Recent changes illustrating our flexible approach
The Real Return strategy has been making full use of its flexible approach to seek to take advantage of the changing and volatile backdrop.
Fixed income
We tactically increased the portfolio’s investment-grade bond exposure in the second quarter of 2020, as a better substitute for cash, and to take advantage of the value that had appeared during the market disruption, which had been underpinned by central-bank demand. Subsequently, investment-grade spreads (the yield premium over US Treasuries) rallied significantly, driven by optimism on the pace of reopening after lockdown and the news of the US Federal Reserve’s introduction of primary and secondary market corporate credit facilities. This illustrated that the potential for any additional return in allocating to corporate bonds to take advantage of the coronavirus market disruption had mostly passed. We therefore then began to reduce corporate-bond exposure and invest the proceeds in what we viewed as more attractive opportunities, such as undervalued equities.
The recovery in investment-grade credit has been much faster than in 2009 as central banks have this time been more coordinated and faster to act. However, at the same time, the fundamentals are mixed and the full effect of the crisis on issuers is still to be revealed. We expect to see a continued increase in the number of ‘fallen angels’ (investment-grade issuers downgraded to high yield) throughout this year, as well as general downward rating migration for the more challenged business models. Nevertheless, with dispersion between industry sectors remaining high, there is still an opportunity to add value through active credit selection.
We increased government-bond duration1 from low levels during the first quarter of 2020, which initially provided some cushion during market turbulence, although government bonds were ultimately used by investors as a source of liquidity in what rapidly became a liquidity squeeze. We increased the portfolio’s return-seeking core after the March sell-off, at the same time tactically increasing exposure to duration as an offset by using 10-year US Treasury futures2 to provide optimal liquidity should we quickly want to sell. We do still see government bonds as a useful ‘hedge’ should the global economy suffer a worse-than-expected recession and corporate profit margins be eroded.
Gold
We have held gold in the strategy for more than a decade, recognising its appeal as a real asset that cannot be manipulated or debased. Gold forms a substantial part of the strategy’s stabilising layer, and has been a proven hedge during inflationary periods. Our gold position has not been immune to this year’s market volatility and, as one of the most liquid assets, initially suffered from the need for mass liquidations. It has, however, begun to work as an indirect hedge in the portfolio and we have been adding to the position. Given the huge level of fiscal stimulus we have seen from governments, in addition to unprecedented monetary stimulus, we continue to favour it as a hedge against the likely resurgence of inflation expectations.
Equities
Since Real Return is unconstrained in terms of its asset allocation, we can, to a significant degree, step away from equities if we see poor near-term prospects. However, we also have considerable potential to harness stock selection in seeking to deliver a superior outcome. It is important to note that global equities are not a homogenous asset class, and one of the consequences of the pandemic has been to catalyse a significant bifurcation between the ‘winners’ and ‘losers’.
During the current crisis, more economically sensitive companies (many of which had already been under pressure for much of 2019), as well as those dependent upon ‘normal’ patterns of human activity, have lagged. Undoubtedly many of these companies are beset with structural and balance- sheet issues that are likely to render them poor long-term investments. Nevertheless, it feels as though a few babies have been thrown out with the bathwater. In all but the most negative public health and economic scenarios, such situations appear to us to represent the best hunting ground for opportunities at the present time, although clearly it is vital to be highly selective. In this vein, we have recently been adding to companies in areas such as mining, industrials and insurance, to achieve a balance alongside strategic positions in sectors favoured by our longer-term thematic work, including health care, technology and branded consumer exposures.
Building a return profile
A multi-asset strategy can build its return profile by drawing on the different return characteristics of the securities that it invests in. In today’s low-yield world, we believe that, with careful security selection, an income of about 2.4% per annum could be a realistic target for investors, while aiming for a capital return of at least 4% per annum from return-seeking assets. Through a business cycle, stabilising or hedging assets can offer the prospect of a lower but still positive annual return, while tactical asset-allocation flexibility can also have the potential to contribute positively. In aggregate, these elements seek to provide a respectable return profile in a very low-yield world.
Conclusion
While policymakers’ unparalleled attempts to stimulate economies via both monetary and fiscal means appear likely to keep the party going for now, the many unknowns that exist around the shape of any recovery from the pandemic and associated economic disruption mean that markets are likely to remain highly volatile. Drawing on our long-term investment themes, which help to provide perspective against a distorted backdrop, our Real Return strategy’s unconstrained nature enables it to offer a flexible approach to asset allocation, with the ability to be nimble and respond to surprises along the way. Such a focus could be valuable for portfolios as both a stabilising element and a diversifier, without forgoing the possibility of participating in capital growth.
1 Duration is a measure of how quickly a bond will repay its true cost – the longer it takes, the greater exposure it has to changes in the interest-rate environment.
2 A future is a financial contract obligating the buyer to purchase an asset at a predetermined future date and price.
Past performance is not a guide to future performance. Your capital may be at risk. The value of investments and the income from them can fall as well as rise and investors may not get back the original amount invested.
Newton Real Return strategy key investment risks
- Performance Aim Risk: The performance aim is not a guarantee, may not be achieved and a capital loss may occur. Strategies which have a higher performance aim generally take more risk to achieve this and so have a greater potential for returns to vary significantly.
- Currency Risk: This strategy invests in international markets which means it is exposed to changes in currency rates which could affect the value of the strategy.
