Portfolios and asset allocators have been left bruised this year and with few places to hide amidst rising rates and poor equity returns.
The Episode Macro strategy has been able to generate strong returns through an ability to take long and short positions in areas in which price dislocations arise.
Over the year the strategy has been short bonds as central banks oversaw a hawkish raising of rates in response to rising inflation.
Fixed income, a mainstay of any investment portfolio has failed to provide the necessary protection it was renowned for Michael Dyer, investment director at M&G said what has been most painful for clients is that bonds have not been there to help them out.
“Prior big corrections in equities have had some ballast from the fixed income portfolio whereas this time investors have been beaten from both ends,” he said.
While fixed income disappointed, equities reacted as expected in an environment of central bank rate hikes.
This marks a regime change in terms of monetary policy since the Great Financial Crisis (GFC) – where central banks would often meet a crisis by pumping liquidity into the system and ensure economies were hitting their 2% growth target.
“While money supply increased rapidly after the GFC, inflation never emerged as the velocity of money collapsed as banks repaired their balance sheets”
In this post-Covid era of high prices, the days of pumping liquidity into the system are over. Indeed, this is a situation where central banks are even willing to engineer a recession to combat inflation.
“Today, central banks have staked their claim that squashing inflation is their number one priority; perhaps accepting that inflation is a worse evil for wealth inequality than some level of recessionary job losses,” he added.
The flexible approach
The approach of the Episode Macro strategy rests on a combination of longer-term assessments of prospective returns and tactical responses to ‘episodes’ of near-term volatility.
According to M&G, episodes are classed as instances when asset price volatility seems to be at odds with changes in what we see as the asset’s underlying fundamentals.
Dyer said by investing in this strategy, you are investing in skill rather than the market.
He said: “You’re not buying a passive 60/40 portfolio, ultimately you’re buying our decisions and whether you want to be long or short a particular asset class.”
So how does this translate into a repeatable edge and ensure success over time?
Dyer said that it comes down to being responsive to what is happening and keeping an eye on valuation and the behaviour of the market.
“Rather than trying to predict what’s going to happen tomorrow, we look at what’s happening today and try to think more probabilistically around where’s the best place to put our chips to benefit from things which might happen tomorrow,” he said.
The ability to respond quickly to changes in asset classes helped the strategy generate positive returns so far this year – having initiated short bond and currency exposures.
That said, as of September its fixed income short positions are now closed and the strategy is now long bonds.
“Given the magnitude of rate moves in September and October, it feels like we’re at a near term inflection point for the long end of the US yield curve,” he said. “But for now, we want to shift from short 5-year rates to long 30-year rates.
“That’s the kind of dynamism that we would expect from this strategy.”
This is where the strategy’s twin framework of valuation and behaviour becomes invaluable, as the data often does not tell the full story.
“We know from enough experience that evaluation can tell you where the market should go, but won’t tell you where it will go because any number of things can get in the way in the short run,” Dyer added.
The value of the fund’s assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. Past performance is not a guide to future performance The views expressed in this document should not be taken as a recommendation, advice or forecast. In Singapore, this material is issued by M&G Investments (Singapore) Pte. Ltd. (company registration number: 201131425R), regulated by the Monetary Authority of Singapore. In Hong Kong, this material is issued for Professional Investors only by M&G Investments (Hong Kong) Limited, located at Unit 1002, LHT Tower, 31 Queen’s Road Central, Hong Kong. If you have any questions about this material please contact M&G Investments (Hong Kong) Limited. Not for onward distribution. No other persons should rely on any information contained within. All forms of investments carry risks. Such investments may not be suitable for everyone. The information contained herein is provided for information purposes only and does not constitute an offer of, or solicitation for, a purchase or sale of any investment product or class of investment products, and should not be relied upon as financial advice.