Toby Nangle, Global Head of Asset Allocation, on the tactics he has used to navigate the ups and downs of global markets over the past five years
WELCOME
The Columbia Threadneedle Multi-Asset team runs a number of unconstrained real return portfolios for euro, dollar and sterling-based investors. One of these is the sterling-based Threadneedle Dynamic Real Return Strategy, which recently celebrated its fifth anniversary and its track record is evaluated here. At the helm of this team is Toby Nangle, who explains in this guide how he and the team use a dynamic unconstrained approach to constructing a diversified multi-asset portfolio. Toby also reveals where he believes the best investment opportunities lie today and how the team is navigating core macro challenges and risk factors such as Brexit within portfolios to ensure volatility is kept in check.
Over the last five years, global markets have performed well in the shadow of significant event risk, from the Chinese banking liquidity crisis of 2013 to the volatility caused by the threat of a global trade war (amongst other issues) earlier this year.
THE INTERVIEW
‘Everything we invest in has to earn its way into the portfolio’
Toby Nangle,
Columbia Threadneedle Investments
Having recently celebrated its fifth anniversary, the Threadneedle Dynamic Real Return Strategy has delivered a gross annualised return of 6.4% over five years to 31 August 2018. Meanwhile, over five years absolute volatility has been at a steady 4.8% - some way below the two-thirds of equity volatility target.* The manager has achieved this through close collaboration with the group’s eight-strong Asset Allocation Strategy Group and in-house analysts, and by sticking to a disciplined approach throughout tougher time periods. Nangle explains: “Our reason for using in-house funds is about joining up the investment strategy. If we used another firm’s strategy, we would have less control from a risk perspective. It also means we can keep it very attractively priced for our clients, while managers using external funds typically have higher fees.” The portfolio is composed of direct investments, passive strategies and internal active fund wrappers. This allows the firm to keep charges competitive. ’
Another feature that makes the Strategy stand out from some of its peers is that it is a long-only and unlevered product, which means it does not take any net short positions. The reason for this, Nangle says, is to keep things simple and transparent. However, this does not mean he does not employ tactics to manage the volatility. A good example of this is the Strategy’s investment process in the lead-up to the Brexit referendum and following the announcement of the outcome. Nangle says: “When we reviewed the portfolio ahead of the referendum, we came to the uncomfortable conclusion that we had a big bet on the ‘Remain’ vote; we had around 12% in European large-cap quality equities. “But rather than liquefy all these stocks, we worked with colleagues in our risk team to find the best way to take out this risk. “We did this by selling short EuroStoxx futures and a long euro/short sterling position on top of that, among a number of other trades. When the market opened on the morning of the results, it was pretty uncomfortable. But we went out and removed the EuroStoxx future, as this was to take us from the point of unknown to known. “We then took advantage of some opportunities that appeared such as UK large-cap stocks that had been hit.”
Reducing volatility
*Source: Columbia Threadneedle Investments. As at 31 August 2018. The strategy launched on 18 June 2013. Gross performance calculated offer to offer, gross of annual management charges, using Global Close prices. Equity volatility measured as MSCI World index. Please note the strategy may not achieve its investment objective. Past performance is not a guide to future performance.
Investment discipline
For Nangle, one of the standout events of the past five years was also the period following the Chinese yuan devaluation in the summer 2015 and going into 2016, when markets were pricing in the risk of a potential global recession. Over this period, the manager took the opportunity to add some risky assets to the portfolio, taking positions in European high yield and Japanese equities, reducing cash holdings and changing the currency mix. “All of this was very uncomfortable when the world was increasingly coming into disarray, but quite quickly we realised that the prospect of global recession was starting to get priced in,” the manager says. “We re-risked into a falling market, and then as the market rallied we took a bit off the table. Having a process that keeps us disciplined is at the heart of our multi-asset strategies.”
