MLC talks end of easing cycle

Funds Management

by Clive Tompkins

MLC Senior Portfolio Manager Dr Ben McCaw speaks to Cassandra Crowe, Research Manager, about the potential end of an era in monetary policy easing and what it means for asset prices.

Cassandra Crowe:
Hi my name’s Cassandra Crowe and I’m the Research Manager for the MLC multi-asset strategies. Today I’m very excited to interview Ben McCaw, Senior Portfolio Manager for MLC. Welcome Ben, thank you very much for joining us.

Ben McCaw: Thanks Cass.

Cassandra Crowe: Ben it’s certainly been an interesting time for investment markets. When you look at traditional assets like bonds and equities, valuations look extremely stretched and when you think about monetary policy, it’s potentially coming to the end of its effectiveness. I’ve even heard you say that we could be at the beginning of the end of an era. Can you perhaps explain a little bit about what you mean by that statement?

Ben McCaw: For us in our team, it’s felt like the beginning of the end of an era for a little while, but there’re a few more signs now that that might in fact be true. As most investors are aware, the feed through of changes in monetary policy to the real economy and the financial side of the economy, are extremely complex. And we’ve been in almost like a one-way street on monetary policy now, for about 20 years. So you’ve got to forgive people for just becoming ingrained in this environment of lower and lower, and lower interest rates, to the point at which the price of cash became extremely distorted.

But I think that the signs that are pointing us towards thinking that the end of the era may be closer now, than it has been in the past, are simply feedback that we’re starting to see from society, back through the political system. So for instance, if we think about monetary policy and its impact on the economy, there’s a feedback mechanism that goes through the financial side of the economy, which has performed very well over the past five or six years, for sure. I mean asset prices now are extremely high. But the feedback through the real economy hasn’t been nearly as strong, in terms of stimulating demand.

That’s changed slightly recently, but the wealth cap that’s opened up for example is I think, putting pressure on politicians to start thinking much more seriously about using physical policy, to stimulate demand. And that in turn can turn around and impact monetary policy, and force rates up again.

Cassandra Crowe: You mentioned asset prices and I guess I wonder, do you think they will continue to be as high as they have been in the past? We see a lot of fund managers positioning their portfolios as though they potentially might continue to be high. But my concern is they might not be aware of some of the risks embedded within those positions.

Ben McCaw: That’s a really good question. And from our point of view it’s hard, because we never pretend to know what’s going to happen tomorrow. So we have no idea whether high asset prices are going to maintain themselves, for a short period of time, a medium period of time, or a long period of time. But one thing we do understand is that things can change. And we believe we’ve got a fairly strong understanding of how asset prices will react, if certain things change in the environment.

So rather than investing as if tomorrow was going to be the same as today, we take an alternative route and think about different futures. And try to put together a strategy that will deliver to clients, regardless of what happens in the future.

Cassandra Crowe: I understand for an exchange is often used for a diversifier to global equities, I know you have some positions in place with respect to the Aussie and the USD. Can you comment a little bit on those?

Ben McCaw: This is related to the comment I made earlier about high asset prices. Sometimes it’s not easy to take advantage of a high asset price and sometimes it is. And so with the peculiarities of the environment over the past five years or so, one of the markets that has been able to be accessed by investors like us where there is opportunity, is in currency markets. It’s not just the Aussie dollar and the US dollar; it’s a whole mix of currencies.

But because of the actions by central banks to manipulate interest rates, that’s created some really good opportunities for us to access diversification. In the context of otherwise finding it very difficult, to be able to diversify against the types of equity risk that dominate the portfolio.

Cassandra Crowe: In terms of Aussie equities now, I know that you and the team actually built an in-house bespoke portfolio for your real return fund, Inflation Plus. Can you tell us a little bit about why it’s so important to have a tailored Australian equity portfolio?

Ben McCaw: That’s right Cass. For quite sometime now, we’ve been managing an Australian equity component within Inflation Plus. The reason for us thinking about, or developing the capability to manage a direct equity allocation within our diversified funds, is because it’s become clear that we need to be able to align the stock selection and the asset allocation, to engineer the outcomes that we have been trying to deliver to clients. And taking control of stock selection, in an important sector like Australian equities is our first step towards doing that.

So just by way of example to illustrate how this helps us out, most investors would be aware that the Australian market is dominated by financials and materials, right. But there are also opportunities in Australia outside financials and materials. The way we manage portfolios, it would be very difficult for us to maintain a meaningful weight to Aussie equities, if we had to take the concentration risk from financials and materials. So we can handle that obviously by building our own portfolio.

But there’s another side to it as well. Banks for instance in Australia at the moment, trade on quite a good dividend yield, which under most scenarios is attractive for our portfolios. The problem though is that if the Australian economy goes into, or swings into the type of environment that challenges the banks, then we’re out-risked from a capital point of view and that’s something that we can’t tolerate. So our solution to that is to participate in the banks and own them, not to the extent that the market owns it, but to about 10 per cent. But to hedge the capital side with puts.

Now the beauty at the moment is that we can collect quite a healthy dividend income from the banks, but the puts are cheap. So the way we look at it is that we’ve enabled ownership of banks to receive a relatively high dividend, or you give up a little bit of that dividend, but get the protection from the puts. So if the market does correct, we don’t lose on the capital side.

Cassandra Crowe: That’s great insight, thank you very much Ben for sharing your thoughts with us today.

Ben McCaw: Thanks for having me Cass.

Cassandra Crowe: You’re welcome.