Also in this issue: Adviser Insights: What's been catching your eye? FE Analytics Masterclass Marcus Brookes: The importance of standing by your principle ...and much more
Has outsourcing to DFM models already reached a plateau?
Model Drilldown: Charles Stanley
Profile: Schroders' Marcus Brookes
FE Analytics: Product Update
Sector Focus: IA UK All Companies
T.Rowe Price: The Value-Growth Debate Moves On
Adviser Insights: Top-rated funds that aren't on your radar
Editor's Letter: Peak outsourcing?
A New Fund Order: JB Beckett
Top-rated funds that aren't on your radar
Sector Focus: AI All Companies
FE Analytics: Diversification benefit
Asset Allocation: Brewin Dolphin
FE Analytics Masterclass: How to use historical portfolios
Column: JB Beckett
Editor's Letter: Welcome to FE Professional
Sector Focus: IA Mixed Investment 20%-60% Shares
FE Analytics: Masterclass
Cover Feature: Has outsourcing to DFM models already peaked?
The AFI Soapbox
Profile: Bambos Hambi
Adviser Insights: Funds grabbing advisers' attention in Q1
Investment Trusts: Miranda Seath
Column: Miranda Seath
Cover Feature: The assault against active
FE Invest: In which sectors do active managers have the best chance of outperforming?
The AFI Soapbox: Ben Willis
Profile: Bambos Hambi
FE Analytics: Masterclass
Cover Feature: The assault against active
FE Invest: Absolute return funds
The AFI Soapbox: The road to returns?
Gary Jackson Editor, FE Professional & FE Trustnet E: firstname.lastname@example.org T: 0207 534 7629 Rob Langston News editor, FE Trustnet E: email@example.com T: 0207 534 7696 Lauren Mason Senior reporter, FE Trustnet E: firstname.lastname@example.org T: 0207 534 7625 Jonathan Jones Reporter, FE Trustnet E: email@example.com T: 0207 534 7640
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Go back a few years and one of the main predictions for the post-RDR world was greater numbers of advisers outsourcing their investment decisions to providers like discretionary fund managers. Because of this, they’d need to spend less time picking funds and have more time to focus on things like financial planning and engaging with clients. In the early days of RDR this view certainly panned out, with some even seeing a future where virtually no financial advisers bothered to pick funds and the bulk of buying decisions lay with a relatively concentrated group of ‘gatekeepers’. That might not be the case any more, however. Between 2015 and 2016, the growth in outsourced assets slowed dramatically and cast a shadow over predictions that around one-third of total advised assets would be outsourced in the very near term. That’s the theme of this month’s cover: Platforum’s Miranda Seath takes a closer look at the numbers suggesting that the trend for financial advisers to outsource investment activities to third parties such as DFMs might be reaching its peak. She also speaks with a number of advisers to discover why some see value in keeping their investment activities in-house as well as finding out what discretionary managers themselves think about this potential change in trend. That’s not the only area FE Professional is putting under the spotlight in this issue. Adam Lewis asks Schroders head of multi-manager Marcus Brookes about the importance of standing by your convictions, Lauren Mason discovers which funds have seen an uptick in interest at the start of 2017 and Jonathan Jones catches up with Charles Stanley about the positioning of the Dynamic Passive model portfolios. From inside FE we bring you a guide to how the historical portfolio tool in FE Analytics can boost your research and reporting while FE Invest tries to identify the fund sectors where active managers have a greater chance of outperformance. So, here’s the second issue of FE Professional – we hope you enjoy it. As always, if you have any feedback don’t hesitate to contact us at firstname.lastname@example.org
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So, are we set for a prolonged recovery? And why has the style cycle been so long and tilted so unfavourably against Value? Part of the multiple year outperformance of Growth stocks since 2007 can be linked to scarcity; in a low growth, low inflation and falling bond yield environment, investors tend to pay a premium for the limited amount of growth that is on offer. Meanwhile, many cyclicals (including Financials) with apparent headwinds are shunned regardless of the discount applied by a sceptical market. The two forces in combination have created meaningful dispersion when sub-dividing the equity universe by style. While some would point toward the runway for recovery of Value versus Growth when considering historic norms, it’s important to note that secular headwinds have emerged alongside cyclical forces, largely to the detriment of cyclical Value-oriented industries. These include the drag on profitability of many materials companies as over-capacity in China and the shift in its economy from industry to services evolves. Many financials companies have also been burdened for multiple years by an environment of growing regulation and litigation, with banks hampered by an overall lack of profitable loan growth. Given this, it’s somewhat intuitive that Value indices have lagged in what has been an extraordinary period. This also explains why expectations regarding the roll back of regulation in the US are creating material interest and movement in segments of the market that may be impacted. In many respects 2016 demonstrates that the true and defining principal of Value investing is that every fear and negative data point has a price at which it’s fully reflected in a stock’s valuation. This is the point at which fear itself becomes the opportunity for those with a true contrarian instinct and this is how it began for the Value rally of 2016. The extreme pessimism toward cyclicals, and especially financials, ballooned out valuation differences for global stocks to extreme levels, at least when considering the past 30 years. This in itself was a reflection of how extreme the difference between Value and Growth stocks had become (Figure 3).
Source: FactSet, MSCI.
Portfolio Specialist, Global Equities, T. Rowe Price
Source: FactSet, MSCI.
Figure 5: Financials are significant proportion of the Value index MSCI World Index sector weightings, as at 28 Feb 2017
Figure 3: Valuation spreads reflected fear of recession in early 2016 Top quintile compared to the market average, 1987 to Feb 2017
This latest peak in valuation spreads occurred in the spring of 2016 as the market focused on ‘crisis’ emanating from a number of sources, from oil prices to China. With hindsight, the peak of concern coincided with the peak of opportunity for Value investors, given the subsequent easing of these concerns. The key question now is how will the economic cycle evolve and what does that mean for stylistic tilts moving forward? One important take away from Figure 3 is that the opportunity for Value has clearly evolved with significant amounts of controversy removed from some segments of the market (and in tandem injected into others). This requires consideration at a minimum.
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Figure 4: The Trump rally and shifting sentiment The evolution of the Trump rally, 9 Nov 2016 to 21 Mar 2017
The Value versus Growth debate has been a source of intense interest and debate among investors over the past few months with Value indices (and investors) finally having some time in the sun after a dire period for the style (Figure 1).
Given today’s start point, in both a Value and Growth context, it remains important to be specific in choosing stocks rather than to be driven by changes in sentiment, especially where change may not be persistent. The Value narrative has caught the attention of many, especially given its links to big changes at the macro and political level, but great Value investors apply the antithesis of populism when choosing stocks. While Value’s success has foundations both long term and over the past year, execution is more arguably important today versus a year ago, given the shifts in both valuations and earnings prospects we have seen.
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IMPORTANT INFORMATION For investment professionals only. Not for further distribution. Past performance is not a reliable indicator of future performance. Source for MSCI data: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. This material, including any statements, information, data and content contained within it and any materials, information, images, links, graphics or recording provided in conjunction with this material are being furnished by T. Rowe Price for general informational purposes only. The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price. The material does not constitute a distribution, an offer, an invitation, recommendation or solicitation to sell or buy any securities in any jurisdiction. The material has not been reviewed by any regulatory authority in any jurisdiction. The material does not constitute advice of any nature and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested. The views contained herein are as of April 2017 and may have changed since that time. EEA—Issued in the European Economic Area by T. Rowe Price International Ltd., 60 Queen Victoria Street, London EC4N 4TZ which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only. T. ROWE PRICE, INVEST WITH CONFIDENCE and the Bighorn Sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc. in the United States, European Union, and other countries. This material is intended for use only in select countries.
