My latest endeavour to make the subject of financial markets and the economy more accessible to everyone is an interview series where I am intend to interview a range of fund managers, investment strategists and government officials, and to share these insights with you. The first of this series is with Adam Ryan, Managing Director at Blackrock and the lead portfolio manager of the Euro Dynamic Diversified Growth Fund. These are the 11 questions I put to Adam:
1. The performance of the fund has been flat in 2015. Although the objective of the fund is to achieve a ‘cash + 4% gross’ return over a three-year rolling period, how do you think you have performed in the context of returns across the various asset classes? Are you still confident that the fund can deliver on its cash + 4% return objective heading into a more challenging return environment, highlighted most by negative cash rates and the negative yields on German government bonds up to 5 year maturity?
Our biggest regret for 2015 was not making enough money in Q1 when markets were doing well. We got a couple of views wrong that held back performance somewhat, in particular being short the Swiss Franc when the SNB reversed its FX policy, and hedging out some European equity risk ahead of the ECB introducing QE. For the rest of the year, we feel pretty good about performance; the period was very much one of capital preservation so in absolute terms we lost money, but we reduced risk in a timely fashion, had in place some effective hedges, and continued to avoid areas (such as Emerging Markets) that saw substantial losses.
Looking forward, things are unlikely to get any easier in the short-term as witnessed in the falls in equities we’ve already seen, and as such, we’ll be playing more defensively for the time being. However, looking further out, volatility brings opportunities both in relative value (which we’re now focusing more attention on), and ultimately absolute value. I’m therefore confident that longer-term we’ll be able to hit our return target, but as this is a long-only strategy rather than a hedge fund this needs a positive return to risk assets over time.
2. Obviously, with the benefit of hindsight there are things that we would all do differently but we don’t have that luxury. However, looking back at some of the decisions you made that didn’t work out, has it changed the way you approach an investment opportunity, how you formulate your investment thesis?
One of the great things about being an investor is that you never stop learning, and 2015 was no different. There are things around specific views that we learnt from (for example in the Swiss Franc, we should arguably expressed this view via options rather than outright to limit our downside risk), but more generally we have spent time thinking about the team and our process; in particular making sure we are cognisant of our biases (both as individuals and as a team) and ensuring that our process takes these into account. We’ve also started thinking more about how we allocate risk according to factors rather than simply by asset class or individual positions – this has been important given the focus on things like momentum in 2015.
3. Developed market equities is the largest allocation within the fund, currently around 30%. How are you positioned for 2016 and do you think the monetary policy divergence theme, US v Europe & Japan, will continue to play out in the performance of their respective equity markets.
There’s been no major change here – we still think there are challenges to EM although the substantial weakness across EM currencies means that we may be getting closer to the bottom. DM markets therefore remain our preferred choice, with a continued preference for Europe.
4. On that same note, this monetary policy divergence theme has played out in the currency markets, the so-called currency wars. What are your thoughts on the Euro, do you think it will break parity with the US dollar in 2016?
We still think the USD remains strong, but it’s difficult to see it repeat the gains made in the last couple of years. It may break parity vs EUR, but it’s not something we’re backing to any meaningful degree in the fund. Instead, most of our USD long positions are vs EM currencies, particularly in Asia.
5. You have maintained quite a high weighting in investment grade corporate bonds since 2009, currently around 25%, which has performed well as yields have declined dramatically. Do you still see opportunity in this market, or is the recent closure of a number of high yield bond funds to redemptions another subprime moment?
I think we’re late in the credit cycle, and arguably in the US it has already turned (witness the rise in HY spreads). This is one reason we have no HY exposure. At this stage I’m not overly concerned about IG, in part because the duration embedded into it should see it do ok in risk-off periods, but it is something we’re keeping a close eye on.
6. It was another difficult year for emerging market equities, made worse by the slowdown in China, concerns about the impact of the stronger US dollar, and plunging commodities prices. Some investors have thrown in the towel, fed up by the years of poor performance. Do you still think there is a case for allocating directly to emerging market equities?
In short, no – I still think it’s too early. There is no end in sight to commodity weakness, particularly oil, and there is still risk in China. That said, the extent to which currencies have devalued means we may be closer to the end and it’s possible we may get there at some stage this year, but I feel we need to see further capitulation from long-term holders to get there.
7. You have done well to avoid the carnage in the commodity markets. Do you see any end in sight, and if so, what kind of investment opportunities look most appealing?
I think it’s tough to aggregate commodities as the supply / demand dynamics are very different across the complex, so it’s perhaps easier to split them down somewhat.
Energy: still no sight of a base forming, and clearly supply is significantly outstripping demand. We need to see both sides of the equation change before becoming more confident of the market bottoming out. At the earliest this would seem to be a H2 story, although weather could influence this to a degree.
