Leonard Charlton, manager of the Melchior Selected Trust European absolute return fund, has a reputation for identifying companies whose share prices are likely to fall. He has proved so adept at this during his career that colleagues have dubbed him the Master of Disaster. Despite being an unlikely moniker for a highly successful fund manager, it fits, especially given his current views.
Charlton is more concerned over the wider economic environment than at any time since launching the fund. French and German purchasing managers’ index figures, a key measure of economic health, are at levels last seen in November 2011, before the European Central Bank’s long-term refinancing option which provides cheap funding to banks. Unlike many fund managers and commentators, he does not believe the LTRO is a gamechanger, although banks would be in worse shape without it. Stockmarket volatility is therefore likely to continue for the next three years, in his view, as Europe’s problems are simply being kicked down the road.
With this fund, Charlton aims to deliver 5 per cent to 10 per cent growth per year regardless of stockmarket conditions. He wants the fund to be uncorrelated to stockmarkets, so whether they are going up, down or sideways the fund’s return should be indifferent. To achieve this, he can buy shares in the anticipation that prices will rise (long positions) or take short positions to benefit from falling prices. If Charlton sees more opportunities for share prices to rise, long positions will outnumber short positions and vice versa if he believes stockmarkets will fall. This means the overall portfolio will be described as net long or net short respectively.
At present, the fund is 4 per cent net short. This has been the wrong positioning so far in 2012 as the fund has been positioned for falling stockmarkets at a time when they have been rising. He is apologetic for the resulting poor performance but his conviction is unwavering – he sees economic problems ahead and believes markets have risen too far too fast.
Nevertheless, Charlton recognises the importance of being pragmatic. If China began to loosen monetary policy, reducing interest rates or increasing investment for example, to boost growth, or if the ECB started to print money to buy sovereign debt, it could signal a turning point for the global economy.
Either of these events could cause him to review his stance and bring the fund back to a neutral or long position.
The portfolio is fairly concentrated with just 53 holdings at present. Charlton aims to own quality businesses while shorting those he believes to be poor. Notable holdings include the advertising agency WPP and Aegis, the media and digital marketing firm. He believes both can benefit from increasing online spending by consumers.
He also likes BSkyB, which he suggests could win the next round of rights to broadcast English football at a favourable price. Another favoured position is Pirelli which has refocused itself from a big conglomerate encompassing telecoms, real estate, broadband and, most famous, the tyre division, to concentrate mainly on tyres. Despite record increases in the price of raw materials, Pirelli expanded profit margins in 2011 and is placing greater emphasis on its more profitable range of premium tyres.
This is a core holding designed to smooth out the volatility of stockmarkets for long-term investors. It is unlikely to perform in the same way as more traditional funds, lagging behind in stronger markets while providing some protection in weaker markets.
I believe Charlton’s robust process has been a key driver of the fund’s success since launch. It had a great 2011 and, despite the poor start to 2012, he remains convinced he can return the fund to profit this year. The only drawback is the performance fee levied in addition to the standard annual charges.
If you share the view that the European debt crisis is far from over, this fund could be worth considering as part of a defensive portfolio.
Ben Yearsley is an investment manager at Hargreaves Lansdown