A sector pair trade of energy versus materials, a regional overweight to Japanese equities and a marked underweight in fixed income are three ways Fidelity International’s Nick Peters is aiming to generate alpha. 
Peters (pictured), who co-manages more than 16 multi-asset funds for the firm, has however adjusted these positions slightly over recent weeks, as oil prices have picked up pace and the Japanese yen has strengthened.
In terms of overall asset allocation, he is currently overweight equities and cash but is underweight fixed income, commodities and real estate.
“We have maintained our overweight in equities,” Peters said. “It has come down over time but we are still reasonably positive. Central bank support continues; it’s may be waning slightly but there is still plenty of liquidity in system.
“Economic growth is continuing to come through from the US but has broadened out to areas such as Europe. Q2 earnings season was also broadly supportive. Everything is pointing in the right direction but the reason our overweight isn’t larger is because of valuations.”
The manager is also underweight Reits, commodities and fixed income due to toppy valuations. Within the equity portion of his portfolio, he has a regional underweight to the US – a market area which has been shunned by several investment professionals who deem it to too expensive.
Performance of indices over 5yrs
Source: FE Analytics
“We are overweight cash in the event that there is any weakness in our underweights,” Peters continued. “We also have a pair trade of energy versus materials which has protected us somewhat as the oil price has come back.
“We also have a global sector pair trade of healthcare versus consumer staples, as well as stand-alone positions such as being long financials and short in consumer discretionary.”
In the below article, the manager highlights the key themes he is utilising to generate alpha while maintaining diversification across his portfolios.
Fixed income underweight
Peters and the multi-asset team at Fidelity have taken profits in their US high yield positions as spreads in the asset class are close to 10-year lows.
“Over the last couple of months, I closed a position I had in the US high yield strategy. Obviously, the benchmark we use is UK-centric so this was an off-benchmark bet that we had on for quite a while,” he explained.
“But, given how spreads have come in so much, I don’t think it’s an off-benchmark position worth maintaining. Spreads at current levels don’t tend to stay here for very long and so I think the risks are to the downside in terms of performance.
“Generally high yield does tend to protect fixed income managers when they start seeing a rise in interest rates, but when spreads come down this far, that protection doesn’t really work as effectively as it would have done in the past.”
Peters also pointed out that volatility in the market area has started to pick up, suggesting that investors have become complacent about the risks surrounding high-yield bonds.
Energy vs materials pair trade
When it comes to investing in global sectors, the team at Fidelity uses US sector futures. While its energy versus materials pair trade is still very much in use across the portfolios, Peters said that recent oil price movements have “gone against” this positioning.
Performance of index in 2017
Source: FE Analytics
“It’s meant the commodities position has come down over time,” the manager said. “When we saw the oil price fall to the mid-forties [dollars per barrel], I took that as an opportunity to add to commodities and reduce the underweight.
“As a house, we’ve been positive on oil for a while. Admittedly the analysts have revised down their price target and so now we’re thinking the long-term target is going to be between $55 and $60.
“When it was down to around $45, that presented attractive upside from my perspective. Especially if you look at how the inventory has unfolded in recent months.”
Peters pointed out that the demand for oil tends to pick up during the summer months which therefore reduces the inventory over that time frame.
This time, however, he reasoned that the drawdown in inventories has been significant, which therefore makes the current oil price of $45 to $46 per barrel more attractive.
“In 2017, supply has been curtailed perhaps more than markets have been expecting and demand has been greater – that’s why you’ve seen inventory drawdown,” the manager continued.
“If we see the oil price getting back to mid-50s or above, I will probably close that energy against materials position but we will have to be patient for now.”
Japanese equity overweight
Within Peters’ equity exposure, he is currently overweight Japan and Europe. He is particularly positive on fundamentals for Japanese equities, but has recently trimmed his exposure.
“I am still positive on Japan; I think valuations look attractive relative to the US in particular.” He explained. “Japan is obviously a beneficiary of global growth and, as I have mentioned a number of times in the past, on a micro level we are seeing changes in corporate behaviour with more restructuring, more buybacks and dividends being increased.
Performance of index in 2017
Source: FE Analytics
“These are all areas that make the market look attractive, but what we’ve seen recently is the strengthening of the yen and that could negatively impact earnings of corporates and so the earnings upgrades are less likely to come through.”
With that in mind – in addition to the strong run the Nikkei 225 has seen from April through to June – Peters said it was “sensible” to reduce the overweight.
“We still have that overweight position, it just isn’t as aggressive as it was at the beginning of the year,” he added.