Skip to the content

Steven Andrew: Why bearish investors need to go against the crowd

27 February 2016

The portfolio manager in M&G’s multi-asset team explains why the worst thing investors can do at the moment is confuse market volatility with long-term levels of risk and offers ways to look through the short-term noise to find value.

By Lauren Mason,

Reporter, FE Trustnet

Allowing sentiment to be led by recent market movements can lead to investors missing opportunities and ultimately failing to benefit from long-term headwinds, according to M&G’s Steven Andrew (pictured).

The manager, who co-runs the M&G Episode Income and M&G Income Allocation funds, says the strong performance of markets in the first half of 2015 and their poor performances from the latter half up until today is vastly based on sentiment change surrounding the same market issues.

Many investors are citing their reasons for bearish behaviour as China’s market slowdown and the collapsing price of commodities, with last year’s Black Monday being sparked by the sell-off of the Shanghai Composite index.

Performance of indices in 2015

 

Source: FE Analytics

However, Andrew says investors are too easily swayed by sensationalist headlines and subsequently overlook real long-term risk in favour of day-to-day market volatility.

“At all times the market is driven by two things – it’s driven by fact and it’s driven by changes in peoples’ beliefs about those facts,” he said.

“We tell ourselves stories that aid our understanding of those facts and we tell ourselves stories that give us comfort, so that we know where asset prices are going and where fundamental values are sitting.”

“Then we use the price as a bit of information and that reinforces beliefs and that leads us to tell ourselves this narrative as we go through any period of time.”

The manager has been vocal in the past about crowd psychology and the fact that investors will run in the same direction as their peers as markets either climb or sell off, despite being unaware of the full implications of macroeconomic factors.

This is a view shared by the likes of Cato Stonex from THS Partners, who told FE Trustnet earlier this month that there are no end of reasons for investors to be positive despite market behaviour.

“I think there’s a little funk in capital markets, and capital markets and investors are all about uncertainty. We had a taper tantrum two or so years ago when there was first talk of raising interest rates, and obviously the Fed raised rates in December and people are not quite sure how to see that,” Stonex said.

“It’s psychological. People really hate to be on their own. They like to do what everybody else is doing, and so crowd psychology is a big thing in markets.”

To prove this theory, Andrew created a graph to show when sentiment changed in 2015 and what the predominant driving factors were. He found that currency divergence, the oil price and monetary policy contributed to both strong and weak performances, suggesting that fear being felt by investors today is largely unfounded.

Sentiment narrative from 2015 to date

 

Source: M&G Investments

“Prices going up is reinforcing the enthusiasm and the optimism you can observe when you get that lower currency for the euro area which is clearly an important factor in their growth, as well as improving data, accommodative monetary policy and the beneficial effect of cheaper energy costs. These were all being interpreted as very favourable factors because they were being reinforced by price moves,” he pointed out.


“Of course today, we’re much more inclined to put the reverse interpretation on those things, that the low oil price is in some way telling us something about global growth and that we are not to interpret that as a boost which, not only do I have trouble with, I fundamentally disagree from the perspective of consumers of energy, it is an undeniable benefit to have those energy costs falling.”

Another concern that is rocking markets at the moment, according to Andrew, is the threat of negative interest rates. While he says this could create systematic issues, he says that investors have chosen to tie this in with concern surrounding the impotence of policymakers which has further damaged market behaviour.

“We can see it’s easy to convince ourselves to be very gloomy, as it is to convince ourselves to be very upbeat and optimistic,” he continued.

“If there’s one thing the past 12 months has taught anyone at all it should be that you need some kind of approach and framework that requires taking a step back and seeing what’s changed, because if we limit ourselves to being shown the facts by brokers and the media then we are at the mercy of the ebb and flow of that noise.”

Andrew believes that a focus on value is prudent. He notes that this does not allow investors to predict asset price behaviour over the short to medium term, but instead measures the genuine risk level of an investment over the long term.

He adds that investors need to draw a distinction between volatility, which is the market’s judgement on asset price on a day-by-day basis, and risk, which is how much money an investor could lose and never see again.

To put this into practice, he looks at the nominal yield of bonds which is adjusted for the market’s inflation expectations to provide a real yield measure. For equities, he looks at real earnings yield – the inverse of the P/E ratio – which has again been adjusted for inflation expectations.

“It’s essentially asking what degree of compensation you require for owning a certain asset,” he explained.

“Has the required degree of compensation adjusted? It has. We require a greater degree of compensation in equities and we require an even greater loss in areas of the bond market. We require a guaranteed loss in bonds for the supposed safety of not putting our money at risk.”

The manager has found that developed market government bonds are highest risk at the moment based on valuations, followed by ‘BBB’-rated bonds and US high yield. The least risky assets currently, according to Andrew, are equities in Hong Kong, Taiwan and Korea.

Valuation risk of assets

 

Source: M&G Investments

“The greater risk is still constituted by those erstwhile safe haven assets as they’ve become yet more expensive,” he said.


“I’m certainly not suggesting you’re going to lose to the extent that you would have done in previous cycles, but certainly into positive real yield territory there could be a 20 to 30 per cent capital loss on things like US 30-year debt.”

“It’s a meaningful shift in a sense outside of volatility. It’s actually a risk move. It’s something you can lose money on and not experience the corresponding upside when the market changes its risk belief.”

On the other hand, Andrew says he is still seeing value within equity markets, although he believes that in-depth market analysis is more important than ever given the choppy behaviour of the market.

For instance, while he says that the US market looks to be “okay” in terms of aggregate valuations, he says there are stellar opportunities within the banking sector in particular.  

“It’s important to adopt an approach regarding the consistent indicators that we can, over a long period of time, acknowledge as telling us something meaningful rather than the indicators that come and go and enable us to frighten ourselves and our colleagues with stories,” the manager added.

Since Andrew was appointed manager of the M&G Episode Income fund in 2010, he has outperformed his peer group composite by 10.38 percentage points with an average total return of 29.88 per cent.

Performance of Andrew vs composite

 

Source: FE Analytics

ALT_TAG

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.