Global Outlook July


Keith Skeoch, Chief Executive Officer

Chart Editor

Tzoulianna Leventi, Graduate Analyst

This and next month’s Global Outlook publications are unusual in that they serve two purposes. The first, as usual, is to bring together some of our best thinkers, portfolio managers and writers to share their experience and insights across a wide range of our expertise. The second purpose is to recognise that all these authors have been acknowledged recently by their award nominations in the Investment Week “Women in Investment Awards”. Those of you who are regular readers will recognise a number of them.

Diversity of thought, paired with a culture of inclusion, is vital when working with clients and customers who face increasingly complex challenges. Our purpose as a firm of “together we invest for a better future” puts diversity and inclusion at the core of who we are and what we do. Our profession has much more to do in this important area, and we are committed to playing our part. I would like, therefore, to acknowledge Investment Week for its valuable work in this area and to congratulate our nominees.

In our first article, Katy Forbes, Head of Absolute Return, talks to the wide variety of investment levers available to absolute return strategies and how some of these have been pulled over the past few volatile months. She also notes the increased requirement for granularity in portfolios as investors continue to differentiate between winners and losers.

Eva Cairns, ESG Investment Analyst, next candidly discusses the ubiquitous “net zero” carbon emission pledges. She applauds the progress being made, but also delves into the detail of these pledges, analysing their scope, the acceptability of offsets and whether long-term corporate plans are adequately captured in some of these pledges. This is obviously an important area and one that is under increasing scrutiny – this article makes it clear that “devil in the detail”.

Katie Trowsdale, a Senior Investment Manager in our MyFolio team, then takes us back to 1934 and the seminal work on value investing by Graham and Dodd. This work is as important as ever, given the valuation extremes we currently see between value and growth stocks. Katie explains the background to the extraordinary run of “growth” over the past decade, recently exacerbated by the economic and market impact of the virus. However, she also suggests some reasons why we may be at a time where “dipping of the toe in the water” of value may be appropriate.

Amie Chesworth, a Senior Analyst in our Alternative Investment team, then takes us to the world of hedge funds. She reflects on the criticism of the longer term returns of the hedge fund index versus equities, but also notes their significant outperformance over the more difficult market environment of the first quarter this year. Like Katy, she reminds us of the importance of granularity, and importantly notes the significant portfolio diversification benefits that hedge funds can offer.

Abby Glennie, our Deputy Head of Smaller Companies, discusses the UK small and mid-cap arena. This was an area particularly hard-hit by the stock market sell off in March, significantly underperforming its larger-cap peers. However, in an article that also chimes with the theme of granularity, Abby notes some of the sectors and stocks that have prospered in the recent more difficult economic environment. In markets where strength and resilience are often assumed to be the preserve of large-cap stocks, Abby reminds us that these traits are available more broadly, if you choose to look.

Finally, Victoria MacLean. Victoria, an Investment Director in our Global Equities team, takes us through the “ABC” of sustainable investing. In a time when there is, correctly, much more focus on the purpose of investment and on the activities of the companies that investors hold, this article gives greater clarity around this area, and potential impact on financial returns and portfolio diversification.


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Generating returns
in uncertain times

Chapter 1


Katy Forbes, Head of Absolute Return

The Covid-19 pandemic has been a shock to consumers, businesses and financial markets on an enormous scale. Markets responded rapidly as the virus spread across the globe in February and March. They also reacted quickly from late-March onwards to announcements of unprecedented stimulus. Absolute return funds can thrive in this volatile environment.

Absolute return funds have the investment freedom to select a diverse blend of strategies to constrain risk and to perform in multiple scenarios, without heavy reliance on the performance of a particular market. Absolute return funds often express long-term themes, but they can be managed flexibly. This allows them to respond to changing market environments. Portfolio shape is key to returns. We can never be sure when the outlook for markets might change, but we can be diligent at monitoring the drivers – macro, monetary, fiscal, geopolitical, behavioural, valuation, or environmental, social and governance – to identify changes in a timely manner. This has been very important so far in 2020, with the global spread of Covid-19 and all the associated implications. Diligent monitoring of key macro drivers linked to the virus, such as the number of new daily cases and governments imposing lockdown measures, was important for navigating markets in February and early March. Portfolios that were able to respond quickly by reducing allocations to risk assets and adding to defensive strategies were at an advantage. Similarly, monetary and fiscal policy drivers have been critical from late-March onwards for informing portfolio managers to increase risk assets again.

