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On guard

The likely magnitude of this present slowdown continues to induce strong debate, leading ultimately to amplified volatility in asset markets, much as it did in late 2007.

We leant against the more sanguine viewpoint espoused by the equity market back then and have adopted the same position today.

We acknowledge that equities appear attractively priced relative to “expensive” bonds but we expect this apparent value to be trumped by a more pernicious downturn than that currently embedded in earnings’ forecasts.

As estimates for both economic activity and earnings are revised lower (a variety of leading indicators suggest this is imminent), we expect equities to undergo further declines.

This will be likely bring about a difficult close to 2010, a year that in many ways has been taxing regardless of which side of the fence you have been perched. By way of example, for all the swings in sentiment and volatility in market prices, a mere one percentage point separates the returns of the two mainstream UK funds that I like to benchmark as the outer limits of the peer group (Invesco Perpetual income and Schroder UK alpha plus).

Thus, both bulls and bears have suffered episodes of frustration and excitement, yet feel underwhelmed by the end result, and are overcome by anticipation fatigue.

Hedge fund managers in general have struggled to produce absolute returns while the environment for traders has been exceptionally hostile.

We set our stall out at the beginning of the year to guard against this complex backdrop. Consequently, the returns for our diversity fund, while competitive, have also been delivered in a pleasantly stable manner.

This is a theme that has been persistent throughout the fund’s life. September 1 marked Diversity’s fifth anniversary – a period over which the fund has the best information ratio of any in the IMA cautious managed sector.

As always, it is the next five years that are most important, not the last. We begin again with a portfolio very similar to that which proved successful throughout 2007-08. Our bias remains towards high quality assets in relatively stable cash-flow industries. While perhaps unfashionable in the short term, our cash exposure remains elevated and many of the absolute strategies we favour are anti-risk.

Generating strong, durable risk-adjusted returns over the long-term is as much about assessing risk as it is opportunity. As we enter the final months of 2010, we believe managing the downside and focusing on capital preservation is the appropriate strategy.

While we acknowledge the apparent relative value of equities, we expect a better opportunity to add risk further down the road. This will be likely to induce further frustration for the bulls and reward those prepared to be patient.

Robin McDonald is co-manager of the Cazenove Capital multi-manager range of funds


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