TRADE TALK: Weighing up the variables

Ranking their funds by the level of dynamic asset allocation they employ, multi-asset fund managers discuss their current positioning and most significant changes in the past year.


Following the length and strength of the recent bull market for risk assets, we entered 2018 positioned defensively in our multi-asset credit portfolios.

This was in expectation of higher volatility in bond markets due to upward pressure on yields from an increase in the net supply of government debt and disruption to globally facing corporates as a result of trade wars.

We maintained limited exposure to emerging market credit, which is sensitive to the US yield curve and volatility in trade and FX markets. We are positioning our portfolios defensively, particularly with regards to US corporate credit risk, which has seen increasing leverage in the investment grade portion of the market and as credit spreads are tightening in high yield markets post-crisis.

However, we continue to find value in in floating rate assets like bank loans and areas of securitised credit. After a tough summer for emerging market assets, we have followed our discipline as value investors and started selectively adding exposures to US dollar-denominated emerging market bonds from sovereign issuers, focusing on countries where our conviction is high.


Within our multi-asset funds, we remain overweight equities and underweight bonds. This has not changed over the last year and we believe it is still likely too early to be moving towards a more defensive investment strategy, given we are not expecting the current global economic expansion to end before 2020. While equities may look expensive relative to their own history, we think they remain attractive relative to cash and bonds where the earnings yield remains above what is on offer elsewhere.

However, we do recognise that the current economic expansion is one of the longest on record and the valuation argument for equities over bonds is likely to continue to weaken as global central banks move towards interest rate hikes and pull back from vast quantities of quantitative easing. We think the primary risks to our constructive outlook are an all-out trade war between the US and China or a rapid tightening in global financial conditions. Financial conditions would be particularly exposed to a spike in the oil price or aggressive rate hikes from the Federal Reserve.


The Global Macro Opportunities Fund employs a dynamic investment approach with the aim of delivering positive returns in varying market environments. Our positioning reflects the most efficient and risk-aware implementation of our global macro views.

In 2017, amid increased synchronicity in global growth, we maintained a relatively high level of equity risk versus history, predominantly allocating to tech and financials. These exposures contributed to strong returns and we maintained this portfolio into 2018.

However, in late January, as we believed markets had moved too far and positioning had become exuberant, we reduced equity risk and added some protection strategies. This shift in positioning enabled us to deliver positive returns as equity markets fell in February.

In contrast to 2017, we saw a deterioration in the macro backdrop from June, as global growth started to disappoint and become more divergent, and trade became an increasing concern. We flexibly adjusted positioning by significantly lowering equity delta, tilting away from cyclical areas and adding defensive strategies such as long US duration and short Japan equity.

We remain cautiously positioned as trade tensions continue and emerging market assets remain vulnerable, while we are adding exposure to areas in which we have high conviction, such as long energy equity and quality growth tech names.


We came into 2018 expecting economic fundamentals to remain robust and for financial conditions to tighten modestly. We expected the post-crisis drags on the global economy to continue fading, supporting above-trend global growth, with the US leading as a result of fiscal stimulus and rising corporate investment. At the same time, we did not expect the US-China trade issues to morph into a broadening ‘Cold War’.

As a result, we came into 2018 with an above-neutral level of risk and a significant allocation to US equities. We had a tentative expectation that as the year progressed, non-US fundamentals would trough and begin to re-accelerate – particularly in Europe and Asia.

In the event, fundamentals continued to slide throughout 2018 as it became apparent that China was once again going through a self-inflicted slowdown due to a deleveraging campaign. At the same time, markets were hit by a confluence of worsening US-China relations, an oil price surge and an unhinging of US yields. As a result, we reduced the overall level of risk in our portfolios, but maintained our overweight to US assets.


We are high-conviction active asset allocators who target inflation-plus returns whilst adhering to drawdown guidelines. We use a proprietary strategic asset allocation around which we tactically deviate. The tracking error we allow ourselves means that these deviations can be substantial. Our tactical decisions are based on a six-to-12-month time horizon, but we are happy taking profits and comfortable cutting losses over shorter time frames.

We have maintained a small overweight to global equities in no small part due to recession risk not being one of our near-term concerns. However, we have increased our alternatives exposure materially as the cycle has evolved, partly by adding commodities (notably in the energy space) and partly via hedge funds, which we felt should benefit from rising volatility.

In the latter category are tail risk protection strategies, which we have introduced across portfolios. These should perform well in the event of a sharp sell-off in risk assets, thus offsetting a sizeable chunk of equity losses. In fixed income, we have been running with less than half of benchmark duration, a decision reflective of rich valuations and reflation expectations in key areas of the world.


