Since the Newton Real Return strategy’s launch in 2004, global equities have constituted a significant portion of its return-seeking core. During this period, investors have enjoyed super-charged gains, with the MSCI All Country World Index (net dividends reinvested) generating an annualised return of +9.6%. The equity component of the Newton Real Return strategy has participated in, and indeed exceeded, these gains, returning +11.6% per annum over the same period.1

State intervention

How does this heady experience stack up in a historical context? The Barclays Equity Gilt Study provides some interesting analysis with regard to real returns. Taking the US as a proxy for global equities – a reasonable substitute given it is the world’s largest equity market – the real return generated over the last decade was 10.4% per annum (to 31 December 2018), although the 20-year comparator is markedly lower at 3.6% per annum, as this period captures both the deflating of the technology bubble in the early 2000s, and the savage market downdraft that accompanied the global financial crisis. The real return for US equities over 50 years is 5.3% per annum, which is not too dissimilar to the 4.7% annualised return delivered by UK equities in the 119 years since Barclays’ records began.2

Population dynamics

Intuitively, an annualised real return of 5% sounds like a reasonable long-range expectation. US real GDP growth has averaged 3.1% per annum over the last 70 years, although it is our view that structural factors (which we call the four ‘D’s: demography, debt, disruption from new technologies, and distortions wrought by ultra-loose monetary policy) could see it decelerate over the next few decades. In this context, a 2% annualised pace of real growth seems to us a realistic expectation.Assuming companies in aggregate retain pricing power and are not burdened with too many new taxes and costs, this 2% growth rate should feed through to the bottom line. Indeed, it should, if anything, be augmented as a result of typical operating leverage and incremental earnings streams from future surplus capital deployment, representing perhaps an additional 1% growth per annum. A further 2% per annum arising from the dividend yield on the S&P 500 Index would give a real return of 5% per annum.

Smart Revolution

1 Performance for period 1 April 2004 to 30 September 2019. Source: Newton, close of business prices, total return, income reinvested, gross of fees, in GBP, 30 September 2019. Performance is stated gross of management fees. The impact of management fees can be material. A fee schedule providing further detail is available on request. Comparisons are made to demonstrate correlation and are for illustrative purposes only. Real Return equity performance is from a representative portfolio which adheres to the same investment approach as the Newton Real Return strategy.
2 Source: Barclays Equity Gilt Study, April 2019.

Valuations: the elephant in the room

However, this rosy picture, which we seek to augment with the additional benefits of careful stock selection and timely asset-allocation shifts, ignores a rather large elephant in the room: valuations. A considerable portion of the stellar return profile of global equities over the last decade is attributable to multiple expansion. While acknowledging the limitations of paying too much heed to longer-term valuation metrics, it is clear that a cyclically adjusted price-to-earnings (CAPE) ratio not far off 30x3 suggests a very real risk of mean reversion. This could put a significant dent in the mooted 5% annualised real return in the investable future. Moreover, the elevated volume of share buyback activity, particularly in the US, has flattered earnings growth and left many developed-world companies now bloated with debt.

Global equities in aggregate are, therefore, unlikely to sustain the double-digit compound returns delivered over the last decade, and are potentially vulnerable to a derating. The catalyst for this could be the result of the ageing economic cycle finally overwhelming less than omnipotent policymakers, leading to a broad-based recession, similar to that experienced in the early 1990s and early 2000s. Another potential scenario could be an aggressive push for fiscal stimulus and the implementation of experimental policy (such as Modern Monetary Theory), spooking fixed-interest investors and pushing government bond yields higher. This could potentially undermine the precipitous valuations of those secular growth and ‘bond-proxy’ stocks that have been at the epicentre of the multiple expansion witnessed over the last decade.

It is important to note that global equities are not a homogenous asset class, and there can be vast performance divergences between stocks and sectors.

Unconstrained asset-allocation approach

Given these potentially challenging scenarios, how would the Real Return strategy fare? The good news is that Real Return is unconstrained in terms of its asset allocation. We can therefore, to a significant degree, step away from equities if we see poor near-term, prospects and greater risk of a major drawdown; indeed, we have been increasingly diversifying the strategy’s return-seeking core with exposure to other assets such as emerging-market debt and listed infrastructure and renewables.

We also have considerable potential to harness stock selection in seeking to deliver a superior outcome and blunt the effects of a wider derating. It is important to note that global equities are not a homogenous asset class, and there can be vast performance divergences between stocks and sectors. For example, in the 2000-2003 bear market (the worst of recent times), while technology destroyed huge amounts of value, there were, at the same time, abundant opportunities in many areas completely overlooked by investors during the dotcom bubble. Many of these bucked the broader market trend, and bounced back dramatically from beaten-up valuations. Consequently, while our aspiration to preserve capital in choppier market phases is primarily driven by the strategy’s stabilising assets and hedges, there is a role for stock selection to contribute. Indeed, the outperformance typically experienced by Real Return’s equity portfolio amid broader market pullbacks has enabled the strategy to generate a compelling asymmetric return profile in this asset class. As the chart below shows, the ability to mitigate the downside in falling markets and capture a significant portion of the upside in rising markets has delivered a superior combined performance owing to the powerful effect of compounding.

Newton Real Return strategy – performance of core equities (inception1 to 30 September 2019)

real-return-role-of-selection

Notes: 11 April 2004.
2Rising and falling periods defined using quarterly MSCI AC World NDR returns.
Source: Newton, quarterly data, close of business prices, total return, income reinvested, gross of fees, in GBP, 30 September 2019. Performance is stated gross of management fees. The impact of management fees can be material. A fee schedule providing further detail is available on request. Comparisons are made to demonstrate volatility and correlation and are for illustrative purposes only. Real Return equity performance is from a representative portfolio which adheres to the same investment approach as the Newton Real Return strategy.

