Strategies set to benefit from improved earnings growth, corporate profitability and a major directional shift in yields will bolster the returns of Standard Life Global Absolute Return Strategies (GARS) heading into 2017, according to the team.
In its outlook for the year, released yesterday, the team admits the fund’s performance was lacklustre during 2016.
While the fund targets positive returns across all market conditions, it lost 268 basis points over the course of 2016 and experienced higher-than-usual levels of volatility, caused by sharp falls during the first six weeks of the year and in the aftermath of the EU referendum.
Performance of fund vs sector and benchmark in 2016
Source: FE Analytics
However, it must be noted that the fund aims for positive returns over rolling three-year periods and as such, it has still achieved its target and doubled the return of its Libor GBP 6 Month over three years with a 4.08 per cent return.
“GARS produced a particularly negative return in the first half of 2016 that has only partially been mitigated by positive returns in the third quarter and a strong final quarter,” the report states.
“Against a backdrop of gains for global equities and bonds, this left clients seeking clear explanations and action.
“While GARS does not target returns specifically in line with equities or bonds, its objective is to generate positive and substantial returns with low levels of risk. This was not delivered in 2016 and our review documents published over the course of the year explain in detail what happened.”
While the behemoth fund achieved a positive return during the latter half of 2016 following a mass market rotation and boost in sentiment, this did not offset the first half’s losses.
However, the team is confident this upward trend in performance will continue given the strategies adopted in the portfolio, which are based on a positive outlook on the global economy for 2017.
That said, the team highlights that 2017 is not without its risks, given the high levels of political uncertainty across the UK, continental Europe and the US.
“The strategies we hold in GARS today are each expected to deliver a positive return in our central, pro-growth view of how markets will fare,” the report said.
“Collectively, they are also selected and sized to deliver a positive result in a wide variety of other outcomes, reflecting the diversity of drivers that propel returns.
“For each strategy, we evaluate the return we expect to generate before then sizing each one to offer a material contribution towards the overall portfolio’s target.
“While events never unfurl exactly as we envisage, the overall scale of performance potential offers a substantial cushion against uncertainty.”
In terms of its equity strategies, the team increased their exposure to the asset classes during the last financial quarter.
In particular, European equities exposure was increased given the attractive valuations on offer, although the team also increased its exposure to US stocks due to the improved earnings outlook.
“Return potential is equally strong from ‘relative value’ equity opportunities,” it continued. “For instance, our strategy preferring US banks to US consumer staples proved extremely successful towards the end of 2016.
“While the valuation difference between these two sectors has narrowed from its previous record-breaking extreme, the relative growth potential still favours further outperformance by the banks.”
Around the same time, GARS also set up a strategy reflecting its preference for emerging market equities over Brazilian equities. This followed the substantial market gains already made in the country as a result of higher oil prices and the impeachment of Dilma Rousseff.
Performance of indices since 2016
Source: FE Analytics
If Brazilian equities are indeed overvalued as the team suspects, the strategy is set to benefit if the emerging market index catches up as Brazil’s market mean reverts.
The team is also positive on certain areas of the global corporate bond market, given the improving outlook for corporate profitability and the tailwind this could provide for global high yield and US investment-grade corporates.
On the other hand, GARS has reduced its exposure to UK and European corporates following their strong performance in 2016.
When it comes to interest rates generally, the team is looking at the relative movements of government bonds between different countries rather than adopting a strategy for an overall yield rise. For instance, it expects the yield difference between Australian and US 10-year government bonds to narrow over the coming months.
“Similarly, we expect the difference in yield between UK government bonds versus those in Germany and France to narrow,” the team said.
“These moves would reflect the divergences we expect to appear in both monetary policy and broader economic performance of these countries.
“For instance, we believe inflation expectations and interest rates will rise in the US, but remain subdued in Australia.”
In terms of the fund’s currency allocation, the team has aimed to keep it as diversified as possible although it currently favours the US dollar, the Indian rupee, the Norwegian krone and the Japanese yen.
These are all favoured for different reasons; for instance, the team likes the yen because it is a defensive currency while the rupee is a play on India’s interest rates remaining high.
“Because the drivers of each currency strategy are so varied, this is an area where we believe we can generate valuable returns while gaining diversification benefits in the current environment,” it said.
Performance of currencies versus sterling over 1yr
Source: FE Analytics
Elsewhere in the portfolio, the team has increased its exposure to global real estate investment trusts (REITs) for income purposes. It believes the asset class will do well, given it is well-protected against inflation.
GARS also holds a number of volatility strategies across asset classes which aim to profit during times of market volatility.
“Collectively, we believe the strategies that form GARS today offer attractive return potential in 2017 and beyond. In addition, the risk characteristics of the portfolio are appealing, with around one-third of the expected volatility of equity markets globally,” the team concluded.
“As we see the balance of monetary and fiscal policy support tip towards the latter, we expect the range of investment opportunities to continue to grow.
“This will not necessarily benefit equity and bond markets overall. However, it is precisely the kind of environment in which the highly diversified approach we take in GARS should prove rewarding for investors.”