’No neutral’
One of the key aspects differentiating the Columbia Threadneedle multi-asset strategies from its peers is the way the team approaches asset allocation. Unlike many of its peers, the portfolio is not built around a strategic asset allocation, but rather follows a dynamic unconstrained approach. This means for real return portfolios that the minimum limit for every asset class is 0%, with allocation to equities permitted to rise up to 75%, bonds and cash to 100%, property to 20%, commodities to 20% and alternatives to 10%. “Everything has to earn its way into the portfolio. The asset allocation is managed dynamically across the risk spectrum, from periods where we seek to protect our investors’ capital, to times where we believe risk assets will be well rewarded and as such we seek to participate in growth opportunities.” The Multi-Asset team believes the traditional approach of combining bonds and equities in a portfolio is not necessarily the best way to improve risk-adjusted returns, citing 120 years of historic data showing that this relationship between equities and fixed income is a relatively new phenomenon. “The way in which bonds have been so successfully combined with equities in the past 35 years has been contingent on them delivering high returns in periods of equity market stress. But in half of the 20-year periods over the past 120 years, having duration instead of cash alongside equities has only dragged down risk-adjusted returns,” he says. “At the moment our portfolio is noticeably lacking exposure to government bond duration, simply because we believe there is a risk that this negative correlation [between bonds and equities] switches, and there will be poor returns coming from that part of the market.”
Strategy Snapshot: Threadneedle Dynamic Real Return Strategy
The past five years have been particularly difficult for multi-asset real return strategies, as many vehicles have struggled to produce steady returns and protect investor capital amid market tumult. The Threadneedle Dynamic Real Return Strategy was launched in June 2013. It targets UK CPI +4% (gross), which it has successfully delivered over the past five years. In addition, though the strategy has seen periods of equity volatility during this period, it has been much more resilient in times of a sell off than traditional assets and has continued to outperform on both a short and long-term basis.
Source: Columbia Threadneedle Investments / Morningstar. As at 31 August 2018. Performance calculated offer to offer, gross of annual management charges, using Global Close prices. The Strategy launched on 18 June 2013. Past performance is not a guide to future performance.
Source: Columbia Threadneedle Investments. As at 31 August 2018. Data is shown is for the Threadneedle Dynamic Real Return Strategy.
We manage the portfolio dynamically, from times where we want to participate in growth opportunities in the expectation that risk will be well-rewarded, to times where we want to reduce risk to protect our clients’ capital. 2014: We were concerned risk was not being rewarded so increased protection assets. We reoriented equity allocation and reinitiated a position in European high yield 2015: The Chinese currency devalued in August, so we reduced our Indian equity allocation in favour of Japanese equities and reduced our Australian government bond position in favour of Mexican government bonds 2016: We increased risk through increasing ‘participate’ assets, and took European high yield exposure from around 10% to around 15%, and increased equities from 29%-33% Brexit: We reduced risk in the run-up to the referendum via UK small cap equities, European equities and European high yield exposure, while increasing our non-sterling allocation. Post the vote to leave we unhedged part of our Mexican Government bond exposure and increased our allocation to UK short-dated corporate bonds and UK large-caps. We also hedged half our UK equity exposure to US dollars 2017: We increased our risk through increasing participation assets such as Europe ex-UK equities and Japanese equities2018: We added to Japanese equities during a period of market weakness
How has the fund’s portfolio allocation changed?
Historic asset allocation since launch
Risk/Reward (gross)
Current asset class exposure
Dynamically managing the allocation to suit market opportunities
Source: Columbia Threadneedle Investments as at 31 August 2018. Past performance is not a guide to future performance. Global equity volatility measured as MSCI World Index. Based on 180 weeks of equally weighted weekly data.
How much of an impact do Brexit negotiations have on the portfolio and how do you navigate this risk?
What are some of the key challenges investors are likely to face during the rest of 2018?
The most important issue we face is on the trade side. We have a US administration throwing trade grenades at its major partners. Macro economists may say that the impact on GDP growth from these events will be relatively small, but this tells you nothing about the distribution of the impact on specific companies. This can be quite immense. I see people are worried, because they are not sure how to price things and this is being reflected in the rating of the market. It is hard to see how the trajectory of the trade distortions will affect the market ratings, and that is worrying. We are taking the approach of focusing the portfolio on favoured risky assets, avoiding a lot of corporate credit risk that could be particularly vulnerable, and not getting over-exposed too early to risky markets.
