Standard Life Investments

MyFolio Market Funds

Risk Levels I to V

Environment

Donald Trump's surprise US election win undoubtedly dominated newsflow in the fourth quarter. After initial caution, global equity markets rallied strongly as investors focused on Mr Trump’s business-friendly, fiscally expansive agenda. This favoured economically sensitive stocks, commodities and financials - notably banks and insurance firms. Meanwhile, the US Federal Reserve raised interest rates in December, with further increases expected. Closer to home, the Italian referendum went against the government, underlining the precarious nature of politics in the EU.

Within government bond markets, Donald Trump's shock election victory hit US Treasuries particularly hard. In the UK, talk of a 'hard' Brexit resulted in sterling slipping lower and an apparent retreat from UK assets. Meanwhile, corporate bonds endured a difficult quarter. Rising underlying government bond yields across the major economies drove this, as investors reset their inflation expectations higher. Despite this, corporate bonds managed to outperform relative to government bonds.

After a difficult period following the EU referendum, UK commercial real estate continued to return to normal in the fourth quarter. The UK IPD Index returned 1.6% over the three months to end-November, giving a 12-month return of 2.6%. Income growth drove this return, with capital values falling over the year. Meanwhile, investment activity remains below the long-term average but improved over the quarter as sterling's devaluation attracted overseas investors.

Activity

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 decided to reduce our allocation to UK equities in order to bring greater consistency and diversification. Similarly, we reduced the allocation to US equities in favour of European, Japanese and Asia-Pacific equities.

During the quarter, we also made the following Tactical Asset Allocation (TAA) changes, increasing the portfolios' overall risk profile amid optimism over improving economic growth.

  • Increased our holding in US equities - we are positive on the outlook for US equities, as we expect equity valuations to remain well-supported despite rising interest rates.
  • Increased our holding in Japanese equities - a weakening yen should have a positive impact on earnings. Meanwhile, Japanese companies have more cash to spend on dividends or share buybacks, which should help drive the market higher.
  • Reduced our exposure to European equities - we moved to an underweight position (relative to SAA) in European equities, reflecting growing political fragility and the risk of a weakening euro, which will negatively affect sterling returns.
  • Reduced our exposure to emerging market debt - while we remain overweight (relative to SAA) in emerging market debt, we reduced our holding to reflect growing concerns of a stronger US dollar.
  • Increased our holding in global REITs - the recent poor performance of global REITs provides an attractive point for us to continue building our overweight position.
  • Further reduced our exposure to UK direct commercial real estate - this move reflects the potential effects of Brexit on GDP and business sentiment given the increasingly uncertain political landscape in Europe.

Meanwhile, we maintained an underweight position in UK equities during the quarter. This position reduces some of the equity risk in the portfolios, in favour of regions where economic growth should be more resilient and political risk more muted.

In terms of the underlying funds, we:

  • increased the BlackRock Continental European Equity Tracker Fund
  • increased the BlackRock Japan Equity Tracker Fund
  • sold the L&G All Stock Gilts Fund.

We made alterations during the quarter because of amends to the SAA aimed at improving returns and meeting the portfolios' risk profile or because of shorter-term TAA changes.

Performance

-3 mths to 31/12/16 (%)1 yrs to 31/12/16 (%)2 yrs to 31/12/16 (%)3 yrs to 31/12/16 (%)Since launch to 31/12/16 (%)
MyFolio Market I Inst-0.078.589.6316.6528.32
MyFolio Market II Inst1.1711.8513.8021.9240.95
MyFolio Market III Inst2.5714.6917.2425.5452.27
MyFolio Market IV Inst3.8918.1021.1030.0363.24
MyFolio Market V Inst4.8721.5724.7634.3973.84

We experienced positive returns across the majority of asset classes over the quarter. The allocations to US equities, UK equities and property delivered the largest contribution to the total return. Relative to the SAA, the overweight holding in US equities was positive for performance. All other tactical positions had only a minimal but cumulatively negative impact on performance.

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 timing differences, fees and slight variations between the asset classes and the underlying fund benchmarks could explain tracking errors. For the active funds, the Standard Life Investments UK Real Estate Fund, the Fidelity Global Inflation Linked Bond Fund and the M&G Property Portfolio underperformed their respective benchmarks during the quarter.

Outlook

While the recent rally could continue into 2017, we remain cautious on the medium-term outlook for global equity markets, with the potential for further volatility driven by politics and the outlook for the global economy. In particular, Europe has a full election slate next year, while the UK is set to invoke Article 50 in March.

Turning to bonds, government bond markets remain challenging. A shift in focus from monetary to fiscal policy has changed investor perceptions of the growth and inflation outlook. As a result, the low point for bond yields may be behind us but 2017 poses a number of risks. For corporate bonds, we are cautiously positive but believe markets will be volatile in the next few months.

Finally, we expect returns from the UK commercial real estate market will continue to moderate. The magnitude of any further decline in capital values hinges crucially on the long-term economic environment following the decision to leave the EU. Despite our more negative outlook, UK real estate remains attractive for those seeking a source of sustainable income.