Multi-Asset Investment Update | August 2018
- 11 mins 42 secs
Barry Widdows, Head of Multi-Asset Portfolio Management, discusses the latest movements in markets, the impact of rising rates on property, pressure on sterling and moving into the Asian properties sector.
PRESENTER: For the latest update from Prudential Portfolio Management Group, I’m joined by Barry Widdows, Head of Multi-Asset Portfolio Management. So, Barry, it’s great to have you back with us in the studio. So from the last time you were on what’s been happening in markets?
BARRY WIDDOWS: Yes. So I mean UK equities had a really good period back in April/May time. We had a period where sterling was quite weak, oil price was quite strong and the market was doing very well. I think since then the market has gone reasonably sideways actually over the summer period. So it’s been a bit more muted. In terms of US equities we’ve seen some continued strength there. The tech stocks have been doing particularly well, and earnings have held up reasonably well across the board. Emerging markets have been under a little pressure, and we’ve also seen some pockets of weakness across Europe.
I think one thing we have seen for sure is more volatility across the board, and that’s been a theme. And one of the reasons I think behind that is actually some of the moves we’ve seen in fixed income markets. We’ve seen a fairly rapid move in short term interest rates across the globe, in particular in the US. If you look at the US two-year rate over the last year or so it’s pretty much doubled in the last 11/12 months, and that’s quite a substantial for the market to digest. And I think the market is really trying to get a handle on how to price other assets on the back of that move on what’s essentially a risk-free rate. And then I suppose the other interesting factor is that we see big moves in asset prices and volatility.
The market is always trying to put a story on those moves. It’s always trying to build a narrative around why this stock is up 5%, this stock’s down etc., whether it’s Brexit, Turkey, etc. We’re really trying to see through a lot of that noise and really focus on the fundamentals underlying. And actually in a lot of asset classes we don’t think the fundamentals have actually changed that much. Investors’ beliefs I guess can change very rapidly and that can cause price action. So we’re really focusing on looking at where that action might be inappropriate and could actually become an opportunity.
PRESENTER: Well we are seeing rates starting to rise, are you concerned about your exposure to fixed income in the portfolio considering this environment?
BARRY WIDDOWS: The short answer is no, not overly concerned. It’s a question we get asked a lot, particularly for our cautious portfolio which has a higher fixed income content. But when we look at fixed income and the moves that have happened, actually a lot of the moves we’ve seen over the recent period, and rates have been rising. But most of that’s been happening actually at the short end of the curve where it’s in response to obviously central bank policy action. Inflation and the longer end of the curve has actually been more muted, so that’s protecting some of the longer term assets.
But also when you think about our portfolio, and actually what we’re holding in our fixed income book, it’s much more complicated exposure than just pure sovereign bond exposure. So for example we’re very diversified across the curve in terms of maturity, across region, across the different types of fixed income assets we’re holding. So we’re holding high yield. We have a high credit exposure. We have leveraged loans in there. We have bridge loans in there. We have private credit in there. So it’s a much more complicated book. And actually what we’ve seen is that this portfolio can actually perform well in a period where rates generally are rising. We’ve actually seen that over the last 12 months or so.
I think the other thing to bear in mind as well is when we think about rates rising it’s not just the fixed income that it can affect; it can affect all asset classes. And we try to think about things in a more holistic sense. So how is the whole portfolio likely to perform in this environment? And think about it in an aggregate view, rather than focus on one particular piece of the portfolio. And finally I suppose the other thing to bear in mind is rising rates actually is symptomatic of really an economy that’s improving, and so longer term that should be good for yields across the portfolio and for risk assets in general.
PRESENTER: But considering the rising rates are you seeing an impact on other asset classes, property for example?
BARRY WIDDOWS: Property is one that’s often touted as a concern and linked to fixed income. What we see, the evidence when we look at it, actually is that property is not as correlated as most people think to fixed income assets. Obviously there are different ways you can calculate that correlation, different. It varies depending which particularly property type you’re looking at, or which fixed income rate you’re using. But if you look at those correlations they’re typically below 0.5 and often close to zero over some periods. And actually when you look at the evidence in the UK market, for periods where gilt yields have risen substantially over the last 20 years or so, so when they’ve risen over 100 basis points, property market has actually risen in most of those periods as well. So it’s continued to perform well.
We’re also seeing in the US market US rates are rising quicker than in the UK. The Federal Reserve is ahead of the Bank of England in terms of the cycle. But there we’ve seen relatively little impact on US property markets. So overall I’m not particularly concerned about any impacts on property. And also property is still very attractive on a couple of aspects. Firstly sterling is pretty weak and so overseas buyers are still very strong, and it’s very much a global asset class. And the other thing to bear in mind is it’s still relatively attractive to fixed income and to gilt in the UK.