Figure 2: The Value cycle and bond markets US Treasury yields vs MSCI World Value/Growth, Dec 2002 to Feb 2017
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Figure 1: Value comes roaring back in 2016 MSCI World Value – MSCI World Growth, Feb 2012 to Feb 2017
Global Value Equity Fund
For those with bullish economic outlooks which encompass the prospect of higher inflation, higher interest rates and higher government bond yields, a Value-oriented bias is certainly consistent. Indeed, when looking historically at valuation spreads and the incidences of spreads narrowing further, periods of improving economic health (or the point where economic malaise ends), have proven fertile periods for Value investors (see 2002-2006 or 1993-1997). For us, this signifies the next stage of the Value opportunity, but it should be considered separately from the initial mean reversion we have seen in the last year. While 2017 is likely to act as a battle ground for Value and Growth as reality and rhetoric meet and corporate earnings show the ‘have’s’ and ‘have not’s’ in fundamental improvement terms, it is interesting to note the post-election rally has already changed in nature into Q1 (see Figure 4), with Mexico, China, Growth and Information Technology leading as momentum in Russia and Energy fades, at least temporarily.
Source: Empirical Research Partners Analysis.
This is a short term perspective, however. Of bigger consequence is the large influence that financials may have on the relative return of Value and Growth over the next stage of the equity cycle, given the sector makes up around 30% of the MSCI World Value Index (Figure 5). This sector has strong links with the global economic outlook via loan growth, and interest rate sensitive profits drivers. Encouragingly, given the pessimism that has reigned over the sector for many years, valuations generally remain reasonable in the context of an outlook encompassing further improvement. In contrast, the second largest component of the MSCI World Value Index, industrials, looks relatively expensive at an aggregate level at least. Here, stock specific returns will be highly dependent on earnings improvement/follow-through, especially against raised expectations.
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Past performance is not a reliable indicator of future performance. Sources: Factset
The Value-Growth Debate Moves On
Rather than there being a single catalyst for the market’s rotation back towards Value in 2016, several changes within the investment landscape have made a contribution. These include a cyclical upturn in developed market economic data, fiscal stimulus in China cushioning domestic growth and a significant recovery in oil prices. Importantly, these positive catalysts came at a point when sentiment had troughed and many cyclical stocks had fallen to distressed valuations, creating the potential for a Value rally. While the change in economic tone began pre-US election, the seismic shift in attitudes post the election of Donald Trump compounded the strength in Value indices as expectations surrounding economic growth, inflation and interest rates shifted upwards with real force. While the longer term picture still reflects the strength of growth indices, rising interest rates and government bond yields have ultimately assisted in Value turning a corner after years of underperformance (Figure 2).
Global Focused Growth Equity Fund
“Whilst DFMs argue that outsourcing frees up advisers to focus on what they are good at, namely financial planning and tax planning, a core group of advisers believe that outsourcing asset allocation paints the wrong picture for clients.”
Advice firms outsourcing to third-party model portfolios
The past few years have witnessed a strong march towards outsourcing but this trend might not be as inevitable as some would argue – and there are signs that advisers are no longer flocking towards discretionary fund management like they once did.
Is growth in outsourcing to DFM models slowing? Some 25 per cent of advised assets are in model portfolios that are run in-house by advice firms (the highest percentage). Assets in third-party models account for 11 per cent of total assets. However, DFM MPS is a much newer investment solution: advisers have been running in-house model portfolios for years. We would expect the percentage of assets in third-party model portfolios to grow but the rate of growth may slow as evidence builds that advisers are exploring alternative options.
Another brake on investment outsourcing could be an increase in the number of advice firms taking on discretionary permissions where these firms are using in-house expertise to run the money. Advice firms are fed up with the administrative nightmare of constantly having to seek client permissions for investment decisions. “We wanted to get discretionary permissions because of administration, so that we didn’t have to write to clients every time we wanted to make a change. Centralised investment propositions are inefficient… clients don’t return documents and this creates a problem downstream,” one says. Discretionary permissions, these firms argue, mean greater efficiency and the control to make decisions quickly. Easing the admin nightmare of writing to clients isn’t the only incentive – advice firms can also take a greater share of fees. As one DFM put it: “Some companies are bringing in people who do have the expertise and getting a slice of the cake.” DFMs are less clear at what point it makes sense for advice firms to take on discretionary permissions. They feel that scale is important and it is more suitable for large firms. But one DFM remains unconvinced that larger firms should take on discretionary permissions and grow their own portfolio management capability when they could acquire a DFM instead. Buying a DFM is an alternative option and a ready-made DFM can look attractive. Advice firms don’t have to build expertise and nurture talented CFAs. Instead they acquire a ready-made set of people, processes and compliance procedures. For firms with scale it is arguably an easier route: “Advisory firms with £1bn could just buy a DFM. A number are for sale at a reasonable price.”
Source: Platforum, 2017
Has outsourcing to DFM models already peaked?
Will outsourcing to DFMs ramp up in a bear market? The chief executive of a discretionary fund manager said to us that “fund management is too complex for advisers. They should focus on goal setting and tax planning.” But the appetite for managing investment risk can be affected by the cycle of the market. Some DFMs have suggested that in a bull market advisers may be more optimistic that they can manage investment risk effectively. The head of investment solutions at a major DFM believes that there will be a resurgence in outsourcing if markets tumble; he thinks that advisers are not too keen on getting flack from clients over poor investment performance. Outsourcing provides a convenient degree of separation and the adviser is able to sack the DFM instead of getting sacked by the client. If assets are in a third-party model on platform, it is very easy to switch. But tying the fortunes of investment outsourcing to the ebbs and flows of the market may be too simplistic. DFMs are not necessarily the silver bullet in tough market conditions: advisers are still on the hook for their choice of outsourcing partner. DFMs tell us that advisers are not always clear that they must take responsibility for the suitability of outsourcing partners, whilst the DFM is responsible for the mandate. One DFM MD told us: “We spend a lot of time explaining to IFAs where the responsibility stops. For introduced business, the client is the adviser’s client but we have a responsibility for the mandate. The agent is the client in this case.” There is also unease that advisers expect DFMs to be able to correct the asset allocation in model portfolios to ride out market downturns. According to one DFM, these corrections are possible in bespoke portfolios but that many advisers are unaware of the constraints of third-party model portfolios (although they did concede that there is greater room for manoeuvre in MPS than in funds that cannot change their asset allocation). “If the market tanks, bespoke DFM is more able to exploit the tools available,” they say. “If it’s MPS, then DFMs are constrained by DT or Finametrica… Do clients know the extent to which DFMs are constrained? Do advisers pass info on the constraints of MPS on platform?” It can also be more challenging than advisers think to sack the DFM. “There are two relationships: one with the DFM and one with the adviser. So it is not as instantly portable as some believe… because if the client has a relationship with the DFM then it is not as easy to move them.” So, if a bear market doesn’t do it, what would make an adviser dip their toe in outsourcing to a DFM model portfolio? At a recent roundtable, the MD of an advice firm who doesn’t outsource was asked the billion-dollar question. When it comes to the crunch, it turns out that risk management is the only real consideration: “Advisers are scared by risk… the risk of clients not getting the outcomes we have said they will get. We need to be able to demonstrate [that we can achieve these outcomes] to clients and we need to be able to deliver… this will push outsourcing forward.”
One senior DFM even felt that taking on discretionary permissions can be quite perilous for advice firms: “The dangerous territory is when the IFA doesn’t really have the wherewithal to make the investment decisions but is getting paid as if they do. It’s an interesting area of liability.”
“Advisory firms with £1bn could just buy a DFM. A number are for sale at a reasonable price.”
Reading between the lines, DFMs are uneasy about the volumes of IFAs looking at discretionary permissions. In some cases it is a competitive threat. But they raise valid concerns over the ease with which advice firms can obtain discretionary permissions: “It should be harder for IFAs to get discretionary permissions.”
There are a number of reasons some advisers choose not to outsource to DFMs. Whilst DFMs argue that outsourcing frees up advisers to focus on what they are good at, namely financial planning and tax planning, a core group of advisers believe that outsourcing asset allocation paints the wrong picture for clients. Advisers can find it challenging to justify upfront fees of between 1 per cent and 3 per cent unless the advice firm is running the money. We routinely encounter advisers who conduct their own investment research and who continue to develop and refine investment strategies on behalf of their clients. For some, this is what keeps their work interesting. Advisers have also told us that there are operational challenges with using a range of third-party model portfolios. One explains: “[There are] client inconsistencies from outsourcing to different DFMs; there are different re-balancing times and it is hard to manage.” These firms may be more persuaded by cheaper, simpler investment solutions such as the Vanguard LifeStrategy range or they may choose to buy in expertise through the template model portfolios created by the research agencies.
