Making opportunities out of increased volatility

As we come to the end of 2021, the number of uncertainties in the world have only increased and many investors will be wondering how they should be positioning their portfolios. Some will prefer multi-asset managers to do this thinking for them.

In this investment update, Steven Andrew, manager of M&G Episode Income, gives his current views on markets and tells us how he has positioned his multi-asset fund.

About the fund

“Back in 2010, we developed the idea of establishing a portfolio that would invest across various asset classes in order to produce a steady income stream for its investors,” said Steven. “The M&G Episode Income Fund was duly launched on 11 November 2010, with the remit to deliver an attractive level of income that increases over time, along with capital growth over the long term. Over time, the objectives of the fund have been formalised and it now has twin aims: to generate a growing level of income over any three-year period by investing in a mix of assets from anywhere in the world, and to provide capital growth of 2-4% on average each year over any three-year period.

“The key to our approach is the generation of what we call ‘natural income’. By investing in a well-diversified blend of assets expected to deliver a sufficient level of income, such as dividend-paying shares, interest-bearing fixed income instruments and property, it should be possible to grow both income and capital without sacrificing your capital base.”

Our current views on the markets

“Although there is clearly growing uncertainty about the prospect of higher inflation, which could lead to higher interest rates, we do not yet believe that the investment background is about to change significantly,” continued Steven. “Although central banks, such as in the US and Europe, have begun to withdraw their policy stimulus measures, which have done so much to support asset prices, they have not yet signalled that interest rates need to be raised quickly in an attempt to curb rising prices.

“While inflation may well pick up, there are other factors that could mean that central banks do not move rapidly, such as the fragile state of the labour market, particularly as employment support schemes have ended. Many central banks, again including the Federal Reserve and European Central Bank, seem to be convinced that much of the upward pressure on inflation is due to the impact of post-lockdown reopening, together with supply bottlenecks and that once these factors have passed inflation will not be a major problem in the long run.

“Overall, we take the view that the current investment environment can be classified as ‘benign’, with economic growth continuing to grow moderately and interest rates only likely to increase from their current remarkably low levels at a slow pace. (This is as opposed to a ‘malign’ situation, with interest rates rising so rapidly to combat inflation that economic growth is constrained).“

How we have positioned the fund

“With this in mind, we feel it is prudent to be positioned to benefit from further economic growth and modestly higher interest rates, whilst being appropriately diversified in case of any growth disappointment,” said Steven.

“For this reason, we maintain a slight bias towards company shares, with our holdings diversified across regions and sectors. We maintain a reasonably sizable exposure to bank shares in the US and Europe since we believe this exposure should enable us to participate in further appreciation of stock markets, while also benefiting from a potential positive response to higher interest rates. Bank shares have tended to do well when interest rates are rising since the money they can earn from lending increases.

“In order to guard against disappointing news about the economy, we balance our holdings of shares and other riskier assets with meaningful holdings of longer-dated (not due for early payment or redemption) US government bonds. In our opinion, long-dated Treasuries would be expected to behave differently from shares in the event of negative surprises around economic activity. They could also offer a reasonable level of return, or yield.

“We also favour government bonds from emerging countries, such as South Africa, Mexico and Brazil, as well as parts of Europe, like Portugal, which offer higher rates of return than developed markets like the UK or Germany.

“A crucial part of our investment approach is to be dynamic, which means adjusting the amounts we hold of different asset classes in response to price movements and changes in valuation. For example, we recently trimmed back our exposure to bank shares after strong performance to reinvest in technology and healthcare business in the US and Asia (though keeping decent exposure to the financial sector). This also means that we are ready to act if greater volatility in the markets present investment opportunities, particularly if, in our opinion, the price movements are not justified by what we see as the facts.

“To sum up, we have tried to position the fund to benefit from further rallies in stock markets, while being protected to a degree from negative news and also prepared to act decisively if increased volatility creates the chance to invest in new areas or themes.”

Please refer to M&G’s glossary for an explanation of any investment terms you don’t understand.
The value and income from the fund’s assets will go down as well as up. This will cause the value of your investment to fall as well as rise. There is no guarantee that the fund will achieve its objective and you may get back less than you originally invested.

The fund is exposed to different currencies. Derivatives are used to minimise, but may not always eliminate, the impact of movements in currency exchange rates. The fund may use derivatives to profit from an expected rise or fall in the value of an asset. Should the asset’s value vary in an unexpected way, the fund may lose as much as or more than the amount invested

Investments in bonds are affected by interest rates, inflation and credit ratings. It is possible that bond issuers will not pay interest or return the capital. All of these events can reduce the value of bonds held by the fund.
Investing in emerging markets involves a greater risk of loss due to greater political, tax, economic, foreign exchange, liquidity and regulatory risks, among other factors. There may be difficulties in buying, selling, safekeeping or valuing investments in such countries.

Further risks that apply to the fund can be found in the fund’s Prospectus at www.mandg.co.uk/literature

This financial promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Conduct Authority in the UK and provides ISAs and other investment products. The company’s registered office is 10 Fenchurch Avenue, London EC3M 5AG. Registered in England and Wales. Registered Number 90776.