The Fidelity Multi Asset Income fund does not hold any property and instead favours a strong weighting to high-yield and infrastructure.
Allocation to property has been low across all Fidelity multi-asset funds in recent months, according to income fund co-manager Eugene Philalithis. The £94m fund can no longer invest in real estate investment trusts after guidance from HM Revenue & Customs prevented ‘interest-paying’ multi-asset funds from buying the tax-efficient vehicles. It can still buy funds of Reits-paying dividends.
“We feel the valuations in the Reit assets are very high and that has pushed yields down,” says Philalithis. “Values have been pushed up beyond fair value for the moment so we are avoiding that.”
Philalithis says the tax constraint does not affect his ability to acc-ess property yield. The portfolio remains completely free of property because of poor valuations and an aversion to open-ended direct property funds and the liquidity risks they pose.
“The liquidity of some of those vehicles and asset classes is not great so we’ve decided to stay away,” he says.
The fund has a long-running allocation to loans that have been offering wide spreads above Libor, despite the benchmark rate remaining low, he adds.
US loans yield about 350 to 400 basis points above Libor, while European debt is slightly higher.
Most of the fund’s loans are US-based, either directly or in funds investing in securitised loan instruments.
The fund also holds securitised real estate debt through the TwentyFour Income fund, which launched in March last year. The closed-ended fund holds relatively illiquid UK and European assets mostly for their income. It aims to pay a 6 per cent dividend each year with a total ann-ualised return of between 7 and 10 per cent.
Like the other loans on its books, the mainstay of the fund’s assets are floating rate, making interest rate risk non-existent.
“We’re focusing on shorter-duration loans and credit protection is better from loans than bonds [because they are higher up the credit hierarchy],” says Philalithis.
The fund is eyeing European loans because Fidelity’s analysis shows they have are more attractive relative to their US counterparts following a recent re-rating of the US loans.
“We’re still looking for the right vehicle for European loan exposure,” says Philalithis.
The European real estate debt market has developed a margin of safety because the securities are being offered below par on wide spreads. “You have a margin of safety as well as an attractive level of income and for us that’s a perfect opportunity,” he says.
Infrastructure has been bulked up slightly this year and is a strong source of income for the fund, making up a 7.2 per cent position.
High-yield is a large overweight, comprising 12.8 per cent of the fund, although that is down from the 19.9 per cent allocation 12 months ago.
The fund’s 23.3 per cent equities exposure is heavily skewed to UK equities, with almost 70 per cent allocated to the home market.
Alternatives make up just 0.3 per cent of the portfolio after being trimmed over the course of last year from 0.9 per cent. The allo-cation is to catastrophe risk insurance-linked securities. Premiums have fallen after a year of fewer natural disasters.
Philalithis says: “The risk reward for catastrophe has been far lower so we’ve been happy to dilute our risk and find returns elsewhere.”
The cornerstone of income from the portfolio is the 43.7 per cent holding in investment-grade bonds.
Again, rising interest rates are front of mind with duration kept fairly low.
“We have a target of about four to five years at the moment. We have a strategy that has worked well over the past couple of years, which is having short-dated instruments that are bar-belled out with longer duration,” he says.
“Longer-term bonds give the hedge in case of volatility because duration is the best way to offset credit risk 95 per cent of the time.”
The strategy will be reversed at some point because Philalithis expects short-dated bonds to come under pressure. The fund will then start to move into cash to combat such a scenario.
“In the environment last May, where yields rose aggressively on the back of taper talk in the US, we saw correlations rise across the asset classes. The only way to protect from that was cash.
“If we think we’re going into that environment again, we would up cash, but you woud also want to manage your long-term exposure through futures.
“We have to be quite nimble about that. We don’t have to sell; we have the ability to use derivatives to hedge our interest rate risk. So we can reduce the market exposure to certain things while still retaining the income.”
The seven-year-old Multi Asset Income fund is the longest-running of Fidelity’s multi-asset strategies and has grown steadily over the past two years, adding £70m.
Philalithis says: “We believe there is a strong demand for income from investors for a variety of reasons, whether for additional income or retirement money or as a substitute for deposit rates at banks.
“Given the traditional areas of income, such as government bonds, don’t offer it at the moment, if you want an attractive level of income you have to up your risk and many investors are not comfortable with that in a single-asset solution.”
About Fidelity Solutions
The Fidelity Solutions multi-asset business runs 18 retail funds. Baseline allocations are produced by Fidelity’s quantitative models while tactical moves are decided upon by an asset allocation committee run by asset allocation director Trevor Greetham. Individual fund managers determine the best way to access ideas. The Solutions division runs more than £39bn.