A key consideration for many investors today is around highly correlated assets moving in tandem. How do you look to avoid this and ensure the portfolio is suitably protected?
When we are putting the portfolio together we are mindful of historic correlation between assets, but it can change and does so all the time. We deal with this issue through continuous management of the investment process rather than using systematic option strategies (eg, perpetually buying put options on equity indices so as to gain downside protection)’ which we feel are relatively expensive and historically not very helpful. At the moment we have a variety of risky positions in the portfolio, but in aggregate they are not pushing the fund into an overall risky place. The correlation between those risky positions will typically be pretty high, but not as high as you would have thought. In our portfolio today the high volatility positions are in Japanese equities, European equities, commodities, an unhedged position in South African government bonds, and a portion in Asian emerging equity markets. These are all fairly risky and will all fall if there is a general risk-off sentiment in markets, but it is about managing the proportion of these in the portfolio. Overall, we are confident that the continual implementation of our investment process will continue to deliver strong positive returns over the medium-term.
Where are you seeing the best investment opportunities?
From a broad asset-allocation standpoint, we have a clear preference for equities over fixed income, given decent economic growth and gentle reflation coming through, both of which are supporting strong company earnings delivery. We think equity valuations look fair in the context of these earnings, and we are optimistic for continued profit growth over the next 12–24 months. Our largest equity positions are focused in those markets most operationally leveraged to the current reflationary environment, like Japan, Europe ex-UK and Asia. Europe has benefited from a lot of policy accommodation from the ECB without many fiscal tailwinds, and has had currency tailwinds coming through to help earnings. In the absence of a global economic crash, we expect this process of healing in the European economy to accelerate into the second half of this year, which will lead to a stronger earnings environment. In Japan, earnings have been phenomenally strong over the last couple of years, margins have expanded from extremely tight levels, and revenues have surprised on the upside. But every time this has happened, earnings expectations have not been pushed up much further, so all the strong performance has not resulted in pretty much any re-rating, unlike a lot of other markets. I feel quite comfortable with that. Japan has the growth characteristics we are looking for and our people on the ground tell us those are still on track. And if I am wrong about markets de-rating, I don’t see any reason why they should not re-rate, which would be even better. Perhaps a less well-known asset for many investors is our (so far, modest) position in South African local-currency government bonds that we initiated in June. The election of President Cyril Ramaphosa in December 2017 and his ambitious reform agenda was greeted with a punchy rally in South African rates, and we too have been encouraged by some of his policy initiatives. We took advantage of the broad-based sell-off in emerging markets (that all but wiped out the Ramaphosa-related rally) to take a position in 2026 bonds at attractive valuations.
The day by day commentary and expectations around the negotiations have quite a big impact on the portfolio. We look at a variety of scenarios and how the portfolio will perform in each of these. Today, the most likely outcome seems to be that we get a withdrawal agreement, so this could all be a rehearsal for a more profound period of uncertainly in two years’ time. But there is also a not inconsequential possibility of a Brexit with no deal, which would be extremely bad for sterling. In this case, the Strategy would be able to protect investors by hedging sterling exposure. But sterling weakness can also lead to good returns in European equities and some large UK stocks, because of the non-sterling base of these companies.
MARKET OVERVIEW
'Investors are worried as they are not sure how to price assets; that is reflected in the rating of the market today'
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Important information For use by institutional clients and consultants only (not to be passed on to any third party). Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Where references are made to portfolio guidelines and features, these are at the discretion of the portfolio manager and may be subject to change over time and prevailing market conditions. Actual investment parameters will be agreed and set out in the prospectus or formal investment management agreement. Please note that the performance targets may not be attained. The analysis included in this document has been produced by Columbia Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Information obtained from external sources is believed to be reliable but its accuracy or completeness cannot be guaranteed. Issued by Threadneedle Asset Management Limited, registered in England and Wales, No. 573204. Registered Office: Cannon Place, 78 Cannon Street, London EC4N 6AG. Authorised and regulated in the UK by the Financial Conduct Authority. Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.
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