PRESENTER: So how then are you positioning your portfolio?
BARRY WIDDOWS: So in terms of positioning I think it’s worth perhaps touching on our strategic positioning. So each year we run an exercise to update our strategic asset allocation, so our long-term positioning. And we’ve just completed that exercise. And I suppose the headline from that is really a continuing theme of diversifying the portfolio into different regions and asset classes, with relatively modest shifts at the main asset class level. We’re moving a little bit away from equities and into fixed income. We’re reducing the cash portion of our portfolio. We’re really trying to get as much of the capital into return generating assets to make the portfolio more efficient. And then really we’re trying to incorporate a couple of longer-term themes which we believe play out.
So for example adding more exposure into small cap equities to try and capture that risk premium over the longer term. That’s something that’s been evidenced well in research. And also trying to move into areas where we see longer-term growth prospects, in particular from demographics. So we’ve been a big investor in African equities for quite a while. We’re continuing to invest more in African equities, and actually looking to introduce African fixed income now. And also in Asia, Asia we think is a big growth story still over the longer term, so we’re continuing to add exposure to Chinese equities in our strategic positioning also.
PRESENTER: And what about other tactical or short-term views?
BARRY WIDDOWS: Sure, so in terms of short term tactical positioning we’re still pretty constructive on equities, and particularly favouring markets where we see higher earnings yields such as Korea and Europe. And in fixed income we are generally negative, particularly in the UK and Europe. And that’s really just based on the negative real yields that you’re still seeing from those assets over a reasonable timeframe. So it’s just not an attractive asset class to be in on a relative basis.
I think it’s worth mentioning also Turkey. Turkey’s been a big story recently. Turkish currency is something that certainly there’s risks investing in Turkey, but it’s something that if you are investing in Turkey you’re getting a reasonable amount of compensation now given where the market’s pricing. So for example if you buy Turkish Lira in the forward currency market for delivery in three months’ time, you’re paying around 7% or 8% less than the current spot exchange rate. And that gives you a bit of a buffer for a future depreciation. And if the exchange rate goes nowhere then you’ll make 7% or 8% over three months. So while the risks shouldn’t be understated, Turkey’s something that we’ve been adding exposure to and looking carefully at.
PRESENTER: Well Brexit has been a key focus, and it’s been putting a lot of pressure on sterling, so have you been doing anything with this?
BARRY WIDDOWS: That’s right, so sterling is trading at round about $1.27 versus the dollar. I guess that’s down about 11% from the highs back in April. And really again the narrative that the market’s been building around that has very much been focused around Brexit. And I think what we shouldn’t underestimate is actually other stuff that’s going on. In particular the dollar has been particularly strong over that period, and actually a large piece of that move is down to dollar strength and not sterling weakness. Nevertheless sterling against the euro has been weak, and so it has underperformed somewhat other currencies, and I think that is perhaps due to Brexit weighing on the currency.
In terms of the portfolio, we’re not particularly concerned. We haven’t taken any action as a result of sterling. When we, we’re really focused on, in terms of Brexit what fundamental impacts might happen from Brexit. So when it’s clear that the real economy might be impacted, then we’d really be concerned about it; less concerned around news flow and price action from the next Brexit headline. So we’re really trying to focus on long term. And when we look at our portfolios we’re really very diversified in terms of our currency exposure, as I mentioned diversifying away from UK assets.
So we have a fair amount of foreign currency exposure. And actually the portfolio tends to perform fairly well when sterling is depreciating. So that gives us some comfort in this environment. We also of course have a reasonably high UK equity exposure, and a lot of that is in FTSE 100 companies and multinational companies, which generate a large portion of earnings overseas. Again that can do well when sterling is weak. So we’re not particularly concerned. We don’t think we have any excess exposure there. And continuing to really look for opportunities where the market pricing might actually create an opportunity for us to take advantage of the sterling move.
PRESENTER: Well finally any other interesting activity in the portfolio?
BARRY WIDDOWS: Asian property is an area where we’ve been looking to add exposure to for a while. That’s part of our strategic move. And we work with M&G Real Estate team closely to do that, and they’ve just managed to secure the purchase of a very large office building in Seoul in South Korea called the Centropolis Towers. It’s a large low profile purchase. We’re very excited about it, and it’s really only the size and stability of the fund, coupled with the expertise of M&G’s Real Estate team that can allow us to take on exposures of this size. But this deal should complete later in the year, and then both the Pru fund growth and cautious funds will get exposure to this asset going forward. So it’s something we’re pretty excited about.
PRESENTER: Super, well Barry, thank you.
BARRY WIDDOWS: Thanks.