Steve Waddington, Insight Investment

Steve Waddington is the portfolio manager of the Multi-Asset Strategy Group at Insight Investment, a division of New York-based BNY Mellon.

When we interviewed him this week, he outlined his investment strategies in light of the pick-up in markets volatility over recent weeks, as well as some of the perceived headwinds and tailwinds for investors.

Waddington explains that he has needed to tinker with his firm's investment strategies and to make some changes in his portfolio to capture new investment opportunities. This has also included the adoption of more options-based strategies.

Listen to our podcast, or read the full interview below.

Transcript

Tony Kaye:  I'm talking with Steve Waddington from Insight Investment, which is part of the BNY Mellon group. Hi Steve.

Steve Waddington: Hello.

Tony Kaye: Steve thanks for coming in. I wanted to talk about what your particular fund does, or your particular role as a fund manager, and then perhaps we could talk about some of your insights into where you see markets heading. What are the key factors there?

Steve Waddington: Okay certainly. As you say, I'm from Insight Investments. We're a trillion dollar asset management company focused on three main areas. We look at liability risk management, active fixed income, and absolute return investing. The Diversified Inflation Plus Fund, which is one of the portfolios we manage is a fund, which is aimed to deliver quite a meaningful growth target. So 5 per cent above inflation on an annualised basis. importantly, it's aiming to deliver that return profile in a much smoother manner that traditional growth assets. What we look to do with that fund is in essence capture a whole range of different investment opportunities into a single portfolio. That means capturing investments which are reliant on broad markets rising to generate returns, so that is investing in equities, and credits, and government bonds. But we also look to expand the investment universe to capture investment strategies which are much less reliant on the overall direction of investment markets. So that means that you're capturing alternative risk premia as well as your traditional risk premia in a single portfolio.

One of other underlying tenets of our strategy is to take a much more dynamic approach to constructing a portfolio than many traditional investments in our strategies do. What that means is that we really understand what the investment environment is like now and what we can foresee in the following 12 to 18 months, for example, and therefore dynamically change the portfolio exposures to reflect any changes in our views. In broad terms, by capturing that very wide range of investment opportunities in a single portfolio, by very dynamically managing that portfolio it means you could have a much more risk controlled approach and deliver that smooth return profile over time. Now we do that by taking a global macro approach. So effectively looking at what's happening around the world and the different economies. What the impact is on different asset classes and sub areas of those asset classes. So, by doing that, we have a strategy which is available to clients around the world, whether it be Australia, throughout Europe, or Asia, or in the US.

We have the Australian domiciled fund fee, the Insights Diversified Inflation Plus Fund.

Tony Kaye: Okay. So I just wanted to ask you about your outlook over this year. We've seen some really interesting things going on, particularly over the last month or so. We've seen a new chair come to the Federal Reserve Bank. We've seen a lot of volatility creep back into the market, and there's been some quite wild swings. And then, only last week, we had a major shock to the market, unexpected, when Donald Trump spoke of trade tariffs in steel and aluminium. So, there's a lot of new things creeping to the market this year that we weren't expecting. What's your view.?

Steve Waddington: Well, it's interesting, you say we've had a few new things creep into the market. There are always interesting aspects growing in markets and creating opportunities, but you're right, we have seen over the last 12 to 18 months a fairly constructive global backdrop and global growth has been picking up and it's become fairly strong around the world and it's also been more synchronized than we've seen at any time since the financial crisis. That's been the case for the last 12 to 18 months, which has also been an environment where we've seen a fairly benign backdrop for inflation expectations. Those two combined together have made this be a constructive market environment for broad asset classes such as equities and credit to perform well.

What we have seen, as you very rightly mention, is a pick-up in volatility over the last month and so while that was driven initially by a start of talking of inflation expectations rising, really it was more contained in that you didn't see the significant moves in rates markets or credit or currencies, but actually you saw that focused on both equity and implied volatility markets. Now those moves were extended, so we saw implied volatility move by a greater amount than at any time in history. It was three times the previous one day move in implied volatility. It's a quite extenuated move and what we're now seeing is the markets adjust to that slightly higher volatility regime, but also with an increased focus on inflation expectations. While ourselves we don't see the underlying backdrop shifting materially, and inflation picking up, although we will see the out terms pick up over the first half of the year, we don't see the backdrop for longer term inflation expectations changing at the moment. But that said, clearly we do have some aspects which could change that environment.

You mentioned the new Fed chair coming in, and so the market needs to adjust to how that communication works with power in place. Yes, a number of factors coming through, and even in the last week as you say we've had the announcement of potential trade tariffs coming into play from the US and retaliation that could come through from some other countries around the world.

Tony Kaye: Yeah, so I think in short, there is concern about interest rates. We all knew that interest rates were rising, but for some reason the market's waking up to some of the consequences of this I suppose. When I say the markets, I mean global markets, and then we've got these unexpected sideline events coming in, which are spooking markets. Have you had to adjust your outlook on markets accordingly?

