The balance between offence and defence is a key element of our investment process. If you judge that decision right, more often than not the rest falls into place.
Over the last two years, our invested portfolio has been aggressive in its positioning. We have sought exposure to depressed stock markets when they have been deeply out of favour and high beta sectors when others were more comfortable owning defensives. Broadly, as the environment has been favourable to risk taking, this has worked well.
Equally as important to this cycle has been judging where to take risk. For example, investors who expressed their optimism through investment in China and other emerging markets have suffered a significantly worse experience and outcome. We have just passed the five-year anniversary of when developed markets bottomed and, while the S&P 500 is at an all-time high, China languishes below where it began. Quite a divergence.
The question is to what extent this represents an opportunity. Our suspicion is that over a 10-year horizon, given their respective starting points, the better risk/reward opportunity likely resides in the East. So the next question is how and when we capitalise on that prospect.
In 2012 we exploited similar opportunities in Europe and Japan. Many markets in Europe, particularly the periphery, had sunk below their 2009 crisis lows and, in Japan, the market was back to levels last seen in 1983. Although our direct exposure to China has remained pretty moderate to date, our indirect exposure has crept higher in recent months. This has principally been achieved through the resources complex, which itself has de-rated substantially in sympathy with Chinese growth prospects.
Most recently, we have also initiated a position in the M&G Recovery fund, which carries a degree of exposure to the sector. Followers of the fund know the last two years have been far from easy for Tom Dobell and his team. In the two years to the end of 2013, the fund has underperformed the UK average by 21 per cent.
But this reminds me of when we bought Fidelity Special Situations at the end of 2011. Back then, the Fidelity fund was languishing at the bottom of its peer group having had the wrong portfolio for the preceding two years. The market shifted its emphasis and the fund has since enjoyed a fantastic period of performance.
Fast forward to today and the M&G team finds itself in a similar situation. In 2011, it was the banks that were the troublesome sector. This time it’s the resources. The miners today are considered uninvestable to many in the same way that the banks were in 2011 and although we are far from commodity bulls, we are naturally attracted to areas of the market where sentiment is so poor. They are unloved, increasingly under-owned and relatively undervalued.
It is worth pointing out the mining sector has been underperforming for over three years and at the turn of the year had underperformed the wider market by 70 per cent over that timeframe. The news-flow is obviously not good but when is that not the case with cheap assets?
Robin McDonald is a fund manager of the Diversity multi-manager range at Schroders