- Derivatives Risk: Derivatives are highly sensitive to changes in the value of the asset from which their value is derived. A small movement in the value of the underlying asset can cause a large movement in the value of the derivative. This can increase the sizes of losses and gains, causing the value of your investment to fluctuate. When using derivatives, the strategy can lose significantly more than the amount it has invested in derivatives.
- Changes in Interest Rates & Inflation Risk: Investments in bonds/money market securities are affected by interest rates and inflation trends which may negatively affect the value of the strategy.
- Credit Ratings and Unrated Securities Risk: Bonds with a low credit rating or unrated bonds have a greater risk of default. These investments may negatively affect the value of the strategy.
- Credit Risk: The issuer of a security held by the strategy may not pay income or repay capital to the strategy when due.
- Emerging Markets Risk: Emerging Markets have additional risks due to less-developed market practices.
- Liquidity Risk: The strategy may not always find another party willing to purchase an asset that the strategy wants to sell which could impact the strategy’s ability to sell the asset or to sell the asset at its current value.
- Shanghai-Hong Kong Stock Connect and/or the Shenzhen-Hong Kong Stock Connect (‘Stock Connect’) risk: The strategy may invest in China A shares through Stock Connect programmes. These may be subject to regulatory changes and quota limitations. An operational constraint such as a suspension in trading could negatively affect the strategy’s ability to achieve its investment objective.
- CoCos Risk: Contingent Convertible Securities (CoCos) convert from debt to equity when the issuer’s capital drops below a pre-defined level. This may result in the security converting into equities at a discounted share price, the value of the security being written down, temporarily or permanently, and/or coupon payments ceasing or being deferred.
- Counterparty Risk: The insolvency of any institutions providing services such as custody of assets or acting as a counterparty to derivatives or other contractual arrangements, may expose the strategy to financial loss.
- Investment in Infrastructure Companies Risk: The value of investments in Infrastructure Companies may be negatively impacted by changes in the regulatory, economic or political environment in which they operate.
Investment performance – 12-month returns (%)
| Jun 19 – Jun 20 | Jun 18 – Jun 19 | Jun 17 – Jun 18 | Jun 16 – Jun 17 | Jun 15 – Jun 16 | |
| Newton Real Return representative portfolio (GBP) | 1.35 | 8.99 | -0.97 | -1.48 | 9.00 |
| Performance benchmark | 4.60 | 4.74 | 4.43 | 4.34 | 4.55 |
Source: Newton, as at 30 June 2020. Performance calculated as total return, income reinvested, in GBP, net of 0.75% annual management charges. Information shown above is for a representative portfolio which adheres to the same investment approach as the Newton Real Return strategy.
1-month GBP LIBOR +4% is used as a performance benchmark for this strategy. The strategy seeks to deliver a total return of 1-month GBP LIBOR +4% per annum over rolling 5-year periods, from a globally diversified portfolio. In doing so, the strategy aims to achieve a positive return on a rolling 3-year basis. However, a positive return is not guaranteed and a capital loss may occur.
Important information
This is a financial promotion. These opinions should not be construed as investment or other advice and are subject to change. This material is for information purposes only. This material is for professional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those securities, countries or sectors. Please note that holdings and positioning are subject to change without notice.
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Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England No. 01371973. Newton Investment Management is authorised and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation. Newton Investment Management Limited is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton’s investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. ‘Newton’ and/or ‘Newton Investment Management’ brand refers to Newton Investment Management Limited.
This material is for Australian wholesale clients only and is not intended for distribution to, nor should it be relied upon by, retail clients. This information has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person. Before making an investment decision you should carefully consider, with or without the assistance of a financial adviser, whether such an investment strategy is appropriate in light of your particular investment needs, objectives and financial circumstances.
This information is made available by Newton Investment Management Limited and BNY Mellon Investment Management Australia Ltd (AFSL 227865). This information is confidential and is only provided to Australian wholesale clients (as that term is defined in section 761G of the Corporations Act 2001 (Cth)). This is not an offering or the solicitation of an offer to purchase an interest in the Newton Real Return strategy. This document is for general purposes only and should not be relied upon as financial product advice. This document has been prepared without taking into account the objectives, financial situation or needs of any person. Before making an investment decision an investor should consider the appropriateness of the information in this document having regard to these matters and read the disclosure document relating to a financial product. Investors should also consider obtaining independent advice before making any investment decisions. Investments can go up and down and to the extent that this document contains any past performance information, past performance is not a reliable indicator of the future performance of the relevant investment or any similar investment strategy.
Newton Investment Management Limited is exempt from the requirement to hold an Australian financial services licence in respect of the financial services it provides to wholesale clients in Australia and is authorised and regulated by the Financial Conduct Authority of the UK under UK laws, which differ from Australian laws.
Newton Investment Management Limited (Newton) is authorised and regulated in the UK by the Financial Conduct Authority (FCA), 12 Endeavour Square, London, E20 1JN. Newton is providing financial services to wholesale clients in Australia in reliance on ASIC Corporations (Repeal and Transitional) Instrument 2016/396, a copy of which is on the website of the Australian Securities and Investments Commission, www.asic.gov.au. The instrument exempts entities that are authorised and regulated in the UK by the FCA, such as Newton, from the need to hold an Australian financial services license under the Corporations Act 2001 for certain financial services provided to Australian wholesale clients on certain conditions. Financial services provided by Newton are regulated by the FCA under the laws and regulatory requirements of the United Kingdom, which are different to the laws applying in Australia.