Steve Waddington: I think on the rate zone changes, what's important is not necessarily just the level the rates get to but the rate of change of those rates. That's what's really causing markets to focus on that at the moment and just how quickly these rates could change. We don't see them changing materially different to what's in the forecast at the moment. What we have seen, obviously those periods of turbulence in markets, they are not periods when we want to just step back from them, but actually capture those opportunity that are created in this environment. To answer your question, have we changed the portfolio shape over the last month? Absolutely. This is an opportunity where we've been able to capture new positions in the portfolio, which benefit from that more volatile environment and we've been able to take down some of the exposures we've held in the portfolio for the last 12 to 18 months, which are more directional in nature. So, where we're just owning the market, we've shifted that now to more option-based strategies, which are much more beneficial in this environment. So, as I said, really bringing out the strategies we operate.

Being able to capture those different sources of return that I mentioned earlier is important, and as we change and transition to a new environment that's absolutely where we want to change the portfolio shape to capture those new opportunities.

Tony Kaye: What are some of those opportunities you've been able to capture?

Steve Waddington: For example, where we have had equity exposure where we owned the market. So, we have what we call “delta one” exposure where the market goes up, we benefit, where the market falls, we suffer. We've shifted that into option-based strategies, which means that if that market moves in our favour, in the direction we think it will move, we benefit. But it if moves in the opposite direction, then we have an element of protection that expires with those option positions, which gives a more asymmetric return profile, which is what our clients are looking for.

Tony Kaye: What are some of the headwinds that you foresee over this year, and also some of the tailwinds that you see?

Steve Waddington: Well, the tailwinds first of all, in terms of the underlying growth backdrop, we still see that as very constructive and moderating slightly from what we've seen, which has been a more accelerating environment for the last 18 months, but certainly still a positive growth environment. But, as we came into this year, what we highlighted was that constructive growth backdrop with a more benign inflation outlook were very constructive for portfolio of risk assets overall. The three main risks to that were one, a more material slowdown in global growth than expected. Second would be a deterioration in the Chinese growth outlook, which could impact other markets and economies as well. Thirdly, would be a real material shift in inflation expectations. We still see China performing strongly, and that slowdown is being managed well. The global growth backdrop as I mentioned has gone from an accelerating regime at times where if you look at PMIs for example, to a more moderating regime, which is still positive for risk assets, but perhaps less potential return than we saw over the last 12 to 18 months.

Inflation expectations, as we just talked through, we think they are certainly more heightened focus for the market at the moment, but we need to be very conscious of the underlying structure of what could change those inflation dynamics. Certainly we think the out turns will pick up over the first six months of this year, but those out turns will then back off a bit as we get toward the end of the year.

Tony Kaye: Is geopolitical risks a big factor in your decision processes?

Steve Waddington: It's something that we need to be aware of. We don't try to say we have any edge over the market in understanding what can happen in certain political events, but we need to take those into account. If those risks are rising and the potential impact of different assets is increasing, then certainly we'll factor those into the portfolio decisions. But the announcements of certain events like we had last week are factors that we need to watch for, because they could impact the underlying growth dynamics and they could slow the trade which has been very positive over the last number of years. If that comes through then that's obviously negative for growth around the world, it would be negative for the earnings of companies, and with already lofty evaluations that could have a negative impact on the overall equity market levels.

Tony Kaye: Are there any particular stocks on your radar at the moment that you're looking at?

Steve Waddington: We tend to look at it on a global macro basis rather than an underlying stock picking basis. I think the benefit of doing that is you get the broad exposures to the markets and then you have greater confidence in delivering overall returns rather than focus on the individual stocks.

Tony Kaye: Ok. So, looking at markets or global markets in particular, what sort of sectors of the market or markets are you looking at?

Steve Waddington: Well if you look at the portfolio shape today, so in broad terms in terms of equity exposure in the portfolio, we have about 27 per cent of the portfolio in broad equity markets. That ranges from the US through Europe, the UK, throughout Asia and the emerging markets as well. In fixed income exposures, the duration in the portfolios is about 2.4 years and that's expressed in government bonds. We also have some investment grade exposure, a small amount of high yield. We've reduced that over the last six months. And our favourite credit market is in emerging markets at the moment. We should still benefit from that positive growth environment. In terms of real assets, we also access areas like infrastructure, and they're accessed through listed investment companies, but we focus on the less economic sensitive, more cash flow positive infrastructure exposures we can capture, which means that they have a much lower profile and linkage through to global equity markets. Again, an attractive characteristic in this sort of portfolio, and they also have an inflation linkage within them, which can be an attractive dynamic within this sort of portfolio overall.

Tony Kaye: So that's defensive assets in infrastructure?

Steve Waddington: It's more looking at different aspects of infrastructure, so we look at social infrastructure, so the managements of hospitals, and schools, and police stations. We have some exposure to some renewable energy sources as well. We also have some exposure to listed aircraft financing, so effectively it's the underlying contracts of those infrastructure, essential infrastructure assets.

Tony Kaye: That's a big growth area and as we know there's supposedly huge investment in the US in infrastructure. Is that an area of interest for you?

Steve Waddington: It's an area we are certainly keeping an eye on and it's one which some of the underlying companies we have do have access and exposure to that, but really the majority exposure is throughout Europe and through Australia at the moment.

Tony Kaye: Well, thanks for your time Steve.

Steve Waddington: Thank you.

Tony Kaye: Thanks for coming in.