Longer-term capital protection takes priority as risk assets look less attractive, says Newton
As Newton’s real return strategy celebrates its ten year anniversary, Iain Stewart, lead manager of the Newton Real Return Fund, and his team believe that the trade-off between risk and potential looks distinctly unattractive, implying that risk assets may be ripe for another correction.
With stresses appearing across some equity markets, Stewart argues investors now need to balance participation in rising markets with the discipline and patience to know when to reduce exposure to risk assets, potentially foregoing short-term gain, in order to provide protection on the downside when needed.
“It’s hard to know where the bubbles are this time but we do see a few ‘clear and present dangers’ such as the valuation of certain technology stocks in the US and China’s growth,” he explains.
The real return team also observes that the world continues to battle a debt problem, one made more difficult as policymakers seek to address the issue by creating even more debt.
“There is now 30 per cent more debt across global markets than there was before the credit crisis and there is still no ‘plan B.’ If QE ultimately ends up not working then we could see even more unorthodox measures and policies to address the debt issue,” says Stewart.
Looking to the wider impact of quantitative easing, Peter Hensman, global strategist at Newton who works closely with the real return team, highlights that there has been a large surge in IPOs, the level of which compares to 2000. Alongside other signs of exuberance, Hensman observes this is indicative that “the hunt for yield is clearly driving a range of investors into asset classes they wouldn’t traditionally be comfortable holding.”
On the broader economic environment, Stewart notes that “the monetary policies in place today have not been greatly effective in adding real economic growth but they have been good at winding up asset prices. We’ve got more risk, and because we’ve got higher asset prices, and lower expected returns, we have a combination of higher risks and lower returns, which is a mix most investors would seek to avoid. We are uncomfortable with how equity markets have risen of late, particularly as earnings haven’t. We see the backdrop as challenging and think it is important to manage the downside.”
When the real return strategy was conceived, Newton managers were exploring the concept of providing investors with an equity-like return while reducing downside and absolute losses. Key for them was to:
o Be active – with a sharp focus on stock selection while having the flexibility to invest across asset classes
o Be patient – adopting the ideology that it would be better to give up some returns today for better returns tomorrow
o Simplicity is key – no leverage or hedge-fund like fees
o Take an asymmetric approach - to try to reduce volatility and protect capital
Over the past ten years the strategy has been active, with exposure to fixed-income assets ranging from zero to 50 per cent. Ten years ago the real return strategy was split roughly 80-20 between what the team consider to be ‘core’ assets and those which provide an insulating layer intended to dampen volatility; today the split is closer to 50-50 when direct hedges, taken via derivatives, are included.
Stewart says: “We’re going to have periods of inflationary worries, deflationary worries, optimism, pessimism, elevated valuations, and depressed valuations.”
Talking specifically about the strategy, Stewart states that the team is continuing with the same approach they have been pursuing over the past few years, which includes exposure to what are relatively defensive equity sectors. The team continues to focus on sectors that are relatively independent of the economic cycle and which have yields it believes are attractive and sustainable.
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