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Newton’s Hutchins: Why investors should lower their return expectations

09 December 2016

Newton Investment Management’s Suzanne Hutchins talks about the Newton Real Returns fund and explains why making positive returns will become increasingly difficult in the coming years.

By Jonathan Jones,

Reporter, FE Trustnet

Investors need to recalibrate their expectations on returns in the coming years, according to Suzanne Hutchins, global investment manager at Newton Investment Management and member of its Real Return team.

The period of lower-for-longer interest rates coupled with low inflation has led to a prolonged period of slow growth, with the current ‘bull market’ so far lasting 86 months, according to the manager.

“Global growth both in the developed and in the emerging markets have been slowing down for quite a few decades,” she said.

This has led to valuations becoming high in most asset classes, with both government bonds and equities (asset classes that usually have an inverse relationship) rising together over the course of the last year.

Performance of indices in 2016

 

Source: FE Analytics

“Whether its government bonds, whether its equity, whether its high yield, whether its houses, whether it’s the art market. I think the only place that is still down in the dumps is the antiques market,” Hutchins said.

“We are in very different times. We’ve gone way past the 1980s and 1990s and the time of great moderation when interest rates were in the double digit and inflation was high.”

“We are in a volatile environment, there is lots more uncertainty and much of that has to do with the amount of indebtedness that we’ve got in the global world.”

“We’ve actually got 40 per cent more debt now than we had in the financial crisis but importantly all asset classes are pretty rich.”

“A lot is inflated and we talk about inflation and where is it? Inflation is really all in financial asset prices rather than in our pockets.”

Monetary policies by central banks have led to low interest rates lasting for far longer than many expected, with the Federal Reserve failing to raise rates in the US so far this year and the Bank of England cutting the base rate following the Brexit referendum vote in June.

“Obviously what we’ve all learnt from policy makers is that they can keep the plates spinning for a lot longer than you and I had imagined,” she said.


As such, investors need a fund that will act like a tyre, when the going is good and the road smooth, it has the flexibility to be a Porsche, buying up all in-favour stocks, explains Hutchins. However when markets are volatile, it has to have the flexibility to take risk-off and protect capital, offering security, similar to a Caterpillar or John Deer tyre, she adds.

“We are very much more in preserving capital rather than trying to go out and take a lot of risk right now and in fact return seeking assets net of direct index protection is going down,” Hutchins said.

Over the course of the year, the Newton Real Return fund has made a number of portfolio changes, with a reduction in its cash position the most dramatic.

“Cash in September 2015 was 23 per cent, and at the end of September this year it’s at 5 per cent so that’s gone down,” Hutchins said.

Performance of fund vs benchmark, sector and MSCI World over 1yr

 

Source: FE Analytics

She says while 12 months ago valuations were stretched, they have become more stretched now. As a result, the fund has bought across a range of asset classes including government bonds and - for the first time – emerging markets exposure.

“We have actually got government bonds in the portfolio and duration has helped in the first half of this year and in the last couple of months but with bond yields backing up 100 basis points it’s had a negative effect on portfolio returns,” she said.

The reason for holding government bonds, despite prices remaining high, is that she still sees a global deflationary environment over the longer term.

“I have no idea whether government bond yields on the 30-year average are going to 3.4 per cent, 3.3 per cent etc. - I don’t know.”

“We’ve protected our government bonds by buying some cheap protection just in case yields go higher but we haven’t sold them as arguably over the longer term I think the backdrop in terms of the real economy is more deflationary.”

Within equities, an asset class which the fund has added 6 per cent to over the last year, Hutchins says there are still good businesses that investors have largely forgotten about.

“I still think there are fantastic businesses out there that have fallen by the wayside because everyone has piled into banks and energy stocks over the last couple of months and been selling lovely media stocks and wonderful consumer goods businesses that are going to be around for the next couple of decades,” she said.


Finally, the fund dipped its toes into the emerging markets, this year, with exposure to debt in Mexico as well as equities in India.

“All this euphoria about Mexico and Trump building his wall – I think Mexican debt looks pretty attractive on a real basis and the currency looks fairly cheap, so that’s an opportunity,” Hutchins said.

“[Meanwhile] India is going through its own liquid cycle at the moment and [prime minister Narendra] Modi has been very courageous in his de-monetisation plan which is irrespective of what’s going on with elections globally and that’s creating opportunity.”

“As they withdraw 86 per cent of the cash and currency out of circulation to make sure that they try and stamp out the black economy and get everyone going to the banks and paying their taxes, there will be a bit of a growth slowdown in India but there are lots of wonderful businesses out there and obviously a deep and growing population and growing wealth as well.”

While the £9.7bn Newton Real Return fund, run by Iain Stewart, has underperformed its benchmark over the past decade, it is ahead of the IA Targeted Absolute Return sector, as the below graph shows.

Performance of fund vs benchmark, sector and MSCI World over 10yrs

 

Source: FE Analytics

The four crown-rated fund has lost 6.72 per cent over the last three months, having been positioned defensively in the run-up to the US elections, which saw US equity markets rally following the election of Donald Trump.

However, the fund has consistently made a positive return over the last five calendar years and has only one negative year since 2006.

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