Mixed market signals pose growth challenge
While an improving macroeconomic picture has helped buoy risk assets in recent months, wider structural weaknesses in the global economy could yet limit any resurgence in economic growth in 2020, say the Newton¹ Real Return team.
As 2019 drew to a close and market risk gave way to opportunity, Newton’s Real Return team increased their strategy’s exposure to both equities and other return-seeking assets, shifting it away from its previous strongly defensive stance in order to rebalance as markets entered the New Year.
At a macroeconomic level the team believes the stabilisation of key macro data in areas such as global manufacturing, coupled with accommodative global monetary policy and some encouraging geopolitical news flow, helped buoy risk assets in the final quarter of 2019. In contrast, it says government bonds fared less well during this period, with yields typically moving higher as the market appeal of some ‘safe-haven’ assets dwindled.
The Real Return strategy produced a positive return of 1.39% (net of fees) in the final quarter of 2019 and a healthy double digit net return of just over 11.4% for the calendar year ². This performance was driven predominantly by global equities, with the majority of top performing securities typically cyclical and higher-beta names in sectors such as financials and technology.
Towards the end of 2019, the Real Return team was also able to generate some additional equity-market upside from positions in S&P 500 index call options. These were held on a shorter-term tactical basis to insulate its defensively positioned holdings from the possibility of further equity market upside.
According to the team, alternatives, particularly in areas such as renewable energy, have also delivered some strong gains for the strategy in recent months. Exposure to corporate debt has also proved supportive, with the broad tightening of credit spreads outweighing the negative effects of a rise in government-bond yields towards the end of last year.
While some ‘safe haven’ assets – including government bonds – suffered in late 2019, others proved more resilient. A rising gold price reflected US-dollar weakness and arguably rising inflation expectations in late 2019, and helped draw a positive return from exposure to precious metals.
As at 31 December 2019 the strategy held just over 29% in equities (part of its return-seeking core), down from 32.54% at the start of last year. Across sectors, adjustments in the equity portion of the strategy now means it holds its highest equity weights in the financials and industrials sectors, which represent 7.67% and 4.24% of the strategy respectively.
From a geographic perspective, North American equities now account for its largest exposure at 9.14%. Europe ex-UK holdings fell from 12.98% at the end of December 2018 to 8.9% at the end of December 2019.
The team increased the strategy’s total bond holdings from 60 in December 2018 to 79 at the end of 2019, hiking its allocation to high yield bonds and raising exposure to investment grade bonds. It also reduced government bond duration, which included decreasing its position in long US Treasuries in favour of exposure to 10-year maturities. Four of the top 10 holdings in the strategy now consist of government bond positions, versus six in January 2019.
More esoteric investments play an important role in the Real Return strategy. It currently has a 10.65% exposure to alternatives and a 6.8% exposure to precious metals, including gold.
What next for 2020?
Newton believes the market outlook for the year ahead presents a mixed picture. Although markets ended 2019 with growing hopes of both a resolution of the US-China trade war and greater clarity on the UK’s withdrawal from the European Union following a conclusive December election, the Real Return team does not expect either of these situations to be resolved definitively in the short-term. A New Year has also already brought further geopolitical concern amid growing tension between the US and Iran.
Beyond geopolitics – and despite some recent positive performance in global equity markets – the team also remains concerned by what it sees as underlying structural weakness in developed economies and significant potential for wider risk ahead in 2020.
Commenting, the team says: “It is important to recognise that the majority of 2019’s equity-market gains arose from multiple expansion rather than underlying earnings growth. We believe the persistent structural issues that continue to afflict developed economies are likely to preclude a strong resurgence in economic growth, meaning that companies may well undershoot ambitious expectations for earnings growth in 2020.
“While risk assets do appear to enjoy favourable momentum in the near term, we remain, as ever, alert to potential risks on the horizon, and will not hesitate to use the flexibility afforded by our mandate to reshape the portfolio should we feel such action is appropriate.”
BNY MELLON GLOBAL REAL RETURN FUND (EUR) RETURN BY YEAR AS AT 31.12.2019
¹Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA), BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA, BNY MFML or the BNY Mellon funds
²Source: Lipper as at 31 December 2019. Fund performance EUR W calculated as total return, based on net asset value, including charges, but excluding initial charge, income reinvested gross of tax, expressed in share class currency. The impact of the initial charge, which may be up to 5%, can be material on the performance of your investment. Performance figures including the initial charge are available upon request
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