Markets are moving into “uncharted territory” as central banks begin to withdraw loose monetary policy, prompting the team behind Standard Life Investments Global Absolute Return Strategies to take more risk-off positioning, according to Aberdeen Standard’s Neil Richardson.
Richardson – investment director within the multi-asset investing team responsible for the Standard Life Investments Global Absolute Return Strategies, or GARS – said that investors should already be preparing for a very different environment than they may have grown used to.
“The further we get from 2008-2017 the more unusual that period will look,” said Richardson. “A 20 per cent [annualised] return for most equity markets but exceptionally low volatility, clearly, that period is long past.
“Anybody who believes investing in a simple equity beta fund is going to generate steady returns is going to be badly disappointed.”
Performance of indices 2008-2017
Source: FE Analytics
The strategist said markets have now moved into a more difficult investment environment, particularly in the US where it is “clearly much later cycle”.
US unemployment is down to levels not seen since 1969, leaving very little slack in the economy, and normalising interest rates are having a depressive effect on growth in the US and rest of the world, said Richardson.
“We spend a lot of time analysing the outlook but we are in uncharted territory,” he explained. “We’re coming from 10 years of extraordinarily aggressive monetary policy with QE [quantitative easing] and now QT [quantitative tightening].
“The impact is already much stronger – particularly in emerging markets – than people would have forecast a year ago. We’re still going through this process and it’s quite difficult to be certain how that continues to play out.”
As well as the unwinding of extraordinary monetary policy enacted since the onset of the global financial crisis, there are a couple of other challenges for markets playing out in the macroeconomic sphere.
The first is the ongoing trade dispute between China and the US, as president Donald Trump has pursued a harder line over perceived unfairness and accusations of intellectual property theft.
Tariffs imposed on China have had a significant impact on Chinese equities and the broader emerging market benchmark.
“It’s the first time in my career – and I started in investments in 1985 – that we have the two largest economies in the world engaged in a trade war,” said Richardson.
“It does feel like the US has a bigger mandate in mind than simply tackling trade: it’s trying to contain China and particularly aggressive Chinese moves to dominance in a number of tech sectors.”
Another potential issue for markets, according to the strategist, is the threat of default by a eurozone member and a key component of the European economy: Italy.
“In Europe we had imagined that sovereign risk would be secured but with a populist government in Italy testing the EU’s patience with an aggressive budget deficit again sovereign risk is rearing its ugly head,” he said.
“So, we have three issues that will provide headwinds that will make future returns from risk assets certainly less reliable and – we think – less rewarding. This is a much more difficult market for a simple diversified growth fund.”
Indeed, the changing investment landscape is likely to pose challenges for multi-asset strategies, such as the GARS fund, testing managers’ abilities to navigate a new market environment.
“We’ve had an enormous bull market in bonds and there’s the potential that that might be coming to an end,” he said. “Certainly, we can’t expect returns from rates to be as good as they have been for the past 30 years.
“At the same time [US] equities look extended in terms of valuation we think the earnings expectations look to high and we see risks in technology.”
Richardson said while US equities have been a strong performer for the strategy and make up the largest single position in the portfolio on a risk-adjusted basis, it has become more cautious given the one-off nature of supportive conditions for the market.
“We know earnings growth has been propelled by tax cuts and the fiscal spend the US government announced earlier this year, so S&P earnings were growing at around 20-25 per cent for a couple of quarters and that’s now going to come off quite steeply,” he explained.
Performance of indices over 2018
Source: FE Analytics
One area the team has become particularly more careful of is technology, where the optimal set of conditions that have propelled the sector’s growth over the past few years is likely to end.
“It has had minimal regulation, minimal taxation and not an awful lot of competition for the majors against a background where global economy has been accelerating,” Richardson explained. “All of these look like they’re going into reverse.”
The strategist noted that the global economy is beginning to slow, while taxation is going to become a much greater issue – highlighting the UK’s digital services tax announced at the end of October. Competition from tech giants in Asia – such as Tencent and Alibaba – as well as an increasingly competitive environment in the cloud computing space will also slow growth. Furthermore, greater regulation about the use of data, following several high-profile scandals is likely to make life a bit more difficult.
“There’s extreme positioning in technology,” said the multi-asset specialist. “Everybody is long tech because it’s the one part of the market that has consistently generated positive returns over last four or five years.
“That has led to valuation extremes and wouldn’t take much to turn from a ‘blue sky’ scenario we’re enjoying now to see quite significant drawdowns.”
Generally, the team has taken a more risk-off approach heading into the fourth quarter increasing duration exposure and offsetting exposure to growth-orientated plays such as the Korean won, European banks and Japanese equities.
“We were taking some risk off the table and protecting the portfolio further into what we thought could be a bumpy period,” he said. “With the benefit of hindsight it was good timing.”
The Standard Life Investments Global Absolute Return Strategies fund has struggled over the past year, delivering a 5.27 per cent loss compared with a 0.76 per cent return for the LIBOR GBP 6 Months benchmark.
Performance of fund vs sector & benchmark
Source: FE Analytics
Over the past 12 months the fund has shed £6.4bn in assets, according to data from FE Analytics, although it remains one of the largest funds in the Investment Association universe with more than £15bn in assets under management.
The fund has an ongoing charges figure (OCF) of 0.89 per cent.