Our latest investment soundbite from FundCalibre is with Steven Andrew, portfolio manager of the M&G Episode Income fund.
The use of the word “Episode” in the name of the fund is to reflect the periods of time when investors’ emotions cause them to act irrationally – which in turn provides attractive opportunities for those willing to go against the herd.
Are you seeing emotional volatility in the markets at the moment?
“We all had such a rough experience in 2022. And then you come into 2023, with investors feeling pretty beaten up, and markets actually start to cheer up. Markets actually start to say, ‘Well, you know what? Maybe the future isn’t as bad.’ And that’s partly a reflection of things having been so bad and so challenging in 2022, [and partly] an element of a ‘relief rally’.
“Economies haven’t slowed down to the degree that they were expected to, and so some of the data has been quite supportive. So, in that sense, it’s not something that I’ve wanted to fight against in that way; it doesn’t feel as if it’s something that’s been overwhelmingly driven by an emotional or behavioral response. It actually feels like a fairly coherent response to the data reassuring me that [markets aren’t] deteriorating very quickly. And so, it’s reasonable to say things might be better than we expected.
“Now we’ve moved on to the fringes of a bit of complacency. Globally, we’ve experienced what would be called the sharpest tightening in monetary conditions – the biggest impact from interest rates in 40 years. It’s very unlikely that you get out unscathed from that. What we can interpret from the experience of the first quarter or this early part of it is, it feels more like we get a bit of a rest, but we need to get ready to get back in there, because it will remain volatile, so there will still be opportunity.”
Let’s talk about the UK. Everyone hates the UK. Is it a bad investment? A contrarian investment? Or is it simply a case of waiting for the sun to shine on the UK again?
“It feels like a fairly rational level of gloom, given what the fundamental economy currently is showing, with the lowest growth and the highest inflation mix. That’s an unpleasant mix. And you have a policy maker [the Bank of England] that’s still facing towards tighter, rather than looser, policies. Now that can absolutely change reasonably quickly.
“What I would say in the UK’s favour would be, whenever you see this sort of clustering of misery and pessimism, you don’t really have to have a very different view to say, well the chances are you might get surprised on the one side of things. Is the UK going to be even worse than everybody expects? Or might it be not so bad as everybody expects? Or at least look not as bad as everybody expects?”
Eventually, at some point it has to become attractive, doesn’t it?
“Yes, it does. To an extent the UK is hampered a little by the fact that it’s shrunk within the global economy – it’s halved! The UK’s proportion of MSCI ACWI has pretty much halved over the past decade. So, in that sense, a reasonable benchmark allocation to it is now 4% or 5%, whereas 10 years ago it was closer to 10%. In that sense, there’s less of a structural appetite for the UK anyway.
“From a fundamental perspective, I would say there are a few things that you’d really want to see in place. You’d want to see the visibility of the end of the tightening cycle. You’d want to see some of the fundamental macro data start to improve a little bit. And I think we’ve still got a bit of a painful journey to go before we get to that stage.”
You have a bit more of exposure to Japan, Europe, and the US. Can you tell us a bit about these areas?
“Europe has had a thoroughly miserable time; miserable pandemic, miserable post-pandemic, and it’s only really quite recently become, if not flavour of the month, much more highly regarded – or much less poorly regarded – by global investors. Attention has turned away from the US as an aggregate overvalued market that everyone has been concentrated in, to one that says, ‘What areas outside of the US look more fundamentally well supported, and moreover they’re cheaper?’ The thing in Europe’s favour has been the fact that – up until recently – it’s been pretty cheap and everyone’s been facing in the same direction [the market has been out of favour].
Can you give us some more views on Japan? It seems to always polarise opinion, but there seems to be growing sentiment towards the region?
“I think there is growing sentiment towards Japan, which is where we’ve got a broader equity allocation. The majority of the holding is spread across that real economic exposure in Japan, where we have seen an element of insulation from some of those global headwinds, particularly around the inflation-chasing, inflation punishment – the cost punishment loop – that the more western economies seem to have ended up in. So, there does seem to be an idiosyncratic Japanese element going on and we want to make sure we’re engaged with that.”
There are no property allocations in the fund, can you tell us why not?
“There are two main factors; the first is liquidity, the second would be fundamentals. The things that we’d look for as a global multi-asset [manager], you want to make sure that you have enough liquidity in the sense that if something shocking happens in one area of the market, that you can sell down certain other areas to go and exploit whatever that opportunity [the market] might have been presenting you with.
