As evidenced by the decision to increase significantly the size of the Global Real Return strategy’s return-seeking core since the pandemic-induced lows of March 2020, our confidence in an improving economic and market backdrop had been steadily building. While the Omicron coronavirus variant has dominated headlines towards the end of 2021 and has the potential to slow growth, we believe it will not derail the economy.
We have described the introduction of a more sizeable portion of fiscal policy in the stimulus mix, together with the tolerance for higher inflation by central bankers, as a ‘regime shift’. Indeed, we think this is a game-changer that will continue to have implications for all asset classes and how they correlate with one another. This has repercussions in terms of how a robust, multi-asset portfolio is structured to meet its return objective while at the same time minimizing volatility. We believe the flexibility and dynamism inherent in our philosophy and approach makes the Global Real Return strategy ideally suited for such rapidly changing market conditions.
Economic momentum looks well underpinned, as pent-up demand is unleashed and the Covid pandemic becomes an endemic phase, with little appetite from politicians to fully lock down economies again. Companies have been set on a restocking cycle, and while this may have been set back by supply-chain bottlenecks, encouragingly we are now starting to see signs that pressure on supply chains is easing, which suggests that we may have seen the peak of supply-side inflation. Further out, we see the potential for corporate capital expenditure to rebound, while government investment in infrastructure, particularly in those areas related to climate change, looks robust. Finally, while emerging markets have lagged in terms of rolling out vaccination programs in 2021, and thus been more vulnerable to Covid-19 outbreaks, this situation is improving, resulting in many of these economies having catch-up potential, although, as always, there is a need to be highly selective.
All Eyes on the Fed
Heading into 2022, the US Federal Reserve’s (Fed) move to signpost its more ‘hawkish’ stance and tightening liquidity conditions has prompted us to watch developments here carefully. As we move through the year, growth is likely to slow as the Fed tapering program comes to an end and interest-rate hikes in the US commence. While we believe the process of rate tightening will be a gradual one and policymakers will be data-dependent, maintaining a ‘Goldilocks economy’ that is neither too hot nor too cold will be a challenge. Any policy mistake will have profound repercussions for asset classes, given the rich valuations across the board heralded by the historic low level of interest rates. If these risks materialize and inflation remains stubbornly high, we will, of course, adjust the portfolio accordingly. In the meantime, we believe that ensuring there is liquidity and tail-risk protection, as well as having alternative capital preservation tools in the strategy, is a prerequisite in this volatile environment, especially when bonds do not offer the diversification that they have done in the past.
Separating the Winners from the Losers
In the near term we have sought to cushion the portfolio from any potential volatility through the addition of direct protection through short futures, and we anticipate a need to be ever more active and flexible. We think this should be reflected in the equity style mix (higher-duration assets are likely to return to favor versus more direct inflation beneficiaries as investors acknowledge that growth is slowing), asset classes employed (the future is likely to look very different from the past), and the degree of direct and indirect protection used.
In a more inflationary world, we believe pricing power will be an invaluable attribute, in addition to strong thematic drivers such as the rise of the consumer (as highlighted by our consumer power theme): there are many companies that are not necessarily consumer-facing businesses that also benefit hugely from the rise of the consumer, such as technology companies and financial businesses. Other trends that directly inform our security selection include technological innovation (smart revolution) and demographic trends (population dynamics). To our minds, careful analysis should distinguish the winners from the losers and enable us to calibrate the degree of exposure to individual secular trends.
Sustainable themes will be high on the agenda as the urgency of issues such as climate change places the spotlight on companies’ environmental, social and governance (ESG) credentials. We have long maintained that ESG considerations are essentially ‘finance 101’ and we see such considerations as valuable elements of the overall ‘mosaic’ of information on a company. As we see it, investors will increasingly demand for greater attention to be paid to these aspects, as well as their being reflected in a company’s valuation. While some areas such as renewable energy have been eclipsed in the recent past by the stellar performance of equity markets, the balance may shift as equity supremacy ebbs.
