The manager of the £953m Artemis Global Income fund has been selling out of stocks and assets bought for their bond-like characteristics and has replaced them with mid caps, particularly those in the US.
He believes popular defensive companies could take a pounding as monetary and fiscal policy is normalised.
“I cannot stress too highly how complicated the world will be over the next 12 to 18 months when big central banks start to tighten policy, it could get very volatile,” he said.
“Bond-proxy stocks, as well as utilities and REITS, will not do well as rates go higher. However, they do represent quite a lot of the income currently in the market and so if you don’t hold them, what the hell do you hold?”
“Bond proxy” stocks – those that investors have bought as an alternative to low-yielding fixed interest instruments – have done well in recent years.
While the term is subjective, stocks that have benefited from lower yields include global mega caps such as pharmaceutical giants GlaxoSmithKline and AstraZeneca.
FE data shows AstraZeneca is up 67.68 per cent over two years.
The iBoxx Sterling Overall All Maturities index – a popular measure of the UK bond market – has returned 3.82 per cent over the same period.
Performance of stocks and index over 2yrs
Source: FE Analytics
“Equity income is going to continue to be very popular and will be one of the most interesting games within the equity world,” de Tusch-Lec continued.
“However, as rates do go higher and policy normalises, as an income manager or investor in income you want to be very diligent about what you own and how it will be impacted by the transition. Like bonds, bond proxies behave badly when rates go up.”
Both the Fed and the Bank of England have hinted that interest rates will rise sooner than markets have been anticipating, possibly even by the end of the year.
“Whilst any rise is likely to be minimal, as the base rate in the UK is at a historical low of 0.5 per cent and has remained unchanged for five years, any rise will signal a strong alteration in the course of monetary policy,” said de Tusch-Lec.
The Governor of the Bank of England Mark Carney recently said that rates are likely to average 2.5 per cent over the next three years.
De Tusch-Lec says he is trying to strike a fine balance between risk and return in his fund, as there is a higher degree of uncertainty in 2014 compared with previous years.
Artemis Global Income, which has five FE Crowns, is number-one in its IMA Global Income sector since launch, returning 83.54 per cent compared with the IMA Global Equity Income sector’s 54.32 per cent.
Performance of fund, sector and benchmark since July 2010
Source: FE Analytics
“At the moment the key is not holding too many bond-proxies. You want some but not too many,” de Tusch-Lec said.
“Value is also important because value stocks tend to do well when the economy recovers.”
“There are a lot of quality plays out there like Sanofi, Microsoft and Novartis. These are very big companies that are quality plays with good brands, but they also have a tendency to not really participate fully in a cyclical upswing.”
The manager says he is looking for stocks that can deliver a growing income and have strong balance sheets, but that are also cheap and not “run of the mill”.
“We are looking for cheap mid caps as a way of squaring the circle,” he continued.
“Ryder is one of our largest positions. It is a US truck financing company which benefits from low rates but also a stronger economy. It’s a cheap stock even though it has done tremendously well over the past few years.”
FE Alpha Manager Leigh Harrison told FE Trustnet in March that he thinks warnings over bond proxies are overly simplistic, and doesn’t think stocks in sectors such as pharmaceuticals and tobacco will automatically sell off as bond yields rise.
FE Trustnet looked at Artemis Global Income in more detail in a recent FE Trustnet article.
