Newton Investment Management expects money will likely flow back into absolute return strategies as equity markets enter a new era of low returns and higher volatility.

Aron Pataki, a portfolio manager at the $95 billion asset manager, said the out-of-favour multi asset strategies should perform well in the “new regime” despite a decade of underperformance. He said investors can expect the S&P 500 Index to generate “one-ish per cent” returns per annum over the next seven to 10 years with “significant downside risk.”

“Valuations are elevated, expected returns across assets are very low and in western countries, policymakers have run out of polices to support their economies,” Pataki told delegates at Investment Magazine’s Absolute Return Conference in Sydney. “Strategies that focus on capital preservation are likely to outperform.”

Record low interest rates and quantitative easing in the US and Europe have buoyed equity markets since the global financial crisis and sent benchmark indices around the world to new records. Over this time, absolute return strategies which are designed to generate steady returns over long periods have lagged, prompting investors to pull money from some of the industry’s largest funds.

Pataki said capital preservation should be key in the new environment because “the larger the loss, the harder the smaller capital base needs to work to get back to zero.” While he conceded that Newton’s flagship absolute return strategy had lagged “substantially” in the rising market, the fund did produce a “small positive return” when volatility spiked.

“This translated to an equity-like return with much lower volatility since inception over 15 years,” he said. “It’s far more important to focus on capital preservation and minimise volatility than chase markets to the upside.”

“Many critics say these strategies have undelivered and not managed to keep up with the rising market from 2009 to 2018, which is true, but they are obviously not meant to keep up,” he said. “But in 2018, 2011, 2008 clients should have got the capital preservation benefits.”

An unprecedented period of negative correlation between bonds and equities, that has coincided with falling interest rates and benefited diversification strategies, may also reverse if policymakers are able to finally lift inflation expectations.

“It’s a big if but if they can do that, through maybe modern monetary theory, then we think that negative inverse correlation…. may flip to the positive,” Pataki said. “That would undermine diversification strategies and in that environment flexibility will be required.”

The portfolio manager said growing populist politics and a return to protectionist policies will impact the supply chains of multinational companies and profit margins in certain industries. He said when the  business cycle comes to an end, policymakers will be forced into even unorthodox policies such as MMT and people skewing.

“These will be less supportive of Wall Street and unlike the current decade which favoured the asset rich, we think these policies will be about redistributing wealth,” he said.

Sarah Jones worked for Bloomberg News in London for more than 12 years covering equity markets and global asset management. Prior to moving to the UK, she worked for Australian Associated Press in Sydney covering economics and monetary policy.
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