Cautious investors had very few places to hide last year. While developed market equities performed strongly, traditional safe haven-assets such as physical gold and government bonds lost money in 2013.
Gold miners, which tend to be used for diversification purposes, suffered a huge fall last year.
Performance of indices in 2013
Source: FE Analytics
Stewart (pictured) manages the £8.6bn Newton Real Return fund, which tries to deliver a positive return in all market conditions without taking on too much risk.
He uses equities for his core growth bucket, but also uses derivatives and traditional safe-haven assets to hedge risk.
Because of the performance of those defensive assets, Stewart says that last year was one of the worst he has ever seen for cautious investors.
“We use government bonds, gold (via ETFs) and gold miners,” Stewart said.
“We use them for insulating the portfolio, dampening volatility and to protect capital. Effectively, we want to hedge against various outcomes.”
“Last year was a particularly bad year to have any of them. In fact, I would say holding gold miners in the fund was the worst experience I have had in my career.”
However, this trend has since reversed.
Equity markets corrected in January as investors became concerned about issues originating out of the emerging markets.
According to FE Analytics, while the MSCI AC World index has posted a negative return so far this year, the leading gold price, gilt and gold mining indices have all spiked.
Performance of indices in 2014
Source: FE Analytics
As Stewart recently told FE Trustnet, he is concerned that the equity market rally and the economic recovery will not last, because they are both built on shaky fundamentals.
He says equities will remain volatile because of their high valuations, but expects traditional safe-haven assets to continue to act as a hedge.
“In a backdrop where there is still quite a lot of risk in the world, I can’t really see why gold would fall again,” he said.
“The gold mining sector is a challenged industry as well, because the cheapest gold has already been found, so costs have risen quite a lot. However, we are now more optimistic.”
“What January showed was that defensive assets can still act as a hedge. While equity markets were falling, gold and gold miners did well and bond yields also dropped,” he added.
A number of experts – such as FE Alpha Manager Martin Gray – have said that government bonds could have a good year in 2014.
This is because inflation is expected to remain subdued, meaning that investors could still receive a positive real yield despite the historically high prices of gilts and Treasuries.
Having reached close to 3 per cent a few months ago, yields on 10-year gilts have dropped to 2.78 per cent.
Gray says he was left frustrated as he missed the bottom of the rally “by a couple of basis points”, but he still expects them to act as a hedge throughout the year.
If this were to happen, investors in Stewart’s Newton Real Return fund should benefit as the manager holds 15 per cent in government bonds.
Stewart has a decent track record of protecting his investors’ capital as well, with his fund delivering a positive return in all but one discrete calendar year since its launch in 2004. The exception was 2011 when it lost 0.75 per cent.
The manager says that his previously high allocation to high yield corporate credit helped him to protect his investors.
“Like everything else, high yield has benefitted from the hunt for yield. We used to have a high proportion of the fund in high yield, but essentially we are running it off. Our exposure is now sub-10 per cent, having been above 20 per cent before 2009,” he said.
“What we hold was issued at good covenants, offered a decent yield and is high up the capital structure.”
Our data shows that the ML Global High Yield index has returned more than 100 per cent over five years, which is a similar return to the FTSE All Share, but with half the volatility.
Performance of indices over 5yrs
Source: FE Analytics
However, Stewart is now concerned about the future of high yield. He says that it is very overvalued, as does Hermes’ Fraser Lundie, who recently told FE Trustnet that large parts of the market are trading above their call price.
Stewart also agrees with the likes of Kevin Doran and FE Alpha Manager Ian Spreadbury that the asset class is now fully valued, but that default rates will begin to spike when interest rates eventually go up.
As high yield bonds have been one of the main beneficiaries of central bank intervention, he expects them to fall just as hard as equities when a larger sell-off inevitably happens.
“Credit markets are now frothy,” he said.
“The risk/reward is still reasonably favourable compared with equities, but we are very picky about what we buy.”
“One of the side-effects of using financial assets as a toll is that you can have zombie sectors or companies.”
“If you don’t allow capitalism to exist by itself, you can get left with companies that shouldn’t exist.”
“The current hunt for yield leads to misallocation of capital. It also leads to all sorts of symptoms that aren’t healthy for the economy. It may lead to a more vibrant economy now, but it will ultimately dampen it over the long-run.”
“It also makes the financial system very vulnerable,” he added.
Newton Real Return has an ongoing charges figure (OCF) of 1.12 per cent and requires a minimum investment of £1,000.