Source: Platforum, 2017
There has been rapid growth in investment outsourcing since the retail distribution review (RDR). Outsourced assets leapt up by a third between 2013 and 2015, from 18 per cent of total advised assets to 24 per cent. It would be reasonable to assume that outsourced assets could reach 30 per cent by mid-2017. But we aren’t exactly seeing that. In fact, our data shows evidence of a slowdown in the rate of growth between 2015 and 2016. Outsourced assets grew by just 2 per cent between 2015 and 2016, to make up 26 per cent of assets at the end of 2016. Each time we comment on the ‘plateauing’ of the trend to investment outsourcing, DFMs contact us to offer a contrarian view. A new cadre of DFMs only provide MPS on-platform and are building successful businesses. More traditional DFM businesses, such as Brewin Dolphin and Smith & Williamson, tell us that they are still seeing rapid growth in MPS on platform. Of course, not all investment outsourcing is to DFM model portfolios. But as DFM model portfolios proliferate, we have tried to understand what profile of adviser is using them, whether the growth of outsourcing to DFM models is slowing and if the current bull market means that advisers are more confident that they can manage investment risk themselves.
Senior researcher at Platforum
“We are uncomfortable with paying a DFM to run an MPS,” an adviser told us. “We can afford to outsource to individual solutions and we can create our own models.” These advisers are pretty intractable. DFMs will have little success in swaying them unless they are plugging bespoke discretionary management, which most advisers deem suitable for a small group of wealthy clients with ‘oddball needs’.
“DFMs are not necessarily the silver bullet in tough market conditions: advisers are still on the hook for their choice of outsourcing partner.”
These middle tier firms, who are most likely to outsource MPS to DFMs, are precisely the profile of firm that might take on discretionary permissions and use third parties for running the money. DFMs tell us that the threshold for holding discretionary permissions is £350m. In contrast, our data tells us that very large firms are most likely to do everything in-house – 50 per cent of firms with over £1bn do exactly that. These firms fuel in-house fund growth and may be slowing down the overall growth in outsourcing.
Percentage of advised assets by investment strategy
Many expected discretionary fund management firms to be a major beneficiary of the retail distribution review, but Platforum’s Miranda Seath examines the evidence that this trend is starting to slow.
Is there a typical investment outsourcer? Our data indicates that those who outsource every element of investing – pure outsourcers, if you will – come in all shapes and sizes. This suggests that using third-party investment solutions may be an instinctive choice; some firms are simply outsourcing enthusiasts. Pure outsourcers make up between 20 per cent to 30 per cent of each advice firm segment, from firms with £0 to £19m in assets up to those with over £1bn. But if we look specifically at advice firms outsourcing to third-party model portfolios, it is possible to identify common characteristics. Advice firms that outsource to third-party models are likely to be medium to large (but not super-sized). A higher percentage of firms with six to 10 registered individuals (RIs), 11 to 20 RIs and 21 to 50 RIs are using this strategy. These firms typically have between £100m and £999m in assets under advice.
One of the few funds to beat its average peer for returns and volatility, MI Hawksmoor Vanbrugh – headed up by FE Alpha Manager Richard Scott, Daniel Lockyer and Ben Conway – is built around a cautious portfolio that aims to have a ‘margin of safety’ when it comes to valuations. The £108.9m fund currently has Royal London Short Duration Global High Yield Bond, Ruffer Gold and Barings European High Yield Bond as its top holdings. It has made 50.48 per cent over the past five years with annualised volatility of 5.15 per cent and is one of a handful of members to be in the top quartile for total returns, volatility and maximum drawdown.
Source: FE Analytics, bid to bid total return in sterling between 31 Mar 2012 and 31 Mar 2017
Pimco GIS Global Multi Asset
Source: FE Analytics MI Tool
One of the most popular funds in the sector, the £3.2bn Jupiter Merlin Income Portfolio has been headed up by FE Alpha Managers John Chatfeild-Roberts and Algy Smith-Maxwell since the 1990s with Amanda Sillars and David Lewis joining them in 2011. The portfolio is built around highly experienced and seasoned fund managers, with household names such as CF Woodford Equity Income, Fundsmith Equity and M&G Global Dividend being holdings. Over five years Jupiter Merlin Income Portfolio has made a 37.64 per cent total return with annualised volatility of 6.19 per cent.
IA Mixed Investment 20%-60% Shares and FTSE UK Private Investor Income over 5yrs
This is the largest fund in the peer group with assets of £4.5bn but is only available to Halifax clients. A 37.86 per cent total return puts it in the third quartile over five years while its annualised volatility of 6.61 per cent is bottom quartile. Just over half of the portfolio is in UK equities through the likes of HSBC, BP and Royal Dutch Shell, with another 42 per cent in UK fixed income.
Premier Multi-Asset Monthly Income MI Hawksmoor Vanbrugh Close Managed Income SF Cautious
AUM in the IA Mixed Investment 20%-60% Shares sector
This £100m fund is run by David Hambidge, Ian Rees, Simon Evan-Cook and David Thornton, with the aim of delivering steady capital returns with lower volatility than equities and no reliance on rising stock markets. On a five-year view it has made 26.11 per cent with 2.75 per cent annualised volatility.
IA Mixed Investment 20%-60% Shares
Premier Multi-Asset Distribution
This £899.8m fund, managed by Marcus Brookes and Robin McDonald, has made 28.43 per cent over five years with annualised volatility of 3.93 per cent. The managers have maintained cautious positioning over recent years, arguing that bond markets are over-valued. That said, they have exposure to equities that look attractive and top holdings include GAM Global Diversified, GLG Japan Core Alpha and Sanditon European Select. In this month’s profile, Brookes explains the importance of standing by convictions and why one-quarter of the portfolio is in cash.
IA Mixed Investment 20%-60% Shares and FTSE UK Private Investor Income cumulative returns
Invesco Perpetual Distribution
David Hambidge, Ian Rees, Simon Evan-Cook and David Thornton run this £621.3m fund of funds, which is one of the few members of the sector to sit in the top quartile for total returns, volatility and maximum drawdown over the past five years. The income-paying fund has a bias towards value and counts Fidelity Enhanced Income, Standard Life UK Equity High Income and TwentyFour Dynamic Bond as some of its biggest holdings. Over five years, it has made a 60.88 per cent total return with annualised volatility of 5.17 per cent.
Royal London Sustainable Diversified Trust
Click a hotspot on the scatter chart to view more about that fund
Source: FE Analytics, bid to bid total return in sterling between 31 Mar 2012 and 31 Mar 2017
Halifax Cautious Managed
Premier Multi-Asset Monthly Income
Premier Multi-Asset Conservative Growth
Source: FE Analytics, bid to bid total return in sterling to 31 Mar 2017
Four of the sector's 146 funds are in the top quartile over five years when it comes to total return, volatility and maximum drawdown:
Best and worst IA Mixed Investment 20%-60% Shares performers over 5yrs
Jupiter Merlin Income Portfolio
This $1.1bn fund sits in the bottom right of the scatter chart after posting the sector’s lowest return over five years (12.24 per cent) with one of the highest annualised volatility numbers (7.35 per cent). Managed by Mihir Worah and Geraldine Sundstrom, the fund is an “all-in-one” global asset allocation strategy that is designed to be a core holding in portfolios. The fund has performed strongly over the shorter term, sitting in the top quartile on a six-month view.
10 most researched IA UK All Companies funds over 1yr
Schroder MM Diversity
MI Hawksmoor Vanbrugh
This fund has made the sector’s highest total return over five years, at 65.06 per cent. This has come with annualised volatility of 6.55 per cent. Managed by FE Alpha Manager Mike Fox, the £384.1m fund has a socially-responsible investment mandate, which means it can only invest in companies that have a net positive benefit to society. Its largest holdings are Amazon.com, Google parent company Alphabet and Microsoft.