With so much uncertainty, it is important to monitor market drivers closely and to respond flexibly to the environment as it changes by altering risk measures and portfolio shape

As well as managing portfolio shape, it is also beneficial to identify the winners versus the losers in the prevailing environment. Absolute return funds have the ability to invest in particular baskets of stocks, bonds, currencies, interest rate or inflation curves. With low yields and duration extension of benchmark indices, elevated corporate leverage and significant economic uncertainty instigated by Covid-19, a detailed focus is likely to become ever more important as we search more deeply for return. So far this year, 10-year yields in the US have outperformed 10-year yields in Germany by approximately 100 basis points (bp), proving that the choice of market really matters to portfolio returns. At the beginning of the year, the Federal Reserve suggested there was a high hurdle to cutting interest rates. But there was so much more scope to support the economy using rate cuts in the US (where policy rates have been cut 150bp this year) than in Europe (where policy rate is unchanged as it is already deeply in negative territory at -50bp) when facing an economic shock. We can see this dispersion in returns across multiple asset classes. The chart below shows the one-year performance of US equity sectors.

We can see that there is huge dispersion across sectors. Some are significantly down over the last year (e.g. energy and financials), while other sectors have flourished (e.g. technology and healthcare). Again, this highlights the importance of granularity. Absolute return funds can also benefit from bottom-up stock selection expertise by allocating capital to carefully selected portfolio managers who specialise in a favoured market.

Another example is in the US inflation market where the downturn in the economic outlook and the much talked about pressure on the oil price has had a significant impact. US inflation break-evens (the spread between the yield for a nominal bond and an inflation-linked bond) have declined in this environment. However, the impact has been much more severe for five-year inflation break-evens –which have declined 70bp, year-to-date – as the link to economic fundamentals and commodity prices is high. By contrast, 30-year inflation break-evens have declined just 30bp, year-to-date, as the impact of stimulus over the long term and potential changes in globalisation are taken into consideration. The exact choice of exposure is important across a broad range of investment markets.

Finally, as well as portfolio shape and granularity, portfolio risk levels are also crucial to returns. Absolute return funds tend to target outcomes (e.g. cash + 5%) and the risk deployed must be consistent with achieving this outcome over the long term. Absolute return funds tend to seek portfolio risk within a range (e.g. 4%-8%), and they shift risk up and down depending on the strength of opportunities available at a particular time. This is often referred to as risk budgeting. This approach can be applied at an individual strategy level or to the entire portfolio.

The impact of the Covid-19 shock to economies and markets is likely to be long lasting. With so much uncertainty, it is important to monitor market drivers closely and to respond flexibly to the environment as it changes by altering risk measures and portfolio shape. Differentiation between assets is likely to be an ongoing feature and absolute return funds can thrive in this landscape.

Chart 1: Dispersion across US Equity sectors

Source: Refinitiv-Datastream, Aberdeen Standard Investments, (as of June 2020).



With so much uncertainty, it is important to monitor market drivers closely and to respond flexibly to the environment as it changes by altering risk measures and portfolio shape

Net zero 2050 – How meaningful
are company pledges?

Chapter 2


Eva Cairns, Senior ESG Investment Analyst

There has been a wave of net zero emissions company pledges. However these are only meaningful if they are backed by credible action plans that do not heavily rely on offsetting.

A wave of pledges

‘Net zero’ is a popular climate buzzword. We have seen a growing number of pledges from countries, cities and companies to become ‘net zero’ by 2050 or earlier to help reach the goals of the Paris agreement. This includes the 241 members of the United Nations (UN) coalition ‘Business ambition for 1.5C Celsius: our only future’ representing over $3.6 trillion in market cap. In addition, the ‘Net Zero Asset Owner Alliance’ brings together investors managing a total of $4 trillion in assets committed to transitioning their portfolios to net-zero emissions by 2050. Members of the ‘Better Buildings Partnership’ are committed to making all buildings net zero by 2050. The list goes on.

We have seen a growing number of pledges from countries, cities and companies to become ‘net zero’ by 2050 or earlier to help reach the goals of the Paris agreement

On the 5th of June 2020, the UN launched a ‘Race to Zero’ campaign to encourage the setting of net zero emission commitments ahead of the major climate change conference COP 26, now scheduled for November 2021. With nearly 2,000 signatories (see Table 1) joining the 120 countries that have committed to net zero, the UN estimates that actors with netzero pledges represent nearly 25% of world’s emissions and 50% of GDP.

Table 1: Race to (net) Zero


Source: UN Race to Zero campaign, June 2020

Why net and not absolute zero?

In some sectors, cost-effective technologies exist to bring greenhouse gas (GHG) emissions down to zero through electrification. However, in hard-to-electrify industries such as aviation, construction materials and agriculture, it will be technically complex, impossible or very expensive to reduce emissions down to zero, so residual emissions will remain.

‘Netzero’ means that these residual emissions will need to be taken out of the atmosphere via negative emission technologies such as carbon capture and storage or natural carbon sinks such as planting forests. Investing in these solutions can be done directly or via voluntary offsetting schemes. One challenge is that many technologies for generating negative emissions at scale, do not yet exist. So companies may pledge net zero to signal that they will do more in the future. However this makes it difficult to hold companies to account for emission reductions in the near term.

The amount of negative emissions required to meet the goals of the Paris agreement depends on the climate change scenario chosen and the assumptions made on policy and technological developments. As a result there is significant uncertainty on how exactly we can reach ‘net zero’. This makes it even more difficult when scrutinising company pledges.

Are company pledges meaningful?

In our view, there are three key questions to ask to help us understand how meaningful company net zero pledges are:

1. What is the scope of net zero pledges?

Most businesses pledge net zero on their Scope 1 and 2 emissions - the direct emissions of their operations and energy consumption. But Scope 3 emissions, which include upstream supply chain emissions and downstream emissions from products sold, can be significant in certain industries. CDP data shows that around 40% of GHG emissions are influenced by companies through their purchases and products they sell. Chart 1 shows Scope 3 emissions estimated by CDP for 35,533 companies in 2014 (number of companies with estimates shown in parentheses).

Chart 1: Scope 3 emissions matter

Scope 3 emissions (in Mt CO2 e)


Source: CDP Climate Change Report 2016, Tracking progress on corporate climate action.

Scope 3 should be included in targets, particularly in sectors where they represent the majority of emissions such as oil & gas, automobiles and financial services.

In oil & gas for example, 85% of emissions are downstream Scope 3 from the sale of energy products. Reducing these emissions is not within the direct control of the company and relies on the actions of others, including policymakers setting the right incentives. Nevertheless, we believe that companies have to take some responsibility and help their customers reduce their emissions by innovating and offering alternative low carbon products. Shell, for example, recently pledged to reduce its Scope 3 emissions by developing alternatives to jet fuels to help the aviation industry decarbonise. This is a commendable approach, but is likely to take a very long time to be reflected in practice.

Another question is the regional boundary of the net zero ambition. French energy giant TOTAL recently announced a net zero ambition, but the scope is limited to Europe only, which covers just over half of its emissions. Global warming needs to be tackled with global targets. The same applies to countries setting net zero targets for emissions produced within their boundaries rather than emissions generated by their consumption, which should include imports. This simply pushes responsibility on to others.

Setting net zero targets is a step in the right direction, but the devil is in the detail of underlying assumptions as there are many different ‘paths to Paris’. The science-based targets initiative (SBTi) provides a widely used methodology of approving targets aligned with 1.5C or well below 2C warming. As of June 2020, 896 companies have committed to setting targets using the SBTi and 387 have approved targets. While Scope 3 targets are seen as best practice and required where Scope 3 represents over 40% of company emissions, they are not included in the SBTi assessment of alignment with a certain level of warming. This is clearly a limitation, but also reflects the complexity and lack of data. The encouraging news is that around 85% of companies with science-based targets have set Scope 3 targets anyway. But this is not representative of the majority of businesses and there is a long way to go to reflect these targets in their actions.

2. How much of the target is achieved via emission reductions vs offsets?

‘Net’ zero means that any residual emissions can be offset, but how much offsetting is acceptable? Some companies choose to offset their emissions via voluntary offsetting schemes, which is often much cheaper and quicker than truly reducing emissions. Credibility of projects is key: any offsetting project needs to meet a set of criteria to be externally verified. This includes the important aspect of additionality which implies that the project would not have happened without the funding.

The voluntary carbon offset market more than doubled between 2017 and 2018 and was sized at nearly 100 megatonnes (MT) of CO2e in 2018, worth $300 million (see Table 2).

Table 2: Cheap, voluntary carbon offsets are on the rise


Source: Forest Trends’ Ecosystem marketplace “Financing Emission Reductions for the Future: State of the Voluntary Carbon Markets 2019”, Aberdeen Standard Investments, (as of June 2020).

