Share prices spiralled into ‘bear-market’ territory in just 16 trading days in March – meaning they dropped more than 20% from earlier highs. The global economy and markets were rocked by two low-probability events simultaneously, a global pandemic and an oil price war. These occurred at a time when both markets and corporate debt were relatively high, which has exacerbated losses in certain areas.
These events remind us that market movements remain as unforecastable as ever and maintaining an element of ‘insurance’ is prudent. Investors with diversified portfolios (meaning they have holdings in various unrelated areas) have largely been better equipped. Government and other high-quality bonds have been resilient, and other areas such as gold have held up. Although these areas often appear ‘dead weight’ in times when stock markets are rising, they can be hugely important in more difficult times.
Presently there is still little visibility as to how things might play out. Markets could take heart from a relaxation of ‘lockdown’ controls. Yet that could lead to a ‘second wave’ of virus cases that forces their re-imposition. The number and scale of bankruptcies could also see renewed cause for alarm, as could the impact on confidence from large numbers of job losses which could extend the period of poor demand and lack of company profitability.
Against this, we must balance the actions of central banks pumping money into the economy, and governments propping up individuals and businesses through grants and loans, allowing them to get through the period of hardship. Borrowing and printing more money might mean that asset prices are ultimately lifted on a tide of inflation, especially if economic activity bounces back strongly and suddenly demand outstrips supply. Being entirely ‘out of the market’ is a risk too.
The truth is no-one knows the outcome. Only educated guesses are possible. What we can say for sure is that portfolios need to be able to handle a range of outcomes in an especially uncertain world. Avoiding too much risk and concentrating share investment in those areas that can do well in current adverse conditions is part of the way to do that. Holding some high-grade government bonds and cash can provide some balance too.
There are also some other options for those looking to diversify portfolios and make them less dependent on stock market returns. Various ‘mixed-asset’ and targeted absolute return funds aim to do this, though investors should tread with caution. Funds can vary a great deal in terms of their objectives, strategy and level of risk. You should always understand what a fund is aiming to do, and how, before investing.
Here is a look at the investments on our Direct Investment Service Preferred List that aim to be ‘plodders’ rather than ‘leapers’, either targeting consistent, satisfactory returns rather than higher ones, or else providing a differentiated option for investors looking to diversify.
This fund invests in a diverse portfolio of assets, aiming to beat the return on cash by 4% a year (before charges) while limiting the scope for losses. However, prioritising capital preservation is an aspiration rather than a promise, and the fund can fall as well as rise in value.
The fund comprises a ‘return-seeking core’ of assets chosen to generate attractive long-term returns, which are offset by a ‘stabilising layer’ of lower-risk assets and hedging positions to dampen volatility and to provide downside protection. The core is currently invested in shares of high-quality companies with predictable and stable cash flows, alongside bonds which the managers believe offer value. At present this includes some emerging market debt. Among the offsetting positions are typically gold and US Treasuries, while the tactical use of ‘put options’ serve to protect the portfolio against a significant fall in the stock market.
While a focus on capital preservation is core to the management team’s philosophy, when risk assets sell off we expect the fund to be affected to some extent, albeit its ‘stabilising layer’ should provide a buffer. With FTSE All-Share falling 25% in the first quarter of 2020, the fund’s single-digit negative return is within acceptable boundaries. The key detractor to returns was equities. However, stock selection versus the broader market was positive, with a bias towards more stable, defensive companies helpful. The fund’s holding of corporate bonds, emerging market bonds and alternatives accounted for roughly a third of the negative contribution within the return-seeking core.
In the stabilising layer, government bonds provided some cushion as coronavirus concerns drove yields lower, although they were ultimately used as a source of liquidity in what rapidly became a market squeeze in mid to late March. Similarly, the fund’s gold position was not immune to market volatility and initially suffered. However, towards the end of the month, it began to work and delivered a positive contribution during the first quarter of 2020. The team continue to favour gold as a hedge against the possible resurgence of inflation expectations.
The managers started 2020 with a fairly positive view of the economic backdrop, resulting in a higher return-seeking core of around 60%, but became concerned about the market’s complacency when signs of the Covid-19 outbreak became evident and took some steps to reduce risk in late January and early February. This entailed purchasing index put options, adding 10-year US Treasury futures and bolstering the Fund’s gold position by 1%.
As the sell-off took hold, the team added further put option protection. Market weakness also created opportunities to buy individual stocks, particularly in the consumer and healthcare sectors where previously elevated valuations had receded. Emerging markets debt exposure was trimmed, reflecting concerns that with the oil crisis impacting many petrodollar-based economies, countries may take the opportunity to restructure their debt. As a result of these changes, the return-seeking core ended the quarter at around 45% of the portfolio, with the fund’s cash position significantly bolstered. The team believe cash provides the flexibility and firepower to move quickly as the situation evolves.
