and though market value is down, income has increased.

TOM: What about equities?

MA: Our immediate reaction to the war was to shift our equity exposure away from Europe, towards markets better shielded from the immediate impacts, like the US. We also turned to emerging markets like Latin America, where we saw an increase in raw material and energy exports. We were able to sell our positions a month or so later and took a healthy profit from it. So, without much reduction in our exposure, we changed the allocation to reduce downside risk, and in fact, our equity component fell less than the market.  We even realised all-time high gains in sectors like telecommunications and healthcare.

TOM: What about companies with significant future growth potential? Is now the time to buy?

MA: We are avoiding high-growth companies for now, because the likelihood is that you will be able to buy many of them for less later. Companies with significant growth potential, especially those that are still in their early stages, will probably be hit harder by the present downturn but could flourish in 10 years or so. You are better off buying that stock towards the end of an economic downturn, once conditions return for them to take off. We are not there yet, now is a time for a defensive approach.

Now is a time for a defensive approach- Mark Azzopardi, Jesmond Mizzi Financial Advisors executive director

TOM: How do you see the situation developing in the future?

MA: I think uncertainty will remain for some time because it is nearly impossible to predict the end of the war. We base many of our decisions on data, not just speculation about which company’s prospects are best. We are constantly looking at many economic indicators such as inflation, PMIs, money supply, the Bare Necessities Index, and so on, to assess market developments. Much will depend on inflation and whether it can be brought under control. It is shifting slightly downwards though it is not yet under control. If it were to be reined in, there will be a significant positive reaction across the markets. Much will also depend on whether economies fall into recession and how central banks react to this. Once this happens, central banks’ monetary policy could once again shift and become more conducive to growth.  What is certain is that as portfolio managers we will continue to hoard some cash and short-term bonds as part of our asset allocation so that we can act quickly when opportunities arise.

 

This interview does not intend to give investment advice and the contents therein should not be construed as such. Jesmond Mizzi Financial Advisors is licensed to conduct investment services by the MFSA under the Investment Services Act and is a member of the Malta Stock Exchange and a member of the Atlas Group. For more information, contact Jesmond Mizzi Financial Advisors Ltd of 67, Level 3, South Street, Valletta, on tel. 2122 4410, or e-mail info@jesmondmizzi.com.

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