M&G (Lux) Global Target Return Fund

Transcription

1 M&G (Lux) Global Target Return Fund Fourth quarter, 2018 Fund manager Tristan Hanson FOR INVESTMENT PROFESSIONALS ONLY Summary of the fourth quarter: 2018 proved to be a challenging year for most asset classes. We review decisions taken over the year and provide additional insight into our investment approach. We retain our core view that today s valuations suggest global equities and selected emerging markets assets should outperform developed market government bonds over the medium term. Risks associated with this fund: For any past performance shown, please note that past performance is not a guide to future performance. The value of investments and the income from them will rise and fall. This will cause the fund price, as well as any income paid by the fund, to fall as well as rise. The fund manager has the freedom to invest across global equity and bond markets, along with other types of assets, including less liquid assets such as asset-backed securities or infrastructure. The fund may use derivatives (such as options, credit default swaps and relative value trades) to gain exposure to investments exceeding the value of the fund (leverage) or with the aim of profiting from a rise or a fall in the value of an asset (for example, a company s bonds). This may cause greater changes in the fund s price and increase the risk of loss if asset prices move unexpectedly. Changes in currency exchange rates will affect the value of investments. Further risk factors that apply to the fund can be found in the fund s Key Investor Information Document (KIID). Things you should know: The fund may invest more than 35% in securities issued by any one or more of the governments listed in the fund prospectus. Such exposure may be combined with the use of derivatives in pursuit of the fund objective. It is currently envisaged that the fund s exposure to such securities may exceed 35% in the governments of Germany, Japan, UK, USA although these may vary subject only to those listed in the prospectus. The fund allows for the extensive use of derivatives. Fund performance Total returns (%) Fund (Net of OCF) Fund (Gross of OCF) 3-month EURIBOR + 4% 3-mth Since launch (pa)* N/A N/A N/A N/A N/A N/A Source: Morningstar, Inc and M&G, as at 31 December Euro Class A Acc shares, income reinvested, price-to-price basis. *The fund was launched on 21 December The past performance shown here is both gross returns (before the Ongoing Charge Figure is taken) in line with the objective of the fund and net returns (after the Ongoing Charge Figure has been taken) to illustrate how charges affected the performance. Investors should note that the net return is what they would receive and is therefore the more relevant figure. Past performance is not a guide to future performance. The fund aims to deliver combined capital growth and income of at least 4% pa above three-month EURIBOR before any charges, over any three-year period and in any market conditions. There is no guarantee the fund will achieve its objective, and you may not get back the amount you originally invested.

2 Summary Looking back over the past year, while the portfolio s overall performance outcome was not the result we desired and certainly frustrating, we believe the decisions taken were consistent with the approach we have outlined for managing the fund. That approach emphasises two main sources through which we aim to generate returns: (i) occasional tactical opportunities arising from the identification of behaviourally-driven market mispricing; and (ii) observations on relative valuations between asset classes, informed by our assessment of prevailing economic conditions. Our assessment of asset class valuations gave the opposite signal to subsequent market direction in In itself, this is no great surprise, as valuation signals provide little predictive power in the short run and offer more insight over longer time horizons. But to take an extreme example, the Bloomberg German government bond index, with a starting yield-to-maturity of only 0.50%, outperformed the DAX German equity index by more than 20%. (Source: Bloomberg, 28 December 2018.) If your belief a year ago was that relative valuations suggested favourable odds that global equities would outperform global bonds by a substantial amount over a multi-year horizon, then this would prove to be a considerable headwind in (We continue to think they will, with much improved odds from today s starting point). On a more cheerful note, several tactical decisions made useful positive contributions to overall performance over the year, improving returns compared to a purely valuationbased approach. We discuss all this in more detail below, as well as our reasoning behind the portfolio s positioning today. Investment approach First, it is worth reminding investors of the reasons for our investment approach. Asset prices are determined both by expectations of future cash flows and the rate at which those expected cash flows are discounted. At the heart of our approach is a belief that human psychology and emotion play a significant role in this price determination process. Most typical investment approaches place a strong emphasis on forecasting future cash flows or economic outcomes. But given the fiercely competitive nature of financial markets, there is little reason to think anyone has a sustainable edge based on their ability to make superior economic forecasts. What can you know that others haven t already worked out? In our experience, such forecasts are usually plagued with behavioural biases: recent trends are extrapolated, herding is apparent and myopic fears exert undue influence. Since forecasting is evidently very difficult and prone to error, we believe giving prominence to economic forecasts in the investment decision-making process is likely to be a flawed approach. Instead, we place greater emphasis on valuations and understanding shifts in discount rates. Random noise makes predicting market movements impossible in the short-run, but over longer periods of time there is empirical evidence to suggest that high risk premia, on average, predict above average returns. In other words, buying assets at aboveequilibrium yields and selling those on below-equilibrium yields is likely to be successful over sufficiently long time horizons. Periodically, the price of an asset (or markets, more generally) can move abruptly and in ways that do not seem justified by any major change to economic fundamentals, reflecting a rapid shift in risk preferences (or discount rates). During such times, the collective focus often becomes extremely short-term in nature, to the neglect of other dynamics that may have more significance over a prolonged timeframe. Recent experience is hugely