The Shifting Role of Bonds
We believe that bonds have become a less attractive asset class in the near term owing to rising real yields and inflationary pressures, but they may regain a role in portfolio construction as more elevated yield levels create attractive entry points. We may choose to use them more tactically than in the recent past, and they will sit alongside other complementary tools designed to offset risk and withstand equity market sell-offs.
Finally, currency may have a role to play, with the potential to use the US dollar as a risk-reduction tool, although our views on the direction of the currency are not skewed decisively in either direction. In the near term, dollar strength is likely to represent a headwind for assets such as gold and emerging-market debt, diminishing the appeal of these assets for the Global Real Return portfolio. Moreover, in the case of gold, we think competing flows for other alternative currencies such as bitcoin, along with the potential for rising real rates, make the commodity less attractive.
Vigilance Is Key
In summary, we consider that, while the economic recovery should continue, most of the good news is already in the shop window. We have been reducing risk in the strategy, and this is likely to continue. We acknowledge that, from a macroeconomic perspective, persistently high inflation can carry the seeds of demand destruction and also run the risk of policy error on the part of central banks. Moreover, China represents a significant source of uncertainty (as our China influence theme highlights) with its new agenda of social prosperity and the likelihood that the quantity and composition of economic growth it generates is set to change from here. This will have repercussions for security selection and we believe it necessitates vigilance and careful analysis for an absolute return-seeking mandate such as Global Real Return.
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.
Newton Global Real Return Strategy – Key Investment Risks
- Performance Aim Risk: 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 returns to vary significantly.
- Currency Risk: This strategy invests in international markets which means it is exposed to changes in currency rates which could affect the value of the strategy.
- 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 strategy can lose significantly more than the amount it has invested in derivatives.
- Changes in Interest Rates & Inflation Risk: Investments in bonds/money market securities are affected by interest rates and inflation trends which may negatively affect the value of the strategy.
- Credit Ratings and Unrated Securities Risk: Bonds with a low credit rating or unrated bonds have a greater risk of default. These investments may negatively affect the value of the strategy.
- Credit Risk: The issuer of a security held by the strategy may not pay income or repay capital to the strategy when due.
- Emerging Markets Risk: Emerging Markets have additional risks due to less-developed market practices.
- Liquidity Risk: The strategy may not always find another party willing to purchase an asset that the strategy wants to sell which could impact the strategy’s ability to sell the asset or to sell the asset at its current value.
- Shanghai-Hong Kong Stock Connect and/or the Shenzhen-Hong Kong Stock Connect (‘Stock Connect’) risk: The strategy may invest in China A shares through Stock Connect programs. These may be subject to regulatory changes and quota limitations. An operational constraint such as a suspension in trading could negatively affect the strategy’s ability to achieve its investment objective.
- CoCos Risk: Contingent Convertible Securities (CoCos) convert from debt to equity when the issuer’s capital drops below a pre-defined level. This may result in the security converting into equities at a discounted share price, the value of the security being written down, temporarily or permanently, and/or coupon payments ceasing or being deferred.
- Counterparty Risk: The insolvency of any institutions providing services such as custody of assets or acting as a counterparty to derivatives or other contractual arrangements, may expose the strategy to financial loss.
- Investment in Infrastructure Companies Risk: The value of investments in Infrastructure Companies may be negatively impacted by changes in the regulatory, economic or political environment in which they operate.
This is a financial promotion. This article is for institutional investors only. Material in this article is for general information only. The opinions expressed in this article are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Any reference to a specific country or sector should not be construed as a recommendation to buy or sell this country or sector. Please note that strategy holdings and positioning are subject to change without notice. Newton Investment Management Limited (NIM) will make investment decisions that are not based solely on ESG considerations. Other attributes of an investment may outweigh ESG considerations when making investment decisions. The way that ESG considerations are assessed may vary depending on the asset class and strategy involved. The research team performs ESG quality reviews on equity securities prior to their addition to NIM’s Research Recommended List (RRL). ESG quality reviews are not performed for all fixed income securities. The portfolio managers may purchase equity securities that are not included on the RRL and which do not have ESG quality reviews. Not all securities held by NIM’s strategies have an ESG quality review completed prior to investment, although since 2020 it has been a requirement for all (single name) equity securities to have an ESG quality review before they are purchased for the first time.
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