Our most dynamic multi-asset strategy – The L&G Multi-Asset Target Return Fund – does not just rely on long market returns from holding equities, bonds and alternatives. It casts its net wider, accessing additional return streams and forms of diversification, ultimately making it less correlated to market trends. The strategy is made up of three distinct return streams:
     •  Market – We want to earn the traditional risk premium by owning asset classes.
     •  Alternative – We use rule-based strategies to capture factors, like value, carry and momentum, while being market-neutral.
     •  Tactical – Targets alpha generation through shorter-term opportunities from across LGIM.

Over time the three will have an equal risk budget, but are dynamically adjusted as a function of our macroeconomic views and valuations. For example, currently we take less risk in the market component given late cycle dynamics darkening the outlook for the market risk premium, while increasing risk in tactical strategies exploiting more idiosyncratic opportunities such as the political risk premium from the back and forth in trade wars and other geopolitical developments.
So far this year, this has paid off. With most asset classes struggling to perform, the tactical strategies have been paying off.


The most important consideration is the stage of the cycle. We are of the clear opinion that being in the late cycle is where equity is the most attractive asset class, in particular compared to fixed income/credit.

However, after an extraordinarily low volatility environment in 2017, we expected a shift into a medium to high-volatility regime, hence had to accept higher levels of volatility but also opportunities to add value via tactical portfolio adjustments (trading ranges). We scaled back exposure to US and emerging market equities in late summer, given trade tensions. We also changed our duration.

After a short duration stance for quite some time on the way up on global rates, we decided recently to increase interest rate sensitivity, in particular on US fixed income. Risk/reward in US Treasuries improved significantly, with the Fed being already matured on raising Fed funds while flattening the yield curve.

Moving forward, assuming inflation will remain subdued and economic growth rather on a lower level, we expect diversification benefits from being longer duration. One of our more strategic calls is emerging market hard currency debt, where we see a broad diversification across regions and countries and an attractive yield level.

This is even more the case given rates increases and some spread widening on the back of emerging market volatility recently.


As active investors, we take a dynamic approach to asset allocation, ensuring our portfolio reflects an interplay of our views on the macro environment and asset class valuations. This is underpinned by rigorous fundamental research. Meanwhile, a long-term perspective and an understanding of asset class characteristics and behaviours enable us to truly harness the benefits of diversification.

Our current central outlook for the global economy is that both developed and emerging economies will continue on their upward growth trajectory. This is positive for asset class returns, although political and economic risks could alter the path of growth.

We also note that many asset valuations are at or above their long-term fair values. It is therefore appropriate to maintain a portfolio with exposure to economic asset classes, to capture the benefits of the continued positive environment, lowly correlated ideas to bring diversification, and portfolio hedges to provide some protection in downside scenarios.

We are selective in our positioning, actively holding attractive opportunities within asset classes, such as nickel and renewable energy infrastructure. This is paired with hedging positions to provide protection against more negative outcomes, such as positions in VIX futures, managed futures strategies and selected currency or government bond investments.


Mirabaud Asset Management’s multi-assets Flexible strategy offers highly active asset allocation encompassing all asset classes.

The flexibility inherent to our active approach is critical in market conditions characterised by enhanced cross-asset correlation or prolonged bearish market cycles.

Such a flexible approach is particularly interesting at the current stage of the cycle; today, after nine years of bullish markets, there are indications of a possible sharp slowdown or even recession. In both scenarios, strong active allocation is poised to outperform passive investments.

The past year has seen many changes to the portfolio. We strongly decreased the fixed income average duration, as inflation expectations increased and as the liquidity cycle comes to an end.

Additionally, some fixed income exposure was switched into US floating rates notes, short-term tips and short-term treasury bills. In a context of rising political risks (the unsolved trade war between the US and China and the Italian budget discussions), we acquired long volatility contracts on VIX and VSTOXX to hedge part of the equity exposure.

Finally, we sold all high yield and emerging debt positions as low rates and low spreads are at risk in a strong dollar and slower growth environment.


Dynamic asset allocation is the key to navigating changing market conditions, particularly as we approach the end of the market cycle. Our active approach blends return-seeking, risk-reducing and diversifying strategies to generate a consistency of return across a wider range of market environments.

Having taken our strategy down a gear at the beginning of the year, we have recently started to tactically increase our equity allocations. We believe that there is a window of opportunity to generate returns as we head into year-end. To guard against being whipsawed in these more volatile markets, we have taken advantage of higher yields to add back government bonds , increasing our risk-reducing allocation.

