Global markets have had a stellar run since 2009, with performance since the autumn of 2012 particularly strong. Cautious investors wary of the QE-fuelled global recovery have paid the price for sitting on the sidelines, with Martin Gray – who recently exited his post as manager of the CF Miton Special Situations fund – a good example.
Though very short-term, Odey’s decision to take profits in anticipation of poor stock market performance has so far been justified.
Markets have had a tough time this week, with the FTSE 100 falling from around the 6,880 mark to 6,660 at time of writing.Whether this sell-off is a sign of things to come remains to be seen – it’s not the first time that the FTSE has spooked markets as it approaches its all-time high.
However, Psigma’s chief investment officer Tom Becket believes that investors should take warnings from star managers like Odey very seriously.
“I read with interest that Crispin Odey (pictured) has totally flattened his “book” in recent weeks in anticipation of rocky times for global asset markets; he is considered a predictive genius,” said Becket.
Performance of indices over 3yrs
Source: FE Analytics
“I have also enjoyed recent comments from the legendary Jeremy Grantham of GMO who stated that he expects the real returns from US equities to be 0 per cent in the next seven years; he is rightly perceived as a deep-thinking investment virtuoso.”
“The regular bearish reports from the miserable maestro, Albert Edwards, are savoured by the financial community. There have been other warnings from my investing heroes, such as Seth Klarman and David Einhorn, of Baupost and Greenlight fame respectively, warning investors over rich valuations and complacency.”
FE data shows that Odey has increased the cash weighting in his CF Odey Opus fund from less than 2 per cent in January 2014 to 15.2 per cent at the end of June.
Becket thinks that risk-assets could grind higher, but on any reasonable outlook says that there is a severe shortage of value opportunities. He has raised his cash exposure across clients’ portfolios in recent weeks as a result.
“[It is becoming more difficult] to find new ideas to invest in,” he said.
“For the first time in my six years as Psigma’s chief investment officer, the creative cogs have ground together, requiring the oil that only a correction in values can bring.”
“Bond, credit, equity and property markets have risen so strongly in the last few years that it is hard to spot immediate value.”
Performance of sectors over 5yrs
Source: FE Analytics
While Becket doesn’t think valuations are serious enough to warrant a plus-50 per cent cash positions, he says it’s a good time to take profits in areas that have performed particularly well.
“This is not to say that you should sell up and run for the hills, but rather glance through your portfolio, sell anything that you don’t trust impeccably and hold a cash buffer; both in anticipation of better opportunities and as protection against a potentially challenging summer,” he said.Holding cash is often seen as a weakness in a fund manager, but while the asset class is currently delivering a negative real return, Beckett says it can be very useful for outperformance in the future.
He commented: “Cash? You are a crank”, you are probably shouting. What justification can there be for holding cash when interest rates are nothing?”
“On a medium term basis, I would find it hard to argue a bullish case, unless we do move in to a truly deflationary world, a risk which we at Psigma still evaluate as a low probability scenario.”
“However, in a world where complacency is rife, where huge and utterly underserved confidence is placed in central bankers and where valuations of all asset classes are uniformly stretched, it is right to consider what might go wrong.”
Becket (pictured) says that the risk of an inflation spike in the US, which could force the Fed to raise interest rates faster than it anticipated, is a very real threat to investors across the world.
“If the bond markets get spooked by the threat of tighter monetary policy then there is a high chance that all asset markets suffer potentially significant losses, especially in credit markets where the excess yield over government bonds has rarely been skinnier and absolute yields never lower,” he explained.
“I am not suggesting that the scenario outlined above is a certainty, far from it, but it is appropriate that all investors recognise that the risk of it has risen, as asset markets have leapt and bond yields have collapsed.”
“The fact that everyone is now so comfortable taking equity risk – investors sentiment surveys are at extremes – should serve as a warning to investors.”
“That we are seeing certain late-equity cycle characteristics, such as mammoth buy-backs and corporate take-overs, should also sharpen the mind to the possibility of an overdue correction,” he added.
Bestinvest’s Jason Hollands agrees. He says he doesn’t see the 5 per cent correction in equities over the past week or so as a buying opportunity, and would have to see something much more extreme to put cash to work in the UK and US in particular.
“Generally we have been very cautious on equity markets this year,” he said.
“I don’t think we’re going to hit a brick wall, but asset classes have been heavily impacted by QE. US equity markets are particularly expensive in our view, but there are few giveaway areas at the moment.”
“The party could go on a little longer, but markets would have to fall considerably further than they have over the past few days for us to get interested.”
“I think that the rise in interest rates will be the defining point, and seeing how markets react to that.”
Hollands favours Europe over the US and UK as further QE is more likely. He has also been using absolute return funds to help dampen volatility in client portfolios, pointing to Threadneedle UK Absolute Return and Insight Absolute Insight as two of his favourite choices.
An increasing number of both multi-asset and single-asset funds have been upping their exposure to cash.
In the first camp, Trojan [13 per cent], Jupiter Merlin Conservative Portfolio [17 per cent] and Schroder MM Diversity Tactical [44 per cent] have a particularly high position.
Looking at more specialist areas, Somerset Emerging Markets Dividend Growth [16 per cent], CF Ruffer Pacific [23 per cent] and Premier ConBrio UK Opportunities [34 per cent] are standout portfolios.
Hollands says that arguments over whether fund managers should hold high levels of cash are dependent on what kind of portfolio they run.
“Some fund managers take the view that it’s their job to make the best returns for their clients, and if that means sitting on cash, so be it,” he said.
“The problem is that sometimes the underlying investor of a fund will themselves be an asset allocator. If they select a European equity fund they will want the manager to be fully invested, as they may have a weighting to cash separately.”
Hollands says that high cash levels in multi-asset funds that provide a one-stop-shop for investors – often for a pension or an ISA – are more understandable, point to Schroders’ Brookes and Troy’s Lyon as good examples.
“For these types of managers, cash is part of the tool kit that they have to diversify,” he said.
“Certain funds like Ruffer Total Return and Trojan are bought for capital preservation, and so the investors should expect the manager to use cash if they see fit.”
Performance of funds and index over 7yrs
Source: FE Analytics
“It’s more problematic when the fund is more of a specialist, as the investor may assume they are fully invested.”
Both Trojan and Steve Russell’s CF Ruffer Total Return fund used cash to good effect in 2008, protecting much more effectively against the downside than their peers and the FTSE All Share.
