Representatives of Schroders will be attending the meeting for this item.
Minutes:
Schroders were represented for the item by their Fund Manager and Client Director.
Before reporting on performance of their Global Diversified Income mandate (dollar based), Schroders indicated that an equivalent UK based sterling fund was now available. Members had previously agreed Schroders offer to switch the current fund to the sterling fund. Transfer costs would be fully met, and possibly exceeded, by a reduction in Schroders management fees.
Printed copies of the Schroders presentation were circulated to Sub-Committee Members in advance of the meeting. Schroders investment objective for Global Diversified Income comprises:
· an income objective with 3-5% p.a. distribution from coupons and dividends; and
· an objective consistent with a 30% equity/ 70% bond portfolio over a market cycle.
Schroders intend to deliver the investment objective by:
· diversification across a broad range of income generating assets;
· direct investment in underlying securities and active management;
· dynamic asset allocation across economic regimes and market cycles; and
· downside risk management to reduce drawdown during periods of market correction.
A graph included returns from the product since inception in April 2012 along with the fund return (GBP hedged) for Year to Date, I Year, 3 Years, 5 years, and since inception. Details of the fund return (GBP hedged) for each year from 2014 to 2018 were also provided. Although the MAI product had performed poorly in 2018 (-5.6%) the position was now recovered and for the year to date a return (GBP hedged) of 7.7% was achieved. A further slide showed year to date and 12 month contributions to the returns by asset class i.e. Equities, Fixed Income, Hybrids, Alternatives, and Cash and Currency with another slide highlighting yields for certain classes (Equity, Investment Grade, High Yield, Government Bonds, EMD, Alternatives and Hybrids) at points since inception.
Another slide highlighted percentage changes of allocation within asset classes between 31st December 2018 and 31st July 2019. Schroders now had a reduced exposure to Equities as of 31st July 2019 at 26.5% compared to 28.0% at 31st December 2018. Schroders were not now taking so much risk in equities other than for the U.S. Fixed Income had also reduced from 51.3% at 31st December 2018 to 49.0% at 31st July 2019 although Corporate Bonds continued to be favoured by Schroders, particularly those in the U.S. Schroders own a lot of 30-year bonds from which they receive significant return. Holdings in Hybrids increased to 13.3% at 31st July 2019 from 3.0% at 31st December 2018 whereas exposure to Alternatives reduced by -7.6% in the same period. The next slide showed the current allocation by asset class as at 31st July 2019.
In transitioning to Global Diversified Income, a further slide showed the current position and weightings of Equity, Fixed Income, Hybrids, Alternatives and Cash for Global Multi-Asset Income and Global Diversified Income. The next slide highlighted Schroders current allocation for Global Diversified Income by Equities, Fixed Income, Hybrids, Alternatives and Cash. With further reference to Schroders transition to Global Diversified Income, details were provided of the difference in currency exposure (sterling and non-sterling) for Global Multi-Asset Income (GBP Hedged) and Global Diversified Income (with no overseas exposure for Global Multi-Asset Income). Further details outlined a breakdown of overseas exposure for Global Diversified Income by currency i.e. USD, JPY, EUR, Emerging Markets, AUD and Other.
The presentation also highlighted attractive income opportunities from high yielding European Equities; an active approach is required and details included sector exposure. Further details were also provided in relation to high yielding Asian Equities. It was felt that Asia had massive potential to continue raising its dividends and pay-out ratios. The slide highlighted that even though Asian dividends have more than tripled over the last twenty years, the region’s pay-out ratio remains one of the lowest in the world.
Before global outlook, ESG and appended slides (none of which were covered in Schroders meeting presentation), further details were provided on Hybrids, introduced to fit between Equities and Bonds (in terms of risk).
The Chairman requested a view on infrastructure particularly in light of the Government’s pooling requirement and encouragement towards infrastructure investment. Schroders responded. On any underwriting of infrastructure debt, Schroders have a team to invest in debt and to understand the nature of infrastructure debt. On Hybrids, a Member indicated that the asset was impacted hard during the 2008 financial crisis and if a passive investment, Hybrids are high risk. If between equity and bonds, she questioned why Schroders invest in bonds; however, although Hybrids (Preferred Securities) produce a similar yield to High Yield Bonds (Preferred Securities 5.8% and High Yield Bonds 6.3%), it is necessary to be concerned about issuer rating with Preferred Securities typically better. Starting yield is important and with almost 26% invested by Schroders in High Yield Debt (High Yield Bonds) as at 31st July 2019 it was necessary to find something else (sensitivity to cyclical risk can be better managed). For Convertible Bonds, Schroders take a conservative approach with investment quite wide. Schroders confirmed that most of the (increased) allocation to Hybrids came from Alternatives.
Concerning High Yield Bonds, Schroders mainly invested in the U.S. These are often referred to as “Junk Bonds” with companies at the lower end – they are not investment grade bonds. The biggest risk is default and they are purely corporate debt.
Schroders confirmed they do not use derivatives although they would be used to hedge equity risk. Mr Arthur confirmed that Schroders were not to use derivatives for income generation in the fund.
Although absolute yield was considered particularly appealing, Schroders focus on value. They expected more dividend cuts in the UK and felt that current dividends are not sustainable. It was suggested a good position if those companies are in dollars. Schroders advised that some are domestic companies that do not have revenues and where there are bond yields there was a view that this is an opportunity to reduce dividends. Global growth is low; if it is necessary to reduce, now would be a good time to do so. It was suggested that with Schroders sending representatives to company shareholder meetings it would be possible for Schroders to be able to influence companies to not have a cut in dividend.
Concerning Schroders having a difficult initial period with their mandate the Director of Finance asked what is different now. For global equities, Schroder’s indicated that the fourth quarter 2018 was challenging. There were also significant concerns about how Alternatives performed. Schroders was working to get closer to asset performance - they try to be as conservative as possible, sacrificing yield and return to have a better risk balance. Concerned about the global economy, Schroders have also moved to longer end government bonds. Schroders had also added to the Japanese Yen and U.S. Dollar and introduced hedging to the portfolio.
Schroders indicated that the risk exposure for their new UK domicile fund is consistent with MAI fund risk exposure. Currency is to purely manage risk. On marketing the new fund, Schroders felt it important to grow the fund and to have success in local authority Treasury Funds where these have greater discretion to invest. The two funds (Dollar and Sterling) mirror each other in terms of risk and both are run by the same Schroders investments team. Schroders have no exposure to gold (no yield). Schroder’s like the U.S. domestic market for returns; Europe and Asia are also high yielding markets. The U.S./China trade war would affect the world. Although Schroders would like to invest outside of the U.S., global market growth was needed.
Schroders confirmed to the Chairman that it would be possible to arrange a meeting towards the end of September/beginning of October about ESG. In thanking Schroders, the Chairman commended their presentation and felt the mandate is going well.
After the Schroders representatives left the room, the Member previously concerned about the Hybrids allocation raised the matter again. She felt that the level of exposure to Hybrids is high risk. However, Mr Arthur advised that Preferred Securities are less volatile than Equities; the Fund will always have investment risk and there might be some negative months. But yields were currently some 4.7% and the approach would try to be defensive. Another Member suggested monitoring the position in reports; if the exposure is too high, the Sub-Committee/Investment Adviser could possibly check. Mr Arthur confirmed to the Chairman that the position with Hybrids is in line with Schroders mandate.