Positioning the MLC Inflation Plus portfolios in the current investment environment

Interviews

by David Chau

MLC’s Portfolio Manager, Dr Ben McCaw discusses market volatility, the outlook for interest rates and equity valuations, and the MLC scenario-based approach to asset allocation.

David Chau: Hello I’m David Chau from the Finance News Network. So joining me from MLC Inflation Plus Fund is Portfolio Manager, Ben McCaw. Ben thanks for joining us.

Ben McCaw: No problem, it’s a pleasure to be here today.

David Chau: Your Fund is about generating greater certainty for investors, but these last 12 months have been anything but certain. So this volatility from the last 12 months, is it fairly typical?

Ben McCaw: Well you’re right, our primary aim with these Funds is trying to control outcomes for investors. And so we manage the portfolios to try and take account of lots of different types of environments. And just turning back to what you said earlier about the last 12 months, the last 12 months have been – they may have been uncertain in two periods, there was a big uptick of uncertainty in January and there was another big uptick in June. But if you take those out, financial markets have actually been quite well behaved over the past 12 months, and uncertainty has been low. The volatility indices, the VIX have been very well behaved over the last 12 months.

David Chau: How do you manage your portfolio to take into account all that uncertainty, yet still generate returns, which exceed inflation?

Ben McCaw: Generating returns that exceed inflation at this point in time is extremely difficult. While markets have been well behaved over the past 12 months, it’s the outlook for uncertainty, or future uncertainty that makes it difficult for us to position the portfolios right now. Markets are expensive and there’re a lot of distortions imbedded in the investment environment. But we believe that if we can control risk now over the short term, we’ll get a much better opportunity in the future to increase our exposure to risk, when the outlook for uncertainty is better, or market prices are more attractive.

David Chau: Let’s talk about global interest rates; the consensus is that they’re heading higher now. So does that imply inflation is going to pick up?

Ben McCaw: The inflation dynamic is very complex, especially if you consider it on a global scale. And you’re right, the consensus expectation when people talk seems to be that interest rates are heading up. But on the inflation side, we’ve seen the yield curve flatten over the past year with the frontend going up and the backend coming down. Market measures of inflation expectations have also come back slightly, over the past 12 months and the gold price is off. So all that combined suggests that even though there’s chatter about inflation rising, the market’s still not really pricing it in.

David Chau: So what are the implications for asset allocation?

Ben McCaw: If you believe that the risk of inflation on the topside is high, but the market’s not pricing in that risk through the bond markets, then I think it’s pretty obvious. You want to remain underweight duration, or reduce your exposure to interest rate risk, which in a nutshell means being underweight bonds.

David Chau: Despite equity valuations being high, they still offer investors the best chance of growth. Are they right to pursue this strategy?

Ben McCaw: First of all you’re right, equity valuations are high at the moment, but that doesn’t mean you shouldn’t own equities. Because you’re also right when you say that equities give you a good exposure to growth, and that’s the challenging part of solving the investment puzzle, at the moment. We believe that you should still own equities, but you really need to pay attention to which equities you own. In our opinion the best exposure to equities right now, comes from owning a defensive sleeve of equities, where you’re investing in companies that have been selected by experts that are able to identify robust return streams, at appropriate valuations.

David Chau: What’s your allocation to domestic versus international equities?

Ben McCaw: We still favour global equities over domestic equities for two reasons. Firstly it’s a bigger pool to fish in, to find the type of companies that I just talked about. And secondly, it enables us to have an exposure to foreign exchange, which is still a valuable diversifier of risk.

David Chau: Last question Ben. What probability do you attach to the markets being positive over the next 12 months?

Ben McCaw: Well as you know, we think about what might happen, so we think about the markets being up over the next 12 months obviously. Some of our scenarios have the market up over the next 12 months, and some of our scenarios have the markets down over the next 12 months. But the most important thing for us is considering all of those outcomes. And while we do attach probabilities to each of our individual scenarios, it’s very difficult for us to come up with a number over one year, for either markets going up or markets going down. The most important thing for us is that we’ve considered all the outcomes that we think investors could face.

David Chau: Ben McCaw, thank you very much for your time.

Ben McCaw: Thank you very much.

ENDS

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