The coronavirus crisis and the extremely uncertain outlook it has created means investors need to embrace flexibility more than ever before, according to the managers of the BNY Mellon Real Return fund. 
Stock markets may have rallied from the lows witnessed in March but have been trending downwards over recent weeks as coronavirus cases continue to rise and some countries enforce renewed lockdowns.
The global economy took a significant hit in 2020’s second quarter and there is still little clarity on how the recovery will look. While some believe normality might return relatively quickly, others note that a ‘second wave’ of the disease could prompt another collapse.
Against this backdrop, Suzanne Hutchins, Aron Pataki and Andy Warwick – who run the £5.5bn BNY Mellon Real Return fund – think investors need to be exposed to a range of assets and be open to shifting between them as conditions change.
Performance of fund vs index over 2020
Source: FE Analytics
“In this uncertain environment, we believe there is a strong case for investment strategies which focus on the diversification of asset types and uncorrelated return streams, and which have the flexibility to adjust positioning both strategically and tactically (even overnight) to reflect the changing economic circumstances,” the team said.
This approach appears to have worked for the fund, which is slightly outperforming global equities this year with significantly lower volatility (16.92 per cent for the fund, versus 26.96 per cent from the MSCI AC World).
But how has the fund been making use of this flexible approach in 2020’s challenging first half?
When it comes to equities, the BNY Mellon Real Return team noted that the coronavirus crisis has seen stocks split into ‘winners’ and ‘losers’ – which has created stock selection opportunities on both sides.
“During the current crisis, more economically sensitive companies (many of which had already been under pressure for much of 2019), as well as those dependent upon ‘normal’ patterns of human activity, have lagged,” it explained.
“Undoubtedly many of these companies are beset with structural and balance sheet issues that are likely to render them poor long-term investments.”
Performance of global equity sectors in 2020
Source: FE Analytics
The chart above shows how some cyclical areas of the market such as energy, financials and industrials are still down significantly from the coronavirus sell-off that started in mid-February. Areas like technology and health have performed much more strongly.
However, the BNY team sees these unloved areas as presenting more interesting opportunities than those that have emerged as the winners of the coronavirus crisis.
“It feels as though a few babies have been thrown out with the bathwater. In all but the most negative public health and economic scenarios, such situations appear to us to represent the best hunting ground for opportunities at the present time, although clearly it is vital to be highly selective,” it explained.
“In this vein, we have recently been adding to companies in areas such as mining, industrials and insurance to achieve a balance alongside strategic positions in sectors favoured by our longer-term thematic work, including healthcare, technology and branded consumer exposures.”
BNY Mellon Real Return also carried out a tactical increase in its investment-grade bond exposure during 2020’s second quarter, in the belief that it was a “better substitute” for cash and underpinned by central bank demand.
Investment-grade bond spreads, or their yield premium over US Treasuries, rallied strongly after the US Federal Reserve introduced primary and secondary market corporate credit facilities and countries started to emerge from their lockdowns.
However, once this rally took place the team determined that the potential for excess returns from corporate bonds due to coronavirus disruption had “mostly passed”. Since then, the portfolio has been reducing its corporate bond exposure and allocating to more attractive opportunities, such as undervalued equities.
“The recovery in investment-grade credit has been much faster than in 2009 as central banks have this time been more coordinated and faster to act. However, at the same time, the fundamentals are mixed and the full effect of the crisis on issuers is still to be revealed,” it added.
“We expect to see a continued increase in the number of ‘fallen angels’ (investment-grade issuers downgraded to high yield) throughout this year, as well as general downward rating migration for the more challenged business models. Nevertheless, with dispersion between industry sectors remaining high, there is still an opportunity to add value through active credit selection.”
Performance of gold in 2020
Source: FE Analytics
BNY Mellon Real Return has maintained a position in gold for more than a decade, favouring the yellow metal for its safe-haven characteristics and ability to avoid being manipulated or debased by policymakers.
The chart above highlights just how strongly gold has performed in 2020, as investors flocked to it when the pandemic caused markets to sell off. It is up close to 30 per cent, in sterling, year-to-date.
“Our gold position has not been immune to this year’s market volatility and, as one of the most liquid assets, initially suffered from the need for mass liquidations,” the BNY team said.
“It has, however, begun to work as an indirect hedge in the portfolio and we have been adding to the position. Given the huge level of fiscal stimulus we have seen from governments, in addition to unprecedented monetary stimulus, we continue to favour it as a hedge against the likely resurgence of inflation expectations.”
BNY Mellon Real Return, which is one of the largest funds in the IA Targeted Absolute Return sector, has made a total return of 121.16 per cent over the past 15 years.
Performance of fund vs sector over 15yrs
Source: FE Analytics
This is the highest return of any of its peers with a track record stretching back this long. The fund is managed by Newton Investment Management, using the group’s global thematic investment approach, which identifies the forces driving long-term change in the world and any opportunities or risks associated with them.
The fund has an ongoing charges figure (OCF) of 0.80 per cent.