Conclusion

In summary, we believe that one of the great advantages of the Real Return strategy’s unconstrained approach is that we do not have to slavishly follow any defined benchmark in terms of our equity selection, and are free to emphasise the characteristics that we prefer – notably compounding qualities, durable business models, robust cash generation, solid balance sheets, and a sound environmental, social and governance (ESG) profile. This does not, however, preclude incorporating more cyclical areas of the equity market that can present attractive opportunities over shorter phases of time. Despite a challenging backdrop, equity holdings remain an important component of the Real Return strategy’s makeup and represent one of the many tools the strategy has to help it meet its performance objective.

3 Source: Prof Robert Shiller, Yale University, http://www.econ.yale.edu/~shiller/data/ie_data.xls, 31 August 2019.

Past performance is not a guide to future performance. Your capital may be at risk. The value of investments and the income from them can fall as well as rise and investors may not get back the original amount invested.

Key investment risks

  • The performance aim is not a guarantee, may not be achieved and a capital loss may occur. Strategies which have a higher performance aim generally take more risk to achieve this and so have a greater potential for the returns to be significantly different than expected.
  • This strategy invests in global markets which means it is exposed to changes in currency rates which could affect the value of the strategy.
  • The strategy may use derivatives to generate returns as well as to reduce costs and/or the overall risk of the strategy.
  • Using derivatives can involve a higher level of risk. A small movement in the price of an underlying investment may result in a disproportionately large movement in the price of the derivative investment.
  • Investments in bonds are affected by interest rates and inflation trends which may affect the value of the strategy. The strategy holds bonds with a low credit rating that have a greater risk of default. These investments may affect the value of the strategy.
  • The strategy may invest in emerging markets. These markets have additional risks due to less developed market practices.
  • The strategy may invest in investments that are not traded regularly and are therefore subject to greater fluctuations in price.
  • The strategy may invest in small companies which may be riskier and less liquid (i.e. harder to sell) than large companies. This means that their share prices may have greater fluctuations.

Investment performance

Sep 18
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Sep 19

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Sep 17
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Sep 18

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Sep 16
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Sep 17

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Sep 15
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Sep 14
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Sep 15

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Newton Real Return strategy (gross) 9.6 2.7 -2.0 11.4 1.3
Newton Real Return strategy (net) 8.8 2.0 -2.8 10.6 0.6
(1 month GBP LIBOR +4%) 4.7 4.6 4.3 4.5 4.5

Performance is stated gross and net of management fees. The net-of-fee returns are calculated by deducting an annual management charge of 0.75% from the strategy’s gross-of-fee returns. The impact of management fees can be material. A fee schedule providing further detail is available on request. The strategy aims to deliver a minimum return of cash (one-month sterling LIBOR) +4% per annum over 5 years before fees. In doing so, the strategy aims to achieve a positive return on a rolling 3-year basis. However, a positive return is not guaranteed and a capital loss may occur.
Source: Newton, total return, income reinvested, gross and net of fees, in GBP, 30 September 2019.

Important information

This is a financial promotion. These opinions should not be construed as investment or any other advice and are subject to change. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those countries or sectors. Please note that portfolio holdings and positioning are subject to change without notice.

Issued in the UK by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England No. 01371973. Newton Investment Management is authorised and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN. Newton Investment Management Limited is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton’s investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. ‘Newton’ and/or ‘Newton Investment Management’ brand refers to Newton Investment Management Limited.

This material is for Australian wholesale clients only and is not intended for distribution to, nor should it be relied upon by, retail clients. This information has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person. Before making an investment decision you should carefully consider, with or without the assistance of a financial adviser, whether such an investment strategy is appropriate in light of your particular investment needs, objectives and financial circumstances.

This information is made available by Newton Investment Management Limited and BNY Mellon Investment Management Australia Ltd (AFSL 227865). This information is confidential and is only provided to Australian wholesale clients (as that term is defined in section 761G of the Corporations Act 2001 (Cth). This is not an offering or the solicitation of an offer to purchase an interest in the Newton Real Return strategy. This document is for general purposes only and should not be relied upon as financial product advice. This document has been prepared without taking into account the objectives, financial situation or needs of any person. Before making an investment decision an investor should consider the appropriateness of the information in this document having regard to these matters and read the disclosure document relating to a financial product. Investors should also consider obtaining independent advice before making any investment decisions. Investments can go up and down and to the extent that this document contains any past performance information, past performance is not a reliable indicator of the future performance of the relevant investment or any similar investment strategy.

Newton Investment Management Limited is exempt from the requirement to hold an Australian financial services licence in respect of the financial services it provides to wholesale clients in Australia and is authorised and regulated by the Financial Conduct Authority of the UK under UK laws, which differ from Australian laws.

Newton Investment Management Limited (Newton) is authorised and regulated in the UK by the Financial Conduct Authority (FCA), 12 Endeavour Square, London, E20 1JN. Newton is providing financial services to wholesale clients in Australia in reliance on ASIC Corporations (Repeal and Transitional) Instrument 2016/396, a copy of which is on the website of the Australian Securities and Investments Commission, www.asic.gov.au. The instrument exempts entities that are authorised and regulated in the UK by the FCA, such as Newton, from the need to hold an Australian financial services license under the Corporations Act 2001 for certain financial services provided to Australian wholesale clients on certain conditions. Financial services provided by Newton are regulated by the FCA under the laws and regulatory requirements of the United Kingdom, which are different to the laws applying in Australia.

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