Risk/reward over 5yrs
Managed by Paul Causer, Paul Read and Ciaran Mallon, this £3bn fund is the most heavily researched member of the IA Mixed Investment 20%-60% Shares sector by investment professionals. Read and Causer run the fund’s bond portfolio and have a wealth of experience in the asset class, while Mallon took over from Neil Woodford in 2013. It has posted a five-year 42.98 per cent total return with 5.19 per cent annualised volatility. The portfolio is currently positioned with a defensive stance, putting its attention on high quality companies and firms paying sustainable dividends.
Source: FE Analytics
The IA Mixed Investment 20%-60% Shares sector is a persistent favourite with professional and private investors, given the more cautious tilt of its members and the exposure offered to a wide range of asset classes. Highlighting the risk-adverse nature of the sector, its annualised volatility of 5.25 per cent over the past five years is lower than that witnessed by the FTSE All Share (10.01 per cent) and the Bloomberg Barclays Sterling Gilts index (7.22 per cent). Likewise, the IA Mixed Investment 20%-60% Shares sector’s maximum drawdown of 6.56 per cent is below the 11.12 per cent to hit UK equities and the 7.69 per cent seen in the government bond index. If we use the FE Risk Scores – which measure volatility against the FTSE 100 – we find that the sector has a risk score of 48. This suggests that the average fund has endured only 48 per cent of the risk of the FTSE 100 over recent years. What’s more, seven members have an FE Risk Score of 35 or less: Coram Global Defensive has the lowest at 20, followed by Premier Multi-Asset Conservative Growth, Close Diversified Income Portfolio, UBS Multi Asset Income, Schroder Global Multi-Asset Income, MI Hawksmoor Vanbrugh, Schroder MM Diversity Income, HC Sequel Cautious Target Return Strategy and Schroder MM Diversity.
This £1.2bn fund, managed by David Hambidge, Ian Rees, Simon Evan-Cook and David Thornton, has the sector’s highest Sharpe ratio over five years. During this time, it has made a 64.84 per cent total return with annualised volatility of 5.56 per cent. The fund of funds portfolio has a value tilt, with top holdings including Standard Life UK Equity High Income, Fidelity MoneyBuilder Dividend and Charlemagne Emerging Market Dividend.
While marginally underweight in equities overall, Brookes says his overweight positions in Europe, Japan and emerging markets should go some way to disprove the theory that he is a “perma-bear”. “To say we are cautious on everything is wrong,” he says.
“Philosophically we know we will not outperform every quarter, but we have a process we have used for a long time which we are very comfortable with,” he says. “We also do moderate our positions, so while we don’t like bonds we did buy back in to them at the end of 2015, before selling them quickly after they rallied. However, as a team we are always willing to admit to when we are wrong.” Brookes and co-manager Robin McDonald have worked together for 16 years and he describes their investment process as based around the top-down and implemented using funds. “It’s all about asset allocation and finding the right fund manager for the right environment,” he says. “You have to have views in your portfolio, not blend away all the risk by investing across a broad range of managers. Asset allocation is incredibly important to funds of funds, but viewing it as a separate discipline to fund selection is wrong. It is part of the same thing.”
“The second way is that it proves we were right all along. Bonds turn out to be disastrous value for clients and go into a bear market. Not only would we be avoiding losses in this scenario, but we would also have cash on the sidelines ready and waiting to pick them up at much better valuations.”
Marcus Brookes is the head of multi-manager at Schroders, which involves leading the multi-manger investment team that manages and advises upon multi-asset, multi-manager solutions, including the Diversity range of funds. The team also advises the wealth managers within Cazenove Capital with respect to fund selection and asset allocation. He joined Schroders in 2013 and is based in London.
When a fund manager has held 25 per cent of their portfolio in cash for the last two-and-a-half years, the natural assumption is that they are extremely bearish about the prospects of global stock markets. But Schroders head of multi-manager Marcus Brookes says such an assumption about him would be incorrect, even though he has no plans to soon to put to work the quarter of his £914m Schroder MM Diversity fund that is in cash.
“You have to keep going. If you start deviating from your process it can become even worse for you and you end up in no man’s land.”
Source: FE Analytics, bid to bid total return and annualised volatility in sterling between 31 Mar 2012 and 31 Mar 2017
“If you start deviating from your process it can become even worse for you and you end up in no man’s land. If we had given up on this stance in the middle of last year, we would have had a much tougher time, but the honest truth is that we are always looking at it.” The fund is ranked fourth quartile in the IA Mixed Investment 20%-60% Shares over three and five years, but Brookes says the fact it returned nearly 9 per cent in 2016 is “a comfort”. “The performance target of Schroder MM Diversity is CPI plus 4 per cent and if you average it out over the last five years the fund has done well,” he says. “If you look at performance versus the sector it doesn’t look great, but you have to bear in mind that we cannot do what the sector can.” This is because the fund is designed to be one-third invested in fixed income and cash, one-third in equities and one-third in alternatives. The peer group, on the other hand, is 60 per cent equity and 40 per cent fixed income. As a result, the manager says, the performance profile is not going to be the same.
Funds currently managed by Marcus Brookes
On the back of this, Brookes halved Schroder MM Diversity’s 20 per cent weighting in bonds to 10 per cent and upped the cash weighting from 10 per cent to 25 per cent. Given that in the time since the Fed has raised interest rate three times, twice in the last four months, and inflation everywhere at about 2 per cent on paper it seems a good call. “What has been frustrating is that the European slowdown in late 2014/early 2015 and the quality sell-off which followed has artificially depressed some of the statistics,” he adds. “However, we are now seeing both of these things start to unwind and bond yields are start to rise slightly.” So how easy has it been for the manager to stand by his convictions when performance is sliding as result? Brookes says the key thing is to stick with your process. “You have to keep going,” he says.
Instead Brookes, who joined Schroders in 2013 after the acquisition of Cazenove Capital, says the high cash weighting reflects the team’s longstanding caution regarding the bond markets. Given how well some areas of the bond market have performed in the time period since the global financial crisis, it’s a call that would have tested the nerve of many – but he says it is one he is sticking to. “We made the call based on the evidence we had at the time,” explains Brookes. “Our caution stemmed from the fact that we could perceive a much rosier outcome for the global economy than the bond market was predicting. A 10-year government bond yielding about 2 per cent simply didn’t look good value given the predicted pathway of inflation getting back to 2 per cent that both the Bank of England and the Federal Reserve were predicting.”
“Asset allocation is incredibly important to funds of funds, but viewing it as a separate discipline to fund selection is wrong. It is part of the same thing.”
This, in essence, is how Brookes’ whole approach works: he is either correct about the macro backdrop and takes profits on the cash positions and buys bonds (after they have fallen in value), or he is wrong, recognises that fact and gets invested. “However, in this instance if we are wrong because the world is not looking a good place to be, I will be more worried about my bullish call on equities than anything else, so it would not be the only decision I have to make,” he adds. It all comes back to one of his golden rules of investing: opinions can change but principles cannot. “We live in a dynamic world that doesn’t move in a straight line, so if new data comes in that is contrary to your view, you must be able to change your mind,” he says. “However your principles – don’t lie, don’t cheat etc – must always remain the same.”
For example, if you are bullish on the UK and think it is in a cyclical upswing being led by the large-caps, being overweight towards Majedie UK Equity (a large-cap manager) would be more appropriate to Brookes than a UK small-cap manager, such as his favoured small-cap fund Franklin UK Smaller Companies. “We think Richard Bullas, who runs the Franklin UK Smaller Companies fund, is a very good manager but he is likely to struggle in a scenario of the FTSE 100 generating strong performance, so in essence you might be using great managers but you are getting the wrong exposure,” he says. “The point is that once you put together the ideas of where you want to go, it strongly indicates what sort of factors you want in the portfolio and the appropriate managers.”
