Are we headed for more normal economic conditions? Part 2
There are signs global growth numbers continue to rise from a low base, especially in light of improving economic conditions in China.
Nevertheless, there are many factors in the global economy that could derail the still-fragile global growth trajectory.
This is the second article in a two-part series that explores AMP Capital’s view of the global economy and how this impacts investment decisions for the Dynamic Markets Fund. The fund uses tools such as options and other hedging instruments to help protect investor capital from adverse market movements.
Self-managed super fund (SMSF) investors may be able to draw on these views to help form their own thoughts about investment markets.
Here are three strategies employed by the Dynamic Markets Fund to protect and drive investor returns at the moment, based on our views on current market conditions.
1. Protection from geopolitical events
A number of European elections have the potential to move markets this year. As a result the fund maintains a high cash exposure as well as a protective option structure.
2. Lower allocation to emerging markets shares in favour of Japanese equities via an allocation to Japanese banks
The relative outperformance of emerging market shares and the underperformance of Japanese shares since the start of this year have led a meaningful improvement in the relative valuations of Japanese shares versus emerging markets shares. Meanwhile, Japanese shares are under-owned. These views have shaped our exposure to this asset class recently.
3. Making an allocation to crude oil and the global energy sector
The correction in oil prices since the start of the year has taken the froth out of the market and led to an improvement in sentiment indicators. Meanwhile, the fundamental backdrop has continued to improve.
For instance, after 30 months of inventory build-up, total US petroleum inventories are poised to slip into a year-on-year deficit for the first time since August 2014. The changing supply/demand dynamic should be positive for oil prices. The exposure to crude oil also offers the benefit of a hedge against rising geopolitical tensions.
Outside crude oil but still in the energy sector, equities are under-owned and yet to price in the recovery in oil prices.
These views have led to our current exposure to energy assets in the Dynamic Markets Fund.
Diversification has always been key to portfolio risk management. But as much of the defensive asset class universe falls into the ‘crowded momentum’ category poses a challenge to portfolio construction and diversification.
To manage downside risk where diversification is extremely hard to achieve, the Dynamic Markets Fund is increasing use of options strategies.
Rock climbing provides an analogy. Ropes and harnesses are vital equipment in rock climbing for the same reason diversification is vital in portfolio management.
But when the climb gets steeper and bumpier, additional protection devices are required. These place temporary anchor points on the rock and help protect climbers. This is how investors are protected through options strategies in a world of extreme valuation dispersion.
Importantly, risk management is at the heart of our process. Analysis of upside/downside potential forms the basis for prudent risk taking.
Being complacent about the uncertainty of outcomes against expectations can lead to unrecoverable drawdowns. And the more expensive the asset, the more likely the potential downside surprise.
To minimise the risk of sustained portfolio drawdowns the fund avoids leverage, stays away from expensive and crowded assets and is diversified across a set of well-priced assets, based on historical risk and correlation and valuation and sentiment indicators.
This allows the fund to protect asset values and reduce portfolio risk over the longer-term.
However, it is important to note that there is no guarantee that the Fund’s asset allocation strategy will provide positive investment performance at all stages of the investment cycle. The Fund invests in securities that are listed on share markets around the world and specific risks may include a slowdown in economic growth, individual companies reporting disappointing profits and dividends and, management changes. Also, with regards to international investments, the relative strength or weakness of the Australian dollar against other currencies will affect the Fund’s performance.
Important note: AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMPCFM) is the responsible entity of the AMP Capital Dynamic Markets Fund (Hedge Fund) (Fund) and the issuer of the units in the Fund. To invest in the Fund, investors will need to obtain the current Product Disclosure Statement (PDS) from AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232 497) (AMP Capital). The PDS contains important information about investing in the Fund and it is important that investors read the PDS before making a decision about whether to acquire, or continue to hold or dispose of units in the Fund. Neither AMP Capital, AMPCFM nor any other company in the AMP Group guarantees the repayment of capital or the performance of any product or any particular rate of return referred to in this article. Past performance is not a reliable indicator of future performance. While every care has been taken in the preparation of this article, AMP Capital makes no representation or warranty as to the accuracy or completeness of any statement in it including without limitation, any forecasts. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Investors should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to their objectives, financial situation and needs.