31 March 2016

Although there have been attempts to attribute the recent volatility to a single cause – oil, for example, or China – we believe the picture is far more nuanced.

We also believe that this year will not be like the last three years – an investment evolution is underway and there are new and complex fault-lines for the global economy.

Fault lines for the global economy

The first important change for markets has been the shift in global liquidity. While the European Central Bank (ECB) and Bank of Japan (BoJ) are still easing monetary policy, the change in policy direction from the US Federal Reserve (Fed) has changed the landscape. At the same time, the significant decline in commodity prices has negatively affected large asset buyers who depend on energy flows, such as those in the Middle East. As a result, a different liquidity environment now prevails.

Secondly, concerns about economic stress in China have been weighing on market sentiment. However, while much of the economic data out of China has been concerning, Chinese policymakers have resisted calls for a more significant devaluation of the currency. We believe this reduced the risk of a major ‘shock’ and subsequently improved the investment opportunity set.

Another risk that is being widely discussed by market commentators is a potential slowdown in US economic activity and its impact on global growth. However, while some US data may be marginally deteriorating, overall economic data releases remain robust, in our view. While we expect some reduction in corporate profitability that will eventually feed through into the labour market, we would argue that these dynamics do not represent a tangible economic weakness that would threaten a recovery. Therefore, we believe this evolution of the investment environment is not a destabilising one.

Moving in different directions

Against the backdrop of markets prone to sharp spikes in volatility, slower global growth and other external risks, the Fed delivered a cautious policy response at its March meeting. Nevertheless, it continues to keep the door open to interest rate policy normalisation, which began in December, with the pace of change dictated by economic data and financial conditions.

The latest moves by ECB President Mario Draghi should be positive for European risk assets, though Draghi has made it clear that he believes interest rate policy has reached its nadir, as banks struggle to impose negative deposit rates. The ECB also expanded the amount of monthly purchases and the range of assets in its quantitative easing programme, including non-bank corporate bonds and announced a new series of targeted longer-term refinancing operations. We believe it is highly significant that the focus of future easing is likely to shift further towards these unconventional measures.

Portfolio impact

This changing environment is manifested in our portfolio in a number of ways: With around $7 trillion-worth of bonds trading at a negative yield at the time of writing according to data sourced from Bloomberg, ‘carry’ is an increasingly significant component of returns. This is particularly true for areas such as structured credit, where yields look compelling. In addition, we have a favourable view of peripheral European sovereign bonds and European risk assets – the above mentioned shift to non-conventional measures further supports that investment view.  

We believe the risk of a profound ‘shock’ is now reduced, with China unlikely to devalue its currency dramatically and the oil price stabilising, and have therefore selectively increased our high yield and emerging market debt allocation.

However, while we increased portfolio risk from a relatively low level, we see potential for further volatility and several new tail-risks, for instance Brexit, that could make for an interesting remainder of the year.

This is a good opportunity set for unconstrained strategies and we believe that we’re well positioned to take advantage of opportunities as they arise. In this environment, maintaining a focus on fundamentals through the noise is likely to be key, along with diversification and a strong focus on risk management.

CARS ref: RSM-3728
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 23/03/2016 and may change as subsequent conditions vary.

This is a good opportunity set for unconstrained strategies and we believe that we’re well positioned to take advantage of opportunities as they arise.