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FE Alpha Manager Luke Newman warns on reflation

Luke Newman, co-manager of Henderson UK Absolute Return, considers the potential impact of reflation policies and what has driven performance so far this year.

Rob Langston

By Rob Langston, News editor, FE Trustnet
Thursday May 18, 2017

Reflation policies promoted by populist politicians could pose a challenge for equity markets, according to Henderson Global Investors’ Luke Newman.

FE Alpha Manager Newman (pictured), who co-manages the £2.1bn five crown-rated Henderson UK Absolute Return fund alongside Ben Wallace, said, while the fund is market direction agnostic, this factor is a potential headwind for equity markets.

He said: “My concern is if populist politicians are successful within reflation aspirations it could prove a headwind for equity markets.

“When you look at benefits to equity marks of yield expansion and higher returns to bans and capex response for industrials companies, they are positive events for share prices in aggregate but smaller in total.

“If we do see inflation restarted in western economies – such as the US, Europe and Japan – that probably causes as sharper unwinding of stimulus policies for central banks and probably increases the need for some normalisation within the rate cycle within a historical context.”

Newman said such a move would be “bad news” for areas such as utilities and consumer staples, which are exposed to reflationist policies.

The manager said he and Wallace made moves to protect the fund and take advantage of opportunities as a result of recent European elections.

He said: “In keeping with previous years, the tactical book looks to build positions ahead of elections; quite a few more material share price volatility and opportunities for us come pre-referendum or elections.

“It also ensures we have some active hedging, typically through tactical positions to protect fund as whole, to preserve capital and capitalise where we can.”

Although the fund has a UK bias, it is able to invest up to 40 per cent of the portfolio in non-UK positions.

“European names have been profitable on long and short side. In the US, probably as a function of the US equity markets being strong, we anticipate that we have made money on the long-side but the short book has not been positive contributor this year,” he said.

The fund, which aims to achieve a positive absolute return over the long term regardless of market conditions, has returned 2.18 per cent. Last year the fund was up by 1.58 per cent, however, over three years the fund has returned 18.1 per cent.

Performance of fund YTD


Source: FE Analytics

“We don’t expect all parts of the book to contribute at various times. We have constructed the portfolio in aggregate to ensure that whatever the macro scenario or direction of markets, we can first preserve capital and then [have] aspirations for high single-digit returns without taking undue levels of volatility.”

Newman said performance of the fund during the first part of the year had been pleasing, noting several ongoing themes within the portfolio.

He said: “The changing characteristics of markets, of increased individual stock dispersion and lower correlation between the instruments we’re trading within, have translated into a better stockpicking environment and we have been able to translate that into strong performance.”

The fund manager said he has continued to employ a barbell strategy for the fund focused on companies exposed to the reflation trade and so-called ‘bond proxies’.

Companies found in the reflation basket include more rate-sensitive stocks such as banks and industrials, said Newman.

He added: “Equally we’ve been short mining and commodities most of this year, although we have covered shorts in the past few weeks.

“It would’ve been wrong strategy to buy every classic cyclical. Although that worked for the early stages of what became known as the reflation trade in 2016, actually it has been a market which rewarded stockpicking and fundamentals to much greater degree.”

Yet, things haven’t been as straightforward in the bond proxies basket of the fund strategy.

“I think a frustration for stockpickers was that individual fundamentals and bottom-up approach was not really being rewarded,” said Newman. “The only real way to invest or trade that area of the market was to have one eye firmly on the shape of the yield curve or bond market.”

Despite concerns about the expensive stocks, the manager said there have been opportunities to take advantage both on the long and short side.

“If a company has a degree of cyclicality in top line, deliver against sometimes high expectations and volume growth in environment such as this then multiples can not only be justified but are a staging post on journey to further outperformance,” he explained.

“However, if performance is not justifying expectations of what is implied in share price, it was environment you shouldn’t be afraid equally of taking some of better quality companies on short side.

“We have had successes in telcoms, healthcare, government outsourcing and retail where the halo has begun to unwind from a number of corporates that really aren’t getting away with mediocre operational performance just because yield compression has benefited the share price. It’s been a real boost to the short book and we have benefited from a breakdown in correlation.”

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Data provided by FE. Care has been taken to ensure that the information is correct, but FE 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.

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