Multi-Asset Investment Update | November 2017

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  • 11 mins 40 secs
Barry Widdows, head of multi-asset portfolio management at Prudential, provides an overview of the year so far, takes a closer look at changes to the market and discusses the recent rate rise.

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PRESENTER: For the latest update from the Prudential Portfolio Management Group I’m joined by Barry Widdows who’s the Head of Multi-Asset Portfolio Management. So, Barry, good to have you back with us. So let’s start with the year so far, what have you been seeing?

BARRY WIDDOWS: Well 2017 has been a pretty good year for multi-asset investors. What we’ve been seeing is really a synchronised period of global growth, which has been pretty unusual, and we’ve seen risk assets generally benefit from that. So we’ve seen equity markets producing double digit returns. We’ve also seen corporate bond markets do very well. I think on the government bond side we’ve had a bit of a headwind in terms of monetary policy starting to normalise after this really extended period of abnormal low rates post the global financial crisis. So returns hampered a little bit there, but generally we’ve seen great returns across the board.

When we look at our portfolio across geographies and across asset classes we’re seeing good absolute returns really across all those. Certainly in some of the North American assets you’re seeing slightly weaker performance, and that’s really due to the weak dollar, but great returns generally. And we’ve seen a period of low volatility, so on a risk-adjusted basis the returns for multi-asset investors have been very good.

PRESENTER: Well staying with markets and since you were last here, anything notable you’ve seen happening there?

BARRY WIDDOWS: Yes, I think probably the major event in the recent period in Q3 was towards the end of Q3 in September, when the Bank of England and the Federal Reserve really came out with some pretty hawkish comments around monetary policy. The Bank of England in particular started signalling pretty strongly that a rate rise was imminent, and the market began pricing that in. We saw quite a substantial move in 10-year government bond yields in the UK, moving around 30 basis points over the period of a week in the middle of September, so quite a substantial move there. Really the markets were giving up some of the returns that they’d made in July and August, there’d been a pretty good run so giving some of that back, and actually credit markets tended to hold up reasonably well.

On the currency side sterling reacted pretty strongly as well. We saw sterling rise seven or eight cents against the dollar, so that was pretty meaningful. On equities, well we’re coming to the end of another earnings season in the US, and what we’re seeing there is again some pretty strong numbers, so we’re seeing around 5% sales growth and around 7% earnings growth from the S&P 500 – both of those slightly ahead of expectations. And I’d say the themes that are coming out there are really what we saw last quarter as well, so it’s again a continued recovery in the oil and gas sector, and also some pretty positive strengths still coming through from the tech sector. And as you know the tech sector has been driving a lot of returns in the S&P; also it’s been a notable theme this year. Recently we’re also starting to see some strengths come through in energy stocks on the back of the recent oil price rally we’ve seen over the last months, so I think that’s a theme to watch going forward.

PRESENTER: So picking up on you mentioning the sterling, and we’ve seen some big moves in this currency. So how do you know when to hedge overseas?

BARRY WIDDOWS: Yes, it’s a very good question. I mean our policy is really to think about how we can improve risk-adjusted returns for policyholders over the long term. And when we look at our portfolio there are a number of different asset classes within that. And if we look at each asset, some assets are impacted more by the currency component than others. So for example take a short-term bond, it’s a relatively low risk asset in its own right. But if that bond is a foreign bond then the currency component can actually be pretty significant, and we’re likely perhaps to hedge that away. On the other extreme, if you think about an emerging market equity, that asset in itself is a pretty risky asset, a pretty volatile asset, and the currency aspect may be less significant in terms of the overall return stream. It might actually be a feature of the asset that you’re trying to capture in the investment as well.

So we tend to consider each asset individually. We’ve got a modelling team that think about these different returns, and try and come up with the optimal hedging strategy over the longer term for our policyholders.

PRESENTER: So talk me through then how your portfolios are positioned, and the rationale behind this.

BARRY WIDDOWS: Sure, so in terms of strategic longer term positioning we remain very well diversified across all the traditional asset classes you’d expect. We’re also continuing to add capital into some of the more alternative areas, so private equity, hedge funds, infrastructure, as well as overseas property and private credit more recently. On the more tactical short-term positioning I’d say we have a few themes that are present in the portfolio currently. Firstly on US inflation, we continue to believe that the market is under-pricing the prospects for US inflation to pick up. We see the labour market as pretty tight there, so there’s not a lot of slack. We think that some of the earnings pressures that could come through there could lead into headline inflation, and we’re positioned to take advantage of that. We also have the prospect that Trump could enact some of the fiscal or protectionism policy, which again could be a boost to inflation.

