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Cautionary notes

The rapid shift between asset classes and the trends within each has led to increased portfolio turnover levels in many funds but has also challenged asset allocators.

Funds in the IMA’s managed sectors are the most exposed to a wide range of asset classes and even the cautious managed, which has typically been populated with funds using a 60-40 equity/bond construction, have broadened out to include varying assets.

While there is always divergence in sector returns due to the style and ability of the individual managers, it can be more exacerbated in the managed sectors due to the broad range in the make up and design of these funds.

Within the cautious sector alone, where one-year returns range from -0.5 per cent to more than 50 per cent gains, there are funds with high-equity and low-bond weightings, the reverse of this, those with emerging market exposure and overseas bonds and those which stick to the domestic market. Many multi-manager products also reside in this sector.

Over the recent volatile market environment, many funds in the cautious managed sector have been criticised for its exposures to areas of the market considered to be high beta.

For instance, SVM recently reported its cautious managed fund is overweight emerging markets, with one of its favourite positions being JP Morgan Russian securities. Just a few years ago it would have been unheard of to see such a stance in a sector labelled “cautious”.

David Jane, manager of the M&G cautious multi-asset fund, also favours emerging market exposure at the moment and he does not believe its inclusion automatically adds risk. That is certainly reflected in his fund’s statistics. Over one year to January 31, the fund has a beta of 1.02 and its annualised volatility figure is 8.96 versus the cautious managed sector average of 8.19. Financial Express data shows the cautious fund as having experienced just three negative monthly periods out of the past 12 months, with its biggest drawdown being -3.98 per cent.

Jane said the use of multi-asset investing is more about trying to return what investors expect than using it to generate higher returns. Getting a broad spectrum of assets and being flexible in their allocation gives him a broader tool set to reach the outcome investors expect from a cautious portfolio.

It is not about the individual ingredients but the outcome and Jane noted the industry needs to become more focused on outcomes. “It is not about being clever, it is about delivering what clients want.”

Volatility can certainly exist in a fund in the cautious sector without any emerging market exposure. Despite its more plain vanilla approach in sticking with a bond/equity construction, New Star managed distribution has been beleaguered in recent years over its underperformance and volatility. Its three-year annualised volatility score exceeds 18.6, double that of the average fund in the sector.

But over the past 12 months, the fund has undergone a transformation, with regard to performance, if not necessarily in design. The fund is now the best performer in the sector over one year and its beta, while still high, has come down from an annualised three year score of 1.73 to a one-year figure of 1.60.

Trevor Green continues to manage the equity portion of the fund, which he has done since 2008, but the fixedinterest element moved to John Patullo and Jenna Barnard when New Star moved over to Hendersons last April.

Before the move, the fund was managed as two distinct segregated mandates but, under Henderson New Star, there is a more collaborative effort between the managers. “We work closely together to discuss whether we want to go down the credit route or equity. For example, recently, we discussed Standard Charter. I like the equity but after discussion with the bond side we decided to underweight the equity and overweight its corporate bond,” says Green.

Another change in the dynamic of the portfolio has been active use of derivatives. The funds’ managers recently took an 8 per cent short on gilts within the portfolio, marking the first time derivatives have been used in that manner in the fund.

While recent stock specific actions and a more cohesive management approach have aided performance, Green and Barnard attribute the turn round in returns to the positioning of the portfolio when it moved to Hendersons in April.

At that time, the decision was taken to continue to run with the beta that existed in the portfolio’s fixed-interest weights. With the market rally only just starting, the decision turned out to be largely beneficial as the very elements which had dragged down the fund, rebounded.

Since then, performance has been maintained through active allocation on the bond side. Green does not believe turnover levels have risen significantly on his side but Barnard said fixed-interest turnover has been high considering the rapidity of moves in the sector. The fixed-interest element of the New Star fund currently has a duration level of just two years, has a zero position in gilts and is light on quality investment grade corporates, which can act as gilt proxies.

Jane believes portfolio turnover within the managed space overall has been higher than is typical, upwards of 100 per cent in his own fund but he believes this has been necessary as it would have been impossible to do well over the past few years by simply standing still. Jane said his fund is unrecognisable today compared with where it stood a year ago as risks in the market have changed completely. Macro themes are less influential today and the market is more stock specific than it has been.

Cautious funds are certainly a popular fund choice in what has been a decidedly uncertain investment environment for UK clients. But advisers also warn that while clients like being cautious on the downside, they tend to complain when these funds lose out when markets are rising. But Jane points out that many forget from a maths’ point of view, a fund which has restricted losses on the downside does not have to gain as much on the upside. “Capital preservation is key – participation in a bull market is a much easier skill,” he says.

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