The average price of voluntary offsets was 3$/t CO2, incredibly low when compared to the 75$ ‘Paris aligned’ carbon price recommended by the International Monetary Fund (IMF). This is because there is a lot of low hanging fruit to abate carbon cheaply. But expected growth in demand for offsets would push up the price and should reach levels equivalent to the optimal ‘Paris aligned’ price for carbon to avoid a free lunch. One issue is that the ability to offset emissions at such a low price does not incentivise investment in solutions to reduce emissions.

EasyJet, for example, announced in 2019 that it was offsetting the emissions of its flights over a three-year period for £25 million per year. This equates to £3/tonne of CO2 and is a pretty cheap way out that can only be deployed because few other companies are doing it. It is probably better than not addressing carbon emissions at all given the lack of viable alternatives to jet fuels. However could the £25 million be spent more effectively by advancing decarbonisation solutions for the industry?

The other problem is the physical constraint. Around 60% of all emissions are offset using forestry and land use projects. How many planets would be needed if we all decided to offset our emissions by planting trees rather than reducing emissions? Shell’s Sky Scenario maps out a net zero 2070 pathway for the energy sector and assumes that carbon removal through reforestation requires 700 million hectares of land - nearly the size of Brazil. There are also social implications given people may need to be displaced to enable reforestation at such large scale.

Carbon offsetting is simply not a viable long-term strategy that can be scaled up. It should be considered in addition to and not instead of substantive reductions. This is also the approach taken by the SBTi which does not consider offsets as emission reductions.

3. How are company pledges reflected in capex plans today?

A recent Financial Times article highlighted that pledges clash with capital spending plans after TOTAL and Shell announced their strengthened climate ambitions. This is really the crux of the problem. To ensure credibility, it is paramount that any long term pledges are reflected in short term targets, capital expenditure and research and development plans. Remuneration should be linked to achieving these targets, too. Where this is not the case, net zero pledges are not credible and have probably been set to boost reputation.

Research by Carbon Tracker, an energy transition think tank, suggests that the largest western oil & gas companies approved an estimated $50 billion of investments that are not consistent with Paris between 2018 and 2019. They state that 60% of capital expenditure is at risk of being ‘stranded’ by 2030 in the International Energy Agency’s (IEA) Sustainable Development Scenario which aims for warming below 2C. The choice of scenario is important and has different implications for risks and actions. Oil & gas companies may for example use transition scenarios with a significant amount of negative emission technologies and a very late peak of fossil fuels to set their climate goals. This helps justify continued investment in fossil fuels.

Active investors have an important role to play in challenging the alignment of projects to net zero pledges by asking how targets have been factored into the capital investment decision-making process. More transparency is needed from companies to see how they decompose their net zero targets into actual emission reductions (broken down by Scope 1, 2 and 3) and negative emissions, including the role of voluntary offsetting schemes. And critically, how capital expenditure plans are aligned to that.

Summary - So what does this mean for investors?

The recent wave of net zero commitments is encouraging. It is also positive to see that Scope 3 emissions are increasingly being included in company targets. However, we need to see more detail on the scope of long term pledges and their reflection in today’s investment plans. Offsetting emissions at low prices, limiting the scope of targets or cherry picking climate scenarios that support current investment plans will not accelerate the decarbonisation of the economy. Net zero pledges made on that basis are likely focused on attracting positive sentiment rather than true decarbonisation.

This may leave those invested in companies with empty pledges with higher stranded asset, carbon and reputational risks than expected. Taken alongside insufficient country pledges, the biggest risk of empty pledges is the impact on our planet and future generations. We are unlikely to limit global warming to well below 2C without credible action plans. All these pledges may give the sense that much more is happening than is really the case. Only with detailed granularity on targets and related investment plans can we judge how meaningful net zero pledges are. And if we think they are not sufficiently credible, we need to hold companies to account through our active engagement and voting approach.


Vox: Offsets

TPI report on net zero in oil & gas

Grantham institute – what is net zero?

Energy & Climate intelligence unit: Net zero

Investors should ask if carbon promise is just hot air

European sting

Carbon tracker – Breaking the Habit, why none of the oil companies are ‘Paris aligned’ and what it takes to get there

FT article on net zero

World Economic Forum, the net zero challenge

UN Race to Zero campaign (website)



We have seen a growing number of pledges from countries, cities and companies to become ‘net zero’ by 2050 or earlier to help reach the goals of the Paris agreement

The widening gap between
growth and value companies

Chapter 3


Katie Trowsdale, Senior Investment Manager

For some time, growth companies have been outperforming their value counterparts – and the trend has been exacerbated by the coronavirus pandemic. How much longer can it continue?

Investors should consider whether a change in market dynamics could result in a reversal in the fortunes of growth and value companies

To date, the pattern has been in place for 13 years, costing US value investors a whopping 185%1 versus their growth equivalents. In early 2020, with the worldwide spread of Covid-19, the trend has accelerated further.

Many value investors have been left scratching their heads, others are running for the door and some value fund managers are admitting defeat. Should value investors hold their nerve during these unprecedented times?

Typically, trends revert to the mean over the course of a cycle. The differential between a growth and value company cannot continue to widen indefinitely. There are three main reasons why the prevailing market backdrop has been supportive for growth companies. First, the more scarce growth has become, the more investors have been prepared to pay for it. Second, the falling interest rate environment has resulted in investors’ willingness to pay up for long-term growth. Third, monetary stimulus has boosted asset prices to inflated levels – so much so that investors no longer care about valuation. Would a change in any of these dynamics trigger a reversal in the outperformance of growth companies?

In 1934, Graham and Dodd defined value investing based on the notion that cheap companies trade at a discount to intrinsic value. Over time, this should result in attractive risk-adjusted returns, as the share price moves back to fair value. Almost 60 years’ later, Fama and French2 illustrated that over the long term, value stocks have delivered higher returns than growth stocks so the current trend is at odds with their findings.

The current dominance of Covid-19 makes value companies – such as those in the travel, leisure, energy and banking sectors – look very unattractive. It is worth asking whether during these unprecedented times, value companies are more unappealing relative to history? In a recent paper, Cliff Asness3 addresses this commonly raised question by assessing the quality and gross profitability of value companies compared to growth companies relative to history. In doing so, Asness3 demonstrates that the net-debt to equity of a value company is lower than its historical average and less than a growth company. He also shows that gross profitability is ahead of longer-term trends compared to a growth company. There is therefore nothing fundamentally broken about value companies relative to history. Over the long term, their attractive valuations should be recognised by the market. Investors just need to be patient enough to realise the inherent value of these companies.

The dominance of growth

We must also consider the dominance of some growth companies, particularly in the US, where five companies make up over 21% of the S&P 5004. This is even starker than at the peak of the boom in 1999, when the top five companies represented 18% of the Index. At this time investors were extrapolating the strong performance of growth companies into the future with no expectation of a reversal in favour of value companies. It is interesting to note what happened subsequently: between 1 January 2000 and 31 January 2007, growth stocks fell 19%, while those once-unloved value stocks rose 47%. This represents an outperformance of 66%.

We could assume that the monopolistic nature of the largest five companies of the S&P 500 will allow them to continue to grow indefinitely, outpacing and dominating any competitors. But on the other hand, we can also question at what point the anti-trust regulators and tax authorities will step in to control their dominance and take an increasing share of their profits in tax.

Changing fortunes

In addition to this, investors should consider whether a change in market dynamics could result in a reversal in the fortunes of growth and value companies. A glimmer of evidence that coronavirus is becoming less of a threat will likely kick-start a chain reaction: a pickup in activity; an improvement in growth and hence an increase in bond yields from historic lows; a potential increase in inflation expectations; a recovery in the oil price – the list goes on. A recovery outlook will take shape, a perfect backdrop for value companies which typically do well in such a situation where companies may be generating, or are about to generate, strong earnings growth. It may be puzzling to some that value has lagged the broader market recovery since the March lows, but investors are waiting for confirmation of a sustained economic recovery, which is almost impossible while the uncertainties surrounding coronavirus continue to dominate. In the meantime, they continue to play it safe with quality growth companies. Recently, however, we have seen some evidence of how quickly markets react to an improving outlook. The S&P US Value outpaced the S&P US Growth by 4% in the first 8 days in June, giving value investors some hope that a reversal will come once a clear path to recovery is evident. Historical evidence suggests value investors should indeed hold their nerve and for those growth investors, who have done so well over the last 13 years, perhaps now is the time to start dipping your toe into those less-frequented value waters.

Chart 1: S&P 500 Value vs. S&P Growth Total Return (%)


Source: Bloomberg, Aberdeen Standard Investments, (as of June 2020).



Investors should consider whether a change in market dynamics could result in a reversal in the fortunes of growth and value companies

Hedge Funds: When the going
gets tough, the tough get going

Chapter 4


Amie Chesworth, Senior Investment Analyst

Hedge funds have a proven track record in providing return and diversification benefits during historical crises. They also play an important role from a portfolio construction perspective.

In recent years, hedge fund news has been dominated by headlines of disappointing performance. The rise of passive investing, combined with higher hedge fund fees, has resulted in a decline in hedge fund industry assets under management. However, through the first quarter of 2020 the value of hedge funds has been clear, providing returns and diversification in a period of extreme volatility and market sell-offs.

There were clear outliers in terms of positive performance. These included commodity, global macro and volatility strategies

Represented by the Hedge Fund Research Indices (HFRI), hedge funds outperformed the MSCI World in Q1 2020. The aggregate returns of hedge fund strategies, denoted by the HFRI Fund Weighted Composite Index, were negative during the first quarter at -11.3%. However, hedge funds strongly outperformed the MSCI World Total Return, which generated -21.1% over the same period.

The HFRI Fund of Funds Composite generated -8.8%, representing +2.5% of outperformance versus the broad hedge fund index. This demonstrates the value of active hedge fund selection.

There were clear outliers in terms of positive performance. These included commodity, global macro and volatility strategies. Global macro strategies that were positioned for the risk-off environment, or those that pivoted their positioning quickly, performed well through the first quarter. Certainly noteworthy, commodity hedge funds successfully navigated the unprecedented dislocations in the oil market. This strong performance continued in April, when West Texas Intermediate futures sold off heavily and the futures curve moved in to steeper contango (i.e. when the forward price of the futures contract is higher than the spot price).

Chart 1: Hedge Fund vs Equity Market Performance During Q1 2020 (%)


Source: ASI, Bloomberg, (AS OF June 2020).

Long volatility and tail risk strategies also performed well, capitalising on dramatic increases in both implied and realised volatility driven by the Covid-19 crisis. Other strong gainers included managed futures/trend-following strategies, particularly those with a short-term nature that were able to quickly shift in to bearish positions as prior market trends altered course.

On the negative side, strategies exposed to equities and credit generally suffered as markets fell, credit spreads widened and liquidity dried up.

Equity long/short hedge fund strategies were among those adversely affected, although sector exposure was enormously influential in March. Funds with exposure to cyclicals were punished, while tech and defensive sectors such as healthcare outperformed. In addition, there was divergence in performance across regions.

US and European long/short managers suffered to similar extents, while China long/short managers were notable outperformers as local markets sold off less aggressively than developed markets. In addition, managers in the region benefited from the earlier spread of Covid-19 as hedge funds in the region had already taken down risk substantially going into March.

Periods of greater uncertainty and dispersion provide greater opportunities for hedge fund strategies to demonstrate their alpha and diversification benefits. This was clear in the first quarter. It has also been demonstrated in the outperformance of hedge funds during historical periods of stress dating back to January 1990 (see chart 2).

Chart 2: Hedge fund performance versus MSCI World Total Return in crisis events


Source: ASI, Bloomberg, (AS OF June 2020).

Over the period from January 1990 to March 2020, hedge funds, represented by the HFRI Fund Weighted Composite Index, generated an annualised return of 8.99%. Annualised volatility was 6.73%, 55% lower than the MSCI World Net Total Return Index over the same period.

The benefits of adding hedge funds to a portfolio are evident when analysing the Sharpe and Sortino ratios of a 60/40 portfolio of equities and fixed income versus a 90% allocation to a 60/40 portfolio and 10% allocation to hedge funds.

Over the period from January 1990 to March 2020, a 90% allocation to a 60/40 portfolio and 10% allocation to hedge funds would have generated a Sharpe ratio of 0.70. This means it would have outperformed a standard 60/40 portfolio, which would have generated a Sharpe ratio of 0.63. The Sharpe ratio increases to 0.76 and 0.79 respectively given a 15% and 20% allocation to hedge funds.

The Sortino ratio, which incorporates a measure of downside volatility, increases to 1.15 from 1.06 when including a 10% allocation to hedge funds over the same period. Similarly, the Sortino ratio increases to 1.21 and 1.27 with a 15% and 20% allocation to hedge funds respectively. This demonstrates the diversification benefits and ability of hedge funds to reduce portfolio drawdowns.

Despite this, research conducted by Aberdeen Standard Investments has shown that the average US state pension fund’s asset allocation to hedge funds remains relatively low and below an optimal level at 4.63%.

Hedge funds provide a long-term way of improving the risk-adjusted returns of a portfolio. We anticipate managers will be able to generate positive alpha and diversification benefits in an environment with the potential for greater volatility and dispersion across regions and asset classes. Therefore, the case still stands for a strategic allocation to hedge funds within institutional portfolios.



There were clear outliers in terms of positive performance. These included commodity, global macro and volatility strategies

UK small and mid-sized
firms: relationships matter

Chapter 5


Abby Glennie, Deputy Head of Smaller Companies

Investing in small- and mid-cap markets is all about finding great companies, and through recent market turmoils we believe the good have got better, and the weak weaker.

Through Covid-19 the strength of the more service-related tech businesses was a prominent feature

Covid-19 has created numerous challenges for companies of all sizes all over the globe. In this environment, small- and mid-sized companies were the biggest casualties of the stock market sell-off, underperforming their larger peers. However, behind the headlines, we saw areas of real strength within those small- and mid-sized companies. In particular, those with resilient revenue streams, nimble and adaptive business models and solid demand characteristics held up well.

The UK market is not the UK economy, and even in the lower end of market capitalisation you can access interesting global growth trends. Bigger is not always better.

More than a game

In recent years, video gaming has become a more dominant sector within the UK small- and mid-cap markets. A number of these businesses have listed, including Keywords Studio and Team 17. Through the recent market turmoil, the sector has shown great resilience. Robust share price performance reflects this dominance. An increased desire for at-home entertainment drove a sharp acceleration in year-on-year spending on video games, confirming that revenue dynamics would remain strong. We are long-term investors, so while short-term increases in demand are helpful, it is the sustainability and pathways to growth that are critical.

Video gaming is a prime example of smaller businesses having strong relationships with global market leaders in their industry. The strength of these relationships was critical during the Covid-19 transition, notably around trust and the need to adapt working practices in what is a high-security industry. Businesses in the tech sector also proved extremely adaptable; many invested in technology infrastructure and quickly catered to employees working remotely. At the helm, strong management teams rapidly implemented agile working streams.

Dining in

Food producers have been equally resilient during the crisis, including Cranswick and Hilton Food Group. Normally, consumers spend around 30% of their overall food and drink expenditure in restaurants, food outlets and more. This has not been possible during lockdown, and more food has been consumed at home. Cranswick and Hilton Food both sell products through supermarket channels, and have benefited from this domestic shift. Fulfilling this increased demand has not been simple though, and once again this has been testament to the high-quality management teams who have adapted their operations in tough environments. This included supplying PPE (personal protective equipment) and initiating social distancing in manufacturing facilities. They have also had to handle distribution challenges and adjust supply chains to capture those sources usually directed to the restaurant and fast-food industry.

Prior to Covid-19, Cranswick had significantly increased exports to China, where African swine fever decimated domestic pork supplies. Hilton operates in many regions around the world, and it was able to maintain these strong supply-chain dynamics throughout the crisis – proof of the strong relationships the company has formed over the years. These are examples of UK-listed mid-sized firms with a global reach. And once again, they show that relationships matter. The quality of service these food producers have provided their customers through the crisis confirms their status as trusted and critical suppliers for the long-term.

Tech savvy

Lastly, we have technology. There’s more to the tech sector than the FAANGs (Facebook, Amazon, Apple, Netflix, and Alphabet). The UK market has long been a good source of technology companies, with many delivering revenue visibility through subscription models. Through Covid-19 the strength of the more service-related tech businesses was a prominent feature. Companies across all industries were vastly lacking in their readiness for a ‘work-at-home’ situation, a move that happened more quickly than any anticipated. Companies such as Softcat and Computacenter, however, were well placed to assist this transition – not just with the delivery of critical hardware, but importantly with the advice and guidance on software and digital infrastructure. Again, this allowed each businessto develop and strengthen trusted relationships.

Just because a company is small its importance should not be underestimated. For example, when the UK government held an emergency meeting, Kainos, the mid-sized software business and a specialist in digital transformation, took a seat at the table alongside the more famous FAANGs. Kainos already had a strong relationship with the government, having digitalised many services such as MOTs and passports. It was therefore a natural supplier to which policymakers turned during the height of the crisis. In an incredibly short timeframe, Kainos produced systems to implement the furlough scheme, ensuring the UK’s workforce was able to access these essential funds. The company’s demonstrable nimbleness and efficiency will cement and build-on its government relationships.

Final thoughts…

The aforementioned small- and mid-sized UK firms and sectors have shown strength and resilience in a tough environment. Many were already on solid long-term growth pathways – recent events should accelerate these journeys. Management teams have demonstrated their quality, while businesses have been adaptable and responsive in fast-moving markets. Critically, lots of companies have grasped these opportunities and strengthened their relationship with their existing customer bases.

So, while investors have been quick to de-rate the small- and mid-sized sectors, we think it’s important to look below the surface. When you do, you find an investment universe rich with high-quality, growing and resilient businesses.


Companies selected for illustrative purposes only and not as an investment recommendation or indication of future performance.


