Multi-Asset moves in times of turmoil

As the shock of the ‘Brexit’ vote subsides it is tempting for investors to lean into the warm embrace of policymakers’ supportive rhetoric, but it is wise to be positioned for further tumult, says the Real Return team at Newton, a BNY Mellon company.

Investors often have a propensity to stick too close to home when it comes to assessing investment risk factors. An example of this now would be to focus purely on the fallout from the UK’s vote to leave the EU, to the detriment of other headwinds on the horizon.

From the perspective of Newton (BNY Mellon) the threat of the UK leaving the EU was only one of the risks facing the global investment outlook at the beginning of June. Others include (but are not limited to):

• The developed world economic cycle looking tired, with profits and cash flows already turning down.
• The giant credit cycle in both the emerging world and the energy complex remaining fragile.
• China’s credit expansion in this cycle eclipsing anything the world has ever seen before.
• Instability in the banks. While risk asset prices have bounced following the immediate aftermath of the ‘Brexit’ vote, bank shares continuing to languish as ultra-low interest rates undermine profitability. This is particularly the case in continental Europe, where the risks are exacerbated by a mountain of dubious loans.

Due to these myriad risk factors, Newton (BNY Mellon) believes market volatility is likely to remain elevated, even if the initial shock across Europe regarding the referendum result has already started to dissipate.

The combination of high asset valuations (implying low expected returns), a challenged profits outlook and increasing evidence that unconventional monetary policies have done nothing more than provide a short-term sugar rush to economies continues to underpin our portfolio construction.

Newton (BNY Mellon) has been cautiously positioned for some time because we see a continued trend of disappointing economic growth. This, together with the overcapacity that impacts large swathes of our economies, argues for investors to be highly attentive to the characteristics best suited to the current backdrop.

Newton (BNY Mellon) believes an emphasis on traditional asset classes and a deep understanding of what you own and how those assets are likely to behave in different market environments is crucial. The BNY Mellon Global Real Return Fund (EUR) seeks alpha through its return seeking core, with a proven ability of stock picking resilient businesses with strong cash generation over time.

The team balances this participation in risk assets with a multi-asset approach to capital preservation through an insulating layer. This is made up of risk offsetting positions aimed to dampen volatility in the return-seeking core of the fund.

In the first half of the year this diversification and hedging has served us well. As at 30 June 2016 Newton (BNY Mellon) had gross exposure of around 54% in the return seeking core (over 50% in equities and the rest in a combination of infrastructure, convertibles and renewable energy). Net exposure in the return seeking core at the same date was much lower at around 28%, with approximately 26% in equity protection (delta adjusted derivative exposure) and over 45% in stabilising assets including precious metals, cash and government bonds.

In the second quarter of 2016 the fund returned 3.67% and over one year it returned 5.10%. Over both of these timeframes the fund has comfortably exceeded its performance objective of Euribor + 400bps.