MyFolio Market Funds
Risk Levels I to V
Global equity markets enjoyed a relatively strong third quarter, with all major indices up in local currency terms. Supporting sentiment was improving US economic data, accompanied by a US Federal Reserve that is erring on the side of caution regarding rate increases. Monetary policy in the UK, Europe, Japan and China also remained supportive. Meanwhile, the fallout from the UK’s EU referendum has been less severe in the short term than many feared, including for the UK economy.
Within government bond markets, the 10-year UK gilt yield, which moves inversely to its price, fell to record lows before edging back up as economic signals proved healthier than anticipated. Meanwhile, corporate credit enjoyed a positive quarter. Strong technical factors, including the European Central Bank’s Corporate Sector Purchase Programme and robust inflows into the asset class, were the primary driver.
The UK commercial real estate market is gradually returning to some normality following the surprise result in the EU referendum. Investment activity remained subdued in the first couple of months after the referendum. Trading volumes in August were £1.6 billion, compared with £4.4 billion in August 2015. However, market conditions then appeared to stabilise, with volumes rising to £2 billion in the first half of September according to preliminary data.
We review the Strategic Asset Allocation (SAA) for each of the MyFolio funds every quarter, with the aim of ensuring that we continue to meet investors’ long-term interests. Following the most recent review, we made no changes to the SAA model.
During the quarter, we made the following Tactical Asset Allocation changes.
- Increased our underweight position in UK equities – following the EU referendum, we positioned the portfolios to reflect a weaker UK economic environment and increasing uncertainty.
- Increased exposure to UK gilts and short-dated global index-linked bonds - we saw the EU referendum result as a threat to global growth and inflation, and negative for the UK economy, which would see nominal yields fall. As such, we removed our underweight exposure to global index-linked bonds and added exposure to UK gilts.
- Removed our overweight position in European equities - we moved to a neutral position in European equities given the significant risk of contagion from the UK’s vote to leave the EU and therefore the potential for lower corporate earnings. In addition, there is elevated political uncertainty in Europe, with Spain, Italy, France and Germany facing headwinds over the next 12 months.
- Changed our US equities position from underweight to overweight - we prefer US equities in order to gain exposure to the stronger US dollar, which we believe will be a key driver of US equity returns for UK investors.
- Reduced our UK direct commercial real estate exposure to underweight - we changed our position to reflect potential headwinds as the economic outlook becomes less clear. UK commercial real estate has underperformed over the quarter and we cannot rule out more downside given ongoing uncertainty.
- Implemented a holding in global REITs - this new position reflects our desire to access improving global real estate markets. For example, US real estate remains buoyant and New York is becoming the focus for international investors as London loses out.
In addition, we have listed below some of the main TAA positions held during the third quarter.
- Underweight position in Pacific Basin equities – we hold this position as Chinese growth remains uncertain because of ongoing economic restructuring and spiralling debt problems. Australia is exposed to lower Chinese growth and has relatively high interest rates. This leads to a stronger Australian dollar than it needs to become more competitive.
- Overweight position in Emerging Market Debt – our preference for emerging market debt helps to diversify the portfolio and balance some of the risks from our underweight position in Pacific Basin equities. We expect that a relatively high yield coupled with strong restructuring will drive emerging market debt higher over the next 12 months.
In terms of the underlying funds, we made the following changes where applicable:
- bought the BlackRock Global Property Securities Equity Tracker
- bought the L&G All Stocks Gilt Index Trust
- reduced the BlackRock Continental European Equity Tracker
- reduced the M&G Property Portfolio
- reduced the Standard Life Investments UK Real Estate Fund.
We bought the BlackRock Global Property Securities Equity Tracker as we introduced a holding in global REITs. Conversely, we reduced the M&G Property Fund and Standard Life Investments UK Real Estate Fund as we lowered our position in UK commercial real estate. Finally, we bought the L&G All Stocks Gilt Index Trust as we implemented a holding in gilts.
|-||3 mths to 31/09/16 (%)||1 yrs to 31/09/16 (%)||2 yrs to 31/09/16 (%)||3 yrs to 31/09/16 (%)||Since launch to 31/09/16 (%)
|MyFolio Market I Inst||4.18||10.64||12.72||18.05||36.52
|MyFolio Market II Inst||5.95||14.62||15.88||22.75||49.09
|MyFolio Market III Inst||7.11||17.76||17.76||25.60||56.40
|MyFolio Market IV Inst||8.57||21.65||20.27||29.30||62.50
|MyFolio Market V Inst||9.99||25.29||23.10||33.00||70.40
From an asset allocation perspective, our overweight holding in US equities was positive for performance. On the downside, an overweight position in UK gilts was negative for performance, as were underweight holdings in Asia-Pacific, emerging markets and UK equities.
At a fund level, the performance of the tracker funds over the quarter was in line with expectations. The returns matched their equivalent indices and tracking errors could be explained by timing differences, fees and variations between the asset classes and the underlying fund benchmarks. For the active funds, the Standard Life Investments UK Real Estate Fund outperformed its asset class benchmark during the quarter, while the Fidelity Global Inflation Linked Bond Fund and M&G Property Portfolio underperformed.
We remain cautious on the outlook for global equities over the medium term, as a variety of political and economic factors point to higher levels of financial market volatility. The major central banks should continue to support their respective economies, although all eyes will be on the US to see if, and when, the Federal Reserve will raise rates.
Turning to bonds, with large sections of core government bond markets now offering negative yields, we are cautious about expectations of further strong returns. For corporate bonds, strong technical factors and slightly cheap valuations are balanced out by political risks and a lower economic growth profile.
We expect returns from the UK commercial real estate market will continue to moderate. The magnitude of declining capital values hinges crucially on the referendum result’s long-term economic impact. Despite our more negative outlook, UK real estate continues to offer an attractive yield for those seeking a source of income.