CIO views: Strong defense for resilience

Asia fixed income: value-focused for upside potential.

In times of market dislocations, we remain guided by our value-focused, active management style. Amid this turbulence, we see the opportunity to make our portfolios more streamlined and position for a high degree of upside potential once markets rebound. We are committed to building resilient portfolios, which can weather times of market stress and deliver strong total returns throughout market cycles. 
Our strategy through past crises and every drawdown period has been to stay consistent to our active total return strategy. We look to: 

1. Stay fully invested. 
2. Avoid forced selling and allow for portfolio declines, staying true to our macro view and underlying fundamentals analysis to support our longer-term convictions. 
3. Reassess our top-down and bottom-up views, by country, sector and single-names given the on-going shocks of global growth, commodities, and fiscal pressures in emerging markets. 
4. Wait for the market to settle, and based on our revised assessment, do relative value switches to optimise our portfolios for an eventual rebound, while positioning for a new credit upcycle.

We believe that staying invested throughout market cycles is the best approach to generating total returns over time, in order to benefit from carry, roll-down, active management and eventual spread compression once markets stabilise. To mitigate default risk, we continue to ensure a high level of diversification across our funds such that cumulative long-term income and total return potential outweigh any default risk.

Equities: wisely offensive strategies.

The current climate highlights the value of our disciplined and focused investment process. We concentrate on companies with strong financials and exposure to long-term structural trends and challenges because we believe this provides sound defensive properties for investors.

For us, companies with robust financials are those that generate excess economic returns. We look at criteria such as capital efficiency, cash flow generation, and limited dependence on financial markets. Focusing on long-term structural trends while understanding key challenges is crucial to separating structural growth from volatile hype. 

Our equity portfolios have limited exposure to industries most exposed to the consequences of this crisis. We have also reviewed the corporate liquidity risk of all our holdings. 

Our strategies have benefitted from exposure to mainland China, as well as companies geared towards stay-at-home entertainment. Healthcare companies too have proven to be supportive. 

We retain our belief that this represents a transitory period of uncertainty - our investment teams are reviewing activities that could benefit from the resumption of economic and social activities.

Convertibles: taking advantage of dislocations.

In the midst of one of the worst market corrections, we are relieved to see that good quality convertible bonds have reacted well. Indeed, strategies such as ours (focused on the best asymmetrical profiles with strong credit fundamentals) have limited the downside to a fraction of that of global equities (approximately 1/3rd at the time of writing). 

As the result of the sharp and deep correction in risky assets, the convertible bond asset class is now offering a large and rising number of technically “dislocated” convertible bonds, which our portfolios are beginning to take advantage of. These technical profiles, combining strong bond protection¹  features, unusually attractive yields and a free option haven’t been seen since the fourth quarter of 2008. 

More attractive still, the fixed-income yield of the portfolio has risen sharply as a result of the market dislocation. Thus, investors are well remunerated for an investment-grade bond credit risk, while obtaining a long option (average maturity of four years) on a market recovery. It should also be noted that our allocation does not currently include the most affected sectors such as energy, transport or travel.

Multi-Asset: diversifying defenses.

Defensive strategies are core to our multi-asset portfolios. Historically, the founding block of portfolio construction is the concept of diversification, or the recognition that the whole (risk) is less than the sum of the (risk of the) parts. 

Although this has worked well for investors, the benefits of diversification have started to wane. 

This year, while bonds and equities have moved in opposite ways about two days out of three (which is slightly more than during the 2008 crisis), the performance contribution of bonds is lower than in the past; a reflection of the low absolute of rates.

Hence, investors need to diversify their defensive assets. In our portfolios, we use up to five different forms of protection:¹ diversification is one, especially when it is sized-based on risk rather than capital allocation. Alternative risk premia (such as trend following or carry strategies) can help, too.

Finally, drawdown management (explicit, dynamic risk management to reduce the risk of loss) and tail hedging (long positions in volatility across asset classes) are fundamental tools to buffer our portfolios. 
We use such defensive properties as part of our overall strategy to both mitigate the downside and capture possibilities on the upside. This enables investors to participate in the opportunities we see eventually arising.
 

Alternatives: defensive by design for convexity.

Our alternative range seeks to be defensive by construction. We are not defensive because we invest in defensive assets, run low risk or have hedges designed to protect¹  from sell offs.

We are defensive because, by design, we focus on strategies: that tend to face little competition (and as a result are not subject to panic or forced selling); and heavily focus on robust trade construction. 

We look to avoid exposure to traditional risk premiums, and rather invest on relative value consideration, using the large spectrum of instruments and solutions available to exhibit truly convex profiles. 

We recognise we can be wrong, but look to minimise losses when we are wrong. This is enabled by the fact markets are increasingly silo’d, and as a result credit, equity and volatility markets may have a different interpretation of market events and are dominated by passive investments. 

Our flagship invests amongst many different uncorrelated strategies - these tend to be nimble and focused on less competitive opportunities, and typically have a key structuring aspect to them. 

In the past two years, this strategy has delivered for investors in both supportive market conditions and when there are strong market dislocations such as in March 2020.