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First State favours fixed income amid ‘acute’ market volatility


First State Diversified Growth fund manager Andrew Harman is expecting “acute” market volatility this year as his £18.9m fund reaches its two-year anniversary.

The  fund is more skewed towards fixed income strategies than equities, with around 52 per cent allocated to bonds while equities make up around 37 per cent of the portfolio.

Harman says: “Investors are going to have a challenging time with very low interest rates globally. It is difficult to generate a meaningful return without taking on risk.”

The fund manager says the trend towards the populist vote will dominate this year, given the upcoming elections across Europe.

He says: “We expect to see a radical change away from the focus of economic free trade, open economies and liberal democracies towards an environment of insular self-protectionism.

“We expect this to translate into periods of acute market volatility.”

Against an uncertain environment, Harman is doing what he can to seize upon opportunities across global markets.

Assets in the Diversified Growth fund, which Harman manages with Guillaume Paillat, are widely distributed into property, commodities, derivatives and currencies. The fund also maintains a relatively high level of cash at 7.6 per cent.

The fund is exposed to more than 800 direct holdings.

First State does not disclose its top 10 holdings on the basis the data does not show a complete picture of the fund as weightings are low.

According to FE, the fund has returned 16.9 per cent against the IA Flexible Investment sector’s performance of 20.3 per cent over 12 months as of 1 March.


Harman says the main return drivers have been currency strategy, UK and global equity holdings, and selective allocations to emerging market debt and high yield corporate bonds. He says: “Since the fund launched in June 2015 there have been a number of market and political events to navigate: Greece’s financial problems, concerns around global economic growth, falling energy prices and two large political events being the UK’s decision to leave the EU and Trump’s presidential victory.”

The interest rate risk of the fund is actively managed and over the past 18 months the duration has been between 0 and 4.5 years, which the team has been increasing more sharply after the Trump vote.

Overall, the main aim of the fund is to provide protection against UK inflation. It also provides growth by achieving returns of 4 per cent in excess of the benchmark UK Retail Price Index over five years.

The UK is set to see increasing headline inflation this year but it is unlikely the central bank will raise rates in the coming months.

Oil prices and sterling weakness has seen consumer inflation rise to 1.8 per cent in January. This was a slight increase from 1.6 per cent in December. However, the core CPI figure remained unchanged in January at 1.6 per cent.

Harman says: “We expect inflation to be more pronounced in 2017 driven by rising commodity prices, tighter labour conditions and some, albeit low, wage growth.”

With inflation on the rise, he argues there will also be an upward pressure on developed market sovereign bond yields.

Given the uncertain impact of President Trump’s agenda on emerging markets, Harman is wary about investing in stocks in the area, and continues to prefer bonds.

He says: “Emerging market equities are at risk if the US starts to break away from trade deals, as emerging markets are highly dependent on an integrated world economy.”

As a result, Harman is 6 per cent short on emerging markets equities and favours emerging market debt on a valuation basis.

He says: “Emerging market local debt is currently attractive on the basis of higher yields and potential for currency appreciation. A number of countries have already experienced large currency depreciation, a tightening cycle and a renewed focus on economic reforms.”

The fund also holds local currency bonds in Brazil and South Africa, where the team sees potential for currency appreciation.

The fund also has exposure to Poland and India, where it expects to benefit from declining interest rates. Over the last year the fund has had a high allocation to foreign currencies but as sterling depreciated after the Brexit vote, foreign currency exposure dropped from 45 per cent to 5 per cent.


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