“With property, I don’t really want to treat it like that. It’s a different asset class that has a longer-term payoff. It has its role from time to time within a multi-asset portfolio to be sure, but not at a time when we want to remain nimble – where it doesn’t pay us to have really high conviction views at the moment. Because thinking that you know what’s around the corner, particularly right now, feels like a pretty perilous thing to be doing. So, at the moment, no thank you. But if we have better valuation, if we have a clearer sight of that global market outlook, then absolutely, we could in the future have some property.”
And lastly, you’ve got some emerging market bonds – why take the risk if we’re going into a global recession?
“Well, it does get to the heart of diversification, and it gets to the heart of what being a global multi-asset portfolio [is].
“Let’s wind it back a little bit and see what the journey has looked like so far: the central banks in many of those emerging markets were quicker to tighten interest rates, quicker to see through the inflation, so, inflation rose, started to come down again, and they are already further along that journey than the Fed [Federal Reserve], the Bank of England, the ECB. And that has also been manifested in the price of those bonds. So, the price of their bonds has already fallen, and the yields are sold off, so, there’s a great deal already in the price.
“And the further reason would be, one of the reasons why these areas have sold off in the past during a global downturn, would be the dollar strengthening at that time; many of their liabilities are in dollars, so they have bother funding themselves, and so, there’s a ‘doom loop’ that then gets created. In a similar way to the post-financial crisis recapitalisation of the bank’s sector, you’ve seen much less vulnerability about the funding of emerging market nations. And in that sense, you don’t have that ‘itchy trigger finger’ that says, these guys are vulnerable if the dollar goes up [because] we’ve already seen the dollar go up, and they were absolutely fine because a lot of their funding is now done in local currency rather than in foreign currency. So, in that sense, there’s greater resilience and there’s a lot in the price. So, we want that diversification.”
Tell us about high yield bonds.
“We’ve always trod lightly in credit. The features that you want are liquidity and dynamism and that’s not always the home of credit. If you want to be in a hurry, it’s not really the place to be. We want to calmly engage with these areas. We’ve seen a really quite substantial restoration of value in the credit market – not just high yield, but also investment grade. And we have stepped into that, but it’s a stepping into that that we’re doing on the basis that it’s more of a strategic ownership than it is to say, yes, they’re going to make us some money this year or they’re going to make us some money in the next six months.”
Can you give us your view on markets for the rest of the year. Do you expect a lot more opportunities from this sort of emotional uncertainty and volatility in markets?
As a general principle, when we think about [these things], it’s really important to have in your mind all of the time, ‘What are these prices trying to reflect?’ They’re trying to reflect the real, economic policy fundamentals. So, we have been through the single most resonating shock, both to real economies, society, [and] financial markets. Then we had an enormous policy response to that – all of that, at the very least, messes up your data. Equally, it messes up the pushes and the pulls of policy and the real economy; it causes changes in the labour market; it causes changes in society’s behaviour and its consumption and credit patterns, all of that stuff. And what has tended to happen in the past, over a very long period of time, is bouts of fundamental volatility then are followed by more fundamental volatility because you overshoot, you undershoot, you overshoot, you undershoot until you get back to some kind of equilibrium. So, when we think about what the market’s reflecting, absolutely yes, you’re going to get overshoot and undershoot in the price.”
If you were to give our listeners one behavioural finance tip or how they perhaps can use it in their portfolio that’s prevalent, what would you say?
“I would adopt that general rule that says you’re looking at prices – let’s not forget what they should be reflecting; they’re reflecting the nature of the world. What do we know about the nature of the world, or the economies or companies or whatever that might be? We know it’s uncertain and we know it takes its time to change – rarely do these things change very, very quickly ie. days and weeks, usually, they take longer than that. If you see price behaviour and everyone is talking about the same thing and everyone is being confident about the same thing, ie. too much certainty – there’s too much certainty of recession, there’s too much certainty of growth – if there’s too much certainty that the Bank of England’s going to do this and that, here’s the time to step back and say, ‘Well, hang on a minute, where’s the opportunity amid this certainty?’
The other thing would be if prices are moving really quickly. If prices are moving really quickly and you can’t if you can’t find facts that support that, and it’s just a made-up story that supports that, alarm bells should be ringing. So, those are the two aspects, but generally speaking, it’s when markets lose sight of what they’re trying to reflect.
You can listen to the full interview here:
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