Partner Insight: Columbia Threadneedle Investments' Toby Nangle, manager of the Threadneedle Dynamic Real Return Fund, reveals where he is seeing the best investment opportunities amid market re-ratings
Where are you seeing the best investment opportunities?
From a broad asset-allocation standpoint, we have a clear preference for equities over fixed income, given decent economic growth and gentle reflation coming through, both of which are supporting strong company earnings delivery. We think equity valuations look fair in the context of these earnings, and we are optimistic for continued profit growth over the next 12-24 months.
Our largest equity positions are focused in those markets most operationally leveraged to the current reflationary environment, like Japan, Europe ex-UK and Asia.
Europe has benefited from a lot of policy accommodation from the ECB without many fiscal tailwinds, and has had currency tailwinds coming through to help earnings. In the absence of a global economic crash, we expect this process of healing in the European economy to accelerate into the second half of this year, which will lead to a stronger earnings environment.
In Japan, earnings have been phenomenally strong over the last couple of years, margins have expanded from extremely tight levels, and revenues have surprised on the upside. But every time this has happened, earnings expectations have not been pushed up much further, so all the strong performance has not resulted in pretty much any re-rating, unlike a lot of other markets. I feel quite comfortable with that. Japan has the growth characteristics we are looking for and our people on the ground tell us those are still on track. And if I am wrong about markets de-rating, I don't see any reason why they should not re-rate, which would be even better.
Perhaps a less well-known asset for many investors is our (so far, modest) position in South African local-currency government bonds that we initiated in June. The election of President Cyril Ramaphosa in December 2017 and his ambitious reform agenda was greeted with a punchy rally in South African rates, and we too have been encouraged by some of his policy initiatives. We took advantage of the broad-based sell-off in emerging markets (that all but wiped out the Ramaphosa-related rally) to take a position in 2026 bonds at attractive valuations.
A key consideration for many investors today is around highly correlated assets moving in tandem. How do you look to avoid this and ensure the portfolio is suitably protected?
When we are putting the portfolio together we are mindful of historic correlation between assets, but it can change and does so all the time. We deal with this issue through continuous management of the investment process rather than using systematic option strategies (eg, perpetually buying put options on equity indices so as to gain downside protection)' which we feel are relatively expensive and historically not very helpful.
At the moment we have a variety of risky positions in the portfolio, but in aggregate they are not pushing the fund into an overall risky place. The correlation between those risky positions will typically be pretty high, but not as high as you would have thought.
In our portfolio today the high volatility positions are in Japanese equities, European equities, commodities, an unhedged position in South African government bonds, and a portion in Asian emerging equity markets. These are all fairly risky and will all fall if there is a general risk-off sentiment in markets, but it is about managing the proportion of these in the portfolio. Overall, we are confident that the continual implementation of our investment process will continue to deliver strong positive returns over the medium-term.
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