Risk/return of Schroder MM Diversity range over 5yrs
Source: FE Analytics
Performance of Schroder MM Diversity under Marcus Brookes and Robin McDonald
Adam Lewis, FE Professional contributor
FE Professional contributor
“How did we make 9 per cent last year? It was not by having zero risk in the portfolio. We had the BlackRock Gold & General fund, which was up over 85 per cent in 2016, while we started buying back into value funds over the last year.” The question Brookes says he gets asked most by clients is when will he put the cash back to work? “It would be one of two things,” he answers. “Firstly, it would be that it turns out we are wrong and the growth profile we thought we were seeing in the global economy turns out to be incorrect. In this instance, with inflation falling back to zero, a bond yielding 1.2 per cent suddenly looks good value and we would buy the life out of them.
The sectors to have seen the largest number of funds with the biggest drop in research are the IA Mixed Investment 20%-60% Equity and IA UK All Companies sectors, with four funds from each making it onto the list. Within the IA UK All Companies sector, well-known names such as Neptune UK Mid Cap, AXA Framlington UK Select Opportunities and Invesco Perpetual High Income have all taken a hit. This could be due to an overall bearishness on UK stocks caused by ongoing Brexit negotiations and the plummet of sterling. However, the fund to see the second-largest fall in adviser interest is Henderson UK Property, which was one of several open-ended UK property funds to suspend trading immediately after the EU referendum in a bid to protect investors from mass outflows.
Vanguard LifeStrategy 100% Equity, the highest risk offering in the five-strong range, came fifth on the list for its jump in adviser research activity. Active funds have come under fire over recent months, as last year’s sudden market rotation caught many managers off-guard and led them to outperform their rallying benchmarks. That said, the fund to have seen the biggest jump in adviser research during Q1 this year is Threadneedle Global Equity Income, which has gone from from 0.14 per cent of the total to 0.19 per cent. The £1.9bn fund has been headed up by former deputy manager Jonathan Crown since the start of the year following the passing of Stephen Thornber, who had run the strategy since its launch in 2007. The fund aims to achieve a growing level of income through valuation anomalies, which may have been caused by a change in management or M&A activity. The manager also looks for stocks with a growth in dividend of at least 5 per cent as well as a forward yield of at least 3 per cent. The dividend must also have a minimum cover of 1.25 times. As such, if an investor had placed £10,000 into the fund five years ago, they would have received £2,369.89 in income alone. The fund has also outperformed its average peer by 10.02 percentage points in terms of its total return over the same time frame with gains of 85.81 per cent. Other global equity funds benefitted from an uptick in interest include Old Mutual Global Equity and Fundsmith Equity (which was already one of the most popular in the Investment Assocation universe). Just outside the top 25 are the likes of First State Global Listed Infrastructure and Fidelity Global Dividend. At the opposite end of the spectrum, the behemoth Standard Life GARS fund – which was by far and away the most-researched fund of 2016 – has fallen into third place in terms of overall adviser research and has therefore suffered from the biggest fall in interest during Q1 this year. While it accounted for 0.4 per cent of adviser traffic last year, it captured only 0.3 per cent this year. That said, it is still one of the most heavily viewed funds on FE Analytics given its presence in the portfolios of many investors. The struggles that the £25.1bn fund have faced have been well-documented over the last few months. While its aim is to achieve a positive return in all market conditions over rolling three-year periods, it experienced heightened levels of volatility in 2016 which led many industry commentators becoming wary of the fund. In 2016, it lost 2.68 per cent. GARS isn’t the only fund within the IA Targeted Absolute Return sector to have struggled during 2016, though. At the year’s end, the four worst-performing funds within the entire Investment Association universe reside in the sector and, out of the 10 worst-performers, seven of them were targeted absolute return funds. That said, GARS is the only fund on the list of 25 funds to have seen the biggest losses in its share of adviser research during Q1 2017 compared to last year.
The funds seeing the biggest proportionate falls in research activity
The funds seeing the biggest increase in adviser interest this year
Vanguard’s LifeStrategy range, Liontrust Special Situations and Threadneedle Global Equity Income are some of the funds that saw the biggest jumps in adviser interest during the opening quarter of 2017, analysis of research behaviour on FE Analytics suggests. In contrast, the behemoth Standard Life Investments Global Absolute Return Strategies fund has seen the biggest fall in adviser interest, followed by Henderson UK Property, M&G Corporate Bond and AXA Framlington UK Select Opportunities. Using the FE Analytics Market Intel Tool, we looked at how many times each fund in the Investment Association universe had been researched in 2016 and worked out what share of the total research activity each accounted for. These percentages seem small, but that is to be expected given the huge number of open-ended funds within the Investment Association universe. We then repeated this for the first three months of 2017 and saw which funds had seen the biggest proportionate increase in interest from professional investors. The below table shows the 25 funds that account for more than 0.1 per cent of total research activity and have seen the biggest jumps in research.
Lauren Mason, senior reporter at FE Trustnet
This is likely to be the result of last year’s aggressive market rotation from quality growth into value, which was triggered by the election of Trump as US president and his promise of reflationary policies. That said, second and third place have been taken by passive funds that reside in the IA Mixed Investment 40%-85% Shares sector – Vanguard LifeStrategy 60% Equity and Vanguard LifeStrategy 80% Equity. Neither fund has an explicit volatility target but stick to their pre-determined asset allocation balance. As such, there is no tactical asset allocation overlay to the funds, which are constructed using entirely from Vanguard’s passive investment vehicles. Both funds have posted top quartile total returns over the three- and five-year periods to the end of March. Since launch in June 2011, both funds (as well as the other options in the LifeStrategy range) have proven very popular with professional investors. This seems to be continuing unabated, with Vanguard LifeStrategy 60% Equity jumping from 0.15 to 0.19 per cent of total adviser research and Vanguard LifeStrategy 80% Equity moving from 0.11 to 0.15 per cent.
Source: FE Analytics, bid to bid total return in sterling between 1 Apr 2016 and 31 Mar 2017
Performance of Liontrust Special Situations vs sector and index over 1yr
The £3.1bn fund, which is headed up by Marcus Langlands Pearse and Ainslie McLennan, lost 3.1 per cent over the last year to the end of March, while its average peer returned 6.81 per cent. Given the headwinds that property funds have faced over the last year, it is perhaps unsurprising that M&G Property Portfolio and Aviva Investors Property Trust have also made it onto the list on those giving up research share. Heightened expectations for inflation could have also led to fixed income funds such as M&G Corporate Bond, Fidelity Moneybuilder Income and Invesco Perpetual Corporate Bond making it onto the list.
The funds seeing the biggest proportionate increases in research activity
What’s been catching your eye?
It’s worth noting that the Liontrust offering isn’t the only special situations or recovery fund to have made it onto the list of top 25; it also includes the likes of Jupiter UK Special Situations, Man GLG Japan Core Alpha and Fidelity American Special Situations.
The only fund to have made it onto the list for last year and 2017’s most researched funds is Liontrust Special Situations, which has seen the fourth-largest leap out of every fund on the list in terms of its interest from 2016 to Q1 2017. While FE Alpha Manager duo Anthony Cross and Julian Fosh’s fund accounted for 0.22 per cent of adviser interest across 2016, this grew to more than 0.25 per cent during Q1 this year. The fund, which adopts the managers’ Economic Advantage stock selection process to identify market leaders that are undervalued, achieved a second-decile total return of 24.15 per cent over the 52 weeks to the end of March, outperforming the rallying FTSE All Share index and beating its average peer by more than 5 percentage points.
FE Professional finds out which Investment Association funds benefitted from the largest upticks in adviser research at the start of the new year.
Why are historical portfolios so important to your research and reporting?
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FE Analytics offers the ability to show real and potential changes to portfolios, but how can advisers make use of this to demonstrate their value to clients?
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Why does having an extended history for a portfolio matter so much?
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We have made enhancements to the portfolio builder in terms of how charges are applied to a portfolio. When setting up a historic portfolio, it is now possible to apply different additional charges to different time periods of the portfolio. For example, when clean share classes have been introduced to the portfolio replacing the pre-RDR share classes, the performance of the portfolio can then reflect the true change to the portfolio, taking everything into account. This can enhance how you use the chart above too. You can show that line C was a portfolio made of pre-RDR share classes with higher fees. Compared to the current portfolio of clean share class funds, lower fund charges and better performance, leading to point B.
