Standard Life Investments

Market funds report - MyFolio

Risk Levels I to V

Environment

Global equities delivered robust returns in the first quarter of 2017, albeit slowing in March, on hopes that US President Trump’s proposed policies would boost economic growth and lift corporate profits. As expected, the US Federal Reserve (Fed) increased interest rates. A relatively upbeat fourth-quarter results season, renewed merger and acquisition activity and growing optimism about global economic growth were also supportive. European stock markets were boosted by signs that the region’s economy was improving. Business surveys hit a five-year high and consumer confidence rose too. Japanese shares were affected by worries about a change in US trade policy. The yen was stronger too, so Japanese exports were less competitive. Japanese economic, wage and company earnings data were fairly positive, however. Other Asian stocks were boosted by China’s improving economy, which helps their exports. Emerging market stock markets performed well overall.

Optimism surrounding Mr. Trump’s election faded, and US government bond yields declined (bond prices rose) as investors sought more defensive assets. Yields on UK government bonds also fell as investors considered the downside risks related to Brexit. Global corporate bonds rallied on the improving economic backdrop. While credit investors accepted that a stronger economy meant rising interest rates, robust corporate balance sheets were deemed positive. However, optimism over global growth subsequently lessened, leaving credit slightly weaker near quarter-end.

UK commercial real estate made a robust start to 2017. Having fallen in 2016, UK real estate capital values turned positive, up 0.4% in January and February 2017, according to the MSCI/IPD monthly index. Sterling weakness attracted overseas investors into the asset class.

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 made no changes to the SAA model.

During the quarter, we increased exposure towards asset classes that should benefit from the improvements in global growth and the rise in inflation that we expect to see. We therefore made the following Tactical Asset Allocation (TAA) changes.

  • Reduced our UK equities position - because we prefer other global equity markets to the UK, given the uncertain outlook for the UK economy and the headwinds it continues to face after the signing of ‘Article 50’.
  • Decreased our US equities position - while still remaining overweight (versus our SAA), we preferred to allocated to other equity markets where we believe growth momentum is more favourable.
  • Increased our overweight holding in Japanese equities - this market should be more sensitive to the upturn in global growth. It also has the added diversifying benefit of being exposed to the defensive characteristics of the yen.
  • Increased our exposure to Asia ex-Japan equities - intra-regional trade in Asia is growing, reducing its reliance on the US, as the region slowly acclimatises to an evolving Chinese economy. We remain underweight (versus our SAA).
  • Increased our holding in European equities - as we are increasingly positive on more cyclical growth markets, we moved from an underweight allocation to an overwight allocation relative to the SAA.
  • Increased our position in emerging market equities - as we are increasingly positive on more cyclical growth markets, we moved from an underweight allocation to overweight relative to the SAA. Furthermore, valuations remain attractive.
  • Reduced our exposure to emerging market debt - we further reduced our holdings at a point when yields were close to the bottom of their post-US election range. We remain slightly overweight versus the SAA.
  • Further reduced our exposure to UK direct commercial real estate - we continue to remain underweight in order to fund more attractive equity positions.

Any changes to the weightings of the underlying funds were as a result of the changes in TAA carried out over the review period.

Performance

3 mths to 31/03/17 (%) 1 yrs to 31/03/17 (%) 2 yrs to 31/03/17 (%) 3 yrs to 31/03/17 (%) Since launch to 31/03/17 (%)
MyFolio Market I Inst 1.88 8.72 8.35 17.72 40.60
MyFolio Market II Inst 2.65 13.00 12.08 24.18 56.44
MyFolio Market III Inst 3.55 17.09 15.49 29.39 67.48
MyFolio Market IV Inst 4.39 21.65 19.29 35.38 77.46
MyFolio Market V Inst 5.20 26.17 22.82 41.59 89.76

There were positive returns across all asset classes over the period. The allocations to US, equities, UK equities and sterling corporate bonds delivered the largest positive contribution to total returns.

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 Royal London Short Duration Global Index Linked fund outperformed its benchmark, while the Putnam Global High Yield Bond, the M&G Property and PIMCO Global High Yield funds modestly underperformed their respective benchmarks during the quarter.

Outlook

Investors face a conundrum. On the one hand, the global economy is improving, with growth and trade picking up. The risk of deflation has fallen and central banks generally remain supportive, setting a positive scene for equity markets. On the other hand, policy and politics are creating uncertainty, with a lack of clarity on the outlook for US trade and tax, and upcoming European elections. As such, a modicum of caution is warranted when making investment decisions.

While we expect bond yields to gradually increase (and bond prices to fall), challenges remain. Away from President Trump’s policy challenges, the US economic backdrop remains favourable and the Fed seems prepared to respond with higher rates. Meanwhile, the European Central Bank is shifting towards reducing monetary support and unwinding negative interest rates. In the UK, higher inflation is proving awkward for the Bank of England if it wants to maintain interest rates at low levels. This very fluid environment for bonds requires us to take a pragmatic approach to new information.

We expect returns from the UK commercial real estate market to moderate. The amount by which property values will fall hinges on the long-term economic impact of leaving the EU. Despite our more negative outlook, UK real estate remains attractive for those seeking a source of sustainable income.