Toby Nangle and Maya Bhandari, managers of the Threadneedle Dynamic Real Return Fund, on how a rigorous research and valuation framework has helped deliver positive returns
Toby Nangle, manager of the Threadneedle Dynamic Real Return Fund, presents an active asset allocation portfolio that seeks to deliver a return in line with UK inflation +4% per annum over a three to five year period. In this ebook, Nangle and deputy manager Maya Bhandari reveal the rigorous valuation framework the team use to help drive the portfolio’s construction. The Fund can be zero-weighted in any asset, Bhandari explains, and there is no ‘neutral’ allocation, so every investment position is a risk position.
The rise of multi-asset solutions in recent years has been well documented and for good reason: years of easy monetary policy have resulted in high asset prices despite the fact that global corporate earnings have gone roughly sideways for ten years.
Capturing risk and returns in multi-asset revolution
Columbia Threadneedle Investments
This has led investors and retirement savers to seek returns in riskier areas of financial markets, such as emerging market and sub-investment grade corporate bonds. And in the wake of RDR, advisers are now tasked with meeting ongoing client suitability requirements, with risk profiling and diversification among the most important components in deciding suitability. Toby Nangle is Head of Multi-Asset, EMEA at Columbia Threadneedle Investments and believes that proper portfolio diversification, along with an absolute return solution which lasts through the retirement cycle, is key to managing today’s episodically volatile market.
Value in diversification
Nangle says: “By confining yourself to a particular local market, you are attaching yourself to the economic developments of that local geography, which might not always be the thing you want. The market in a particular geography can also be sector-skewed. “As an extreme example, Nokia was a very successful global firm, which at one point in 2000 represented around 70% of the market capitalisation of the Finnish stock market. “Those investing passively in their home equity market are still waiting to recoup their losses seventeen years later. Similarly, Japanese domestic investors are waiting to recoup losses 27 years after the Topix peaked in 1989. “One of the great things about the multi-asset style of investing is the ability of fund managers to capture individual high-risk, high-return investments and bring them together. And if the assets are poorly correlated, you’ll get a much better risk-adjusted return at the portfolio level. “Ultimately, a diversified portfolio requires the fund manager to ensure that the full portfolio is not just one trade implemented through a variety of asset classes.”
“A diversified fund has to be dynamic with the ability to manage different opportunities and risks as they appear,” he says. “This means being responsible for every position in the portfolio and being exposed to areas where future growth on earnings is visible. “Through our Dynamic Real Return fund, we aim to blend the best ideas from around the world to deliver inflation plus returns for investors, but with controlled volatility.” Sitting in the IA Targeted Absolute Return sector, the Threadneedle Dynamic Real Return Fund seeks a real return of UK inflation +4% gross of fees and returns have come from a broad range of investments rather than any one allocation. The benefits of asset allocation have certainly become clearer to many investors over the past ten to 20 years. Regulatory developments, along with the changes to pension’s freedom and new hybrid products across equity, fixed income, and alternatives, have been pivotal in moving the focus for institutional fund management to multi-asset. And the growing interdependence of companies and national economies reflects a paradigm shift, requiring a global perspective to uncover and evaluate opportunities.
The next investment cycle
Despite some wobbles along the way, equity and fixed income markets have seen a prolonged period of performance over the past few years, says Nangle. “We are currently focusing on the degree to which we’re going to have nominal reflation coming through around the world. The market has um-ed and ah-ed about this but we are still firmly in the steady reflation camp. In our view, the areas of the world that should do well in this environment are Europe and Japan from an equity perspective. “As we start to see nominal reflation across Europe, revenues should grow and operating leverage should boost profitability quite meaningfully. We’re really pleased to see evidence coming through to support this thesis. We’re looking for extremely strong profitability growth over a sustained period which will allow valuations for European equities to rise.”
Source: IFR World Robotics 2016
Fund Snapshot: Threadneedle Dynamic Real Return Fund
Threadneedle Dynamic Real Return Fund: performance since inception
Aligning group and fund investment processes
The fund focuses on high risk-adjusted returns, combining macro and micro insights.
Management of the fund is dynamic, active and index-unconstrained.
The fund focuses on high risk-adjusted returns, combining macro and micro insights.
The fund uses a three-stage investment process which is used across all multi-asset strategies at Columbia Threadneedle Investments.
The fund was launched in June 2013 against a target of UK inflation +4%. It has delivered on this through periods of equity volatility since launch when it has been much more resilient during a sell-off than traditional assets. Since inception, the fund has generated positive returns consistently, primarily through well managed asset allocation. The annual returns range from 3.31% in 2015 to 8.65% in 2016. The fund has achieved these returns at approximately half the volatility of global equities.
