Brookes, who has headed-up the Schroder MM range with Robin McDonald since October 2007, has been very cautiously positioned in 2014 as he has become increasingly concerned that both bonds and large parts of the equity market are on the brink of collapse.
He has therefore held large portions of his fund in cash, in some cases more than 40 per cent.
Though Brookes has outperformed over the longer-term, this positioning has hurt his returns relative to his peers. According to FE Analytics, his £1.5bn Schroder MM Diversity fund is currently languishing in the bottom quartile of the IMA Mixed Investment 20%-60% sector year to date, and over one and two year periods as well.
Performance of fund vs sector in 2014
Source: FE Analytics
Brookes apologies for his lacklustre returns but says his portfolio is perfectly positioned for increased volatility, which is likely to categorise the next 12 months or so.
“Typically, everyone is right together and everyone is wrong together. Being contrarian and having a willingness to be different is really important but if you are prepared to do that, you have to be patient,” said Brookes (pictured), speaking at the annual Schroders New York press trip.
“That’s why I am asking our clients to be patient with us at the moment as we have just put in a fourth quartile year, but I’m absolutely convinced I’m right, it just hasn’t worked yet.”
Brookes, with his contrarian stance, has a good track record of shifting his portfolio in the past, such as holding defensive equity managers such as Neil Woodford in 2010 and 2011 and moving into cyclical portfolios like Fidelity Special Situations when the market bottomed in 2012.
With that in mind, he talks to FE Trustnet about the two main decisions which have led to his underperformance – and why he’s sticking with them:
Next to no exposure to bonds
Brookes, like a number of his peers, has been caught out by the strong performance of bonds in 2014.
Performance of indices in 2014
Source: FE Analytics
“Our view has been that the ending of QE would mean that whatever support asset classes have had would end and it would be “show me the money” time. Our own view was that government bonds would be the first to show weakness,” Brookes said.
“At the beginning of the year they were yielding 3.25 per cent and today they are yielding 2.2 per cent, so I think that goes down as being the wrong call.”
However, unlike others, the manager hasn’t been dipping his toe into the gilt or treasury market as he believes they are grossly overvalued. He says 10 year US treasury yields, which most of the global bond market is priced off, can only go up from here now that the US Federal Reserve has stopped its QE programme.
“The thing is I don’t think they can go down from 2.2 per cent to 1 per cent as QE has ended – whose is going to buy these things at 2 per cent.”
While some bond bulls have argued that large pension funds will calm the market in a sell-off to take advantage of higher yields, Brookes thinks that unit holders in traditionally safe bond funds are in for a nasty surprise over the short-term.
“Once these things start losing you money people start to think, why’s that happening? We’ve just had a 30 year bull market in bonds; you don’t lose money in high grade government bonds?”
“This is going to be a bit of a shock to a lot of people.”
Instead of using bonds, Brookes has a 34 per cent weighting to cash in his Diversity fund and uses absolute return portfolios such as Morgan Stanley Diversified Alpha Plus and Bill Eigen’s JPM Income Opportunity fund – who is also very bearish on fixed income.
Very underweight US equities
Brookes told FE Trustnet earlier this year valuations in the US were approaching levels similar to those seen in the run-up to the 1929 stock market crash and was therefore very underweight the region.
He held no dedicated US portfolios in his Diversity fund and only has exposure to North American companies via a select number of global equity funds.
However, like bonds, the S&P 500 index has rallied this year, returning 20 per cent and considerably outperforming UK, European and Japanese equity markets in the process.
Performance of indices in 2014
Source: FE Analytics
Brookes still retains the view that US equities are due a very difficult period as huge amounts of investor complacency has crept into the market.
“You’ve had nearly 40 new all-time S&P highs just this year. In quarter one, there were the highest level of IPOs since the internet bubble and 74 per cent of those companies have no earnings. Extraordinary, isn’t it?” he said.
“The bull market is now 67 months in length. The stock market has been up a very, very long time now.”
He also points out that, according to the AAII monthly investor survey, the amount of bearish investors in the US is currently at a record low.
That being said, the major reason why the FE Alpha Manager is so bearish on the US is because companies’ share-buy backs have made the market look a whole lot more attractive than it actually is.
“Corporate America hasn’t been investing, it has been using its excess cash flow to undertake share buy backs,” he explained.
“Why have they done that? Well, in my opinion we are in the latter stages of an economic cycle and profits have been harder to get so why would you invest now because you aren’t necessarily going to sell a tonne more stuff than you already are.”
“It is much easier to buy back your shares because if there are less shares but the same earnings number, it looks like you have earnings growth. This happens towards the end of every economic cycle like in 2007.”
“US companies have done $2trn of share buy-backs over the last two years and that has been a major, major reason why the US equity market has gone up.”
Though the manager is staying well clear of US equities, he is becoming increasingly bullish on Europe and Japan as he says they are attractively valued and hated by most investors. FE Trustnet will highlight his views on these regions in an article next week.
Alex Paget spoke to Marcus Brookes in New York as a guest of Schroders.