Metals: we’ve seen some supply destruction and a number of commodities are below the cost of production, so suspect we are close to a base being formed, but any gains will only come through if and when investors become more optimistic on global growth.
Agri: weather dependent so no view.
Gold: shorts are back at all-time highs, and suspect a floor has been put under gold at $1050/oz. Volatility in markets means that gold could be increasingly sought as a safe haven, so think this is best placed in the commodity space to appreciate.
8. Central banks have become a huge player in financial markets since the global financial crisis, creating an environment which has encouraged risk taking, buying a range of securities on a large scale, including stocks. We are taught the basis of the capitalist model is the free market but are financial markets still free given the influence of central banks? Is it all going to end in tears, with another market collapse, or do you feel confident that Janet Yellen and her central bank peers can normalise policy without creating significant market dislocation?
I don’t think we are operating in free markets at all – the lack of liquidity in bond markets tells you this, as does the increasing use of capital controls in EM. As such, the risk of it “ending in tears” cannot be discounted. I think the central banks can still avoid this scenario, but even if they do, the “wobbles” along the way will cause significant volatility on a more frequent basis.
9. Everyone is focused on the US Federal Reserve and how quickly they move down the path of raising rates in 2016. With everyone in agreement, what do you think the odds are that the Fed will be forced to reverse course, and implement a new round of quantitative easing?
It’s possible, although not our central scenario. At this stage we remain comfortable about the US economy but the key is the consumer – if this starts to weaken materially, then we will become much more concerned about the overall economy and therefore the likelihood of a change in US monetary policy.
10. Forecasting is a difficult task, but it forms an important part of your role. With that in mind what is your outlook for 2016 and where do you see the big opportunities and risks? Could you elaborate on how you implement downside protection, the use of stop losses and volatility strategies?
The 2016 outlook is for more of the same from a macro-economic perspective, namely positive but dull growth from developed world, and further weakening in EM. From a markets perspective, this should, at the margin, be enough to drive positive returns but only if we see decent earnings growth and to that end, the lack of top line revenue growth is a concern. We’re also 8 years on from the GFC and the subsequent bull market, so we’ve clearly built in a lot of good news and very little looks cheap any more when considering valuations.
In terms of downside protection this is very much a dynamic process, taking into account options pricing and our fundamental views on markets, rather than being something that is always built into the fund as this tends to be too expensive. From time to time we will use stop-losses, but lack of liquidity in markets in recent years means this has reduced given the increased “gap” risk. Instead, we tend to allocate a review level for our research views, which triggers an in-depth review of individual positions, which may result in us cutting a position.
11. Finally, there are endless indicators one can follow to gauge the market. What are you watching closely, the main indicators that you feel can add real value to your dynamic asset allocation process, in order to dial up or down the risk in the fund at an appropriate time?
These fall into 2 categories: ones we always look at, and ones we will focus on at specific points in the cycle. In terms of those we always look at, the most important are the suite of leading economic indicators that we have put together. These aim to give us a heads-up on how economies are likely to be moving in the next 6-12 months, and can play a big influence on market moves. Aside from these, interest rate and inflation expectations are also key.
In terms of those we focus on at specific points in the cycle, these will differ from economy to economy; for example, in the US we are focusing closely on consumer data, as this is the strongest part of the economy right now, and any weakening here could lead us to revise our view on US growth; in Europe, bank lending is key to improving the sustainability of the recovery we are seeing; in China, we focus on data from independent sources rather than official data and spend time adjusting the series for seasonal patterns and changes in calculation methodology, with areas of focus being property (especially tier 3 & 4 cities) and lending data.
Would you have any specific leading economic indicators that you could highlight?
We’ve built a set of proprietary LEIs to cover the major economies – inputs are data-focused (as opposed to some which use market prices as inputs), particularly those which have a forward-looking bias (PMIs, Consumer Confidence/Sentiment, Housing etc.). We also look at the “nowcasts” done by Atlanta Fed amongst others.
Thanks for your time Adam. Best of luck for the year ahead.
Vincent McCarthy, CFA
Appendix 1: Adam Ryan Biography
Adam Ryan, managing director and portfolio manager, is a member of BlackRock’s Multi-Asset Strategies (MAS) group which is responsible for developing, assembling and managing investment strategies involving multiple asset classes. He is head of the Diversified Strategies team and is lead portfolio manager of the Euro Dynamic Diversified Growth (DDG). Mr Ryan’s service with the firm dates back to 1999, including his years with Merrill Lynch Investment Managers (MLIM), which merged with BlackRock in 2006. His background is in fixed income portfolio management where he was Head of Fixed Income for MLIM’s Private Client business before developing and managing diversified multi-asset portfolios for both private and institutional clients. Mr Ryan earned a BA degree with honours in engineering from Cambridge University in 1991.