Real Return team urges caution for remainder of 2019
Having successfully defended capital in the volatile final quarter of 2018, and participating well in the rebound of risk assets during the first quarter of 2019, the Real Return team at Newton, a BNY Mellon company, has been rebalancing its portfolio to attempt to withstand some of the prevailing headwinds in today’s markets.
Newton’s Real Return team is leaning towards carry strategies as a way of generating a return from income, while maintaining a relatively defensive overall posture. Aron Pataki, portfolio manager on the team, which manages the BNY Mellon Global Real Return Fund, says the portfolio was heavily defensive in the final quarter of 2018 but the team did move to capture some of the upside of the January rally when markets bounced back.
Duration has been one of the areas in the portfolio that has been managed dynamically through the past year. Pataki points out that in Q2 2018 duration, on the strategy, was towards one year, rising to almost six years by the end of Q4, similar to its position back in 2008. Currently, he says, duration on the portfolio is closer to four years. “We use this duration positioning in a similar fashion to our gold holdings, as a cross-asset class hedge in the portfolio,” he explains.
Some of the duration was scaled back after the team sold down its U.S. government bond position, which accounted for a weighting of c.20% as of the end of Q4. Cash has since risen to a high single digit percentage of the portfolio, he says, largely in very short-dated euro government bonds and credit to aim to avoid capital erosion.
The gains taken from its U.S. Treasuries allocation are being deployed in other areas, including select emerging market debt opportunities. These offer a comparatively high yield, he says and demonstrates just one example of the team’s carry plays in order to boost income-producing assets in the strategy. Right now, he points out, the yield on Real Return is c.3%, which goes some way towards the Fund’s performance aim of Libor-plus-4% return over five years.
The team are also maintaining direct hedges, something that dragged slightly on returns in Q1. This small loss was more than offset by a positive contribution from the principal indirect hedge, developed market government bonds, and the allocation to risk assets in the opening quarter of 2019. Pataki says the team favors short Russell 2000 index futures, as a hedge. It is an index Real Return has used since mid-2018 and one Pataki says is a useful hedge given what he believes to be downside sensitivity of US small and mid caps. He thinks they look particularly vulnerable at the moment given high leverage and elevated valuations.
“The global economy is facing a number of structural and cyclical issues and so we think it is prudent to stay cautiously positioned and take some risks at the margin. We think volatility will remain a key factor in markets this year but there remains a lot of optimism out there,” Pataki concludes.
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