S hould multi-managers make asset allocation calls to boost returns for investors? Not if a number of players in this fast-growing market are to be believed.They argue it is impossible to add value consistently through asset allocation plays and that fund of fund managers are better off simply taking a neutral stance and concentrating on producing outperformance through good fund selection. Picking the right funds is a crucial part of creating positive returns but I am bemused by the argument that asset allocation is not an important part of the mix. It is a fundamental part of what we do – being in the right place, with the right managers, at the right time. It is the three R’s of multi-manager investing. Among the major decisions we have made over recent years has been the shift from technology into value stocks early in 2000 just after the market peaked. The switch from gilts to equities on March 12/13, 2003 as equity markets reached lows was also very beneficial. Last year, favouring equities and commodity-related investments over bonds and cash proved to be a winning strategy. We did well out of hedging the dollar, underweighting US equities and maintaining exposure to financials. We also gained from our decision to overweight global emerging markets and, within that, reducing our Asia exposure from the start of the year. We also overweighted Japan in the first quarter of the year and then pared this exposure back during the next nine months. We are not, of course, infallible – last year, for example, we had exposure to the Indian market at the start of the year and sold after the post-election market bounce but we made the move too early and missed out on additional gains which towards the end of the year. But overall, asset allocation calls have added value for our investors. Our analysis shows in each of the past five years’ asset allocation has added between 30 per cent and 50 per cent to our performance. It has never been a value detractor. If we know we can add value through asset allocation, would not we be absolving our duty to investors by not seeking out these themes? But adding value through asset allocation does not mean we are constantly turning over the portfolio. Many of our themes are long-term plays. Our asset allocation views evolve by making use of good independent research and internal analysis rather than having an epiphany. We have, for example, favoured the natural resources theme for the past two years and Eastern Europe for three years. We do keep some funds for very long periods. We have, for example, held Findlay Park US smaller companies since its launch in 1998 and before this had been investing continuously with James Findlay since 1992. It also does not mean we take more risk. If we did not make asset allocation calls because we believed it would be too risky we would be hugging the average. This strategy was effectively what got the pension industry into so much trouble. So what makes it a better idea for the Fof industry? What are the asset allocation calls we believe will be driving investment returns during the remainder of this year? US foreign policy is likely to be the key macro consideration. We are positive on the outlook for global stockmarkets in overall terms and have a preference for equities over bonds. We would expect some commodity plays and oil stocks to be sold by investors who have made money and remain happy having our US exposure hedged back to sterling. We have become relatively agnostic on the direction of the dollar versus sterling. There are good arguments for the weakening of both currencies so it is not so much a case of which currency will be stronger but which will be weaker in the next two years. In the meantime, we feel confident that our exposure to small and mid-cap US equities with a value-style manager will serve us well. We have been positive on commodities for a while and believe the story has a lot further to run despite the strong gains has already seen. A number of analysts are predicting a fall in commodity prices of 10-15 per cent in 2005 at a time when London Metal Exchange inventory levels are at multi-year lows and China’s GDP growth is running at 9.5 per cent. In addition, mining exploration was down massively between 1997 and 2002. This does not, in our view, add up. It takes up to 10 years from a discovery for mining production to get on track. Companies are working to increase production at a time demand is very strong and prices are high. We believe infrastructure bottle necks and long lead-in times are likely to protect prices for a while yet. We expect M&A activity will continue to be a major theme in mature markets and the UK is likely to be a major beneficiary. The UK economy appears to be in good health, with GDP growth in the fourth quarter of 2004 turning out to be higher than anticipated at 0.7 per cent against the consensus expectation of 0.5 per cent. We are concerned this headline number is flattered by the 1 per cent increase in service sector growth at a time when manufacturing output and industrial output fell. The UK economy appears to be heavily reliant on maintenance of existing levels of Government spending and sustained consumer confidence. The latter could be dented if the recent uptick of inflationary pressure requires a further rise in interest rates in the spring. This would also unsettle the residential property market. UK equities look good value relative to other financially risky assets, particularly as previously mentioned, corporate activity continues. Active stockpickers who are prepared to venture down into the small and mid-cap arena should do well in this environment. Within this area, the Aim market is proving increasingly attractive to companies seeking a listing, even those who would qualify for the main market. This, overall, is positive news but does create a challenge for the fund managers we invest with to sort out the good companies from the bad. European equities have, for many, been one of the surprise performers, particularly small caps. This has, in part, been caused by international investors redirecting fund flows to the area. It also shows how a weak economy does not necessarily result in weak stockmarket performance. A lot of small-cap stock prices in Europe have spiked up in the short term and a correction would now be healthy. Looking further east, Emerging Europe remains attractive. GDP growth is robust, corporate tax rates are falling and corporate earnings are growing at a time when valuations are far from stretched. We continue to favour investments in this area. Japan and Asia have attractive valuations and we continue to favour the region. We will inevitably hit the occasional speed bump but the rewards are there for patient investors.
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