The key to building portfolios resilient enough to withstand different market environments is to remain flexible, according to JP Morgan Asset Management’s Shrenick Shah.
Although diversification remains a valuable attribute at this point in the cycle, the co-manager of the multi-asset £1.2bn JPM Global Macro Opportunities fund said being able to adapt to different environments is more important.
While investors often get significant returns from equity markets towards the end of the cycle, volatility also tends to increase.
As such, from a portfolio management perspective, the uptick in volatility means some positions in multi-asset portfolios have to be adaptable to respond to various circumstances, the manager said.
“Whilst 2017 was a nice upward-trending, strong-synchronised-growth year, we are seeing that shift,” he explained. “So, when we are talking about recessions and causes, this is one we are keeping an eye on to make sure we don’t get hurt from this particular angle.
“Most investment processes need to have some adaptations as we go into late cycle, so we are being more flexible.”
He added: “Late cycles typically last around two years and often you get significant returns from equity markets, but you also get increased volatility, so we need to increasingly be flexible to manage around these periods and prepare the portfolio for an eventual recession.”
Performance of indices month-to-date
Source: FE Analytics
Although it hasn’t been particularly volatile for many, 2018 has seen two US markets sell-offs: one at the beginning of the year and the most recent one earlier this month.
The latter one, spurred on by the Federal Reserve’s rate tightening cycle and growing concerns over global growth, saw US markets sell-off by just over 3 per cent.
And, although it didn’t catch many by surprise, it has also raised concerns about whether markets are going to see the eventual return of volatility characteristic at this stage of the cycle.
As such, the FE Alpha Manager said he has three strategies in place in order to increase portfolio resilience.
These, he said, are focused on short-term developments, medium-term cyclical trends and long-term structural trends.
“We have a heavier penalty on liquid assets like emerging market debt for example, so for us to hold emerging market debt at this point of the cycle becomes more difficult to do,” the JPM Global Macro Opportunities fund manager explained.
“The other strategy we have in the portfolio in this context is diversifying across time horizons. I think people are very confident with the notion of diversifying across assets but not that much when it comes to different time horizons.
“As we get to the end of the cycle we are trying to lessen our exposure to business cycle strategies and increase our exposure to structural and to higher frequent strategies just to lessen the dependence on whether we are going into recession or not.”
The short-term strategy, he said, consists of being long South African hard-currency debt and short local-denominated debt.
“South Africa’s potential pace of economic growth is low,” said the FE Alpha Manager. “There are two key imbalances: the fiscal deficit and the current account deficit. The sum of the two imbalances is deteriorating, it’s going down.
“This is mainly driven on portfolio flows. As the US rises interest rates, US debt become a lot more attractive than South African and you get a flow of funds shift.
Performance of index vs Fed funds rate over 10yrs
Source: FE Analytics
“We are making the bet that as we get this flow of funds shift as the US continues to rise interest rates there is money leaving South Africa and in that situation of a twin deficit that is going to leave the currency quite vulnerable,” the FE Alpha manager highlighted.
The second strategy, he said, is a cycle play, and consists of being short sterling versus long dollar due to the domestic economy’s low growth prospects over the long term.
“The potential growth in the UK has taken a step down because productivity remains quite low and the impact of net migration reduces the labour force growth,” said Shah.
“Investment in the UK – post-Brexit – has gone really nowhere whereas investment post-2016 in the US has accelerated quite notably.”
The final and most interesting strategy according to the JP Morgan manager is a structural play that is not influenced by the business cycle and will continue to outperform whether there is an economic recession or not.
“We see very fertile ground for structural implementations in the tech effective arena. A secular long-term [idea] not really affected by the business cycle is electronic payments,” the JP Morgan manager added.
“The total addressable markets for consumer to business payments is around $45trn and what we are seeing very steadily is an increasing share of that.
“That increasing pool of retail spending is growing at 5 and 6 per cent per annum, the shift to electronic payments is around 1 per cent per annum which gives you a base growth structure for the industry of about 10 per cent per annum.”
A good example of such an investment is American payment products provider Visa, a company he said that the team likes and believes offers good value compared to its returns prospects.
Performance of fund vs sector since launch
Source: FE Analytics
Since launch in February 2015, JPM Global Macro Opportunities has delivered a 19.76 per cent total return compared with a gain of 4.36 per cent by the average fund in the IA Targeted Absolute Return sector, although it should be noted that the sector is home to a range of strategies.
The fund has an OCF of 0.75 per cent.