Fund in focus: BNY Mellon Real Return

Posted by Liz Rees in Fund and industry updates category on 08 Jan 20


The proposition

Capital preservation is the main aim of this fund. The target is to produce a return of cash (1 month GBP LIBOR) plus 4% per annum over 5 years before fees, as well as a positive return on a rolling 3-year basis. However, this is not guaranteed and the fund could still lose investor’s money. The fund may use derivatives to achieve its goals as well as to reduce risk.

The team

The nine-strong Real Return team, led by Suzanne Hutchins, has expertise in global strategy, thematic investment, currencies and bonds.

The managers draw on the extensive global research resource of 34 analysts covering equities, bonds, thematic and responsible investment. They can also access BNY’s specialist alternatives team.

Philosophy and process

The team believe that the complex, and often unpredictable, nature of markets requires a dynamic investment process that is unconstrained and flexible. This incorporates economic and thematic views, asset class analysis and bottom-up stock selection. The managers actively engage with companies, as they believe this leads to better performance.

BNY leads with global thematic analysis and their global strategists identify financial, social, political, technological and environmental drivers. Hutchins considers that this thematic framework helps to uncover the beneficiaries of change whilst also highlighting areas of risk. Current themes include demographics, financial inclusion, the smartphone revolution and healthy consumption. Incorporating these reduces the investable universe from 20,000 to 3,000 companies.

The industry analysts then look for companies with superior returns on capital, high barriers to entry, strong management and good governance. They seek companies with healthy balance sheets, strong cash conversion of profits and sustainable margins.   

Similar criteria are applied when analysing bonds. The credit analysts conduct research on their sectors on a global basis and take into account inflation, interest rate sensitivity and currencies, when recommending bonds.

Analyst ideas reduce the list to 500 from which the managers construct a portfolio of around 100 holdings. Valuation is the key factor in assessment of return versus risk and careful analysis is carried out to ensure they do not overpay. The process is robust and repeatable.

The fund has two clearly defined segments. The first is a core of growth investments that are held for the long term. It currently comprises corporate bonds, emerging-market bonds, shares and alternatives. The second, to manage risk, is a ‘stabilising layer’ made up of cash, government bonds, precious metals, index-linked gilts and currencies.

Derivatives are used to protect against market volatility and to tactically gain exposure to market upside or to boost income. The fund does not take short positions in companies (by selling investments it does not own) as this incurs extra risk.

The fund will occasionally use Investment Trusts and Exchange Traded Funds for exposure to commodities and illiquid alternatives such as infrastructure, renewable energy and aircraft leasing.

Positioning

The split between the core and the stabilising portion reflects the team’s outlook. The fund is currently cautiously positioned, with around 43% invested in bonds and 27% in shares with a tilt to defensive names. Most of the portfolio is in developed markets spread across the US, Europe (including the UK) and Asia.

The biggest individual holdings are Invesco Physical Gold ETF, long-dated US government bonds, and bond ETFs. The greatest equity sector exposures are in financial services, industrials and technology. Top holdings include including Asian insurer AIA, software giants Microsoft and SAP, UK-based Prudential and life sciences company Bayer1.

Performance

Since launch on 5 September 2012, to 27 December 2019, this fund has returned 31% compared with 21% for the IA Targeted Absolute Return Sector2. The underlying strategy has delivered positive gross returns every calendar year since 2004 including during the financial crisis.

Performance over the last year has been strong, with the fund returning 13% versus 5% for the sector2. Asset allocation, share selection, government bonds, hedging of risk assets and gold exposure all contributed positively.

We consider the fund to be fairly priced. The team closely monitors the cost of implementing protection whether through the purchase of options or futures.

Outlook

The team believes that four structural factors could restrict global growth; demographics, excessive levels of debt, disruption from new technologies and the distortions created by ultra-loose monetary policy. They consider a 2% annualised rate of real growth is realistic.

Hutchins believes valuations are expensive. In her opinion, double-digit returns from global equities are unlikely to continue and a de-rating is possible as we approach the end of the economic cycle.

Although some headwinds have abated, with trade wars on hold and the UK General Election giving more clarity, lower expected returns necessitate a selective approach. Hutchins is still finding opportunities in well-managed companies in growth sectors, which could outperform when considering dividends. She also favours safe haven assets such as gold.

Our view

This fund stands out for its steady and consistent returns and has not deviated from its stated strategy. Although it may miss some of the returns delivered by a strong bull market, it has protected investors during market falls.

We like the unconstrained yet conservative approach that uses alternative sources of return whilst taking care not to increase risk.  Stock markets do not rise in a straight line so the fund is a good option for those keen to smooth out the inevitable bumps. It also currently offers a reasonable yield of around 2.2%.

1 Factsheet @ 30 November 2019.
2 Source: FE Analytics, total return in Pounds Sterling, at 27 December 2019.

Important information: Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Nothing in this article is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment.