Getting the most out of large cap investing

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Is there was a way to outperform the S&P 500 without increasing volatility? James Stavena, portfolio manager of the BNY Mellon Dynamic US Equity strategy, explains why he thinks there is.

Since it has historically been difficult to outperform the S&P 500 in active US large cap strategies, many investors choose to access the asset class passively. However, what if there was a way to outperform the S&P 500 without increasing volatility? James Stavena, portfolio manager of the BNY Mellon Dynamic US Equity strategy, helps explain.

In March, when stocks sold off in light of the pandemic, the BNY Mellon Dynamic US Equity strategy was able to stay afloat using what some may consider a unconventional positioning for a large cap strategy. Going into the crisis, it held a levered equity position of 110% but was able to offset volatility in the equity market by using a small US Treasury allocation.

As the crisis was underway in late February, we had an allocation of 20% to US Treasuries,” Stavena says. “Treasuries rallied 30% while equities dropped 30%. So that Treasury position was essential in hedging the overweight to US equities and it was the biggest driver of outperformance during the first quarter.

Another driver of outperformance was the purchase of deep in-the-money call options, Stavena says. Through the use of derivatives, the strategy maintained a levered exposure to equities which ultimately reduced volatility during March’s selloff.

As the S&P 500 selloff began, our call option positioning went essentially to zero and net equity exposure dropped to 100%. So by design, whenever the market drops in the 10-15% range, options are placed so they will de-lever the strategy very quickly.

Under the hood

The strategy aims to outperform the S&P 500 by 300 to 400 basis points (bps) per annum with comparable volatility. To do this, it uses an allocation tilted toward large cap equities with smaller components comprised of US Treasuries and cash, along with derivatives, which make up its levered equity exposure.

In the day-to-day management of the strategy, we move our allocations in the response to changing levels of the equity risk premium and the term premium. The inputs to our asset premia calculations are classic fundamental metrics of valuation with macroeconomic adjustments,” Stavena says.

Specifically, we use forward-looking earnings on the S&P 500 as well as expected returns on corporate bonds and cash. We then supplement these with macro forecast for growth and inflation. The entire process is quantitative and systematic.

The quantitative approach to large cap investing, as well as DUSE’s supplementary exposures to Treasuries and cash yields, is what allowed it to hedge against the S&P 500’s downward spiral in March and ultimately outperform, according to Stavena.

Equity Exposure and S&P 500 Returns Q1 2020

Source: BNY Mellon Dynamic US Equity team, accessed July 2020.

BNY Mellon Dynamic US Equity W USD Acc calender year performance since launch as at 31 July 2020¹
31/12/2016 To 31/12/2017
31/12/2017 To 31/12/2018
31/12/2018 To 31/12/2019
BNY Mellon Dynamic US Equity W USD Acc
-7.31
36.51
S&P 500 NR
21.10
-4.94
30.70

Source: Lipper IM
Fund performance calculated as total return, based on net asset value, including charges, but excluding initial charge, income reinvested gross of tax, expressed in USD. 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.

BNY Mellon Dynamic US Equity W USD Acc discrete annual performance to 30 June 2020
30/06/2017 To 30/06/2018
30/06/2018 To 30/06/2019
30/06/2019 To 30/06/2020
03/11/2017 To 30/06/2020
BNY Mellon Dynamic US Equity W USD Acc
11.13
10.33
30.29
S&P 500 NR
13.71
9.75
6.87
24.34
Source: Lipper IM
Fund performance calculated as total return, based on net asset value, including charges, but excluding initial charge, income reinvested gross of tax, expressed in USD. 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.

¹Launch was November 2017

Past performance is not a guide to future performance.

The value of investments can fall. Investors may not get back the amount invested.

Objective/Performance Risk: There is no guarantee that the Fund will achieve its objectives.

– Geographic Concentration Risk: Where the Fund invests significantly in a single market, this may have a material impact on the value of the Fund.

– Derivatives Risk: Derivatives are highly sensitive to changes in the value of the asset from which their value is derived. A small movement in the value of the underlying asset can cause a large movement in the value of the derivative. This can increase the sizes of losses and gains, causing the value of your investment to fluctuate. When using derivatives,the Fund can lose significantly more than the amount it has invested in derivatives.

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This is a financial promotion and is not investment advice.

Portfolio holdings are subject to change, for information only and are not investment recommendations. Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes.

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Before subscribing, investors should read the most recent Prospectus and KIID for each fund in which they want to invest. Go to www.bnymellonim.com. The Prospectus and KIID are available in English and in an official language of the jurisdictions in which the Fund is registered for public sale.

The Fund is a sub-fund of BNY Mellon Global Funds, plc, an open-ended investment company with variable capital (ICVC), with segregated liability between sub-funds. Incorporated with limited liability under the laws of Ireland and authorised by the Central Bank of Ireland as a UCITS Fund. The Management Company is BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML), regulated by the Commission de Surveillance du Secteur Financier (CSSF). Registered address: 2-4 Rue Eugène Ruppert L-2453 Luxembourg.

Issued in the UK by BNY Mellon Investment Management EMEA Limited, BNY Mellon Centre, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorised and regulated by the Financial Conduct Authority.

Issued in Switzerland by BNY Mellon Investments Switzerland GmbH, Talacker 29, CH-8001 Zürich, Switzerland. Authorised and regulated by the FINMA

Issued in Europe (ex-Switzerland) by BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML), a public limited company (société anonyme) incorporated and existing under Luxembourg law under registration number B28166 and having its registered address at 2-4 Rue Eugène Ruppert L-2453 Luxembourg. BNY MFML is regulated by the Commission de Surveillance du Secteur Financier (CSSF).

74021, 3 Feb 2021

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