This fund aims to offer lower volatility, but it will not appeal to all tastes. It does, however, provide genuine diversification from equity markets, something many funds in the sector cannot claim to.
Manager, James Clunie, aims to produce a longer-term average return of 4% over and above the interest rate on cash (as measured by the three-month LIBOR) through balancing traditional ‘long’ positions in stocks he believes are undervalued with ‘short’ positions in those he believes are overpriced where he can profit from any fall in value. The fund price may move in the opposite direction to the prevailing market trend, and that has often been the experience in the past few years as a broadly ‘market neutral’ positioning combined with a preference for ‘value’ stocks has resulted in disappointing performance.
It has been something of a perfect storm for the manager as cheaper stocks simply got cheaper and many popular ‘glamour’ stocks he shorted continued to rise, despite a lack of profitability in many cases. A particular nemesis was Tesla whose meteoric rise from October 2019 was costly. However, more recently performance has stabilised, and the fund is demonstrating some resilience amid volatile markets.
In terms of recent action in the portfolio, a number of Clunie’s underperforming stocks such as Hyve Group (a conference and exhibition organiser), Capita and buildings materials supplier Forterra have seen a mini resurgence, as has Legal & General who announced last week that its current intention was still to recommend a final dividend. He believes the willingness to pay (whether it does so or not) is indicative of the underlying strength of its capital position.
Meanwhile, the manager has added to his position in Tesco following a slight dip as it reported results, and to Cameco, the uranium miner. Clunie believes an opportunity is opening up in the stock as a result of Kazakhstan, a country that accounts for 42% of global uranium production, announcing the closure of its uranium mines for three months as a Covid-19 quarantine measure. Combined with other production cuts, global uranium production has fallen by half. As a result, the price of the metal has started to rise following a multi-decade bear market. Clunie believes the few companies remaining in the industry should finally enjoy strong returns.
In terms of short positions, Clunie continues to add to an owner of gyms and to a manufacturer of surgical robots. He explains that many medical procedures are being deferred and hospitals around the globe are putting off purchases of equipment as they grapple with the pandemic. This, he believes, is significantly impacting operations and financial results at medical equipment providers.
Personal Assets Trust is managed by Sebastian Lyon of Troy Asset Management and has an ethos of wealth preservation. Lyon’s first principle is not losing money – rather than being concerned with relative performance against a benchmark. He blends a variety of assets to try and help shelter investors from market volatility, although like any investment it can fall as well as rise.
Historically, the Trust’s consistent, stable performance has been down to its mix of assets. Mr Lyon maintains a balanced approach, allocating portions of the fund to four areas: equities, index-linked bonds, cash and gold. This has proved a resilient combination as returns from these areas tend to move independently of each other rather than up and down in tandem, although past performance is not a guide to the future.
This is not an investment option likely to set pulses racing, and the manager’s more cautious stance has led to some rather dull periods of performance. However, the Trust has tended to come into its own during difficult times. This proved the case during the global financial crisis of 2007 and 2008, and recent performance amid volatile markets has also been strong – though past performance is not a guide to the future. It is the sort of resilient holding that could be considered for part of a more stable core of a long-term portfolio.
In recent months, the fund has reaped the rewards of the manager’s long-held concerns surrounding valuations in many parts of the equity market, low economic growth globally and heightened political risk. Lyon typically invested only around a third of Trust assets in equities over the course of 2019 while he waited for better value to emerge, with substantial exposure to shorter-dated US Treasury Inflation Protected Securities (TIPS), UK gilts and gold.
That positioning continued into 2020 and has proved a resilient combination, especially with the equity exposure made up of large companies in defensive industries such as Microsoft, Nestle, Unilever and Coca Cola. While these have not been immune to volatility they have fared well in relative terms versus the rest of the market. As long-time investors will know, the manager favours strong businesses and avoids high levels of debt, cyclicality and capital intensity.
The equity weighting within the trust has increased in the past few weeks from around 32% to 40% as Lyon has taken advantage of weakness to add to existing holdings including Unilever, Diageo, Nestle and Medtronic. He also initiated a holding in Visa. Consequently, the trust’s position in cash and short-dated government bonds has fallen from around 25% at the start of February to around 14%, with a 30% exposure to (mainly US) index-linked (i.e. inflation-linked) government bonds maintained.
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Preferred List review – targeted absolute return & cautious multi asset
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