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Value views

As lead manager on Prudential’s range of with-profits funds, Martin Brookes often finds himself making assetallocation calls that involve moving billions of pounds around markets.

Last year, for example, his team shifted around 15 per cent of its £70bn with-profits portfolio into bonds, highlighting growing risks in equity markets.

Brookes, who joined Pru in 1987, sits in the firm’s 21-strong portfolio management group, responsible for management of insurance funds and assets that back the unit-linked and pension products.

This team is responsible for asset allocation across the various portfolios and also selecting and monitoring managers running the money.
Brookes says this allocation tends to drive 85-90 per cent of investment returns in the long run and his general approach is to make punchy moves into areas offering fundamentally good value.

He says: “We tend to wait for the episodes that trigger this value and usually make a substantial shift every 12 to 18 months. Our approach is clearly not global macro, moving in and out of the FTSE to catch short-term trends but we make large moves when our model highlights good valuations.” Last year, for example, the team reflected their growing caution by moving around 16 per cent of the funds from equities into corporate bonds, also raising the quality of the credit portfolio.

Brookes says his high-yield and subordinated bank debt holdings performed extremely well last year and he has subsequently been moving into lower-risk paper.

“Twelve months ago, valuations on equities and bonds were extraordinary cheap so investors were well paid for taking on risk. We also saw the intervention of central banks through low interest rates and other policies as a potential catalyst to boost markets so basically sat on our risk assets in expectation of recovery.”

A year on, Brookes says both the factors that encouraged this more bullish view are less evident, with much fuller valuations and Governments beginning to withdraw their stimulus packages.

“We are not suddenly negative on markets but feel there are some headwinds for ongoing growth and recent months have been a good time to take risk off the table, locking in profits and also securing the funds against any possible downturns.”

This has seen the team reduce the equity-backing ratio from around 70 per cent to 54 per cent, with the majority of the selling in Asian and emerging market equities. Again, Brookes stresses he remains bullish on these regions in the long term but sees current valuations as up to speed with events and not offering the value of 12 months ago.

With continued issues over consumer deleveraging, he highlights heightened risk for equities despite the dramatic improvement in company earnings forecasts.

He says: “Given the absence of a large valuation buffer, it is our view that investment-grade corporate bonds look more attractive compared with equities. Broadly, we believe valuations on equities, credit and commercial property are now in a fair value range, priced to deliver an appropriate risk premium, given our base case assumption of an anaemic global recovery.”

On property, Brookes has been largely nervous on this sector for the last three years, selling around £5bn of assets over that period.

owards the end of last year, with capital values down 40 per cent, he began to recover some enthusiasm, particularly as distressed selling is ongoing.

“We started going to auctions again but the big bounce in the sector, with overseas buyers extremely active, has already taken valuations back to the level where we felt uncomfortable in the first place.”

Brookes sees the sector as potentially volatile in the next 12-18 months but predicts attractive points to buy back in, retaining a strategic position in the UK market as a diversifier.

Overall, the group believes private sector demand can improve enough to offset winding down government and central bank support programmes.

That said, the portfolio management group expects any recovery to be subdued and volatile and Brookes notes growing sovereign risk.
He also highlights two factors that could hinder a traditional cyclical recovery.

His first concern is ongoing problems in the banking sector, with uncertainty about asset values almost certain to restrain lending in the year ahead. He also says household deleveraging, which has continued into 2010, runs the risk of seriously restricting consumer spending.

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