Buying sterling assets at the end of 2018 proved a savvy bet for the Columbia Threadneedle multi-asset team, as political uncertainty dominated the domestic investing landscape.
Toby Nangle (pictured), global head of asset allocation and lead manager of the fettered Dynamic Real Return and Global Multi Asset Income funds, says the team looked through the portfolios and took the percentage of sterling exposure of underlying assets from the “high 50s up to the mid-80s”.
But he says the decision was taken to hedge their bets on the uncertainty of the Brexit outcome and better control risk, rather than gamble on the currency appreciating.
While this might have looked “pretty stupid” from a return perspective through August when sterling weakened, Nangle says it meant the portfolios weren’t making windfall gains from an unintended position.
“We were taking our risk positions in areas where we thought we had some added value, so local currency emerging debt for macroeconomic reasons, and allocations to other different equity markets and stocks,” he explains. “Those are all things we were doing on purpose, but we didn’t benefit by accident from a collapsing sterling.”
There was a short-lived bounce within domestic currency in the immediate aftermath of the 12 December general election as the Conservative party swept to victory and the chances of a chaotic exit from the European Union diminished.
‘The worst outcome would actually be a really smooth Brexit’
“The Dynamic fund invests globally, and for a sterling-based volatility objective and inflation-plus-four objective,” says Nangle. “Actions we took earlier in the year because we didn’t want to be trading views on how UK politics was developing and how Brexit negotiations were going meant we bought a huge amount of sterling into the fund. That helped enormously.”
The team’s central case on Brexit is that a trade deal will be agreed with Europe covering goods, not services, but it will be a thin deal and not enormously advantageous for the UK economy. As such, the team sees less reason to hedge all currency exposures around the world.
“For a total return sterling-based investor looking globally, the worst outcome would actually be a really smooth Brexit,” Nangle suggests. “The best short-term total return would be associated with a really disruptive Brexit, which could prompt sterling to fall. If you have a very smooth Brexit, a dollar in an overseas account is going to be worth a lot less.”
Lower US growth, Asia moving into positive territory
The wider view on the global economy is that it remains on a weakening path. Nangle expects lower US growth in 2020 than in 2019, and relative stability in Europe, the UK and Japan. He expects better growth in emerging markets, meanwhile.
Viewing asset allocation from a risk-adjusted returns perspective, the CT multi-asset team dislikes government and index-linked bonds, is neutral on cash, equities, commodities and property, while favouring credit.
Equity regions it favours are Japan and Asia Pacific ex Japan. It is neutral on US, UK, emerging markets and Europe. With the eurozone and US seemingly contracting, the team believes China and Asia are moving into positive territory and it is confident in an inventory cycle playing through in these regions.
“It may or may not feed through into a global upturn in manufacturing but we won’t have enough information to know whether that’s the case for a few months,” says Nangle. “We are cautious but will be focusing on Asia because that’s where the upturn will be strongest felt.”
‘Asian income is technology heavy’
In the Dynamic Real Return Fund, Asia exposure is through internal funds and some passive exposures in the form of future contracts. In the multi-asset fund, it’s been through the George Gosden-run Threadneedle (Lux) Asian Equity Income Fund.
“Income tends to be globally thought of as something that’s either energy, materials or banks heavy. Asian income is technology heavy,” says Nangle.
If there is a global manufacturing recovery, he believes this will first be evident in Asia, though that could be clouded by inventory cycle. However, there is another secular theme brewing that advantages Asia: Chinese internalisation.
“One of the side effects of the US/China trade spat is that China has been seeking to ensure it has great self-sufficiency over its supply chain. And that’s one of the things that prompted the US administration to hike tariffs and try to build up intellectual property protections.
“There was a timeline for this and most analysts were looking for it being at least five years before China could produce a 5G base station without any US components. That has been accelerated meaningfully, and it’s not China itself but it’s coming to the Greater China region. So that internalisation theme is also involved.”
Duration regrets on UK government bonds
When it comes to currency hedged bonds, the team favours emerging market local debt, Australian and Nordic bonds. It is neutral on the US, Germany and UK, and dislikes Japan.
On UK bonds, Nangle regrets not extending duration during the latter part of 2018. “Gilts at 1.5% didn’t look like the asset of choice, yet they rallied down to 40 basis points and proved themselves. If you bought 30-year UK bonds you’d probably be beating pretty much any asset class in the world. Missing out on that was a disappointment.”
On a positive note, the team has been increasing allocation to emerging market local debt on the back of stabilising global growth and disinflationary trends, as well as improving external balances and smaller current account deficits.
“Emerging market debt has some really interesting characteristics and offers a different way of taking equity risk,” says Nangle. “While yields are below where they were, say, a year-and-a-half ago, that’s been more than met by falls in inflation. There have been big disinflationary moves across emerging markets, so the amount of real yield you’re getting is slightly higher in developing markets.”
On the credit side, the team has been neutral on investment grade, high yield and emerging market debt. When it comes to high yield, the team has not bought longer-duration assets, preferring to extend portfolio Nav into shorter-dated high yield.
Nangle says: “In the high-yield market the yield curve is very flat, so two-year bonds offer similar yields to six to 10-year paper. By buying the shorter-dated bonds we lose a lot of return volatility but also the opportunity to get strong price returns in a rallying bond market. However, all the credit work we do in-house is rewarded in that relatively non-volatile higher-income yield.
“It’s tempting to think that a bottoming out in global manufacturing would help high yield perform very well, but longer-dated high-yield bonds are vulnerable to a sell-off in government bonds that might accompany a stronger economy. Buying shorter-dated high-yield bonds doesn’t expose the fund to this duration risk.”
