Asset allocation: Santander’s Vaughan turns to absolute return funds

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Santander Asset Management fund manager Toby Vaughan has turned to absolute return funds amid concerns about government bond valuations.

Vaughan, who co-manages Santander’s five risk-targeted Atlas Portfolios alongside Tom Caddick, says the decision to allocate 15 per cent of the £218m Atlas Portfolio 4 to absolute return strategies was driven by weakness in the pricing of traditional defensive asset classes.

He says: “Because we are underweight fixed interest due to valuation issues, we don’t want to just be forced into raising our equity allocations. So we moved the portfolio more aggressively into low-risk absolute return strategies – these are regulated vehicles with daily liquidity and daily pricing.

“We have an allocation on the fund of 15 per cent to absolute return and we have held that for some time. We expect to continue to hold roughly that position over the coming quarters as well.

“Given the elevated volatility in traditional asset classes and the lack of yield in defensive asset classes, this is an attractive potential return profile.”

Another concern for Vaughan is the lack of a safe haven in government bond assets.

He says: “The risk is you don’t get the diversification benefits from developed market government bonds that you have had in the past because they are expensive.

“We saw this in August for the first time in a while. When risk assets were selling off materially you would normally expect to have some shelter from developed market bonds, but that didn’t necessarily happen in August. That is reflective of the environment we are in.”

The Atlas Portfolio 4 fund sits on the defensive end of the risk spectrum, with around 40 per cent of the portfolio held in equity investments and 60 per cent in lower-risk instruments and cash. The multi-asset fund of funds portfolio delivered returns of 5.69 per cent in the year to 30 June 2015, 28.64 per cent over three years and 43.79 per cent over five years.

Vaughan says the fund has been “generally overweight equities, but in a very small manner” over the past 12 months. In terms of geographic preferences, in January the fund manager shifted from being overweight US equities to an underweight position, and moved back into European equities.

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He says: “That was about the momentum of growth, the direction of the policy environment and relative valuations. We were not concerned about the US growth profile but we thought there was superior momentum in economic growth and corporate earnings growth in Europe.

“We were very aware the policy environment is more likely to be stimulative in Europe for some time, whereas in the US towards the end of the year we are talking about the removal of stimulus.”

Vaughan also managed to temper the negative impact of the recent China crisis by reducing the fund’s emerging markets equities exposure from 7 per cent to zero at the end of 2014.

“We also took away emerging market debt funds. Those decisions were more about the fundamentals than anything to do with valuation. It was just general concern about the macroeconomic outlook in the developing world and the impact of a China that was not just slowing but was restructuring as well.”

While asset allocation is usually managed based on the firm’s medium-term outlook, Vaughan says he has proactively reduced equity positions twice over the past 12 months. The manager reduced equity exposure by around 5 per cent at the height of the Greece crisis and by 3 per cent during the recent China sell-off.

Vaughan says: “Corrections can be quite savage over the short term, so sometimes we need to pursue a shorter-term risk management strategy.

“They are not changing the risk profile of the fund but it is being proactive during those more extreme circumstances.”