In the Cazenove seven-strong multi-manager range, the near £1bn Multi-Manager Diversity fund is the flagship and co-manager Robin McDonald highlights the benefits of its three-way split between equities, bonds and alternatives.
While McDonald and co-manager Marcus Brookes broadly maintain this positioning, the pair has flexibility to go 5 per cent underweight in both the equity and alternative buckets and be more aggressive when negative on bonds, as they are at present.
McDonald says: “If you look at a typical cautious managed fund, the allocation is 50 per cent equities and 50 per cent bonds and if the manager is negative on government debt for example, most of the fixed income will be in credit.
“With credit, particularly high yield, the correlation with equities is higher so you end up with a portfolio offering little in the way of risk diversification. In contrast, our approach allows us to buy the equities and bonds we want while the alternatives bucket provides a source of uncorrelated returns.”
McDonald said a central part of the process is not being skewed too far towards asset classes at the top or bottom of markets, with the managers seeking sensible allocations that reward risk taking.
“Unlike many peers, we are willing to buy out of favour areas, adding European equity exposure in the fourth quarter of 2011 and again mid- last year and Japanese equities throughout 2012. Our strategy also means we tend to get out of high-risk, expensive situations, whether nominally high-risk such as banks in 2008 or nominally low-risk such as corporate bonds today.”
According to the pair, corporate bonds are currently as expensive as they have ever been in absolute yield terms.
McDonald highlights a recent issue from B-rated private hospital company Tenet, with seven-year paper yielding 4.5 per cent.
He says: “With inflation around 2 per cent, that means a maximum upside of 2 per cent a year in real terms with 100 per cent downside risk, which is not particularly attractive for a bond in junk territory.”
With this view in mind, the team is underweight on fixed income on Multi-Manager Diversity at just 19 per cent, spread across more dynamic bond funds with a short duration bias.
“In aggregate, we have looked to avoid interest rate risk and while we have credit exposure, most cautious managed peers will have more than twice as much in bonds.
“We were last at our full fixed income exposure at the end of 2011, at which point we moved our conventionally defensive portfolio to a more aggressive stance and have trimmed bonds even since.”
This move out of bonds has contributed to a large cash position of the fund, approaching 24 per cent of assets, with more than half of that ‘borrowed’ from the model fixed income allocation.
McDonald and Brookes are also taking advantage of their scope to underweight the equity and alternative buckets, seeing markets as broadly expensive despite good opportunities.
McDonald says: “While several managers are cautious on markets, there are not that many bearish portfolios out there, particularly in the hedge fund world.
“Economic fundamentals are dubious but with all the money printing, it is hard to short anything. It is therefore very difficult to have a bearish portfolio so we have stayed underweight on our alternatives allocation.”
Alternative exposure focuses on managers who have added value in tougher markets, such as Jupiter’s Philip Gibbs and Eclectica’s Hugh Hendry.While the fund is almost a quarter in cash, McDonald highlights the fact it has still produced solid performance due to where they have taken risk, with European and Japanese equities both significant tailwinds.
Buying equities last year was a key part of the move to a more aggressive portfolio, which the managers maintained through 2012 and into this year.
Top 10 Holdings at 31/12/12
M&G OPTIMAL INCOME STERLING 8.97%
FIDELITY SPECIAL SITUATIONS 8.09%
JUPITER ABSOLUTE RETURN 317.06%
GLG JAPAN COREALPHA EQUITY I H USD 6.47%
MAJEDIE TORTOISE A GBP 6.22%
CAZENOVE EUROPEAN INCOME A ACC 5.26%
JPM INV INCOME OPPORTUNITY A ACC NAV USD 4.44%
CAZENOVE UK ABSOLUTE TARGET P1 GBP 4.19%
MORG STNLY DIVERSIFIED ALPHA PLUS ZH GBP 3.99%
McDonald says 2011 was a difficult year for equities and defensive managers outperformed, with the fund’s exposure to Invesco Perpetual’s Neil Woodford and JO Hambro’s John Wood both positive for returns.
“But coming into the fourth quarter of 2011, we felt the valuation premium attached to defensive stocks over cyclicals was too high and wanted to move back towards some beaten-up value names.
“That said, we were keen to avoid companies heavily exposed to Chinese infrastructure and wanted to focus on Western cyclicals, which, in fund terms, meant a move from Woodford to Sanjeev Shah’s Fidelity Special Values.”
This shift has benefitted performance – as more defensive managers struggled last year – as did the European and Japanese exposure, with the latter hedged into dollars.
“In absolute terms, European equities were back trading at March 2009 levels last year while Japan was at three-decade lows but investors were still pumping money into the perceived safe-haven S&P 500 at all-time highs.”
For European exposure, the pair opted for Cazenove’s own European Income fund run by Chris Rice, as it offered the value slant they wanted.
McDonald said the policy is that where in-house managers are best of breed or offer a particular skew, they will hold them but the preference would usually be for equally competitive offerings elsewhere.
In UK equities, for example, they have avoided Cazenove’s offerings, despite strong performance, seeing the universe as sufficient.
Moving to macro views, McDonald said they have slowly grown less cautious on China after much of the over-optimism has fallen out of valuations.
“We are more comfortable owning companies with exposure to China, not necessarily in commodities but more on the retail side.”
The effect of quantitative easing has had a significant effect on risk markets over the last two years and McDonald is wary of the potential fallout.
“More generally, we recognise financial manipulation has kept asset prices afloat and see some markets as overcooked – people are predicting a new bull market for equities but markets have already doubled from lows.
“We still see plenty of valuations outside historical norms and expect to benefit as these normalise. In Japan, for example, people are bullish about the change of government but we would highlight the valuation starting point.”
Looking out into 2013, McDonald believes we will not escape a wobble in markets at some point, potentially falling 10-20per cent.
On inflation: “We see inflation as a risk more in the second half of the decade. With the economy still unstable, we would not expect the kind of runaway inflation that scares bond markets in the short term.”
On gilts: “We see little value at current levels but government bonds can serve a purpose in portfolios – you can make plenty of money from gilt yields falling from 2% to 1.5%, especially if there is a wobble and the rest of your portfolio is down over 10%. Our issue has been the negative returns on offer and we have been unwilling to play games with expensive assets, preferring to use the dollar for hedging.”
On China: “We are more comfortable owning companies with exposure to China, not necessarily in commodities but more on the retail side.”
On QE: “We recognise financial manipulation has kept asset prices afloat and see some markets as overcooked.”
On the great rotation: “We see the rotation idea as misunderstood. Unless, companies are issuing new equities or bonds, there are only a finite amount available, so for someone to buy, some else has to sell. What is happening is greater appetite for bonds is pushing prices up.”