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The big themes Standard Life GARS is positioned for this quarter

27 October 2016

Adam Rudd, multi-asset investment director at Standard Life Investments, highlights the macroeconomic themes the team is watching closely and the ways they’re aiming to benefit from these.

By Lauren Mason,

Senior reporter, FE Trustnet

The continuing demand for yield, the rebalancing of China’s economy and heightened political risk across the board are likely to be some of the biggest market drivers over the medium term, according to Standard Life Investments’ Adam Rudd (pictured).

The multi-asset investment director on the Standard Life Investments Global Absolute Return Strategies fund (also known as GARS) says there are often as many themes in the portfolio as there are strategies, but says these currently fall into a small handful of categories.

GARS aims to achieve 5 per cent more than the value of cash over rolling three-year periods and does this through the use of derivatives, long and short positions and pair trades among other strategies.

This has worked well for the team over the long term but the fund has come under fire recently for making losses over the last year – it is down 3.63 per cent over the last 12 months while its benchmark is up 68 basis points.

Performance of fund vs benchmark over 3yrs

 
Source: FE Analytics

Despite this dip in performance, Rudd believes the team has identified the biggest market themes to keep an eye on and the right strategies to benefit from them over the medium term.

One of the big themes he thinks is set to continue is the ongoing hunt for yield. Following the introduction of ultra-loose monetary policy after the financial crisis, developed market government bonds have seen their prices rocket.

The popularity of the asset class and the subsequent lowering of yields has then seen many investors move into dividend-paying stalwarts or ‘bond proxies’ and areas of the fixed income market that offer higher yields (albeit with more risk) than government bonds.

 “We like instruments such as long-dated US investment grade credit, here we use a segregated portfolio that’s managed by the credit team in Boston,” Rudd explained.

“They have an investment grade portfolio where we’ve asked them to try to minimise downgrade risk. It has an average maturity rate of about 13.5 years and a yield on the portfolio of just over 5 per cent, we think that’s relatively attractive.”

The multi-asset investment director says corporates in the US have responded to low yields by issuing a lot of debt at the back end of the yield curve or, in other words, debt that is held for 10 years or longer.

This has been done to fund M&A or share buybacks. Rudd says it is an area of the market where the yield curve is particularly steep (the gap between yields on short and long-term bonds is greater) and as such, says it is an attractive area of the market to be exposed to.


Another area set to benefit from the hunt for yield is the pan-European equity income space, according to Rudd.

“Our equity fund managers run a high-yielding portfolio where the emphasis is not just on the magnitude of the dividend yield but also its growth and sustainability and we think that is a good place to invest in in equities,” he continued.

“High yield [credit] has also benefitted this year from the ongoing search for yield and we still think it’s a good source of relatively high yield and attractive returns.”

Performance of index over 5yrs

 

Source: FE Analytics

Another broad theme the GARS team is playing is the rebalancing of China’s economy from being manufacturing-centric to driven by domestic consumption.

Rudd says it is inevitable that Chinese growth will continue to slow – while it has currently stabilised at around 6.5 per cent according to Chinese figures, he believes this won’t last for much longer and will progress to a lower, albeit sustainable, level.

“We prefer to express that view through being short the Singapore dollar, short the Korean won and, to some extent, short the Australian dollar,” he said.

“We think all of these are likely to be more reactive and less directly managed than the Chinese yen or the renminbi, but at the same time will suffer from many of the same drivers as the rebalancing in China takes place and the source of the growth changes.

“We think those strategies are likely to be quite protective if you have any issues with global trade or specifically with Chinese credit risk. The other aspect is that yields in places such as Korea and Australia are likely to fall if you get a weakness in China.”

Conversely, the team believes the US – which is a more domestically-focused economy – is likely to be more robust and interest rates there are likely to stay high relative to Australia. As such, he is long the US dollar versus his short currency positions.


A third theme GARS has repositioned for is the heightened levels of global political risk. Aside from Brexit, Rudd says the upcoming US election, the Italian referendum in December and elections in across Europe next year could all contribute to market performance.

To benefit from political risk-premium rising, the GARS team is long the US dollar versus the euro.

Performance of currency vs the US dollar over 5yrs

 

Source: FE Analytics

“Political risk is rising. On the euro we don’t exactly know when it will happen or which of these individual events that are upcoming will be the cause of risk aversion bouts, but we think there will be some - whether it’s the Italian referendum of the French election, for example. We’re comfortable being short the euro for that reason.” Rudd said.

The multi-asset investment director says the team is also long US equity large-caps versus small-caps for similar reasons, given that large-caps are more diversified globally in terms of their revenue exposure.

He said: “Small-caps are less able to navigate any challenges to their business models. If you get changes in political risk in the US, there’s almost a greater reactivity in the large-caps compared to the small-caps.

“On top of that, if any increase in political risk is associated with an equity market correction, the [short position in] high beta small-caps could actually be beneficial in an environment where you get weaker US equities.”

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