“As tricky a macro environment as you could imagine”

Published on 4 March 2022

Managing risk for macro investments in the post-pandemic, inflationary environment confronted by war in Europe is a situation unseen in the lifetimes of most people.

James Athey, senior investment manager at Abrdn, outlines the pattern of events that are likely to drive up inflation even further this year, the challenges volatility creates in managing these risks – for example in identifying risk exposure – and the difficulty in seizing opportunities where they do arise. Positioning will potentially be a bigger driver of performance than fundamentals.

Dan Barnes: Welcome to Trader TV – your insight into trading for professional investors. I’m Dan Barnes.

With the war in Ukraine, ongoing COVID crisis and changing central bank policy, the investment landscape state is intensely complicated. Joining me to discuss how portfolio managers can navigate this is James Athey, senior investment manager at Abrdn.

James, welcome back to the show.

James Athey: Hi Dan, thanks for having me back.

Dan Barnes: So firstly, how would you characterize the risks, which macro funds are exposed to?

James Athey: Complicated. Without being too glib, this is as tricky a macro environment, really as I think you could imagine. It was already quite difficult anyway from the outset of the pandemic to the response from governments and central banks, and to the outcome of those responses more recently, which has obviously been dramatic shifts in the inflationary environment.

And then we’ve moved quite quickly through the gears on the Russia and Ukraine conflict, which may potentially have really far reaching consequences across the globe, particularly in certain Western markets and through similar transmissions to those issues we were already facing, which is to say, pushing inflation higher, potentially pushing growth slower.

Dan Barnes: That’s very interesting. And how is the market volatility that’s creating impacting the ability to manage risks?

James Athey: As a general rule, the higher the volatility prevails in financial markets, the lower the gross level of risk that many investors will run. Now they’re potentially two sides of the same coin. But you can have high volatility environments, which are a little easier to navigate. You can have high volatility environments which are less easy to navigate, and I think this definitely falls into the latter category.

The correlation that we’re seeing across assets, within asset classes, across asset classes and the combination of that in a high volatility environment, I think is making it quite difficult to know, at a portfolio level, exactly what you are exposed to in some of the big beta moves. And that’s obviously a concern and difficult to manage. Normally in these circumstances, reducing risk, getting to the sidelines in non-core strategies is a pretty sensible place to start.

Dan Barnes: Where we do see volatility potentially creating opportunities, fx in relative value, how easy is that to take advantage of at the moment?

James Athey: It’s really difficult because, you know, we’ve seen this through shock events in the past that, you know, as the famous maxim goes; ‘the market can remain irrational longer than we can remain solvent.’ And I think we’re seeing this in some of the most liquid markets out there, FX for example. Positioning is possibly a bigger driver of the performance of certain assets and asset classes than fundamentals are, so you can try and position for some of the normalization or mean reversion. You can try and even position for your fundamental outlook to play out. But in the very short term, you must understand and recognize that those are not the dominant drivers of price action, and therefore things can move further against you.

As a real money long term investor, I want to be able to position for, you know, fundamental mispricing. I think it’s just important to recognize the amount of risk that you put into those strategies is appropriate, given the heightened uncertainty and volatility.

Dan Barnes: That gives us a very good insight into trying to take advantage of the situation. In terms of the adverse effects this is having on portfolios, what can a fund manager do to manage those?

James Athey: If you don’t have Russian assets in your benchmark in your investment universe, that’s a very good start. The safest thing to do is to have no exposure to them. Now when you’re a long only, real money investor as we are at Abrdn, it’s difficult to get to a truly risk neutral position because even if you are neutral vs the benchmark, that still means that you have absolute exposure to those assets. And so with heightened uncertainty, the risk of sanctions, the risk of stranded assets, the potential for gaps to appear between onshore and offshore, Russian liquidity and Russian pricing, it’s quite difficult.

At the moment I’ve taken a cautious, short approach, so I own some Russian exposure, but less than the benchmark. Where I do own local bonds, own them in Euro clear so that it’s internationally settled rather than domestically settled to try and minimize the risk. And then in terms of the broader portfolio understanding where those transmissions are, geographically speaking, near neighbors to Russia, I’ve seen their asset prices affected. To some degree, I see that as opportunity to Polish zloty fx. The central bank has said they can’t think of a currency which is too strong in order for them to deal with their inflation positions. It’s a weakness that we’ve seen there and we’re quite comfortable opposing.

And then in a more broad sense, understanding where you have oil exporters vs importers, where you might have sensitivity there, and what the central bank response might be in the western world. For now, we are of the opinion that central banks will not be perturbed from continuing down this path of monetary tightening, because the most pressing risks they face really is high inflation and unanchored inflation expectations, which this Russian Ukraine situation really exacerbates.

Dan Barnes: Then how would you characterize a risk outlook for the rest of 2022, given that we still have this conflict, the ongoing pandemic and these changes in central bank policy?

James Athey: Yeah, I mean, you wouldn’t necessarily know it by observing price action in some of the major indices. You know, we’re so used to, ‘buy the dip type’-of mentality, this Pavlovian response, where any decline in equity prices is a buying opportunity. Now in our estimation, the various strands of this macro environment, broadly speaking, all act as headwinds to risk assets. We would look at the fiscal impulse between last year and this year being a negative, the monetary tightening that we’re seeing, that we’re expecting of being a negative, lower growth driven mostly by falling real incomes, input cost prices rising, squeezing the consumer’s ability to engage in discretionary consumption, a hit to sentiment coming just from a war breaking out right in the heart of the global economy, right in the heart, really of Europe. All of these suggests to us that attaching historically high multiples to equity markets is not particularly wise. So as much as it’s complicated across the macro environment, for risk assets in particular, we really do think that the rest of this year is going to be a tricky time.

Dan Barnes: James, that’s been great. Thank you so much.

James Athey: Pleasure, Dan.

Dan Barnes: I’d like to thank James for his insights today, and of course, you for watching. To catch up on all our other shows or to subscribe to our newsletter, go to TRADERTV.NET.