Trimming exposure to UK and European equities before the Brexit referendum then adding to short-dated bonds and the US dollar after the vote have helped Columbia Threadneedle’s Toby Nangle to produce some of the absolute return sector’s best returns post-23 June. 
Following the referendum result on 23 June, many investors have been facing the question of what to do with their portfolios given the UK public has voted to quit membership of the European Union. While both the market and the bookies appeared to believe that the UK would opt to maintain the status quo and remain in the union, it was the Leave campaign that proved victorious after winning 53.4 per cent of votes cast.
However, Nangle – who runs the £267.1m* Threadneedle Dynamic Real Return fund – has an approach that involves constantly appraising the risk/reward balance and this meant that he was not overly exposed to the fallout of either a Remain or Leave result.
In an article published on FE Trustnet recently we looked at the process behind Nangle’s funds, which has a heavy emphasis on determining how risk across asset classes is likely to be rewarded then allocating to them in reflection of how much risk the team feels comfortable taking.
“As an unconstrained active asset allocation fund we can pick and choose what battles we want to fight, as we are not beholden to any asset class, rather invest on each individual asset class’ prospective risk and return merits,” Nangle said.
The flexibility of the fund’s approach was recently highlighted in the run-up and aftermath of the UK’s referendum. Between 23 June and halfway through July 2016, Threadneedle Dynamic Real Return achieved a 4.34 per cent total return, net of fees.
This is 68 basis points more than the FTSE All Share and 4 percentage points above the average return made in the IA Targeted Absolute Return sector. Of the 104 funds in the peer group, Threadneedle Dynamic Real Return is ranked 15th over this period.
Performance of fund vs sector and indices between 23 Jun and 15 Jul 2016
Source: FE Analytics. Sterling total return with income reinvested, between 23 June 2016 and 15 July 2016. Returns net of fees. Past performance is not a guide to future performance.
Broadly speaking, the fund’s management team builds the portfolio around whether it has a strongly favour, favour, neutral, dislike or strongly dislike view on risk. In the run up to the UK’s vote to leave the EU it was moved to the ‘dislike’ category given how markets had behaved in advance of the vote, meaning the fund is more likely to invest in assets that aim to protect investor’s capital and are less volatile, as they believe volatility will not be rewarded as well.
Nangle and his team had been reducing risk in the run-up to 23 June and the portfolio had been constructed in such a way that a vote either way would have minimal impact.
Before the vote was held he said: “Effectively we are waiting for the fat pitch, this has meant to-date we have not positioned the portfolio to benefit from either a ‘Remain’ or a ‘Leave’ vote, as we would rather wait for a valuation opportunity rather than gamble on guessing correctly the views of the Great British public.”
On a portfolio level, this involved reducing UK small-cap exposure, hedging its physical European ex UK equities allocation through a EuroStoxx 50 hedge on around 4 per cent of the positon, reducing Japanese equities and removing its currency hedge, and trimming European high yield exposure.
Before the EU referendum appeared on the horizon, the team had a favourable view of UK, eurozone and Japanese equities, as well as European high yield. The high yield space had been a particularly important driver to the fund’s strong performance after being reintroduced to the portfolio in December 2014 on the back of compelling valuations.
However, the fund’s focus on achieving the most appropriate risk/reward balance and flexible nature meant they were reduced when the management team foresaw the potential for them to come under pressure.
“In the run up to the vote we positioned the portfolio so that it would not be positively or negatively impacted by the referendum vote,” the manager said. “Over the month we reduced the overall risk within the portfolio, when we moved from neutral to dislike risk. We built a sizeable non-sterling exposure to protect the fund in the event of a Leave outcome.”
As the graph below suggests, the decision to move away from sterling was prescient given the strong falls that have been seen in the pound since the referendum result became known.
Performance of sterling vs US dollar, euro and yen between 23 Jun and 15 Jul 2016
Source: FE Analytics
The fund’s dynamic asset allocation and flexibility means that Nangle has made further changes to the portfolio after the Leave victory was announced, in order to position it on the most attractive part of the risk/reward spectrum.
“Post-referendum, we have removed the final holding in UK small-cap equities and the EuroStoxx 50 hedge. We also reduced our underlying European ex UK equities and UK property allocation,” the manager said.
“We un-hedged part of the Mexican government bond exposure, while we increased our UK short-dated corporate bond and UK large cap equity exposure, as well as increasing the US dollar exposure via currency hedging some of the UK equity exposure into dollars.”
The fund has now completely removed its UK property exposure although, as the table below shows, it has a favourable view of the asset class outside of UK. Other areas it continues to see opportunities in include Japanese equities and high yield bonds.
Columbia Threadneedle’s asset allocation strategy view – June 2016
Source: Columbia Threadneedle Investments as at 30 June 2016. For illustrative purposes only.
While the group remains positive on property over the medium term given its strong income characteristics and orientation away from the risky central London office market, Nangle judged that there appeared to be more compelling investments from a risk-adjusted basis over the next twelve months for the Dynamic Real Return fund – which has no income requirements – while the impacts of Brexit are revealed, and so the team exited their property holding for the fund.
*As at 30.06.2016.
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