Brookes, who heads up the Schroder MM range with Robin McDonald, has voiced his concerns about the market on a number of occasions over the past 12 months or so and has maintained a very high weighting to cash as a result.
Performance of indices in 2014
Source: FE Analytics
Though certain industry experts have predicted that 2015 will be a much better year for risk assets than this year – viewing the performance of equity markets so far in 2014 as a pause in an upward trend – Brookes says he remains cautious and urges investors not to become complacent.
The overriding reason for his bearishness is due to his belief that the Bank of England, along with the US Federal Reserve, will begin to raise interest rates next year, which is likely to cause increased market volatility.“While the economy hasn’t been spectacular, it has actually grown quite well. I just don’t think it’s necessarily appropriate to keep those emergency levels of interest rates going, as we have had for the last six years,” Brookes (pictured) said.
“The governor of the Bank of England, Mark Carney, has already told us that spring is likely to be the time when interest rates start going up. It will be slow and gradual and they will try and measure the impact on the economy so that they don’t go up too fast or too slowly.”
“But, I do think people have got used to low interest rates and to low mortgage rates – and this is going to change. Perhaps, 2015 is going to be slightly more difficult than 2014 and perhaps people need to be slightly more cautious.”
He says this means investors are facing a difficult year, especially as the rally in both bonds and equities over recent years has drained the value out of the market.
“We end 2014 with almost every asset class offering investors scant potential return for their risk,” Brookes said.
“Five years into a period of unprecedented interest rate suppression, this should come as no surprise. The returns generated from every mainstream asset since 2009 have been striking. Those returns are now in the past.”
Performance of sectors and indices since Mar 2009
Source: FE Analytics
“We believe the next few years will be characterised by lower returns, more volatility and greater risk.”
His first concern is with the current bond market, which he recently described as “extremely overvalued”.
Owing to equity market concerns and more macroeconomic woes, bond yields have fallen in 2014 meaning that the asset class has delivered decent returns – surprising many investors in the process as this year was touted as being the end of a multi-year rally in fixed income.
However, with 10-year gilts currently yielding just 1.95 per cent – having started the year at close to 3 per cent – Brookes says investors are wrong to think bonds will offer any form of protection or return next year.
“Almost irrespective of one’s economic outlook, the margin of safety in fixed income markets is wafer thin,” the manager said.
“Aggregate yields globally are as low as they have ever been. Spreads are also closing in on their all-time tights. As a result, correlations within fixed income have picked up worryingly. Traditionally fixed income does not do well in a rising rate environment.”
“If US rates do rise in 2015 as the Fed is telling us they are likely to, every fixed income asset class will take a hit. In spite of this, judging by the scale of continued inflows, the majority of investors appear comfortable with the risk/reward set-up.”
“We’re not, and therefore have only limited exposure. By definition, prospective returns today are pretty much as low as they have ever been, risks are high and liquidity is terrible. Investors need to tread carefully here.”
Brookes has long been of the view that the bond market is expensive and has therefore held a high weighting to the money market as an alternative.
Our data shows, for example, that his £1.4bn Schroder MM Diversity fund has a 34 per cent cash weighting, while global fixed interest accounts for just 9 per cent of his portfolio.
Possibly a bigger concern, however, is that Brookes isn’t overly excited by the equity market either. He says that though there are pockets of opportunities, investors need to very wary where they allocate to.
“Assuming global aggregate demand can continue to expand in 2015, we would have sympathy with the view that equities offer a greater short-term prospective return than fixed income,” he said.
“Nevertheless, we judge equity valuations from a longer-term perspective, particularly in the US, to be on the expensive side at present. This tells you next to nothing about their potential for 2015, but does indicate their vulnerability to disappointment.”
“Like fixed income, from a positioning standpoint investors appear very comfortable with the risk/reward trade-off in US equities.”
Two areas the manager prefers are European and Japanese equities – both of which have struggled this year.
Brookes says they have relative value on their side and the potential for a catch-up in profitability.
For exposure to these areas within his Diversity fund, the manager currently uses the GLG Japan Core Alpha, TM Sanditon European Select and Schroder European Alpha Plus funds.
Given his views on the current market, Brookes favours using alternative investment strategies rather than sticking to more traditional asset classes.
He holds the likes of Morgan Stanley Diversified Alpha Plus and Majedie Tortoise, which are absolute return portfolios.
Brookes and McDonald have managed their Schroder MM Diversity fund – which sits on the FE Select 100 list as the FE Research team rates it as one of the best one-stop shops available to investors – since October 2007.
Performance of fund vs sector and index since Oct 2007
Source: FE Analytics
According to FE Analytics, it has returned 38.96 per cent over that time, placing it in the second quartile of the IMA Mixed Investment 20%-60% sector.
It has beaten its UK CPI benchmark over the period as well. It has an ongoing charges figure (OCF) of 1.15 per cent.
