Emma Wall: Hello and welcome to the Morningstar Series "Why Should I Invest With You?" I am Emma Wall and here with me today is John Roe of Legal & General Investment Management to talk about how the macro influences investment decisions.
Hello.
John Roe: Hello.
Wall: So how does the macroeconomic cycle influence your investment decisions?
Roe: It's entirely a macro driven process. There is around 30 of us, five economists, eight strategists and then the fund managers. And it's all about where are we in the economic cycle and then what does that mean in terms of trade ideas and then how can we put them together, to get the right kind of outcome. So it's the big driver for us.
Wall: And then with that in mind what would you say the big macro themes investors should be aware of or even wary of this year are.
Roe: So I think at the start of the year theme to be wary is horrible narrative that this was the year it was all going to go horribly wrong, everyone went terribly gloomy and in some cases overly defensive. Very crowded positions, we looked at 25 different brokers and fund managers most of them were negative on equity, negative on credit, have seen a huge rally, not only that but the Fed pausing. People talk about 2020, 2021 as being the next recession and as that timing gets pushed out investors need to be really careful.
The average equity return in the 12 months before the peak is 15%. So there is this real risk of kind of overly downbeat it's going to happen eventually and then as it gets pushed out you miss out on these big rallies like we've seen year-to-date.
So that will be the first, would be very careful as soon as the market buys into a consensus this is it, you got to be very, very careful I think to try and take the other side even though it feels pretty tough at the time. You got to really manage the behavioral biases that we all suffer from as investors if you are going to do that.
Wall: With that in mind however it's probably worth caveating that it may not be another 2017 where basically everything gave us positive returns. Surely even in a year before the beginning of the end there will be stuff that does better than others.
Roe: Absolutely. So you get these peaks and troughs and definitely an increase in volatility, so it gets spikier. We had this very low realized equity volatility in the last few years and we would definitely expect that to pick up. I mean from here for example U.S. credit, spreads have basically gone all the way back to start October levels nearly.
So there is not a lot left to be got out of the asset class. Whereas European credit or U.K. credit still got lot further they could run. So I think we will get more peaks and troughs I think people need to be a little bit more nimble definitely once we – once people in the market buy into a positive narrative we then need to start to go the other way.
So as soon as the positions get crowded, we just start and see more U.S. retail buying of equities for example which can be a warning sign because they tend to be quite late into buying it. So it's very much trying to lean against the consensus view even though our natural tendency might be to have the same thoughts as everybody else.
Wall: Now I can’t have a macro specialist in the studio and not mention Brexit. How concerned are you, obviously bearing in mind that you are lucky enough to have a very broad range of investments to chose from across different asset classes and globally, is Brexit a concern?
Roe: It’s a concern for the U.K. population. Is it a concern for U.K. investment returns?
We think actually the risk for U.K. investment returns is a soft Brexit. So if you got a soft Brexit, big rebound in the pound back towards say 1.40 against the dollar. You could see some very negative investment returns because of the overseas currency exposure. The pound has been very much the main channel for playing Brexit. We heard the other day its too risky, it's too uncertain. Actually the chance of a hard Brexit is very low over 400 MPs have come out and said we will not support hard Brexit. That’s very hard, it was only just over 600 very hard then to get a hard Brexit.
So against that backdrop actually the risks are skewed to a very soft Brexit and for that reason more pound, less exposure to Gilts which again are pricing in the risk of downside. So very much we are on the – be very careful about the soft Brexit from an investment return perspective.
Wall: John, thank you very much.
Roe: Thank you.
Wall: This is Emma Wall from Morningstar. Thank you for watching.
