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Risk and return

10 minutes with…David Coombs

David Coombs joined Rathbones in 2007 after two decades at Barings and launched a pair of absolute return funds, total return and strategic growth, in June 2009.

According to Coombs, the portfolios are absolute return in the sense they have no index benchmark but he is not promising to make money in all market conditions. With that in mind, both are listed in the unclassified sector as Rathbones is uncomfortable with the general nature of the absolute return peer group.

Coombs says: “We are also concerned about sectors such as cautious managed, where caution is basically deter-mined by equity versus bond allocation. Our funds will remain unclassified unless these peer groups introduce more of a risk and correlation element to ranking products.”

This focus is evident from the mandates of total return and strategic growth, with risk as integral as return in the overall target. The former aims for cash plus 2 per cent, with one-third of equity volatility, while strategic growth seeks consumer prices index inflation plus 5 per cent, with two-thirds of stockmarket risk.

Coombs describes the process as correlated versus non-correlated rather than the traditional equities against bonds approach.

There are three asset buckets on both funds, liquidity, alternatives and beta, and Coombs uses active and passive exter-nal vehicles plus structured products and derivatives.

Liquidity consists of cash, government debt and high-quality corporate bonds and makes up more of the lower-risk total return portfolio. The alternatives allocation is designed to have little correl-ation to equities, providing diversification and split into liquid and illiquid assets.

The former includes precious metal and agric-ultural commodities plus various macro and long-short equity hedge funds, while the latter is made up of property and relative value/credit hedge strategies.

The beta bucket houses various economically sensitive assets, namely equities, corp-orate bonds, private equity and industrial commodities.

The higher performance target requires Coombs to take more risk on strategic growth, with 65 per cent in beta assets at the end of March. Coming into this year, Coombs high-lighted three big macro risks – a sell-off in gilts, emerging markets becoming increas-ingly overvalued and sov-ereign debt concerns in Europe – and has looked for ways to benefit.

“We have little exposure to conventional gilts due to concerns about a poorly timed interest rate hike in coming months, especially with elevated oil prices,” he says.

“Most of our government bond exposure is in linkers. These are expensive but a way of playing the oil price, which has stoked up inflationary fears, despite being deflation-ary in the long term.”

A reduction in fixed interest has been a theme across the portfolios, with the credit allocation on strategic growth dropping from 23 per cent in June 2009 to very little today.

“Corporate bonds are coming off a two-year bull market and we are nervous about current inflows into high yield. Investors have been attracted by falling default rates but spreads have come in a long way and we have been selling high yield all year.”

As for sovereign risk in Europe, Coombs sees the euro in decline, with eventual debt restructuring required for some peripheral countries. As a result, he has no direct euro exposure and a position in Baring German growth, giving focused exposure to what he sees as the continent’s strongest economy.

He sees emerging markets as expensive and has run expos-ure down to nothing on total return, citing the region’s val-uations at a premium to dev-eloped market as a sign to sell.

“In China, for example, there are consumer stocks on 40-50 times earnings and we are happier playing this theme through German and Japanese exporters,” he says.
Looking at the macro picture, Coombs sees the oil price and European sovereign debt as the key factors for the rest of 2011.

“If things escalate in the Middle East and oil continues rising, that could potentially tip weaker European countries back into recession and that includes the UK.

“As corporate balance sheets are generally strong, this background means we want to avoid Western consumer exposure and focus on companies selling into emerging markets.”

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