Historical portfolios allow real and/or hypothetical changes to a portfolio to be tracked. Allowing you to make quick changes to fund switches or adapting weightings will keep your portfolio as up to date as possible and mean more accurate research and reporting.
Having definite points in time where you know exactly what the holdings were and appropriate weightings lets you research and report far more accurately on any individual portfolio. At the present time, the Portfolio Comparison Report and the Custom Portfolio Report Builder only reports on the current holdings. Once you have created tabs containing historical data for a portfolio have been entered, the ‘Current’ tab will show the portfolio drift since the last date tab. However, it is still important that the entire history of the portfolio is considered when looking at data over longer time scales. For more information on the historical changes within a portfolio we also provide a ‘Historical Holdings Summary Report’.
FE Analytics Masterclass
Showing the benefits of active management and the results of your hard work compared to a client’s pre-existing investments can be a very powerful tool. If you have historical data, you can input it into a portfolio and this allows you to explain to the client using clear visuals exactly how much better off they are, or how recent economic or lifestyles events may have affected their investments. To plot the chosen portfolio on a performance line chart, select ‘Chart Options’ to choose specific data from periods/ times of change within that portfolio. Using the example below, it is possible to see that if the change in 2013 had not been made, then the portfolio would now be at point B. Results show that when conducting robust research and efficient maintenance of the portfolio, the client has benefited from the fund switching/rebalancing to gain even better performance.
Turn historical portfolios into a powerful tool for showcasing your hard work
Following active managers' poor recent showing, FE Invest’s Charles Younes attempts to find out if they have a greater chance of outperformance in certain equity sectors.
The first observation we could make is that, despite being (very) difficult, it is possible to find few active managers who have proven their active skills over time. This is especially the case for UK equity managers, either listed in the IA UK All Companies or IA UK Equity Income sectors. One-fifth of these managers have generated excess return by taking active risk, although half of the active risk was rewarded with relative excess performance over the last five years (information ratio of 0.5). Please note that their performance has significantly deteriorated over the last year, as most expected a ‘Remain’ vote last year. One investor could also interpret those numbers by stating that an active manager is only worth the active risk for a short investment horizon, such as six months or one year. Indeed, the information ratio tends to be higher over shorter periods. Nevertheless, this would expose investors to the timing risk. Across the study we further observed that the active funds which performed well over the last six months or one year were very different to the ones outperforming over the last three or five years. The market rotation toward value in 2016 was probably one of the predominant drivers for these differences. With that in mind, it also suggests genuine investors that are confident in getting the timing right as well as having a strong understanding of the underlying strategies could invest in an active fund for such short periods. There is also further evidence to suggest investing an active manager for a period of five years, instead of the typical three-year investment period, is more worthwhile. To this, I am an advocate. A five-year investment period better corresponds to an entire business cycle. The above number shows that information ratio significantly improves over five years while it would appear almost impossible for skilled active managers to outperform over 10 years. These results also assume that the investor can pick these skilled active managers. In the case of UK equity income, it means you have one chance out of five to pick a skilled active manager who will be able to generate an information ratio above 0.5 over five years. For the global equity manager, this number decreases to one chance out of 10. Following those types of odds, I thought it would be more pragmatic to look at the numbers for an average equity manager, as measured by their sector average.
% of funds with information ratio >0.50
What has become known as the active-passive debate is now a foundational discussion posing an existential threat to some within the investment industry.
Source: FE Analytics
Using a three- or five-year investment period, these numbers once again show the superiority of the active UK equity manager. A random selection of any equity manager could still yield an investor excess return to the FTSE All Share index. This is especially the case for UK equity income managers – which have a higher weighting of the most talented managers in the country. Martin Cholwill, Richard Colwell or Gervais Williams to name a few.
Source: FE Analytics
Source: FE Analytics
Let’s highlight the sectors to avoid. The bad reputation of US equity manager is once again justified. We have not been able to identify an active fund with an information ratio higher than 0.5 relative to the S&P 500 index. Unsurprisingly it is also the sector where an average active manager will return you less than the benchmark despite taking active risks. We also must highlight the IA Global and IA Global Equity Income sectors. Although we have managed to find few skilled active managers, it looks like it is more crucial to be very selective. The average manager, as measured by the IA Global and IA Global Income sector, has significantly underperformed the MSCI World index over different time periods. In addition to the stock picking and industry risks, active global manager must also understand the country/geographical risk. It looks like this active risk is much harder to manage, which might explain their underperformance. But this study on information ratio suggests that we should not be down-heartened in active management. Like absolute return managers, it is possible to pick a skilled equity manager who adds return in excess of the active risk. It is clear UK equity investors have a good chance of selecting a genuinely skilled active manager over a business cycle. Even with a lack in selection skills, it also looks like that an average manager should be able to positive relative return. That said, we are more concerned for US equity investors.
It raises fundamental questions of what is to be expected of asset managers. Should they be using their superior skill to outperform the market or should they accept the more modest role of simply tracking indices? The presiding argument for investing in index trackers and passive exchange-traded funds is simple: they tend to cost less and perform better than their active counterparts. On the contrary, active managers would highlight times of outperformance in varying periods, with regular reference to market collapses and the benefit gained through not holding all the components of the index. I decided to enter the debate and crunched numbers for equity managers. I believe the information ratio is the most useful metric to look at when analysing the capacity of active managers to outperform the benchmark as it is a versatile and useful risk-adjusted measure of actively managed fund performance. It assesses the degree to which an active manager uses skill and knowledge (as measured by its tracking error) to enhance the fund returns. It is calculated by deducting the returns of the fund’s benchmark by the fund’s overall returns. This result is then divided by the fund’s tracking error, which is a measure of the volatility of the fund’s excess returns. The value that is arrived is an expression of, for each unit of extra risk assumed, the success of the manager’s decisions (‘tilts’) away from the benchmark. The higher the information ratio, the better. It is generally considered that a figure of 0.5 reflects a good performance, 0.75 very good and 1 outstanding. I also took into consideration the investment period as the length of holding an active fund could vary between managers. The first two tables summarise my findings.
Active management: Where to place your hope?
FE Invest research manager
% of funds with information ratio >0.75
Information ratio for average fund
Brewin Dolphin's balanced portfolio asset allocation
Brewin Dolphin’s Managed Portfolio Service (MPS) comprises five portfolios – cautious, income, balanced, growth and global equity – and spans Distribution Technology’s risk profiles three through to seven. Launched in August 2008, all five of the portfolios have outperformed their respective benchmarks since inception. In the case of the firm’s balanced portfolio – which sits in the middle of the range with a risk profile of five – the total return has been 64.21 per cent over the past five years compared with a 61.49 per cent gain in the FTSE WMA Stock Market Balanced index.
Gutteridge points out that JPM US Equity Income is long sectors such as financials and energy, which are expected to benefit from new US president Donald Trump’s deregulation plans. However, he is keen to stress that the team is not looking to make “some big clever Trump trade”; for example, it is not making any large US infrastructure plays as it expects the market to be disappointed by the impact of a Trump presidency here. Brewin Dolphin is also running an overweight to emerging markets, which account for 2 per cent of the balanced portfolio. “Emerging markets are a small allocation to our benchmark, so our overweight may be scoffed at by everyday investors. We have a modest overweight to a very small allocation in the benchmark,” Gutteridge says.
Global asset allocators remain wary of sterling and the February edition of the Bank of America Merrill Lynch Global Fund Managers Survey showed that the pound was the most underweighted of the mainstream assets. Many expect the pound to fall further as Brexit negotiations start and Europe presents a strong front to the UK, but Gutteridge is more sanguine. “We think that risk is so well understood that, based on valuations and the UK economy doing okay, sterling is quite well supported and might do a bit better than most fear,” he says. “We don’t hang our hats on our currency calls and our process is about incremental moves, but we are leaning into the view that sterling could perform well from here.”