It is easy to get caught up in political headlines but the key challenge for markets is that the Federal Reserve is tightening liquidity and that the economic cycle is maturing, with growth momentum peaking and inflation rising. These conditions are typically not a good combination for asset prices; therefore, next year could pose a more challenging environment once again. Perhaps for the first time in a decade, 2019 will be the year that we move towards more conservative investments.


Portfolios in our Multi-Asset Fund (MAF) range are managed to a share of equity volatility rather than an absolute volatility level. Allocations between the core asset classes are long-term and divided into three buckets: growth, defensive and uncorrelated.

Since our investment universe is global and designed without a home bias, there is plenty of scope to adjust portfolios dynamically within their risk profiles. For example, following the China-led crisis of 2015, we identified attractive opportunities in emerging market assets and started to increase exposure. Initially, we added to emerging market local currency bonds to capture high real yields, followed by emerging market equities which were trading at compelling valuations.

These positions were in place for 18 months, but we became more cautious about emerging markets in general as trade tensions escalated this year.

This, combined with the threat of higher US interest rates and a stronger US dollar, led us to reduce these allocations in the first half of 2018. This proved to be a sound decision as turmoil has increased since then.


Our multi-asset investing team manages over £100 billion (€115 billion) in assets. The team bases its regional asset class allocation decisions on a three to 12-month view.

Recent leadership changes at the Fed arguably changed the backdrop for multi-asset investors and global balanced portfolios have underperformed bank deposits in 2018.

Despite this, we continue to identify opportunities. Relative-value positions can offer uncorrelated returns as well as potentially reducing risks. For example, we purchased US dollars to protect against rising interest rates. At the same time, the dollar has benefited from lower taxes and fiscal stimulus. This has been positive for our long dollars, short euro position. Another positive has been our long position in yen relative to sterling, given the impact of Brexit uncertainty and the fact Japan’s currency tends to perform well during periods of risk aversion.

Looking ahead, we believe global growth will remain steady and retain a positive view on equities, notably US equities. Elsewhere, emerging Asia equity valuations already discount trade risks and we think the benefits of easier Chinese financial conditions are underestimated.

In bond markets, emerging market sovereign bonds yield over 6% – sufficient compensation for the attendant currency risk. Recently, we increased our exposure to US government bonds, as higher yields and somewhat slower US growth have increased their appeal.


The Newton Multi-Asset Income Fund was purposely structured to be completely unconstrained in its approach to provide the best possible opportunity to provide a stable, sustainable income for investors. This approach ensures that there are no artificial asset allocation constraints as we believe multi-asset investing is as much about what you don’t own as what you do.

Our role is to construct a portfolio that best meets an outcome of attractive stable income in the context of attractive total returns. This means we will be very dynamic in our allocations to each asset class, using the flexibility that our clients provide us to make a meaningful difference in the strategic asset allocation, such as currently having limited exposure to bonds, until such a time as bonds offer attractive risk-adjusted returns.

Instead, we have favoured investments in infrastructure and renewables, where revenue streams have limited sensitivity to the economic cycle, enabling them to deliver stable income streams, much like bonds, but where prospective returns looked superior.

Whilst we have been increasing the bond allocation more recently, as interest rates in the United States have risen, it has been as low as circa 12% of the portfolio back in 2017 and as high as 25% at the beginning of 2016, but nowhere near a traditional 40% bond allocation that is normally seen in multi-asset portfolios. We have recently increased the bond allocation to circa 20%, but in lower-duration bonds to limit the impact of continued interest rises that we expect.

We will be tactical when there are obvious opportunities, but in our view, timing the market is very difficult and we remain focused on delivering stable attractive levels of income first and foremost. Because of the success of the strategy and the flexibility it has, we have recently launched the strategy in Europe, where we see increasing interest from clients.


The M&G Global Target Return fund is highly dynamic, with flexibility to go long and short. For such funds, which seek to limit volatility and drawdown, this dynamism is becoming increasingly important. For much of the last decade, multi-asset funds have been able to deliver lower volatility and strong returns simply by holding static mixes of long equity and bond exposures. However, with many government bond yields reaching extreme lows and now showing signs of rising, more active approaches will be needed.

It will be important for managers to be able to respond to changing correlation patterns and create return opportunities out of short-term volatility.

This has certainly been the case this year for the fund I manage. The portfolio has favoured global equities but I have scaled exposures in response to volatility, adding tactically after volatility in February, March and October. At the same time, active scaling and both long and short positions in government bonds have reflected the way in which certain bonds have shifted from being a diversifier to a source of volatility.

©2018 funds europe



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