Asset allocation: Cornelian’s Kilpatrick derisks portfolio from equities

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Cornelian Asset Management chief investment officer Hector Kilpatrick is taking risk off the table by selling part of its equity and private equity allocations, on the belief fixed interest and short-dated treasuries will deliver better returns.

Over the last three months, Kilpatrick, who manages the £115m SVS Cornelian Growth fund, increased the allocation to fixed interest from 13.5 per cent to 21.7 per cent, as well adding to short-dated US treasuries.

He also increased the fund’s positioning in absolute return funds by adding the £220m Jupiter Absolute Return fund, now a top 10 holding at 3 per cent.

Kilpatrick says: “Companies’ price earnings ratios have increased over time and we feel that they are beginning to discount in the future.

“It is likely that we’ll get sub-trend growth going forward and therefore earnings growth is unlikely to accelerate from here, so we have decided to book some of the gains that we’ve had in equities and private equity.”

Kilpatrick decided to reduce part of the fund’s UK equity exposure by 3.5 per cent, now making 23.6 per cent of the fund’s allocation, as well as cutting international equity exposure – to the US and Japan – by 5 per cent.

He also completely sold down his 2.5 per cent private equity holdings.

“The valuations that private equity companies have used to mark their own investments look quite high, and we see a similar question mark over valuations in the listed market and that is why we’ve been taking good profits out of both asset classes.”

Despite reducing exposure to the UK and Japan he still favours the markets.

“In Japan companies earnings are up and growth has further to go,” he says.

Kilpatrick currently holds a 6.8 per cent asset allocation in Japan and 10 per cent in Europe, which has been a constant position that he’s not planning to increase.

However, one of the problems which remains in the West, he explains, is low productivity.

He says: “We need a boost in productivity going forward with companies investing for the benefit of their shareholders and the economy.”

On the emerging market side, he is underweight the region as the market has been underperforming in relative terms recently. In particular, he says the Chinese economy is “critically slowing down”.

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“The Chinese economy is becoming uncompetitive. If they want to start to generate significant exports then they have to go up the value chain or they have to devalue and we’ll be concerned in the medium-term: they might cut interest rates and devalue in which case that will produce a deflationary shock around their near neighbours and indeed in the West.”

But he thinks central authorities will help to manage Chinese bad debt. “We believe they have enough fire power to cover some of the local government financing vehicles which are going to go bad, so that might not be as disappointing as people suspect.”

Kilpatrick joined Cornelian from Scottish Value Management where he managed the SVM UK Alpha Fund. Prior to this, he spent over six years at Standard Life Investments as investment director, in the Continental European equities team.

The growth fund was launched 10 years ago but was then folded into the firm’s multi-asset range 5 years ago, which currently holds £375m.

Cornelian’s suite of funds, which is one of the longest-running in the fund market, has five funds ranging from “defensive” to “progressive” and is tiered to different risk bands.

The funds are housed within the IA Unclassified sector and are managed to sit below specified volatility limits. The funds are not constrained to any lower volatility limits, so the investment team can protect portfolios by derisking at any time.

Kilpatrick says: “Where we differ from our peers is that we don’t keep the fund within a risk band. What we say is that we will never exceed the upper risk limit for that client, but if we really don’t like the outlook for those risk assets going forward, we can derisk the portfolios substantially.

“For all of our clients we want to increase their real wealth over time, protecting and enhancing it and that is why we don’t like to have a lower risk limit to the funds.”