influential in determining perceptions of riskiness. Assets whose prices have suffered large price declines or high volatility are perceived to be very risky, while a smooth, upward journey instils a sense of safety and comfort. These feelings are at odds with the likelihood that, following large changes in price, the future risk characteristics of the asset in question may be very different from the recent past. Over many years, we have developed a framework to identify tactical investment opportunities during episodes, which are events whereby assets appear to be mispriced as a result of rapid and poorly calibrated shifts in risk preferences. This is relevant both to specific episodes (eg the rapid decline in the Mexican peso after Trump s 2016 election victory) or more generalised examples, such as the widespread and prolonged aversion to owning equities following the 2008 global financial crisis. This approach has served the M&G Multi Asset team s longer-running strategies very well over the past two decades and we believe it will continue to do so in future. We believe it is durable because, while appearing simple, it is psychologically difficult to implement. Buying assets that have fallen rapidly or selling those that have performed very well with low volatility is uncomfortable. We are all social animals, and deviating from the consensus generates unpleasant feelings of loneliness, self-doubt and fear of stigma. This is why opportunities appear, but also why few are able to capitalise on them. Our observation that most market participants behave in a myopic fashion suggests behavioural episodes will continue to appear periodically, and that attractive value opportunities will come and go to the benefit of patient investors.

3 Looking back at 2018 It is worth reprising in detail what we said this time a year ago: Consequently, the global equity risk premium remains attractive considering that real yields on G7 cash and government bonds are mostly negative Our expectation that global equities will deliver higher returns than G7 government bonds over the medium to long term remains unchanged. That said, market conditions may prove less than plain sailing in While equity valuations outside the US have not shifted dramatically, there is a general consensus that global economic conditions are favourable, in contrast to previous worries about secular stagnation. Furthermore, US equity valuations have increased, even though equities look more attractively priced elsewhere. Moreover, the recently enjoyable experience of owning equities could precipitate its own volatility if investors are shaken from their currently comfortable state. One way the equity risk premium could compress is through a sharp increase in government bond yields The greater risk to fund performance would likely come from an unforeseen deflationary shock to the global economy. Given the fund s positioning, this would likely pose a risk management challenge, and this is something to remain mindful of In 2018, I believe a patiently optimistic mindset is appropriate. Economic conditions do not turn with the calendar year, but it seems plausible that surprises will occur to a greater extent than they appeared last year. In this case, volatility may be higher, which should bring opportunities to patient investors. (Source: Investment Review 2017, M&G [Lux] Global Target Return Fund.) As global equity markets enjoyed a strong start to 2018 alongside a government bond market sell-off, the fund s positioning generated strong returns in January. At the time, luminaries were talking about melt-ups, while others, including the IMF, hailed evidence of synchronised global growth. (Source: World Economic Outlook Update, IMF, January 2018.) The tactical decision to reduce equity and credit exposure in late January in response to higher prices and buoyant sentiment helped cushion the fund when, in February, the first volatility event of the year arrived, with a sharp drop in global equities and the collapse of various low-volatility ETFs. Viewing the sell-off as somewhat episodic and the valuation case still favouring global equities, we increased equity exposure in response to lower prices. Headwinds to the performance of the fund gradually increased from the end of April. Relative value observations both at an asset class level and regionally within equity and bond markets failed to work. US equities continued to outperform other developed markets (DM) and emerging markets (EM); European bond yields increasingly diverged from US yields, which continued to rise. A combination of increasing trade tensions, weakening European economic data, the blow-up in Italian political risk and classic currency crises in Turkey and Argentina occurred, while GDP and profits growth expectations remained robust in the US, in part thanks to tax cuts. As we suspected could happen, rising US bond yields put pressure on valuations of other asset classes. Just like in February, another sharp move in US yields in September- October was the catalyst for a further abrupt sell-off in global equities and credit. With global equities having weakened substantially more than forecasts for profits, we increased equity exposure in late October and December, at times using call options to mitigate downside risk. Had our investment strategy been isolated to US markets, performance over the year would have fared better, as until the fourth quarter US equities generally outperformed US bonds. The underperformance of equities was much more pronounced outside the US, serving as a reminder that valuation signals are often not much help over the short-run. Tactical shifts While the value component of our strategy proved a headwind, several tactical shifts in asset allocation were successful. Within equities, generally over the first half of the year we managed to sell into strength and buy into weakness on a few occasions. Within government bonds, while the fund had negative duration throughout the year, two tactical purchases of two-year US Treasuries (UST) were profitable trades, adding over 30 basis points (bps) to fund performance. Other responses to sharp movements in global markets are as yet inconclusive and remain open positions. Following the sharp repricing of Italian sovereign risk in May, we initiated a relative value trade in Italian 10-year bonds versus German 10-year bonds. The carry on this position is positive, but spreads remain wide. (Source: Thomson Reuters Datastream, 28 January 2019.) We also added a small position in the Mexican peso following a period of weakness in relation to actions taken by the new President Lopez-Obrador. During the fourth quarter, we tactically increased overall equity exposure, including the addition of call options on the US S&P 500 following its sharp sell-off.

