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This is a financial promotion for First State Diversified Growth Fund for professional clients only in the EEA and elsewhere where lawful. Investing involves certain risks including:

The value of investments and any income from them may go down as well as up and are not guaranteed. Investors may get back significantly less than the original amount invested.

  • Currency risk: changes in exchange rates will affect the value of assets which are denominated in other currencies.
  • Emerging market risk: emerging markets may not provide the same level of investor protection as a developed market; they may involve a higher risk than investing in developed markets.
  • Derivative risk: the use of derivatives may result in large price fluctuations and gains or losses that are greater than an investment in the underlying asset.
  • Credit risk: the issuers of bonds or similar investments may not pay income or repay capital when due.
  • Interest rate risk: interest rates affect the value of investments; if rates go up, the value of investments fall and vice versa.

Reference to specific securities or companies (if any) are included to explain the investment strategy and should not be construed as investment advice, or a recommendation to invest in any of those companies.

For a full description of the terms of investment and the risks please see the prospectus and Key Investor Information Document.

If you are in any doubt as to the suitability of our funds for your investment needs, please seek investment advice.

The '03 Summer Of Rising Yields

This is article 2 of our 5-part ‘Expecting the Unexpected’ series. If you enjoy reading this article, don't miss the other four in the series by clicking the links on the right hand side of this page.

• Global bond markets have a torrid two months, starting in Japan

• Yields rocket but remain contained within bonds and mortgages

• Lesson learned: ‘Defensive’ assets can prove themselves wrong

The First State Diversified Growth Fund borrows part of its wisdom from history, using times where markets have suffered significant falls in asset prices to enable fund manager Andrew Harman – part of First State’s £12bn multi–asset team – to ‘replay’ past stress scenarios to test the impact on today’s portfolio. 

We extend our insights from history by also ‘replaying’ broader macroeconomic shifts. By looking at risks factors embedded in equities, fixed income, and commodities, where the portfolio invests - for example shifting interest rates, the widening of spreads or volatile currencies - Andrew and his team can prepare the portfolio for the worst in order to meet an important short-term objective of protecting investor’s capital on the downside. 

Let’s look to an example: the summer of 2003. Harry Potter was in the midst of its magical march towards global literary dominance with the launch of its fifth book; Twenty20 cricket had just got under way with its first official matches; and supersonic Concorde, which captured the imagination of many at its launch in the late 60s, made its final flight due to safety concerns following the Paris Air Disaster.

Unfortunately trouble was also brewing in the global bond market, and the summer ushered in its worst sell-off since 1994. June kicked-off with investors poorly receiving a 20-year Japanese Government Bond (JGBs) sale, forcing yields to rise as Japanese banks and hedge funds moved to unwind their positions. US data also proved better than expected, adding to the selling of JGBs and dollar treasuries, with dollar bond investors also becoming spooked by Fed policy signals from unexpected interest rate moves.  

Try our DGF Navigator for a transparent view of our asset allocation decisions since the launch of our Fund.

Mortgages further exacerbated selling, particularly in the mortgage backed securities (MBS) market. As interest rate expectations began to change so did the durations on MBSs. Investors rushed to manage their exposures to rate changes - as is usual in the MBS market – hedging by selling treasuries, swaps and related derivatives. Because the hedges reached into a variety of segments in the fixed income market, changes in MBS durations therefore affected the whole FI market.

It was an uncomfortable time for investors with an important lesson to be learnt from the volatile summer: defensive assets, in this case bonds and mortgages, will not always act as such under certain market conditions. 

Our testing of these scenarios in today’s portfolio has led us to consider carefully how defensive assets are deployed.  

Looking to an example, a classic defensive asset for a portfolio would be government bonds, but presently we see a need for caution in investing here: a seeming end to the 20-yr bond bull-run. Rising short- and long-dated yields demonstrate this, as evident in US 10-yr treasuries breaking through the 3% level; but there’s also the bigger concern of inflation pushing higher than it has done for years. 

Seeing waning value and a pathway to higher yields, our approach has been to invest in inflation protection to counterbalance the portfolio, currently taking up positions in Australian, UK and US inflation-linked bonds. This, we feel, is an attractive ‘inflation compensation’ versus nominal bonds. We have no allocation to corporate credit. 

We also use non-correlated positions in both equity and bond markets to generate returns. This approach, we believe, balances the risk/reward proposition and minimises our reliance on ‘safe’ assets.

In the portfolio today we hold fixed income, commodities and equities, and add balance by investing in foreign currencies. This varies considerably over time, with historic net allocations spanning from 45% to almost 0% of the portfolio, and we will look to all manner of developed market and emerging market currencies to generate returns and/or reduce risk.

Here is how our portfolio performed during the stress test:

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In the next article we will continue to explore the lessons of history with a look at the liquidity squeeze of 07/08.

See our full list of ‘Expecting the Unexpected’ articles below:

Important Information

This document has been prepared for informational purposes only and is only intended to provide a summary of the subject matter covered and does not purport to be comprehensive. The views expressed are the views of the writer at the time of issue and may change over time. It does not constitute investment advice and/or a recommendation and should not be used as the basis of any investment decision. This document is not an offer document and does not constitute an offer or invitation or investment recommendation to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any material contained in this document.

This document is confidential and must not be copied, reproduced, circulated or transmitted, in whole or in part, and in any form or by any means without our prior written consent. The information contained within this document has been obtained from sources that we believe to be reliable and accurate at the time of issue but no representation or warranty, express or implied, is made as to the fairness, accuracy, or completeness of the information. We do not accept any liability whatsoever for any loss arising directly or indirectly from any use of this information.

References to “we” or “us” are references to First State Investments.

In the UK, issued by First State Investments (UK) Limited which is authorised and regulated by the Financial Conduct Authority (registration number 143359). Registered office Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB number 2294743. Outside the UK within the EEA, this document is issued by First State Investments International Limited which is authorised and regulated in the UK by the Financial Conduct Authority (registered number 122512). Registered office: 23 St. Andrew Square, Edinburgh, EH2 1BB number SCO79063.

Certain funds referred to in this document are identified as sub-funds of First State Investments ICVC, an open ended investment company registered in England and Wales (“OEIC”). Further information is contained in the Prospectus and Key Investor Information Documents of the OEIC which are available free of charge by writing to: Client Services, First State Investments (UK) Limited, Finsbury Circus House, Finsbury Circus, London, EC2M 7EB or by telephoning 0800 587 4141 between 9am and 5pm Monday to Friday or by visiting Telephone calls may be recorded. The distribution or purchase of shares in the funds, or entering into an investment agreement with First State Investments may be restricted in certain jurisdictions.

Representative and Paying Agent in Switzerland: The representative and paying agent in Switzerland is BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich, Switzerland. Place where the relevant documentation may be obtained: The prospectus, key investor information documents (KIIDs), the instrument of incorporation as well as the annual and semi-annual reports may be obtained free of charge from the representative in Switzerland.

First State Investments (UK) Limited and First State Investments International Limited are part of Colonial First State Asset Management (“CFSGAM”) which is the consolidated asset management division of the Commonwealth Bank of Australia ABN 48 123 123 124. CFSGAM includes a number of entities in different jurisdictions, operating in Australia as CFSGAM and as First State Investments elsewhere. The Commonwealth Bank of Australia (“Bank”) and its subsidiaries do not guarantee the performance of any investment or entity referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of the Bank or its subsidiaries, and are subject to investment risk including loss of income and capital invested.