“We recognise the value trade that is going on at the moment, which means that the consumer plays used by the likes of Stewart Investors and Fidelity are underperforming on a relative basis but these are the longer-term positions that we want to take in emerging markets.” The Asian and emerging market equity funds being used in the portfolio include Newton Asian Income and Fidelity Emerging Markets, both of which have established strong reputations. Another area where the team has a sizeable allocation is to absolute return funds, which have a 9.7 per cent weighting in the balanced portfolio. “Absolute return is one of the hardest sectors when it comes to finding managers or teams that have the skills to deliver what we require: a low correlation to the other asset classes,” Hood says. “Finding funds in that space that do something different and complement each other nicely is quite a difficult task.” He highlights the Aviva Investors Multi Strategy Target Income fund as a core holding of the portfolio. The £2.4bn fund is seen as one of the closest rivals of the popular Standard Life Investments Global Absolute Return Strategies fund, following its launch in December 2014. Suggesting absolute return strategies that sit well alongside Aviva Investors Multi Strategy Target Income, Hood points out that the balanced portfolio also holds Old Mutual Global Equity Absolute Return and JPM Global Macro Opportunities while offerings such as Henderson UK Absolute Return are used in the team’s other portfolios This allocation to absolute return fits in with the generally cautious outlook being taken by the team behind the Brewin Dolphin Managed Portfolio Service, which is blended with a pragmatic view of the global economy’s health. “It’s probably healthy to be permanently anxious as clients would prefer us to be cautious. I’ve been at the company for around 13 years and I can never recall a time when everyone was saying ‘this is an easy period to be investing’,” Gutteridge says. “Nevertheless, there is a level of anxiety in the asset allocation committee that has made us retrench a little closer to benchmarks than where we were two years ago. We made a move away from equities and into absolute return products, trying to dampen volatility. “But clearly equities have been very strong and we’re still overweight them. We see the economy being in reasonable shape, global inflationary pressures being relatively muted and the US tightening monetary policy modestly – and that leaves equities in an okay position.”
Balanced portfolio's top 10 holdings as 31 Dec 2017
Far from chaining investors to a single index, passive investments can be combined in a plethora of ways to deliver tailored exposure to markets and risk assets at a much lower cost than actively managed funds, the team behind the Charles Stanley Dynamic Passive portfolios says. Charles Stanley caters for clients with varying risk appetites through the six products in its Dynamic Passive model portfolio range, with Dynamic Passive 1 being the lowest risk offering and Dynamic Passive 6 the highest. The products use index-tracking investments to offer risk-tailored portfolios at a competitive cost. Jane Bransgrove, director and portfolio fund manager on the range, says: “The models are designed to use passives to implement whatever our asset allocation strategy is. “The attraction compared to using active funds is that the underlying ongoing charges are less and that’s going to be something that is more visible.” Launched in September 2012, all six products have beaten their various Libor plus targets since inception. The firm’s Dynamic Passive 4 model, which can be seen as its most balanced portfolio, returned 54.30 per cent between launch and the end of March 2017, versus a return of 3.7 per cent from its target of Libor times 1.75.
Source: Charles Stanley, as at 31 March 2017
Asset allocation of Charles Stanley Dynamic Passive 4
FE Professional finds out how the team at Charles Stanley expresses its active allocation through passive strategies.
Performance of Brewin Dolphin balanced portfolio vs index over 5yrs
“As we’ve got a very broad UK index obviously we’re getting both large and mid-cap companies in there, so we have a higher weighting to mid-cap where we want to have a more domestic and smaller company bias than the FTSE 100.” Part of the rationale behind this, other than the domestic focus, is to limit the portfolio’s exposure to certain sectors, including mining, oil and financials, which have a higher weighting in the FTSE 100 than they do in the FTSE 250. “You get higher weighting to things like commodities when you are tracking the main index,” Aldous says. “So that is an area where we can try and adjust our sector exposure. That’s probably the area where there is the most variety in terms of types of tracker.” While there are options to do this in other countries, so far the fund has only taken UK mid-cap exposure, but that does not mean that it does not make active decisions on other areas as well. The US is the highest allocation in the Dynamic Passive 4 portfolio, but the management team are currently in discussions as to whether to reduce its exposure to the world’s biggest economy. “We are still overweight but it is something we will look at,” Bransgrove says.
Aldous adds: “The US investment case may well be drawing nearer a close but the underlying economic data from the US was strong last year regardless of the Trump election. “We saw earnings growth in the US but around the world there’s a real growth recovery going on in virtually all the major investment areas. “That was one driver but the Trump reflation factor was very positive. We got into that very early and had a more positive view on Trump than perhaps the rest of the world did. We felt it would be good for the markets.”
“On a fund basis we have been rewarded, over the long term, by being overweight to medium-sized UK companies. Clearly this has been a headwind since the EU referendum, but running the position post the sharp sell-off is so far proving the right strategy.” When it comes to current positioning, Gutteridge notes that the team is less bearish on sterling than many other investors and is positioned accordingly. The pound is down by close to 20 per cent against the dollar over two years, with sharp falls being seen after the UK voted to leave the EU – but it had been declining prior to this.
“The UK funds we use have a mid-cap leaning. we’re overweight the FTSE 250 and we also have UK smaller companies funds in there, so there is a degree of gearing into the UK economy,” Gutteridge says. “They have not been a good Brexit trade; certainly in the days following the referendum it was clear that the right thing would have been to have been out of them on 22 June. But as it was we were in them and the right thing to do then was not to sell them but to persist with that trade.” The most meaningful geographical allocation taken by Brewin Dolphin is its overweight to US equities. In the balanced portfolio, there is a 19.5 per cent weighting to the US – an overweight of around 2 percentage points – and it is largely this position that makes the portfolio overweight equities as an asset class.The balanced portfolio’s largest individual fund weighting is to the Vanguard US Equity Index, an index-tracking product. The team is happy taking exposure to the growth businesses that dominate the US index, rather than rotating into value. “If you think about the style rotation at the moment – value, energy, financials catching a bid and growth being left behind – then being in a US value fund means you’re betting against companies like Facebook, Amazon, Apple, Google and Microsoft. That’s something we’re less comfortable with and we arrived at the view that a tracker isn’t a bad investment proposition,” Gutteridge says.
Source: Charles Stanley, as at 31 March 2017
The top 10 holdings of Charles Stanley Dynamic Passive 4
Source: FE Transmission, bid to bid total return in sterling over 5yrs to 31 Mar 2017
“We are more constructive on emerging markets now. We’d been underweight for a very long time – throughout 2013, 2014 and 2015 – but in 2016 we narrowed that to neutral and then eventually moved to a modest overweight when it was validated. “At this juncture, we still dislike the emerging market index as it is dominated by stated-owned businesses – Chinese banks, Gazprom, Petrobras – and we don’t want our emerging market exposure to be dominated by those kind of companies.
On this basis, the Brewin Dolphin team thinks UK equities – where it holds a longstanding neutral allocation of 35 per cent in the balanced portfolio – are “reasonably well placed”.
Performance of sterling vs the US dollar over 2yrs
While passive investing is seen by some as not giving investors the scope to take active positions, Aldous says the portfolios can still make sizeable asset allocation decisions. The first and most obvious area is in the UK, where the Dynamic Passive 4 portfolio has exposure to a UK mid-cap tracker. Bransgrove says: “This is an area where we have got some variety in terms of exposure to companies that are either domestically or internationally focused. Although the exposure to mid-cap is less than 2 per cent across the models it does allow us to try to tilt the UK equity component.
Charles Stanley Dynamic Passive 4 vs benchmark over 5yrs
Christopher Aldous, managing director, says: “How we derive our asset allocation and portfolio construction is through an optimisation process based on the Black-Litterman process. That will throw out raw scores based on volatility and a mixture of historic and forward-looking returns.” The Black-Litterman process is a model that takes the equilibrium asset allocation of the market and applies investor views (in this case risk appetite) to rebalance the portfolios accordingly. “That provides the basic top-down allocation into equities, bonds, alternatives and property but then regions and thematic plays are allocated by the investment team,” Aldous explains.
