The importance of macro context
The underlying economic environment influences us all on a daily basis, whether we like it or not. Our personal finances are affected by interest rates, job prospects by economic growth and how much we can spend by inflation. These are deliberately simplistic examples, but we have used them to highlight the fact that the ‘real economy’ also has an undeniable impact on the stocks in which we invest. Understanding that impact, and positioning the CF Canlife Global Equity Fund to benefit from changes in the macro outlook, is crucial.
For example, over the last ten years, falling interest rates have benefited defensive ‘quality growth’ style sectors such as consumer staples, healthcare and technology. Value underperformed because the macro environment was not conducive to it. However, in 2016 there was an inflection point as these more cyclical, value parts of the market began to outperform in the second half of the year. This came about because the market realised that rates could fall no further, after the Bank of Japan (BoJ) and the European Central Bank (ECB) refused to go further into negative territory. As a result, there was a complete rotation in sector performance, with previously unloved areas such as financials doing incredibly well. They were then further boosted by the election of President in Trump in November, as the market priced in higher infrastructure spending, inflation and interest rates.
At Canada Life Investments, we apply a rigorous macreconomic overlay to portfolio construction as we aim to position the CF Canlife Global Equity Fund in the stocks and sectors that we believe are the most suited to our macro forecasts. For example, we increased the Fund’s weighting to the financials sector significantly in early 2016, having seen the uptick in economic indicators. Although this was a contrarian position at the time, it proved to be very beneficial for the Fund’s performance in 2016, as it returned 31.6% for the calendar year, versus the 23.9% gain of our average peer.*
As indicators picked up, our cyclical exposure increased
Source: Citigroup & Canada Life Investments, as at 6 June 2017.
Who were the winners
In particular, US and European banks were some of the biggest winners in the second half of 2016. Valuations were very cheap and – with a higher net interest margin now forecast – profitability looked much improved. Holdings such as Banco Santander in Europe and Bank of America in the US significantly outperformed the market due to the sustained improvement in investor sentiment during 2016, as shown in the above graph. This caused risk assets in general to rally, at the expense of the more defensive areas of the market.
How do we see the current picture?
However, the environment is very different now. We do not doggedly seek to stick to one particular style and, despite having more of a value bias last year, we seek to add value through both asset allocation and stock selection. The Fund’s asset allocation strategy is reviewed on a quarterly basis and this resulted in some changes in 2017, as we became concerned that the macro picture would be softer than consensus expectations.
For example, US Gross Domestic Product (GDP) was estimated just 0.7% in the first quarter of the year. Although this was then revised up to 1.2%, it was still worse than the market had forecast and the worst reading for some time. The Citigroup Economic Surprise Index was also a heavy faller. Elsewhere, we were wary of increasing global political and economic uncertainty. Therefore, despite global equities shrugging off these worries and performing strongly so far year-to-date, the CF Canlife Global Equity Fund has maintained its relatively defensive positioning, as we expect a choppy market over the course of 2017. Approximately 30% of the portfolio is invested in consumer stocks such as Grifols and Edgewell Personal Care, which we believe are well-placed to weather this likely volatility. We are also overweight in Europe, which has seen off a wave of populism for now and is enjoying increasing economic momentum.
A real economic reflection
Currently, the Fund has a large-cap, blend bias, indicating the portfolio’s mixture of growth and value stocks. We maintain a high conviction, stock-driven portfolio but are practical about the economic drivers running in the background. At £362m, the Fund is also nimble enough to access small and mid-cap names where appropriate. Mid-caps have been one of the biggest drivers of outperformance for the Fund over the years and we look to increase our exposure to the space when we have the opportunity, be that fundamental, valuation or macro-driven. Currently, the Fund has 9% invested in mid-caps.
Although our more defensive positioning has seen the Fund lag the IA Global sector average year-to-date, the Fund has returned 131.3% over the last ten years, versus the peer group’s 113.4% (to 31/05/2017). The Fund’s process has also worked across differing market conditions, outperforming the falling market by 9% in 2008, as well as staying ahead of the sector in the sharply rising markets of 2013 and 2016.* Given we expect market volatility to increase going forward, we continue to believe that pragmatism will be key in generating long-term investor returns.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. The contents of this article are not intended as investment advice.
*Source: Performance figures from Morningstar, bid to bid, with net income re-invested for C share class. Sector is IA Global.
The information contained in this document is provided for use by institutional investors, professional investors and professional advisers and is not for onward distribution to, or to be relied upon by, private investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and are subject to change at any time without notice. The contents of this article are not intended as investment advice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com.
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CLI00812 Expiry on 15 June 2018