Secondly we’ve seen a theme I think in markets year to date really where again tech stocks have been outperforming, energy stocks underperforming, and we think there could be a rotation towards energy stocks starting to perform better. And we’ve seen that in the last few weeks, particularly with that oil price rally. If we look at a market like Canada for example, it’ll be well positioned to take advantage of that if it continued with a higher exposure to energy stocks. When we also look at Canadian stocks we actually see a little better value than US stocks, and we also see a higher exposure to financial stocks. And if we’re in this regime where monetary policy starts to normalise, we could expect financial stocks to benefit, so we see an advantage of being exposed to those areas too. I’d say also we remain tilted towards the late cycle markets where we see a little more value, so markets such as Japan, such as Asian equities in emerging markets.

PRESENTER: Now we have just seen a rate rise from the Bank of England, indeed the first in the last 10 years, so what sort of impact has had that for you?

BARRY WIDDOWS: Sure, so the Bank of England rose rates at the start of the month as expected. I think the first thing to note is a rate rise in itself is not a bad thing for investors such as ourselves; it’s really a sign that the economy is strong enough to take it, and the Bank of England has the confidence to go ahead with that rise. It’s also in the longer term you’d expect us to be able to invest our assets at the higher yields, and if the economy is ticking over well it’s great for the equity and the corporate side of the portfolio too. So in essence it’s really a good story longer term.

In the shorter term of course it can be negative for holders of bond assets. What we really saw this time was actually most the market move happened back in September when the rate rise was first muted by the Bank of England, not when they actually made the announcement. So back then we did see some impact on sovereign yields as I mentioned, the credit markets actually held up OK, and we’re predominantly invested in credit markets. When the Bank of England actually made the rate decision, I think what you saw there was really sterling actually weakened because the tone was rather dovish of their announcement. And of course the market had built in the expectation that the rate rise was coming. So really we saw markets move the opposite way, and the dovish sterling, the weaker sterling led to actually a pretty good for UK equity markets.

Going forward I think the market’s really trying to digest whether this was the start of actually a longer term hiking cycle, or whether this really was just the removal of the extraordinary easing that they put in place post Brexit. And it seems to be they’re coming down on the latter. So if you look at the yield curve currently, there’s not a huge amount of further rises priced in. The curve is pretty flat or even inverted at the short end. So I think the market is not expecting too much further. As long as I think rate rises are gradual and measured, our portfolio performed fine during this rise, and there’s no reason I would expect it to perform any different going forward.

PRESENTER: And any other interesting activity in the strategy recently?

BARRY WIDDOWS: I think another interesting angle is in relation to ILS, or insurance linked securities. What we had during this period was a lot of weather activity of course through the Caribbean and Florida in relation to hurricanes. So these insurance linked securities are securities where the return is linked to that type of activity; for example wind in Florida. We tend to hold these types of assets in our portfolio, because actually not only do they produce good returns generally, but they’re also very uncorrelated with the other types of assets we hold in our portfolio, so they’re very useful from a portfolio perspective.

So during this period of course we have suffered some losses on those assets, as you’d expect. But generally in our wider alternatives book we had other returns that made up for that, and that’s uncorrelated nature playing out. So actually the book as a whole did fine. And what we’re finding is that actually now is a very opportune time to deploy more capital in that area. After you’ve had some of these events typically you see premiums actually increase in this sort of areas as companies need to replace the insurance that they’ve gone through, and also as there’s a perceived high risk of this sort of event happening again, it’s the short-term memory. So actually research has shown this is an opportune time to deploy capital there, so that’s an area we’ve been looking at recently.

PRESENTER: So finally how do you see the rest of 2017 playing out?

BARRY WIDDOWS: Sure, well Q4 has actually started very well, and we’ve seen some great returns so far during the quarter. There’s also not a huge amount of events before now and year end that can actually rock the market. Certainly the market will be focusing on the Federal Reserve, the meeting in December there, but again that’s largely priced, not too many surprises expected there. And the market will also be thinking about Trump and his tax policy, and whether he’s able to actually enact that, and see how that progresses. In the absence of those big events I think the market will be focusing on corporate earnings, and on the macroeconomic data releases, and really getting back to fundamentals. And then when you think about the UK, clearly Brexit remains an overhang. There’s risk there, and there’s also wider risk coming to show in UK politics generally, and whether Theresa May can stay in power. But barring any major political event or any geopolitical event, I think really a lot of the themes that we’ve seen so far could actually continue into 2018.

PRESENTER: Barry, thank you.

BARRY WIDDOWS: Thank you.