The FE Alpha Manager (pictured), who heads up the £840m fund with star manager Martin Gray, is surprised by how strong equities have performed this year, given the vast number of risks still facing markets. "I don’t really understand it to be honest," he said. "Our macro view hasn’t really changed all that much – I think we’re going to see a sustained period of low growth, high unemployment and austerity, which is not a good place to be if you’re an equity investor."
"It seems people are buying equities just because they think they are better value than bonds. This isn’t something I necessarily disagree with, but what’s to say you have to buy either if both are expensive?"
"In many ways I think it comes down to boredom – a lot of people have been sitting on cash for a long time and want to put their money to good use."
His views contrast with those of Barings' Percival Stanion, who said in a recent article that macro risks are on the decline, giving a green light for risk assets to perform strongly.
The CF Miton Special Situations Portfolio – a fund of funds – has around 35 per cent in cash at present, and just 35 per cent in equities. It sits in the IMA Flexible Investment sector, which means it can hold up to 100 per cent in equities.
Commenting on the cash weighting, Sullivan said: "We’re just not seeing enough opportunities. We’re macro investors, not stockpickers, so we’re not going to back an asset class for the sake of being fully invested."
Sullivan says many investors seem to have become complacent and should take a moment to consider unsolved problems in the eurozone and the US before upping their risk exposure.
"There’s still a lack of competition, high unemployment and high debt-to-GDP levels in the region and, crucially, earnings are down."
"Yes, Draghi’s stimulus packages have helped, but what happens when the money runs out? Are the German people going to say 'enough is enough?' I don’t think this has been priced in."
"It’s head-scratching stuff. Why are people buying when earnings are down? People are turning a blind eye to fundamentals."
When asked if a Lehman-style crash is a possibility, Sullivan said: "Deep down I don’t think you can rule it out. Fundamentals and the markets just don’t add up. It could come from something political."
"If something left-field were to happen – say an increase in interest rates in the US, which is a lot more likely than it was six months ago, I think you could see some shockwaves."
Sullivan and Gray’s defensive stance acted as a drag on relative performance last year: our data shows the fund was down 0.63 per cent in 2012, while the average IMA Flexible Investment sector was up 10.13 per cent.
It is a bottom-quartile performer in the sector over three years, although its stellar performance during the 2008 crash means that it is still top quartile over five years, with returns of 20.19 per cent.
Performance of fund vs sector over 5yrs
Source: FE Analytics
The fund has returned 176.77 per cent over 10 years – a figure only beaten by six portfolios in the IMA Flexible Investment sector.
It is not the first time CF Miton Special Sits has had to endure a significant period of underperformance.
Gray correctly anticipated a debt-related crash in the mid- to late-2000s, but was 18 months or so too early in his estimations. This led to the fund falling well short of its sector in 2006.
Although some industry commentators have referred to Gray and Sullivan as "permabears", the latter denies this.
"If you look at the fund between the up markets of 2002 and 2007, you’ll see it outperformed," he said. "We’re not saying we won’t buy equities, we’re just saying we’re not comfortable at these elevated levels."
Performance of fund vs sector since launch
Source: FE Analytics
"If the FTSE was to drop by 1,000, 2,000 or whatever it may be, I’d have no problem in buying."
Sullivan says he and Gray were wrong-footed by the most recent surge in markets, as a result of the US avoiding the infamous fiscal cliff, but that they have no desire to snap up what many refer to as "cheap" areas of the equity market.
"I was disappointed with the way the market reacted [to the fiscal cliff], because I thought this had already been priced in," he continued. "I’d hesitate to call it a resolution, because all they did was put the decision back."
"There’s a lot of talk about cheap markets, but I’m not so sure. Take Europe, for example – people are referring to historically low price-to-earnings [P/E] ratios, but it’s important to remember that this is a two-tiered market."
"On the one hand you have large cap exporters which are defined as defensive because they earn their profits from overseas. Then on the other, you have domestically focused companies that are cheap, because they get their earnings from the periphery and nobody wants to touch them."
"If you pair this together you get a 'cheap' market, but you’ve got to understand what you’re buying."
The manager points to Japan as a genuinely cheap market, but sees this as a relatively long-term play. He has around 10 per cent in Japanese equities, and includes GLG Japan Core Alpha as a top-10 holding.
He says he has no interest in banks, which he believes are too opaque.