In musical or literary composition, a leitmotif is a recurring theme. Complications and trepidations stemming from geo-political headwinds have become the leitmotif of the investment arena.
As has been the case for much of the past few years, trade tensions continued to keep markets on edge as the US struck out against China and the European Union (EU) with further tariffs and regulations targeting foreign companies.
In the UK, Brexit persisted as a slow-motion drama as the country got its third prime minister since the victorious Leave vote in the June 2016 referendum. At the time of writing, an election is to take place on 12 December.
This followed parliament’s support for the latest exit agreement negotiated by Prime Minister Boris Johnson, but rejection of the very compressed timetable for examining the deal and leaving the EU. The EU also granted an extension to the end of January 2020.
What may happen post-election, and depending on the winner and make-up of the next parliament, involves several possible scenarios including — a negotiated exit from the EU; a crash-out, no-deal Brexit unwanted by markets; perhaps a second referendum; or more confusion.
Just in case that wasn’t enough, a drone attack on Saudi Arabian oil infrastructure sent jitters through global markets, and endless anti-China protests rocked Hong Kong, long valued for its stability.
Above all this lies an already challenging economic environment on the back of a union between growth-unfriendly, long-term trends, such as ageing populations, and medium-term headwinds, such as high levels of public and private debt.
It’s little wonder that global growth expectations are being scaled back.
Defensiveness evident in portfolio positioning
Navigating uncertainty is a fact of investment life and our Investment Futures Framework acknowledges this. Certainty about the future is impossible and so a thoughtful way of progressing is to imagine what’s ahead as multiple possibilities, as opposed to landing on a single outcome and dogmatically positioning portfolios accordingly.
By understanding the different ways in which the future might unfold, we make informed choices about the trade-offs between risk and return. A higher exposure to shares will increase returns in some scenarios, but reduce returns in others.
In positioning MLC’s multi-asset portfolios, we consider multiple outcomes in many possible scenarios.
For the MLC Inflation Plus portfolios, our focus is on limiting both the probability as well as severity of negative returns over each portfolio’s time horizon, while extracting as much return potential as sensibly possible.
Consistent with MLC Inflation Plus portfolios’ dual aims, we have selectively increased gold exposure through futures to protect against a range of possible shocks.
We also appointed Oaktree Capital Management, L.P. (Oaktree) to manage part of our global high yield bonds and loans allocation. Oaktree’s portfolio gives us access to a greater diversity of investments by country as well as by security. This will help improve the return potential of our fixed income strategies without a material change to their risk profile.
At the same time, the change in central bank rhetoric and negative real cash rates has led to an improvement in the return potential for global credit and so we’ve further increased exposure to global short maturity corporate bonds.
For MLC Horizon portfolios, we are maintaining relatively defensive positioning partly from exposures to Inflation Plus, but also through deviations from benchmark fixed income allocations. We think this flexibility is required and continually test our thinking. We continue to have high conviction in the appropriateness of this positioning, but also recognise that the period of low bond yields (high bond prices) could be prolonged.
Furthermore, we are utilising derivative strategies to enhance the defensiveness of the MLC Horizon portfolios’ share exposures and to manage foreign exchange rate risk. We have been carefully reducing foreign currency exposure recognising Australia’s strong terms of trade and improving current account will likely strengthen the Australian dollar, so the diversification benefits of investing in overseas currencies are likely eroding.
A similarly relatively defensive orientation is evident in MLC Index Plus portfolios. This is being achieved through adjustments to the fixed income strategy, and allocations to the real return strategy, which aims to provide returns unrelated with share market movements.
With uncertainty high, we believe nimbleness and strong risk management are especially important at present.
This communication is provided by MLC Investments Limited (ABN 30 002 641 661, AFSL 230705) (MLC), a member of the National Australia Bank Limited (ABN 12 004 044 937, AFSL 230 686) group of companies (NAB Group), 105–153 Miller Street, North Sydney 2060.
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