The £25bn Standard Life Investments Global Absolute Return Strategies (GARS) fund has lowered its exposure to US and UK equities as it sees more compelling opportunities elsewhere, while moving into global miners on the basis that they now look attractive on a valuations basis.
In the fund’s latest investor update, multi-asset investment director Adam Rudd said the fund reduced its equity beta strategy and lowered the portfolio’s risk exposure to stocks on the back of high valuations and strong currencies.
Specifically, the fund has taken its US and UK equity beta down to zero, having previous held respective allocations of about 6 per cent and 1 per cent to the two country’s markets.
Rudd said: “Part of the reason for reducing our equity beta has been the strong performance of equities. But in these two markets in particular we felt that currency strength was going to be a detractor.”
“The short-term effects of weaker oil prices do mean, in the US in particular, the hit to manufacturing and capital expenditure is more acute in the short term until the benefits to consumption come through.”
“We felt that equity risk was more attractive in other regions so we’re taking very pointed risk in our equity beta. We like European equities, Japanese equities and global miners.”
As the below graph shows, both the UK and the US have outpaced Europe and Japan since markets bottomed out from the financial crisis in March 2009. The S&P 500 has been the clear leader with a total return of almost 210 per cent over this time.
Performance of indices since 6 March 2009
Source: FE Analytics
The manager says that the UK presents “a number of risks” in the short term but key among the team’s concerns is the impact of next week’s general election and the potential for the country to face an in-out referendum on membership of the European Union.
This would create another 18 months or so of uncertainty and could prompt the UK stock market to lag peers that do not have such significant clouds hanging over their immediate future.
Meanwhile, GARS has previously relied on the US as a driver of its equity returns, as the strong recovery of its economy from the financial crisis fed through in higher earnings and a significant market rally. However, the team now thinks the stronger dollar will make it more difficult for international-facing businesses to lift earnings.
It is European equities that the team find most attractive in this asset class, as it is the portfolio’s largest equity risk position and one of the largest strategies in the whole portfolio. Indeed, it was one of the fund’s most successful strategies across the first quarter of 2015.
Rudd argues that a combination of supportive monetary policy from the European Central Bank (ECB), a weaker euro and a lower oil price bode well for the formerly unloved region. In addition, he says signs of future economic growth, such as an uptick in loans, have not been appreciated by the market.
“It’s been pleasing to see the strength of European equities this quarter,” he said.
“It was also the quarter the ECB began physically buying bonds as part of its QE programme so in a sense it may not be surprising to see that where we’ve been short the euro, against the US dollar and also against the Indian rupee, those positions have performed particularly well.”
As well as reducing the portfolio’s equity beta strategy, the GARS team closed its global oil majors strategy, which it entered towards the end of 2013. The strategy has returned between 3 and 4 per cent since inception, which was below its target and a result of the unexpected plunge in the oil price last year.
“It’s not a bad result considering that oil has halved in price between when we put the strategy on and when we took it out,” the manager said.
“We correctly identified that the stocks were cheap compared to what the oil futures curve had been, but because of the fact that oil’s fallen, the valuation being realised has not meant an increase in the share prices but rather steady share prices in an environment of falling oil. Because of that we didn’t expect the valuation to allow us to generate an excess return any longer, so we took out that position.”
Removing this strategy allowed the team to implement a global miners equity beta position. GARS previously ran a global miners versus Swiss equity position, but this was closed after the team took profits after the Swiss National Bank’s move to scrap its currency ceiling on the Swiss franc.
The original global miners versus Swiss equity position suffered in 2014 on the back of weak commodity prices but the investment team believe the new strategy has the potential to generate a “strong” return from here.
Performance of indices during 2014
Source: FE Analytics
“For the mining equities, we believe the stocks are undervalued compared to what we expect the long-term cash flows are going to be from mining production and sales of the commodities they are extracting,” Rudd said.
“The emphasis here is on the increased capital discipline from the miners. Because of a huge amount of cash was generated in the ‘commodities super cycle’, a lot of that went into investments and cap-ex. As a consequence of which, the supply has been increasing steadily.”
“But because we believe the companies are starting to concentrate more on returning capital to shareholders in the form of share buybacks and dividends – and are emphasising less on new productive capacity – we feel that will allow the earnings to strengthen and we think the share prices are undervalued for that reason.”
GARS has built a strong reputation on the back of its success in meeting its aim of positive investment returns in all market conditions over the medium to long term. It typically runs around 30 strategies and is managed by a large team, headed by Guy Stern.
The fund, which appears on the FE Research Select 100, has made a 55.78 per cent total return since launch. With annualised volatility of 5.40 per cent, it has been more volatile than the average fund in the IA Targeted Absolute Return sector but less volatile than the FTSE All Share and government bonds, measured by the Barclays Sterling Gilts index.
Performance of fund vs sector and indices since launch
Source: FE Analytics
FE’s analysts said: “Overall, the team has succeeded in sticking to the absolute return performance target.”
“The fund has had a couple of difficult periods, typically when all asset classes have fallen together, such as in in 2008 or more recently in June 2013; any loses have been made back relatively quickly however. It should be noted that the fund’s long-term performance has been achieved with only one-third of the risk level of equity markets.”
Standard Life Investments Global Absolute Return Strategies has a clean ongoing charges figure of 0.89 per cent.
