Brookes, who manages the £1.4bn Schroder MM Diversity fund - has become increasingly bearish in his macroeconomic outlook over the past twelve months and has a view that fixed income is unattractively priced.
This has led him to heavily reduce fixed income exposure and increase his cash weighting to 32 per cent in anticipation of a market correction at some point in 2014 – but he is sticking with Woolnough’s fund despite the controversy over its size.
“Our holding in the fund has been very fruitful and successful. We invested in it when Woolnough launched it in 2006 and I think we will still be holding it in a year’s time,” he said.
“However, the issue for us is if the market has some sort of movement – upwards or downwards – and Richard fails to capitalise on that movement, we would become worried about the size of the fund.”
“But the fund continues to outperform and Woolnough says that he finds running the fund ok at its current size.”
The M&G Optimal income fund, launched in December 2006, has grown its AUM –assets under management – to almost £20bn, and the manager himself has admitted it is a problem.
However, the fund, managed by another FE Alpha manager Richard Woolnough, has managed to steadily make returns despite its size and a steady rise in government bond yields.
Brookes says he expects a relatively flat market over the near term and until that changes his holding of the M&G Optimal Income fund, his third largest, will remain unchanged.
However, he says it will be closely scrutinising the fund’s performance as markets shift.
Brookes says Woolnough’s move into equities over the past few years has made it attractive.
Managers within the IMA Sterling Strategic Bond sector are permitted to hold up to 20 per cent of their fund in equities and Woolnough has consistently held around 11 per cent over the past three years.
“At the time a few people had issues with the fact that it could hold equities despite being a bond fund and said it should only hold bonds but for us the clue is the clue is the title of the fund,” Brookes said.
“There are times when the yield in equities can just be too good relative to the bond yield.”
Woolnough recently told FE Trustnet he expected a recent bear market in bonds was coming to an end and that he anticipated buying more soon.
His fund has returned 85.59 per cent since it was launched in December 2006, which includes the financial crisis and its aftermath as well as the European sovereign debt crisis in 2011.
It trumped the average return in its IMA Sterling Strategic Bond sector, which was less than half at 39.08 per cent. It also stayed ahead of its benchmark – the FTSE All Share- which rose 49.16 per cent over the same period.
Performance of fund, sector and benchmark since Dec 2006
Source: FE Analytics
The bond market has been particularly challenged since QE tapering in the US was first hinted at in May 2013.
However, Woolnough has also managed to outperform the sector since then with returns of 4.4 per cent compare to a 3.03 per cent average. The fund also stayed ahead of it benchmark over this period which rose 4.15 per cent.
Performance of fund, sector and benchmark since 22 May 2013
Source: FE Analytics
Brookes says he started to become bearish in the first half of 2013 and started reducing his bond holdings accordingly as the market began to tank despite falling equities markets. The two have historically been observed to be inversely correlated.
“We think fixed income is expensive so we are at our lowest fixed income holding and we have a lot of cash in lieu of that.”
“We are just worried about the valuations that we are being asked to pay in a period where we can see interesting rates rising and the recovery moderating.”
“However, we are not as bearish as we could be as there is still plenty of room to go for that but we are in tricky times and the fund needs to reflect that.”
The Schroder MM Diversity fund has returned 20.26 per cent over three years, beating its IMA Mixed Investment 20-60 per cent sector average of 15.16 per cent and staying ahead of inflation – measured by the Consumer Price Index - which rose 2.06 per cent.
Performance of fund, sector and benchmark over 3yrs
Source: FE Analytics
Brookes says despite his recent bearish stance he thinks the global market is performing well but its medium term health is almost solely dependent on the impact of a withdrawal of fiscal stimulus and low rates in the UK and US.
The manager explains he’s only not buying bonds because he fears a rate rise will come through too soon.
“If QE tapering and a higher interest rate environment does get delayed then I would happily buy bonds with a positive real yield, but that would probably be more apparent in high yield than government bonds,” he added.