4 Risk management A notable feature of market movements for much of 2018 was the lack of diversification provided by USTs. In fact, not only did USTs not protect portfolios, but rising yields (falling bond prices) were the catalyst for declines in equity markets. This was therefore a very different regime to that which has prevailed for most of the past 20 years, when equities and government bonds have generally had an inverse relationship. Early in the year, our sense that the correlation between bonds and equities might shift this year was very beneficial, as shorting bonds boosted returns during equity weakness in the first quarter, contrary to conventional wisdom. An inverse relationship between equities and government bonds did, however, reassert itself in the fourth quarter, as growth expectations deteriorated and weakness in risk assets led to a downward reassessment of US interest rate expectations. Twice during the year, after particularly sharp yield rises, we purchased USTs for their potential diversification properties. These tactical trades were closed out at a profit, as we mention above. Of course, with the benefit of hindsight, German bonds provided a better hedge for investors who had long equity risk last year. But with valuations as unattractive as they are on German bonds, we believe these assets may in fact prove to be very risky (or at least value-destructive) over a longer period of time. We identified buying credit protection as a potential hedge against equity risk, including buying protection on sovereign credit default swaps in EM countries, where protection was less costly. Widening credit spreads did assist the portfolio in various phases, but did not move sufficiently to offset weakness in long positions in EM and global equities. Within equities, put options on US equities provided some protection in the first and fourth quarters, but were costly during the third quarter, as US equities outperformed. This is always the challenge of being long options time is typically against you. Opportunistically, we have been long call options on equities to profit from expected upside, but also to curtail losses should our view not come to fruition. This worked very well in January, when positions introduced in 2017 benefited. Time will tell for more recent purchases in the fourth quarter of The risk management challenge remains prominent for anyone interested in generating adequate returns. Attempting to hedge out all risk will only result in cash-like returns at best. We believe that by adhering to our ideageneration process will produce returns over time, but positions have to be scaled appropriately to manage risk in accordance with the fund s mandate. If we believe we can find effective portfolio hedges at sufficiently attractive prices, we are most happy to include them in the portfolio. If such hedges do not seem to be available, it is necessary to scale the other positions accordingly so as to prevent unacceptable outcomes for investors. Fund positioning The fund s positioning as at the end of 2018 is shown in Figure 1 below. Figure 1. Fund positioning Asset breakdown Net exposure (%) Equity (direct) 25.4 Equity (options, nominal) Outlook 0.1 a Government bonds Corporate bonds 2.0 CDS (emerging market sovereign) Euro 93.3 a) Nominal valuation. Delta-adjusted valuation of equity options is 3.2% Duration Modified duration Source: M&G, as at 31 December years It is hard to believe now, but a year ago the consensus economic view was one of synchronised global growth. Today, it is easier to articulate risks to the global economy stemming from China, trade wars, interest rates and problems in Europe. The realisation that consensus views are repeatedly and profoundly surprised in this way is the reason we seek to avoid forecasting and exploit market overconfidence in either direction. Global equity valuations are more attractive today than in the first quarter of the last time such pessimism over global growth was evident, and also a level from which global equities provided strong returns over the subsequent two years. Compelling valuations for equities, combined with an attractive set-up for many emerging market assets (higher carry and depressed exchange rates) allows the construction of a portfolio with high expected returns from the long side.

