After almost a decade of positive returns, the end of last year was enough to remind investors of the virtues of absolute return funds once again. There was a see-saw in the fortunes of major equity markets over the course of 2018 with returns for the year wiped out by October and December market falls. Witnessing such indiscriminate market losses across major markets, Newton’s Real Return team admits: there was really “nowhere to hide” in October and December.
Between the threat of a contracting Chinese economy, heightened risk of a US recession, skittishness over the direction of monetary policies, and political troubles continuing to plague Europe, the team is doubtful that a pick-up in global growth is due any time soon.
Putting this in context, Newton global strategist Brendan Mulhern underlines the usefulness of the 'crisis-response-improvement-complacency' framework first outlined by Morgan Stanley chief economist Robert Feldman. This strategy, he says, has helped the Real Return team navigate the vagaries of the post-financial crisis world in which state intervention has become the norm.
Feldman’s framework goes something like this: The ‘response’ to the ‘crisis’ of mounting financial-market stress and global economic slowdown began in late 2015 with the collective efforts of the Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of Japan (BoJ) to embark on a joint asset expansion programme – later known as quantitative easing (QE) – to the tune of US$15 trillion, he notes. Simultaneously, the People’s Bank of China (PBoC) effected a massive debt-fuelled stimulus package. Together, this spurred the perceived ‘improvement’ in the global economy and subsequent financial returns in 2017.
Yet this ‘improvement’ was artificially inflated, Mulhern says, and the subsequent ‘synchronised global growth’ of 2017 made some policymakers complacent, with policy tightening witnessed around the world.
The consequences have been profound, says Mulhern. “Last year was the year that global money growth stalled,” he says. “We saw a sharp slowdown in credit creation from both central banks and the private sector. Since then the reversal of the 2016/17 credit surge has led to renewed asset-price declines and waning economic momentum.”
A track record of drawdown protection
With a negative backdrop appearing, interest has correspondingly grown for capital preservation – and the ability of funds to not just withstand the volatility of markets but have the capacity to recover rapidly.
When Real Return was designed back in 2004, it was in response to the recognition that the investment world was changing, with a backdrop where investments were no longer purely about the “high return/the-trend-is-your-friend” dynamics as typified in much of the 1980s and 1990s – and arguably more recently.
Instead, front and centre was an emphasis on preserving capital, with the team adopting a target of Libor +4% as a way to encourage it to think as much about not losing money as making it – to emphasise the asymmetry of returns.
While many absolute return managers may make similar claims, not many in the strategy’s peer group have been able to prove it effectively and others haven’t been around long enough to prove their worth. Funds in this area have grew substantially since the 2008 financial crisis.
Post 2008, there have been three periods that stand out where risk assets – based on the FTSE World index – have been challenged: a 29-month-long global equities trough that started in October 2007 and kickstarted the global financial crisis; the nine months beginning at the end of June 2011; and the 10-month-long equity down market that ran from 31 May 2015 to 31 March 2016.1
Taking the example of the 2007 downturn, the FTSE World index fell 32.98% in GBP term and investors didn’t recover the losses for more than two years; by comparison the Real Return strategy was back in positive territory in less than a year.
Shallower dips make for a quicker recovery, a feature that has been a cornerstone of the consistency of performance on which Real Return prides itself. In losing less at its worst point, the declines were managed over a shorter timeframe, and therefore the team was able to recover more quickly, thus paving the way for the fund to deliver positive returns in the difficult discrete calendar years 2007, 2008 and 2009.
Recent returns bear out the validity of this approach. Against a background of heightened volatility in both equity and fixed income markets through the close of 2018 the BNY Mellon Global Real Return Fund gained 0.13%, in euro terms, in December and fell just 1.0% for the full year.2 This compares with an MSCI World NR one-month return of -8.48% and a 12-month return of -4.11%, also in euro terms.
Positioned for opportunity
Now, given the heightened risk to asset prices at present, the investment team remains conscious of the need for capital preservation. Even so,they are also aware of the opportunities current market conditions present.
“The array of structural, geopolitical and, increasingly, cyclical risks facing investors at the present time are not yet fully discounted in today’s asset prices,” according to the Real Return team. “Recent market declines have undoubtedly improved the profile of prospective returns and brought the securities on our ‘wish list’ closer towards buying territory. While the strategy’s recent capital-preservation efforts have been encouraging, we believe this job is not quite yet fully accomplished, and we are increasingly readying the strategy for the next phase in financial markets. In this stage, we anticipate refocusing attention upon return generation. This is likely to involve significantly increasing exposure to favoured equities as more compelling valuations broaden the opportunity set. We also envisage increasing exposure to asset classes such as corporate debt as factors such as elevated corporate leverage, declining profitability and growing liquidity risk conspire to push yields higher,” explains Catherine Doyle, the investment specialist on the Real Return strategy .
Past performance is not a guide to future performance.
The value of investments can fall. Investors may not get back the amount invested.
- 1 Lipper data, accessed 31 August 2016.
- 2 Source: Lipper as at 31 December 2018. Fund performance is calculated as Total Return,including ongoing charge, but excluding initial charge, net of performance fees (where applicable), 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.