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Asset allocation: Threadneedle bets on Australian bonds to offset China fall

Sharp falls in Chinese growth will send surrounding economies tumbling but a bet on Australian government bonds could provide enough insurance to smooth out any problems, Threadneedle head of multi-asset allocation Toby Nangle says.

Nangle says the £49m Threadneedle Dynamic Real Return fund aims to deliver CPI plus 4 per cent each year while keeping volatility to just two-thirds of equity markets.

“Inside this fund I’m doing what most people outside the financial world think fund managers do, which is I’m buying different exposures and combining them to provide a good real return,” he says.

That means ensuring the fund grinds out returns while dissipating ructions from possible events.

Emerging markets offer the best growth prospects although there is also a good chance of them being knocked off course, says Nangle.

“As an asset allocator, I like the fear and loathing investors have toward emerging markets. I like risk premia.”

He is allocating to funds  focusing on developing nations with strong balance sheets and current accounts. However, with China – opaque as its macro figures are – coming further off the boil, a sharp shock is not out of the question.

“I like to get the risk premia but also protect against the threats of slower Chinese growth, which I think are real.”

This meant buying long-dated Australian government debt Nangle believes is likely to appreciate if the nation’s mining boom slumps on poor demand. The fund uses derivatives to sell the Australian currency risk.

“Australia is two economies. You’ve got a mining economy that has led to high house prices and very high investment, and a manufacturing and industrial economy that’s been in recession for three years.” 

The Reserve Bank of Australia’s interest rate has been steady at 2.5 per cent since a 25-basis-point cut in July last year. It was 3.25 per cent two years ago. 

The current rate is the result of a “sterling” RBoA balancing act between keeping mining from overheating and not strangling the struggling wider economy, he says.

“But if China stumbles, the booming mining economy will probably fall. That would mean generalised weakness throughout the country and the central bank could cut rates further.”

That would send the price of the Australian sovereigns up, offsetting the impact poor Chinese demand would have on South-east Asia.

Searching for earnings growth in the US, UK and Japan is another aim for the fund.

Nangle expects US earnings to grow by roughly 10 per cent in the coming year. Far from them being expensive, they have retained the same value relative to other developed equities in the past few years because their earnings have improved, he says.

UK exposure has been reduced as Nangle is nervous about the strength of sterling, the diminishing expectations of earnings expansion and political risk as the general election approaches.

Japanese equities are a big play for the fund, with 13 per cent held in the £290m Threadneedle Japan fund.

“For the past 20 years if you felt optimistic about Japanese equities the best thing you could do was to sit in a dark room and wait for the feeling to pass,” he says.

But Nangle believes things appear different this time. Decades of bitter experience have, through “natural selection”, made Japanese business managers cynical, he says.

However, they are buoyant about the prospects in the wake of prime minister Shinzo Abe’s inflationary campaign. They are also much more focused on return on equity than in the past, which is great news for investors, says Nangle.

“You can be seduced by great macro stories but it’s best to speak with the people on the ground.

“Our earnings expectations have been much higher than the market and we’ve seen our earnings predictions beaten time and again over the past few months. 

“Japan is much more volatile than the others but it’s the one where we have the most conviction.”



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