Threadneedle Dynamic Real Return Fund asset class exposure
Threadneedle Dynamic Real Return Fund investment process
Portfolio Manager, Columbia Threadneedle Investments
What is your investment process and approach?
What is the fund designed to do?
The Threadneedle Dynamic Real Return Fund is an active asset allocation portfolio which seeks to deliver UK inflation +4% returns with up to two-thirds of the volatility of equities over a three to five year period. Our fundamental economic research, alongside a rigorous valuation framework, helps drive the portfolio’s construction. In addition, the fund can be zero-weighted in any asset, and there is no ‘neutral’ allocation (composite of market indices), so every investment position is a risk position. Every trade has to “earn” its way into the portfolio.
Which investments are displaying the best opportunities at the moment?
Something we would like to increase our exposure to is US long-dated inflation-linked bonds. We have got a small position, about 1.25% of the fund invested in this asset currently. We bought the position at a real yield of about 1% and if we were to have a repricing of long-dated bonds, anywhere up to 2%, we may gradually increase our exposure to this sector. We believe long-dated and inflation linked bonds will start to fill the sort of role that historically long-dated fixed income was doing. This will then enable us to also take on more risk elsewhere in the portfolio due to it being non-correlated, or negatively correlated, with other asset markets. We don’t see very many opportunities to do that right now, but we’ve always got our eyes peeled. When there are opportunities to add such assets to the portfolio, we will do so.
What key risk parameters do you identify and how are you mitigating them?
Risk is our starting point for portfolio construction: the overall risk of the fund, but also the risk associated with individual portfolio positions and how they interact with one another. We can have low or high levels of aggregate risk in the portfolio, which in turn is driven by where we see better risk-adjusted returns coming through. We look at various forms of market risk, currency risk and operational risk. The team identifies chief risks that we are managing, and makes sure these are taken on purpose, rather than by accident. Risk is therefore undertaken deliberately, and it is taken with the view that those particular assets will have an attractive reward attached to them. On some investments, we use hedging techniques to mitigate risk. In addition, we also combine a variety of risks that have historically been poorly correlated, and so qualitatively expect them to be poorly correlated in the future.
What is your level of exposure to certain investment themes and regions – and why?
We believe there will be stronger economic growth in the Eurozone and this will allow European companies with high levels of operating leverage, that is to say high fixed costs, to generate margin and revenue increases. Therefore, we’ve recently increased our European equities allocation to around 15%. Another theme we are interested in is Japanese equities. Our Japan position has been in place for four years, and performance has been driven entirely by earnings. So far, there has been no valuation movement from cheap to fair in the sector – so in our view it remains cheap. A third theme is in UK short-dated investment grade bonds. We are getting a good pick-up in this area of fixed income, over and above Government bonds, because investment grade is generally unloved by pension funds and insurance companies in the current market due to the fact it is expensive to allocate capital against the sector within a Solvency 2 framework.
Simply put, we ask ourselves two questions, the answers of which inform our investment strategy across asset allocation portfolios, including Dynamic Real Return. The first is what is going to happen in the real world: for instance, how will inflation, economic growth, earnings and policy decisions develop over the next 12 to 24 months? The second question is: what is in market prices? For example, if we anticipated that the Bank of England was likely to increase rates by 25 basis points next month, and our risk premium analysis revealed that this was fully priced in across UK assets, we then know that there is essentially nothing to be gained by taking a view on that market development within the portfolio. Once these two key questions have been answered we discern with colleagues where our differences within the market are, and concentrate the portfolio positions on those areas.
'Risk is our starting point for portfolio construction: the overall risk, but also the risk associated with individual portfolio positions and how they interact'
Maya is a portfolio manager and member of the Global Asset Allocation team. Before joining the company, Maya spent over 10 years advising buy-side companies on their multi-asset strategies. Most recently, she was a strategist and director at Citigroup within the Global Macro Strategy & Asset Allocation team where she developed broad global macro themes and investment ideas across asset classes. Maya holds an MA (Honours) in Economics from Edinburgh University, and a MPhil in International Relations from Cambridge University. Company start date: 2014 Industry start date: 2003
Toby is currently Global Co-Head of Asset Allocation and Head of Multi-Asset, EMEA. Before joining the company, Toby worked at Baring Asset Management, initially in the fixed income team and subsequently as Director of the Multi-Asset Group. He holds degrees in History and International Relations from the University of Cambridge. Company start date: 2012 Industry start date: 1997
Toby Nangle, Global Co-Head of Asset Allocation, Head of Multi-Asset, EMEA
Maya Bhandari, Portfolio Manager
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