SINGAPORE (Sept 23): The fourth quarter of last year was a challenging time for many multi--asset funds. Trade relations between the US and China soured further, and additional tariffs were imposed. At the same time, the US yield curve inverted for the first time since the eruption of the global financial crisis (GFC) in 2008, sparking fears of a recession. The combination of these factors led to a rare worldwide plunge in the prices of most major asset classes.
Under “normal” circumstances, a multi-asset fund should in theory have been able to mitigate losses through a diversification of asset classes. Yet, equities, bonds and commodities were falling at the same time across major financial markets, offering little refuge for the funds. For example, the MSCI World Index and S&P 500 Bond Total Return index were down 10.4% and 10.3% respectively in 2018. Crude oil price, such as for Brent crude, was down 8.2% during the year.
Fortunately, there were pockets of safe haven assets that were relatively unscathed. One was Asian high-yield bonds, which stayed flat during the quarter and are up about 10% year-to-date, says George Efstathopoulos, portfolio manager at Fidelity International. He is one of the trio of portfolio managers who collectively manage three Fidelity multi-asset funds.
According to Efstathopoulos, the Fidelity funds had on average trebled their exposure to Asian high-yield bonds on an incremental basis from August last year until January this year. The Global Multi Asset Income Fund increased its holdings to 12% from about 3% to 4%. The Asia Pacific Multi Asset Growth & Income Fund raised its holdings to 25% to 30% from a range of 9% to 10%. And the Greater China Multi Asset Growth & Income Fund, which has a greater appetite for risk, enlarged its holdings to 30% to 35%, from 10%. “That helped with drawdown protection,” he tells The Edge Singapore in an interview.
Meanwhile, the First Eagle Amundi International Fund and First Eagle Amundi Income Builder Fund rotated into gold--related securities. This was one of the few asset classes that generated positive absolute returns in 4Q2019, says Matthew McLennan, portfolio manager and head of the global value team at First Eagle Investment Management. Both funds also benefited from their “material” exposure to cash and cash equivalents. In addition, the latter fund benefited from “limited” exposure to corporate high-yield and emerging-market bonds, thus enabling the fixed-income component of the fund to end the quarter at par. Overall, both funds showed resilience during the quarter, says McLennan.
The performance of Aberdeen Standard SICAV 1 — Diversified Income Fund and Aberdeen Standard SICAV 1 — -Diversified Growth Fund was insulated by their exposure to alternative asset classes. This included royalties from social and renewable infrastructure and healthcare, as well as litigation finance, says Mike Brooks, head of diversified multi-asset at Aberdeen Standard Investments. As a result, while global equity markets dropped 17% from peak to trough, both funds dropped by just a third of that. “With different drivers and influences from equities and developed government bonds, these reduce the funds’ correlation [with] traditional assets and markets,” he adds.
Still, about a quarter of the Singapore-registered multi-asset funds available to retail investors were underwater in the one-year period to Aug 30, according to Morningstar data. Most of the funds recorded single-digit returns, with only two recording low double-digit returns.
Plunge in asset prices unlikely
Now, the resilience of multi-asset funds could be tested again. Notably, trade tensions between the US and China are set to escalate. The former is expected to raise the tariff rate imposed on US$250 billion ($344.1 billion) worth of Chinese imports to 30% from 25% come Oct 1. Another US$300 billion worth of Chinese imports, some of which were slapped with a 15% tariff on Sept 1, will see the remainder tariffs come into effect in December. However, on Sept 12, Trump said he would postpone the implementation of the tariffs by two weeks, ostensibly because of China’s national day.
In addition, the US yield curve has inverted again, igniting a fresh round of recession fears. And perhaps, more importantly, economic indicators are showing signs of a weak global economy.
In response, central banks around the world have eased monetary policy to boost growth. Earlier this month, the People’s Bank of China lowered its reserve requirement ratio by 50 basis points for all banks, with an additional targeted 100bps cut for qualified smaller financial institutions. The lower cost of funds would encourage banks to reduce their loan prime rate. On Sept 12, the European Central Bank cut interest rates by 10bps to -0.5%. Then, on Sept 18, the US Federal Reserve cut interest rates by 25bps to a range of 1.75% to 2%.
