The funds are among the most popular in the UK, with the income fund alone amounting to £4.7bn. Performance has been consistently ahead of the sector for many years, but has slipped over the past 12 months.
The Jupiter Merlin Income fund currently sits in the third quartile of the IMA Mixed Investment 20%-60% Shares sector over one year, with returns of 6.88 per cent against 8.03 per cent from the average fund, according to data from FE Analytics.
This is in most part due to a very poor six months which have seen the fund lose 2.95 per cent – a fourth-quartile return. The average fund in the sector has made 0.17 per cent over the period.
Performance of fund vs sector over 6months
Source: FE Analytics
Smith-Maxwell, speaking exclusively to FE Trustnet, says that the team was surprised by the downturn in emerging market equities and simply got it wrong on emerging market debt.
"The reason for that [underperformance] is the exposure that we have had to Asian Income funds and emerging market debt," he said.
"Those have been long-term portfolio holdings which have worked very well in recent years but in 2013 have been a strong headwind."
The developing world has underperformed the developed by 12.01 percentage points over the past six months, according to data from FE Analytics.
Performance of indices over 6months
Source: FE Analytics
"It’s still a strong secular growth story long-term," Smith-Maxwell said. He explains that the dollar being weak against sterling hasn’t helped his investments in emerging markets.
Emerging market debt funds buy the bonds of governments or corporates in the developing world, which can be denominated in local currency or US dollars.
Many analysts have suggested that US dollar debt is safer in that there is less currency risk: if a currency falls in value then the value of a bond issued in it falls in your home country.
Buying only US-denominated debt did not protect the Merlin funds, however.
"We only owned dollar EM debt, but that has been compounded by the contagion from the re-pricing of local currency emerging market debt," Smith-Maxwell said.
The manager says that the team got it wrong and has sold down this position.
"We have significantly reduced our exposure to emerging market debt because there is the risk that it’s an over-owned asset class, certainly emerging market currency debt, and there will be some contagion," he said.
"We should have owned less."
Smith-Maxwell says that the team sometimes has to accept short-term volatility in the interests of maintaining the income stream from its investments.
Jupiter Merlin Income is yielding 3.3 per cent, a top-quartile figure for the sector. Jupiter Merlin Balanced’s 2.4 per cent is top quartile in the IMA Mixed Investment 40%-85% Shares sector, although it does not explicitly target a yield.
While the Jupiter Merlin team – which includes FE Alpha Managers Peter Lawery and John Chatfeild-Roberts – has taken radical action on its EM debt exposure, it has only trimmed back its holdings in Asian equity income funds.
The same asset allocation problems have affected the range of funds, which have lagged their benchmark over the past six months.
The £1.56m Jupiter Merlin Balanced fund has lost 1.95 per cent while the IMA Mixed Investment 40%-85% Shares sector has made 1.39 per cent.
Performance of fund vs sector over 6months
Source: FE Analytics
The £1.88bn Jupiter Merlin Growth fund has made 12.41 per cent while its IMA Flexible Investment sector average has made 0.8 per cent.
While the team has been trimming its exposure to Asian income funds, it still remains keen on Latin America. It holds Findlay Park Latin American in both the Growth and Balanced portfolios.
"We have retained our exposure to Latin America, which is on discounted prices," Smith-Maxwell said. "It was hit very hard in the middle of this year; valuations have now bounced back, but it has lost quite a bit in the short-term."
Data from FE Analytics shows that the region has underperformed even more than the general emerging market indices this year.
Performance of indices in 2013
Source: FE Analytics
"The stock market in Brazil has been hit by negative sentiment towards China," Smith-Maxwell said. "But Jaguar are opening a plant in Brazil and there’s an example to me that the middle-income Brazilian consumer is alive and well."
Jupiter Merlin Income is still a top-quartile performer over five and 10 year periods, as is Jupiter Merlin Growth. Jupiter Merlin Balanced is second-quartile over five and first over 10.
The ongoing charges on these funds are 2.33 per cent, 2.57 per cent and 2.41 per cent respectively.
FE Trustnet will be carrying more of this interview on Monday in which Algy Smith-Maxwell gives his take on the trouble in the bond market and explains which sectors he is bullish on and which ones he is concerned about.
