More defensive positions and a continued focus on capital preservation have been among the key themes among Fidelity International’s multi-asset income team, says portfolio manager Eugene Philalithis.
The portfolio manager said Fidelity’s range of multi-asset income funds – Fidelity Multi Asset Income & Growth, Fidelity Multi Asset Income and Fidelity Multi Asset Balanced Income – had performed well despite some of the challenges over the past year.
He said: “It’s been quite a strong performance from markets over last 12 months and returns been pretty good.
“We managed to participate in upside of markets and protecting on downside when there was volatility in the fourth quarter last year.”
Performance of funds over 1yr
Source: FE Analytics
Philalithis says he had started to focus on the prospect of higher inflation last year, which is expected to remain a key theme for the team this year.
He said: “Last year we were concerned about the possibility of higher inflation and interest rates; [we didn’t expect] runaway inflation but higher [levels] than the market was expecting.
“Oil prices bottomed out in early 2016 and since then have more than doubled, which has had an impact on inflation but given where we see oil now, we don’t expect to see runaway inflation anywhere, even in the US.
The manager added: “If you look at emerging markets, inflation is falling and is below target in some areas. It means that inflation pressures are slightly easing
“It means that though we expect further rate rises from the US with Federal Reserve quite keen to normalise interest rates, we don’t expect there to be more rate hikes than market is expecting.
“That is supportive in general for bond yields but also means that if there is continued search for yield then that puts pressure on yields of other asset classes and the yield we can deliver to our end investors.”
Philalithis says the team has started to look “more favourably at defensive assets”, particularly in the US Treasury market where yields have risen from the lows of last year.
In government bonds the team has moved to a neutral position from a slightly negative stance, which offers some diversification and protection if there is a pick-up in volatility.
The team also moved into investment grade debt, mainly in the Asian and US markets, where there is less interest rate risk, shorter durations and higher yields.
“We don’t have material exposure to Europe investment grade, we think it’s probably one of the most overvalued marks and would be exposed to change in view or stance by ECB with respect to the QE programme and the risk of a European ‘taper tantrum’,” he said.
Over the past 12 months, the team has taken some profits from its high yield allocation as spreads and yields have fallen following a run of strong performance.
“At the beginning of 2016 there was quite a lot of volatility in markets,” Philalithis said. “We decided in the strategy to increase allocation to high yield because of the valuation and thought that markets were overreacting to some negative news and concerns around China and falling oil prices.”
He says it has reduced its exposure to Asia high yield “more meaningfully” following a convergence of spreads and yields.
The team has added exposure to hybrid bonds – debt instruments with equity-like characteristics – finding value in the financial sector.
He said: “We believe there is still value in this part of the market, particularly in European bank debt where we are seeing continuation of the deleveraging story from a credit perspective.
“The fact that yields haven’t rallied or compressed as much as we’ve seen in corporate bonds because the ECB hasn’t been involved in buying those assets.
“There is still yield and bit of value compare to other parts of markets.”
With a focus on capital preservation and maintaining diversification within the portfolio, the team has added equity market hedges to protect against a potential market correction.
“We have been using equity market derivatives to protect the portfolio against pick up in volatility,” said Philalithis.
Performance of CBOE SPX Volatitity index over 1yr
Source: FE Analytics
“Volatility has been quite low, lower than average, so we are using these hedges to protect against an increase in volatility while still being exposed to an asset class we think on medium-term basis is very attractive and offers a good level of income.”
Philalithis added: “Generally all assets contributed positively to performance and it was particularly encouraging to see high conviction views such as high-yield and hybrids add to returns of portfolio.
“Equity holdings done quite good despite difficult fourth quarter where we saw the search for yield, bond proxies suffer in line with rising yields and some of that is due to the allocation to financials: maintaining positions and adding in weakness where we saw value improving.”
Another area favoured by the team includes local currency emerging market debt, which has recovered from falls following the US presidential election. It has focused on increasing its loan exposure given that they sit higher in the capital structure than high-yield bonds and offer attractive levels of income with better protection.
Two other positions in listed funds have been added to the portfolio: Sequoia Economic Infrastructure Income Fund and Civitas Social Housing.
Performance of listed funds over 1yr
Source: FE Analytics
“The economic infrastructure fund is a slightly different approach to the way we have traditionally invested in social infrastructure,” Philalithis explained. “Economic infrastructure is slightly more risky and has bit more exposure to the economic cycle. The way to mitigate the risk is by looking at the strategy as an investment in debt.
“We’re more senior in the capital structure but can expect attractive yields of 6 per cent per annum. It’s developed marks and very diversified. The difference is that it has a much higher allocation to the US market, a very large market in terms of infrastructure but very difficult to access in the same way as social infrastructure in Europe.”
The Civitas Social Housing Reit also offers attractive yields, says the portfolio manager.
“The yield is at level of 5 per cent per annum and attractive compared to other Reits. Its features appeal in the sense that leases are long and inflation-linked,” he said.
“The locality of social housing compared to other markets is also a positive feature: it diversifies other risks and counterparties are high quality local authorities. You’re not taking much credit risk with counterparties in the same way we do with infrastructure assets.”