The management team is using two index trackers to exposure here – Fidelity Index US (12 per cent) and BlackRock US Equity Tracker (6 per cent), which track the S&P 500 and the FTSE USA indices respectively. While the top end of each tracker will be relatively similar, the FTSE USA consists of 620 stocks while the S&P 500, as the name suggests only has 500. Understanding the differences between their composition allows the team to make an active call on the exposure reflected in its portfolios. Another area the team is taking an active allocation view is in Asia, where Dynamic Passive 4 has a 12 per cent weighting (not including separate emerging market allocation). “We are conscious that Trump might not help the region but we think they are better positioned than they have been in previous years when there have been concerns that the region might not be as strong,” Bransgrove says. “They’ve had a number of reforms that have helped them cope with anything that is coming out globally. We get our exposure through an index that is both in Pacific and in Asia so it has some developed elements in it including Australia.” However, the index does not have a high weighting to China compared to, for example, certain ETF offerings. “The Pacific index doesn’t have as much exposure to China as some of the ETFs available but there is some in there,” Bransgrove says. “Without knowing how that is going to play out, we are happy that the country is managing its way through transforming its economy. Although the growth numbers might not be as good as people think, Chinese growth is not going to collapse and is still good relative to other emerging economies. “Where you’ve got regional index trackers it is important to look at the underlying exposures because there are quite a lot of different indices in Asia and Pacific so you are getting different exposures. We are conscious of where we are investing so it will be influenced by our calls on particular countries.” In this case, the indices chosen have a lower weighting to the countries that the managers are tentative on, such as China and Australia, though they cannot completely rule out the regions. Where the team looks to gain diversification is through alternative assets, with an 8 per cent weighting to L&G Global Real Estate Dividend Index in Dynamic Passive 4. “Global property we see as an alternative bucket so though it is obviously a growth asset it gives us a bit of diversification,” the portfolio manager says. “The underlying holdings are still securities so it fits somewhere between physical property and ordinary equities. In terms of how it performs compared to the property cycle it tends to react quicker than the global real estate.” However, like with the US the team is currently reviewing its position as interest rates in the US begin to rise and the expectation is that the European and UK central banks have stopped their aggressive cutting. “We’re conscious with things like property and their attraction on a yield basis they can be impacted by what’s happening with rates so we have one eye on that as well when we’re investing in them.”
also managed to close out our underweight to emerging markets in early 2016. Relative to peers we also appear to have a greater gilt weighting and have taken our Japanese equity weighting on an unhedged basis, benefitting from the appreciating currency in 2016,” Gutteridge explains.
Hood says: “The UK position was pretty in line with the benchmark going into Brexit and it hasn’t changed since. The view the asset allocation committee has held throughout is that the FTSE All Share derives a lot of its revenues from overseas and benefits from sterling weakness almost as much as a lot of the overseas indices.” Gutteridge adds that the team’s conversations tend to be more about whether to add to UK funds rather than if they should be cut. This is because if a weaker sterling meant that more international exposure was appropriate, then the expectation of a stronger pound means greater UK exposure might be warranted. UK equity funds held in Brewin Dolphin’s balanced portfolio include Threadneedle UK Equity Income, Investec UK Special Situations, CF Woodford Equity Income, Liontrust Special Situations and Old Mutual UK Smaller Companies, while some passive exposure is taken through Fidelity Index UK.
Ben Gutteridge, head of fund research at Brewin Dolphin, and research analyst David Hood say this outperformance has been driven by a combination of asset allocation and fund selection. “Within asset allocation we have had a longstanding overweight to the US, which has been a powerful tailwind. We
Jonathan Jones, reporter at FE Trustnet
“It’s not just about it being cheaper, it’s about us being okay with that being a core holding in expressing our US view. Where we are rich in alpha we will go for it more aggressively; where alpha is less achievable, we’ll move towards passive.” While the US has been a notoriously difficult market for active managers to perform in, Brewin Dolphin does not only use passives for exposure here. Some 6.5 per cent of the balanced portfolio, for example, is in Clare Hart and Jonathan Simon’s £3.9bn JPM US Equity Income fund. “We’re very happy to have a large passive exposure in the US but in some mandates it’s useful to have an income-focused fund for the US,” Hood says. “The US is not the biggest dividend-producing region as there are tax incentives for firms to do buybacks over dividends. But where we are looking to fulfill an income mandate we go for a more income-focused fund like JPM US Equity Income.”
Going passive to be active
Head of investment research and advisory services at The Share Centre
The recent completion and upgraded expansion of the Panama Canal in 2016 is estimated to have cost in the region of $5.25bn, allowing it to significantly increase the size and number of vessels it could accept thereby saving time and money on journeys. Closer to home, the UK is currently gripped with two enormously expensive projects, namely HS2 (projected cost of circa £55bn) and Hinckley Point C (projected cost of circa £18bn). The impact environmentally from both of these and whether they truly offer value for money and a strategic benefit will continue to debated long and hard, but that’s for another day! But globally, infrastructure spending is pivotal and Oxford Economics recently presented research forecasting that worldwide infrastructure spending by 2025 will stand at $9trn, up considerably from $4trn in 2012. Economies need reliable infrastructure to help get goods and services to market and this means there will continue to be development and maintenance of efficient strategic assets like road, rail, sea ports, gas, electric and water utilities over the next few years. In countries like China and India this will result in new facilities whereas in the US and Europe it is likely that current facilities will be upgraded, ultimately improving their efficiency. Infrastructure spending drives a country’s economic growth and provides jobs. Companies involved in infrastructure development are naturally seen as being defensive and mature, providing reasonable levels of dividends and dividend growth, with many having inflation-linked pricing built into their models and services. This is further aided by high barriers to entry, strong pricing power, sustainable growth and predictable cash flows, making the asset class a relatively safe haven in an uncertain financial world. With such strong characteristics, infrastructure stocks are often referred to as bond proxies, seen as protecting capital to provide a stable income while minimising volatility relative to the wider equity market. Sector experts point out that what the reference to bond proxies ignores is the potential for many infrastructure stocks to grow their asset base, cash flows and dividends, and the resulting fact that this growth accelerates alongside the GDP of the underlying economy. Put simply, infrastructure assets are an essential component of GDP growth. A portfolio of infrastructure stocks selected for exposure to attractive geographies and sectors provides all the positive attributes of bond returns – visibility, stability and duration – but with the addition of cash flow and potential dividend growth. This is where the return profile deviates when compared to conventional bonds, where the coupon remains fixed for the life of the investment. Whilst from an equity perspective, infrastructure investments generally have lower volatility than other sectors in the equity market. With such high barriers to entry, companies are likely to monopolise the service or operations they provide with the added benefit of strong regulation, governmental oversight and the likelihood of some inflation protection through pricing power. In addition, they are normally disciplined in their capital management and take a responsible approach to stakeholders/shareholders. The majority of Western developed economies have significantly underinvested in their infrastructure over a number of decades whereas developing economies continue to invest significantly. In addition, investing in infrastructure has seen its profile raised in recent times given the political imperative to support and facilitate economic growth, particularly in developed economies where capital expenditure as a share of GDP has fallen and where we have over indulged in share-buybacks. With such a broad variety of infrastructure companies returning a reliable yield of between 3 and 4 per cent per annum over the years, those investors seeking a reliable income return (albeit not guaranteed) have generally been well rewarded for taking equity risk. With demand in infrastructure investment only likely to accelerate, investors are beginning to see the emergence of a number of new exciting investment opportunities. Andy Parsons is head of investment research and advisory services at The Share Centre and a member of the FE Adviser Fund Index panel.
The Share Centre’s Andy Parsons explains why infrastructure investments can offer stable income while minimising volatility - without some of the less desirable properties of bonds
It’s at the very heart of everything we do and use, but for many it stirs up emotion, anger and resentment at the slightest thought of idyllic landscapes being transformed as it evolves. And yet infrastructure is needed, whether that be road, rail, sea or utility projects; globally the population is expanding and our thirst for improved, updated and quicker facilities is only increasing. Projects don’t come cheap but costs and benefits can vary significantly.