Luke Newman, co-manager of the Henderson UK Absolute Return strategy, gives his outlook for 2017. He sees political and economic uncertainty persisting and explains that the accompanying volatility in markets will create further opportunities for an equity long/short strategy such as his. Luke discusses the potential within the financial sector, the value of high yielding stocks and the likely headwinds for companies impacted by minimum wage legislation.
What lessons have you learned from 2016?
2016 has been a year in which macro factors have dominated, and we have needed to react quickly to these pressures. Key events included:
- The inflexion of oil and commodity prices in Q1, requiring us to close shorts within that sector and move tactically long.
- The volatility in equity and currency markets in the aftermath of the Brexit vote and US election, requiring a rapid and flexible response.
- Inflationary pressures building towards the end of this year, necessitating a reappraisal of financial stocks, and resulting in us increasing our core longs in insurers and taking tactical long positions in banks.
Therefore, the need for flexibility has been reinforced, and underlining that is the importance to us of a tactical trading book within an absolute return strategy with its ability to both preserve capital and provide absolute returns for investors.
What are the key themes likely to shape the markets in which you invest in 2017?
In 2017, we expect a lot of the volatility seen in capital markets to continue. From a political footing, we will have the after-effects of the Italian referendum to contend with, followed by the French and then German general elections later in the year, as well as the ongoing Brexit negotiations. We expect the populist pressures that we’ve seen as a feature of 2016’s elections and referendums across the developed world to continue.
From an economic footing, inflationary pressures and the pace of normalising interest rates globally will prove crucial in the ultimate direction of capital markets. So, more uncertainty, more volatility, but that can provide opportunity on both the long and the short side of our strategy.
What are your highest conviction positions moving towards the new year?
We’ve moved to a barbell strategy i.e. hedging our bets due to the uncertainty we see. On one side, we’ve increased our long positions within banks and other financials – business models that should benefit from any inflationary pressures and acceleration of the interest rate cycle. As a result, we retain our established core long positions in insurers Aviva and Legal & General.
On the other side of the equation, we think it is still too early to dispense with many of the higher quality ‘bond proxy’ and compounding yielding areas of the market. Even if we see a gradual normalising of interest rates globally, this will be coming off a very low base, and the hunt for yield will continue to dominate financial markets. We believe good quality businesses that can compound their cash flows and deliver a steady growing stream of dividends to their investors continue to offer value. Publishers such as Informa and RELX, gaming company GVC and software provider Micro Focus fit into this category.
On the short side, we have also been very active. This has partly been driven by the impacts of minimum wage legislation across the developed world. That is good news for vast swathes of the electorate, but potentially bad news for significant areas of the economy. Many companies within sectors such as leisure, government outsourcing and retail, may see their margins coming under pressure, and their share prices therefore look perilous at current levels. We have positioned accordingly and, having already seen a number of profit warnings that can be attributed to this trend, we expect it to continue into 2017.
What should investors expect from your asset class and your portfolio(s) going forward?
The absolute return sector is a very ‘broad church’. Many different strategies employ different techniques aiming to preserve capital and generate a positive return. As an equity long/short manager our focus is on minimising volatility for the strategy as a whole. This is done through deploying capital in a more fundamental core book – aimed at identify those long-term winners and losers – while also staying fleet-of-foot and pragmatic within a shorter-term tactical book. I think the latter will be our key tool in minimising drawdowns, stabilising the volatility that we see in markets, and hopefully allowing us to grind out that steady stream of absolute return for our investors.
For further insight from Henderson Fund Managers on investment outlooks for 2017, please click here
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For Professional Investors only. The information in this article does not qualify as an investment recommendation.
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