5 Indeed, the opportunity set appears to be more attractive today than at any time over the two-year life of the fund. Heightened volatility late last year suggested not only deteriorating growth expectations, but also manifest confusion over the appropriate price levels of the major asset classes in today s macro environment. The increasing role of quantitative strategies and adherence to volatility-based risk models may exacerbate this. Core to our approach is a belief that market volatility should be viewed as a source of opportunity provided by fluctuating markets, rather than something to fear. The combination of attractive valuation opportunities and ongoing market volatility makes for an encouraging environment for our investment approach. Tristan Hanson Fund Manager For Investment Professionals and Institutional Investors only. Not for onward distribution. No other persons should rely on any information contained within. Distribution of this document in or from Switzerland is not permissible with the exception of the distribution to Qualified Investors according to the Swiss Collective Investment Schemes Act, the Swiss Collective Investment Schemes Ordinance and the respective Circular issued by the Swiss supervisory authority ("Qualified Investors"). Supplied for the use by the initial recipient (provided it is a Qualified Investor) only. In Spain the M&G Investment Funds are registered for public distribution under Art. 15 of Act 35/2003 on Collective Investment Schemes as follows: M&G Investment Funds (1) reg. no 390, M&G Investment Funds (2) reg. no 601, M&G Investment Funds (3) reg. no 391, M&G Investment Funds (5) reg. no 972, M&G Investment Funds (7) reg. no 541, M&G Investment Funds (9) reg. no 930, M&G Investment Funds (12) reg. no 1415, M&G Investment Funds (14), reg. no 1243, M&G Global Dividend Fund reg. no 713, M&G Global Macro Bond Fund reg. no 1056 and M&G Optimal Income Fund reg. no 522, M&G (Lux) Investment Funds 1 reg. no The collective investment schemes referred to in this document (the "Schemes") are open-ended investment companies with variable capital, incorporated in England and Wales in respect of M&G Investment Funds and in Luxembourg in respect of M&G (Lux) Investment Funds. In the Netherlands, all funds referred to are UCITS and registered with the Dutch regulator, the AFM. This information is not an offer or solicitation of an offer for the purchase of investment shares in one of the Funds referred to herein. Purchases of a Fund should be based on the current Prospectus. The Instrument of Incorporation, Prospectus, Key Investor Information Document, annual or interim Investment Report and Financial Statements, are available free of charge, in paper form, from one of the following - M&G International Investments S.A., German branch, mainbuilding, Taunusanlage 19, Frankfurt am Main; the Austrian paying agent: Société Générale Vienna Branch, Zweigniederlassung Wien Prinz Eugen-Strasse, 8-10/5/Top 11 A-1040 Wien, Austria; the Luxembourg paying agent: Société Générale Bank & Trust SA, Centre operational 28-32, place de la Gare L-1616 Luxembourg; the Danish paying agent: Nordea Bank Danmark A/S Issuer Services, Securities Services, Hermes Hus, Helgeshøj Allé 33, Postbox 850, DK-0900, Copenhagen C, Denmark; Allfunds Bank, Calle Estafeta, No 6 Complejo Plaza de la Fuente, La Moraleja, 28109, Alcobendas, Madrid, Spain; M&G International Investments S.A. or its French branch; the French centralising agent of the Fund: RBC Investors Services Bank France; or the Swedish paying agent: Nordea Bank AB (publ), Smålandsgatan 17, Stockholm, Sweden. For Switzerland, please refer to by M&G International Investments Switzerland AG, Talstrasse 66, 8001 Zurich or Société Générale, Paris, Zurich Branch, Talacker 50, P.O. Box 5070, 8021 Zurich, which acts as the Swiss representative of the Schemes (the "Swiss Representative") and acts as their Swiss paying agent. For Italy, they can also be obtained on the website: For Ireland, they are available in English language and can also be obtained from the Irish facilities agent, Société Générale SA, Dublin Branch, 3rd Floor IFSC House The IFSC Dublin 1, Ireland. For Germany and Austria, copies of the Instrument of incorporation, annual or interim Investment Report, Financial Statements and Prospectus are available in English and the Prospectus and Key Investor Information Document/s are available in German. For Greece, they are available in English, except the Key Investor Information Document/s which is available in Greek, from the Greek Representative: Eurobank Ergasias S.A. 8, Othonos Street, Athens. Before subscribing investors should read the Prospectus, which includes a description of the investment risks relating to these funds. The information contained herein is not a substitute for independent investment advice. This financial promotion is issued by M&G International Investments S.A. Registered Office: 16, Boulevard Royal, L-2449, Luxembourg. The Portuguese Securities Market Commission (Comissão do Mercado de Valores Mobiliários, the CMVM ) has received a passporting notification under Directive 2009/65/EC of the European Parliament and of the Council and the Commission Regulation (EU) 584/2010 enabling the fund to be distributed to the public in Portugal _ _EUR_SICAV