Senior multi-asset portfolio manager David Vickers says low volatility and complacency in markets makes a pullback ‘inevitable’ and he’s getting ready to face the shocks.
“Markets are currently complacent. The likelihood of a 10 per cent pullback at this stage in the cycle is high and so on a relative basis, we have to have more protection in our portfolios,” he said.
“Inevitably the market will fall back. It’s like death and taxes. We’re leaning into the wind, not taking risk out, just managing in a more risk-adjusted manner. The risks of a drawdown you don’t see coming are much greater than the upside.”
“If you’re very nervous about markets, take money out of your portfolio. If you’re somewhere in the middle like we are, [add some protection]. It pays at this point in the cycle to deploy much more of your money in an active sense.”
Russell’s global head of investment strategy Andrew Pease adds that low levels of volatility are increasingly worrying and expects the calm to come to an end soon.
“One thing that does worry me is low volatility. It could cause problems for a lot of asset classes. Anything that causes doubt on sustainability of earnings or the sustainability of the growth cycle could cause volatility to spike up,” he said.
The VIX, a measure of expected volatility, hit a record low late last month, causing some experts to shift uneasily as it’s often a signal of impending trouble.
However, Pease says equities are likely to continue to outperform as developed markets recover “despite the fact valuations are quite stretched.”
“Value is obviously expensive. The market is quite high and it is quite worrying when you see such low levels of volatility,” he said. “But we’re still moderately positive. [Things will be] ok if the US economy continues to grow.”
To counteract the risks, the Russell Investments team has hedged 10 per cent of his multi-asset portfolios using defensive derivative positions.
“We’ve been buying protection pretty constantly over the last 12 months, to prepare for this 10 per cent correction,” said Christophe Caspar, who works alongside Vickers.
The manager is also increasing his exposure to real estate investment trusts (REITs) and high-yield bonds because he expects default rates to remain low as developed markets continue to recover.
“We don’t have a huge swathe in government bonds like you would normally expect at this point in the market cycle,” he said.
In a recent FE Trustnet article, FE Alpha Managers John Pattullo and Jenna Barnard said the low default rates among high-yield bonds justified low yield spreads and made them an attractive investment relative to other areas of the fixed income market.
Caspar adds that the team still favour equities, though they currently have less exposure than they’ve had for some time.
Vickers warns investors need to revise down their return expectations and worry more about protecting their capital for a lower return than reaching for the last bit of the equity rally – something he thinks will catch a number of investors out on the downside.
“In these markets, a portfolio geared towards a 5 per cent return may be better than one targeting a 7 per cent return as on the former you only have an 8 per cent chance of going broke, whereas on the latter, you have a 23 per cent chance,” he explained.
“In this scenario, lowering you return expectations makes more sense because we’re so far into the market cycle.”
“Six to 10 per cent returns are the most you can probably do for the next two to three years,” Caspar added.
The firm’s FP Russell Multi Asset Growth fund, run by Vickers and Christophe Caspar, has trailed its peers in the IMA Mixed Investment 40%-85% Shares sector since launch in October 2012, returning 11.93 per cent. The sector made 18.72 per cent over the period.
Caspar took over the portfolio in May 2013 and Vickers joined in November 2013. Since then the fund has gained 3.37 per cent while the sector is up just 1.68 per cent, according to FE Analytics.
Performance of fund vs sector since Nov 2013
Source: FE Analytics
The fund does have one of the lowest max drawdown figures in the entire sector over the last year though, emphasising the managers’ emphasis on downside protection.
The only funds with lower max drawdown figures over the last 12 months are the Miton Global Diversified Income fund, which was taken over by David Jane earlier this month, and the Vanguard LifeStrategy 40% Equity portfolio.
Caspar and Vickers’ FP Russell Multi Asset Income fund has also fared well relative to the IMA Mixed Investment 20%-60% Shares sector since November, picking up 3.95 per cent.
Performance of fund vs sector since Nov 2013
Source: FE Analytics
The Russell Multi Asset Growth fund has clean share class ongoing charges of 1.14 per cent while the Russell Multi Asset Income fund levies charges of 1.06 per cent.
