Old Mutual Global Equity comment - Sep 19
The concurrent rise in historically safe assets like bonds alongside traditionally higher risk assets, such as equities, continued unabated in 3Q. This suggests investors remain uncertain about the outcome of a series of geopolitical and macroeconomic issues including trade talks and the path of monetary easing. The broad regional stock market rally continued through 3Q, with the S&P 500 Index’s 19% YTD gain, after gaining 1.2% over the past three months. In so doing equities maintained their largest year-to-date gain in over two decades and served to extend the longest bull market in history. In the absence of irrational exuberance, investors were drawn to equities in their quest for income in an increasingly negative yield environment. Slowing global growth forced global central banks to keep monetary policy loose. Falling rates on ultra-safe strategies have fuelled interest in corners of the market investors may conventionally have considered too risky.
In 2019, year-to-date returns in most equity indices have been driven predominantly by defensive sectors, which have been treated as proxies for long duration bonds and favoured as being resilient against economic woes. This is a perception which has led to investor crowding and stretched valuations for stocks which are disproportionately impacted by moves in bond yields. However, the S&P 500 Index has only risen 2.2% over the past 12 months, following the seismic sell-off in 4Q18. Equity indices attained fresh historic highs in July. This was driven in part by expectations of the US Federal Reserve’s first interest rate cut in more than a decade. In August, the indices fell again as the trade frictions with China once again escalated and fears of a US recession increased.
In the final phases of 3Q19, major equity indices clawed back their earlier losses. Since mid-August 2019, beneath the seemingly calm veneer of broad equity markets there has been a meaningful rotation between winners and losers. This has been characterised by a sharp increase in cheap value stocks, with previously outperforming defensive and quality stocks retreating. The recent rally in sovereign bond yields, and growing expectations of a thaw in the US-Sino trade war, have provided catalysts for these significant rotations amongst equity market sectors. These rotations were driven by upside surprises in economic data and optimism over trade talks that drove short covering. By contrast, last year’s 4Q unwind was brought on by a growth scare: data deceleration, trade tensions, and central bank tightening. Volatility was not limited to equities at this time. Government bond yields in the US and Europe fell in August, while Brent crude oil recorded its largest percentage jump on record following an attack on Saudi Arabia’s oil infrastructure. Moving into 4Q19, the main drivers of returns in equity markets remain corporate earnings and global economic growth, both of which remain in the ‘cross hairs’ of the ongoing trade war.
The returns to value, quality, momentum and growth have been weak over not just 3Q18, but over the past 12 months. There has been inconsistency in many factor returns, and intermittent spikes in correlation between factors. Overcrowding in medium-term factors, particularly in North America, has contributed to this effect, which has been accentuated by capital outflows and liquidity being withdrawn from strategies using these factors. Many of the medium-term factors employed by the team have overlapped with some of these overcrowded areas. In turn, this has contributed to a period of extended softer performance. The fund performance was weak across most stock selection criteria throughout the period. At a portfolio level, for example, it has proven challenging to blend value with a series of our other factor sets. The nature of the relationship between value and momentum, as well as between value and company management, has detracted from returns in our funds this year, as evidenced by the weaker contribution from the market dynamics and company management factor sets. The long track record of success validates the benefits of such an approach; however, there will be episodes when it struggles. We believe the proposed model enhancements will mitigate such effects going forward.
Market environment indicators have maintained some regional dispersion in volatility profiles with Japan and North America respectively exhibiting low and high volatility. All other regions remain unchanged, anchored in medium volatility states. In addition, all four regions have retraced from their previous pessimistic sentiment states. All regions are now firmly positioned in neutral sentiment states. Over the course of the month, all regions have experienced an uptick in risk tolerance. By month-end, all regions have posted risk appetite levels which are range bound between one-third, and fiftyfifty risk on. As such this represents an improvement in risk appetite relative to previous months, following the value rally during September, but across most regions, risk appetite still remains somewhere between risk-averse and risk-neutral.
The fund aims to offer superior returns over the medium to longer term by investing in shares from developed countries around the world.
This fund is suited to investors wanting to diversify their portfolios by adding an international equity component or investors who are taking a specifi c view on the performance of global equity relative to other asset classes.
The fund has a broad-based exposure to quality shares from developed countries across the globe. The fund is managed by Merian Global Investors, who aims to maximise returns by managing country and sector exposure. This fund remains as fully invested in foreign equities as possible, given regulatory constraints.
The fund aims to offer exposure to a specifi c asset class. It therefore holds a higher allocation to international assets and equities than what is allowed in terms of Regulation 28 of the Pension Funds Act. This fund is therefore not Regulation 28 compliant.