Asset allocation: Why Henderson is selling down UK small and mid caps

Henderson multi-asset manager James de Bunsen has set out the three key areas for the UK Income and Growth portfolio as he maintains his support for Japan, moves into emerging market debt and sells out of UK mid and small caps in favour of large cap funds.

De Bunsen says the value of EMD, particularly dollar-based, is more attractive now despite dividing opinion and suffering a rotten 2013.

He says: “We have recently added some emerging market debt exposure to the portfolio; we had none until about a month ago. We think the market is looking more attractive on a valuation basis. When you look at the high-yield sector, it is at an all-time low in absolute terms.”

De Bunsen has a 2 per cent exposure to EMD through investment in the Absolute Insight Emerging Market Debt fund managed by Colm McDonagh. He says: “Essentially, Colm has an absolute return mandate so he does well when EM does well, but he manages very tightly and returned a flat performance last year.”

The Insight fund fell short of its IMA Targeted Return sector, losing 0.16 per cent compared with 6.26 per cent returns. But the average fund in the IMA Global Emerging Market Bond sector lost 9.42 per cent.

Small and mid cap trimmings

Another interesting change made by the multi-manager in the past month was a reduction in exposure to UK small and mid cap companies.

“We have trimmed our exposure to small and mid caps because we see valuations are becoming increasingly stretched. We think the performance cannot persist and if there is an increase or decrease in risk appetite, mid and small caps are looking a bit vulnerable.”

The move has led de Bunsen to increase his holdings in UK large cap funds despite underperformance in 2013. He has increased holdings in Veritas Global Equity, Artemis Income and Majedie Income.

Despite underperforming the IMA Global Equity Income sector by 10 per cent last year, in the first quarter of this year the £2.7bn Veritas portfolio has returned 9.37 per cent versus a sector average of 4.32 per cent.

De Bunsen says: “The last couple of years it has underperformed; the manager is quite contrarian and that is how he positioned it. The year to date it has performed incredibly well.”

The £6.5bn Artemis Income fund has outperformed the UK Equity Income sector over three years despite underperforming over three months, six months and one year.

The Henderson portfolio is overweight Japanese equities and the multi-manager team has recently made changes to the way it hedges its weightings in the sector. De Bunsen had hedged the weightings back into sterling when investing in Japan around 18 months ago but on the strong performance of the yen he has moved to an unhedged position.

“When you look at the performance of the yen recently against the dollar, it is pretty strong. We do not think the Bank of Japan is itching to change its quantitative easing programme so we do not think there is going to be another leg down in the yen. This is a tactical move so if we see signs things may change, we will go back to hedging it.

“It also acts as a volatility hedge because when risk sentiment falls, the yen tends to rise as people sell riskier assets and buy back the currency. We still like Japan. It is pretty volatile and the highest beta stockmarket in the world at the moment so it is a key overweight for us.”

The weak yields on Government and investment-grade bonds have been the drivers for the portfolio’s high cash position and overweight property holdings. The portfolio remains overweight in direct UK property holdings, largely through the Henderson UK Property Unit trust, a very stringently managed fund, according to de Bunsen.

“We invested about 15 months ago and the initial rationale was it had more attractive yields than Government or investment-grade bonds.

“Clearly, it is not fixed income and there are other risks but the Henderson fund is quite defensive and conservatively run. It is almost a zero void rate, investing in properties around the South-east of England without much exposure to high-street retail, which we think is still a bit impaired. We were getting an initial yield of 4.5 per cent so we think it’s sensible.

“The UK economy has done so well and surprised everyone. This is reflected in a stronger jobs market, which usually means a boost for property and renting.”

The high cash holding is a further indication of the lack of faith held in Government bonds. De Bunsen says: “We have more cash than maybe others do. We do not think Government bonds or investment-grade bonds are the diversifiers they used to be and the low yields mean they do not look attractive.

“Particularly on the back of tapering announcements, cash comes into its own as an asset class as well as a dry powder for buying other assets when they look like a good price.”

About the Henderson multi-asset range

The Henderson multi-asset range has six funds across absolute return, income and growth, managed, active and diversified.

The funds are run by a 13-person team led by head of multi-asset and deputy head of equities Bill McQuaker, who has been in the industry for 27 years. In January, Henderson appointed multi-asset director Paul O’Connor as co-head of its multi-asset team alongside McQuaker.

The range establishes investors’ individual attitudes to risk using Distribution Technology and assigns a risk profile between 1 and 10.

The Multi-Manager Active fund seeks capital growth by investing in both UK and overseas markets. The portfolio generally invests in equity funds but the managers look to give exposure to commodities, fixed income and other asset classes when appropriate.

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