Still, could we see another plunge in prices of most major asset classes around the world?
“Another plunge in prices across major asset classes will be unlikely. The current weak market sentiment and fear of trade escalation resulted in a shift of investors’ risk appetite into bond and gold recently,” says Ricky Chau, portfolio manager of the Franklin Select Global Multi-Asset Income Fund.
Michael Fredericks, lead portfolio manager of the BGF Global Multi-Asset Income Fund A2 USD and BGF Dynamic High Income Fund A2 USD, agrees. “A global recession leading to a sharp drop in prices is not our base case, yet macro risks appear to be rising. The evolution of trade is difficult to forecast and tensions are unlikely to disappear anytime soon. Any further escalation in trade tensions could lead to a sharp selloff, but again this is not our base case,” he says.
Nevertheless, fund managers are cautious. McLennan of First Eagle IM says the risks to the global economy and financial markets are aplenty. For one, geopolitical tensions are flaring in many parts of the world. Secondly, global debt levels today are higher than they were before the GFC and nearly US$14 trillion of debt have negative yields, he notes. This is compounded by the historically high valuations of many assets. The fast changing nature of today’s world driven by disruptive trends only adds to the complexity. “It is difficult to assess which one of these will trigger the next crisis, but… it could be timely to take a more prudent stance,” he says.
Investec Asset Management head of multi-asset income John Stopford and -Investec Global Multi-Asset Income Fund portfolio manager Jason Borbora-Sheen say the dovish action taken by central banks could be a case of “too little too late”. This is because the lagged effect of prior policy tightening and disruptions to global trade are likely to increase the likelihood of a recession in 2020, they explain. As a result, “uncertainty [is expected] to remain high, [with] more volatility in the second half of the year”.
BlackRock’s Fredericks also worries about the central banks’ lack of firepower to loosen monetary policy. After a decade of an unprecedented ultra-accommodative environment, global interest rates are already close to zero or negative. This means that fiscal stimulus is needed to augment monetary stimulus. However, “this is easier said than done”, he warns.
Seeking shelter
So how will multi-asset funds minimise risks and maximise returns? At Fidelity, -Efstathopoulos says the three funds are currently overweight Chinese equities as part of its contrarian approach relative to other investors. He notes that Chinese equities are cheap as their valuations surprisingly did not soar upon their inclusion in MSCI’s global indices. Moreover, Chinese companies’ earnings growth is robust across more sectors, unlike before. “There is breadth and depth of corporate earnings coming through,” he says.
Also, the funds are keeping their holdings in Asian high-yield bonds, particularly those in China. Efstathopoulos says he still favours them because they are supported by policy measures that reduce funding costs for companies. Although the returns may not be as high as in the past year because of spread compression, he foresees returns of about 6% to 6.5%.
Franklin Templeton’s Chau says the Franklin Select Global Multi-Asset Income Fund has been reducing its exposure to global equities, but increasing its exposure to bonds and cash. In particular, he sees investment opportunities in emerging-market bonds as valuations are fair. “The exchange rate risks in local currency bonds are mitigated by a dovish global central bank policy and this may prompt a continued search for yield,” he says.
On the other hand, McLennan of First Eagle IM says he sees opportunities in equities deemed cyclical in nature and where the market has valued them as if they were already in a recession. For instance, he notes that the share price of a US timber company has taken a hit on concerns of slowing homebuilding. However, the company’s “true value” resides in the ownership of forests, which is an asset that is limited in supply and difficult to replicate, he says.
“Like this stock, the vast majority of our equity holdings, while being potentially volatile over the short run, own or control such scarce, difficult-to-replicate and resilient real or intangible assets. Hence, we believe they should be well-positioned to endure what could be a more challenging economic, financial and geopolitical environment in the decade ahead,” McLennan says.