Through Covid-19 the strength of the more service-related tech businesses was a prominent feature

The ABC of investing
with a purpose

Chapter 6


Victoria MacLean, Investment Director

The landscape of sustainable investing is complicated and often confusing in its terminology. A simple framework can help in assessing intention and success in execution.

The framework outlined below allows investors to differentiate between funds based on their investment objective

Navigating the concepts behind responsible and sustainable investing

There is a wide array of terminology used to describe funds that all have in common a purpose. That purpose is often described as being over-and-above the consideration of financial returns. In fact, it is about understanding the effects of an investment, and either avoiding certain effects or positioning positively towards others. The impact on financial returns is a separate question which relates to a cost-benefit analysis of those effects. The framework outlined below allows investors to differentiate between funds based on their environment, social or governance investment objective.

The ABC Framework

The framework comes from the Impact Management Project’s investment classification guide.5 It sets out an ABC that allows investors to align their investments with their intentions: ‘Act to avoid harm’, ‘Benefit stakeholders’ and ‘Contribute to solutions’.

Act to avoid harm’ covers many of the traditional products that exist in the market. Historically, harm was seen as a value judgement: ethical funds would be based on a list of screens that depended on what the investor determined a harm, based on ethical or moral principles. Gradually, avoiding harm evolved to include risk-based assessment of a company’s activities from an environmental, social and governance (ESG) perspective. Many portfolio managers talk about integrating ESG into the investment process, which may simply mean awareness of the risks. Funds in the A category go beyond that, seeking to avoid companies where those risks are deemed too high or which have negative effects that investors do not want exposure to on ethical grounds.

Benefit stakeholders’ goes a step further. At a minimum, it requires that investors avoid harm but it also asks that they consider positive impacts. Companies in this category would be classed as ESG or sustainable leaders, but it is important to distinguish between those that lead in risk management and those that lead in driving positive outcomes. To illustrate the difference, consider a company such as Inditex, an international clothing manufacturer and retailer. Minimising risk would mean considering safety and human rights practices in the supply chain, as well as water and energy efficiency practices. Benefiting stakeholders would take into account their targets to have 25% of garments under the sustainable Join Life brand by 2020.6 This is an emerging area within ESG or sustainable investing, but it is one with significant potential. It recognises that sustainability is not just about risk: it creates opportunities for companies. There are structural growth opportunities to be captured, as well as opportunities to improve supply chains in a way that creates a competitive advantage over the long term.

Contribute to the solution’ builds on taking into account positive impacts, but requires that the overall impact of the investment is a significant positive outcome for an otherwise underserved population or for the planet. This is generally referred to as impact investing. Inditex may be moving towards a more sustainable model but the purpose of its business is to sell clothes not to contribute to solving the world’s problems. This category of investments covers those who start with that intention, usually framed in terms of the UN’s Sustainable Development Goals (SDGs). But it requires more than just intention. Measurement and quantification of outcomes are important elements of impact investing, and one of the biggest challenges. There is a significant role for investors to play in engaging with companies and encouraging them to provide better data that will allow for improved measurement of outcomes. This category is also about opportunity, but it goes further than benefiting stakeholders and is targeted at investors who are looking to contribute to addressing the world’s long-term challenges. As an example, Kornit Digital operates within the clothing supply chain using printing technology with zero wastewater and a low carbon footprint.7 This directly addresses SDG 6 relating to sustainable water management.


The ABC framework should be seen as a scale. There is not a clear line where minimising risk ends and benefiting stakeholders or contributing to solutions begins. The important thing is that it gives investors a tool to look past a portfolio’s label as ‘ethical’, ‘responsible’ or ‘sustainable’ and to try to understand what the portfolio is designed to achieve. This allows the investor to align their own intentions with their investments. Flows into ESG, sustainable and impact funds have been increasing, but confusion about the differences between them remains. Analysing funds in terms of their intention can help distinguish them by purpose. Understanding purpose also allows for a better analysis of outcomes, and measuring those outcomes will be crucial in understanding how they interact with financial returns.



1 S&P 500 Value vs. S&P Growth TR in USD 01/01/2007 – 14/06/2020.

2 The Cross-Section of Expected Stock Returns, June 1992.

3 Is Systematic Value Investing Dead? 8 May 2020.

4 Source Bloomberg June 2020.

5 New Guide to Mapping the Impact of Investments

6 Inditex, “Our Commitment to Sustainability”




The framework outlined below allows investors to differentiate between funds based on their investment objective

The views and conclusions expressed in this communication are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.

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