Investors shouldn’t be looking to significantly de-risk their portfolios following the recent volatility in markets as economic fundamentals in the developed world remain sound, according to Andy Merricks, but with rates staying at their low levels, he expects market ‘hokey cokey’ to continue for some time. 
Markets have been highly volatile over recent months. Firstly, following a downward trend in the early summer months, global equities fell in unison during August as concerns were raised about growth rates in China as the world’s second largest economy took the decision to devalue its currency.
While there was somewhat of a recovery afterwards, the US Federal Reserve’s decision to keep rates at their ultra-low levels saw further falls as investors worried that growth was not as strong as first believed.
All told, FE Analytics shows the FTSE All Share is down 3 per cent since the start of August with volatility of 19.13 per cent and a maximum drawdown of 10 per cent.
Performance of index since August 2015
Source: FE Analytics
As readers will have no doubt noticed, many have warned that the substantial price moves, uncertainty over future rates and murkiness surrounding the trajectory of the global economy mean that the falls (the FTSE All Share is down more than 7 per cent since its peak) are a prelude to a far more sinister event.
The fact that this very strange market cycle has been going for close to seven years also has many commentators cautious.
However, Merricks, head of investments at Skerritts Wealth Management, isn’t overly concerned. He says the US will raise interest rates when it feels comfortable and while they remain at their current levels (and as the economy isn’t deteriorating) equities will continue to perform well.
“It’s an argument that we’ve made time and again in recent years and it’s one that we’ll continue to stand by for now. If interest rates remain low, money being what it is will seek a return from somewhere,” Merricks (pictured) said.
“If it isn’t getting it from cash, it will look for it from other asset classes and so every time there is a setback in the bond markets or equity markets, cash will buy back into those markets at more reasonable levels as long as the fundamentals are sound.”
“We would argue that the fundamentals in the developed markets remain fairly sound – profitable companies, low unemployment, reducing personal debt levels – whereas in the emerging markets they are not.”
However, that’s not to say Merricks is expecting equities to move in a straight upward line. He says that volatility is likely to remain a persistent theme and therefore, unlike a number of commentators who FE Trustnet has spoken to recently, he is sticking with active managers within his clients’ portfolios.
“Volatility will remain high as money continually goes into, then comes out of, risk assets in search of this return. A kind of investment hokey-cokey if you will,” Merricks said.
“And this is why we feel that those who concentrate on the lower charging tracker or passive kind of buy and hold index style of investing will lose out to a more active, opportunistic method of investing which will, admittedly, carry with it more risk of timing error.”
He added: “Passive investors could be range bound for some little time whereas active investors will at least have the potential of buying the dips and selling the peaks. Whether they can do it successfully enough to make it any more profitable than simply buying and holding passively is another question entirely.”
This view on actives versus passives is very different to a number of market commentators over recent weeks.
The likes of FE Alpha Manager John Bennett and City Financial’s Mark Harris have said that given the index has struggled due to the performance of some of its largest constituents (namely mining and oil stocks), trackers are likely to perform well when those sectors show signs of mean reversion.
Performance of active funds and indices in 2015
Source: FE Analytics
Indeed, FE Alpha Manager Alex Savvides says that just being overweight rallying mid-caps (which most active managers have done this year) will no longer be the best way to outperform, so he has bought mega-caps to move his JOHCM UK Dynamic fund more in line with the index.
“It just so happens some of my most interesting ideas at the moment are in the FTSE 100 and they are right at the top end. Actually, as you are transitioning into those stocks, you get accused of index hugging which is quite funny really because your tracking error comes down as you have to shift a lot of capital into these names.”
He added: “You will get small-cap returns from mega-cap stocks over the next three years and if you are not in them, you will miss out.”
However, Merricks says he is leaving large-caps alone (due to possible volatility) and is instead buying into small-caps, an area where tracker investors cannot gain access to due to liquidity constraints.
“Since 2008, if you are in the UK and have little or no debt (low interest rates) and you have had and kept a job, you’ve probably never had so much disposable income in your life. Which is why restaurants are full, airlines are raking it in, new car sales have never been higher (even VW until a few weeks ago) and hotels can charge pretty well what they like,” Merricks said.
“The UK smaller companies sector is dominated by firms whose focus is upon the domestic economy and consumer.”
“There will obviously be winners and losers but that’s why we’d favour a smaller companies fund rather than an index, and is why we will be putting some of our clients’ cash into these areas as we enter the final quarter of 2015.”
Smaller companies have certainly had an enjoyable 2015 relative to large-caps and Merricks is currently using the Liontrust UK Smaller Companies and AXA Framlington UK Smaller Companies funds for his exposure.
He has been a long-term backer of the £390m Liontrust fund, which is headed up by the FE Alpha Manager duo of Anthony Cross and Julian Fosh.
Performance of fund versus sector and index over 10yrs
Source: FE Analytics
According to FE Analytics, it has been a top quartile performer in the IA UK All Companies sector and has beaten its FTSE Small Cap ex IT benchmark over one, five and 10 years. Over 10 years it is up 209.38 per cent, beating the index by more than 120 percentage points in the process.
The fund, which takes a growth approach, has also beaten the sector and index in six out of the last 10 years. Its clean ongoing charges figure (OCF) of 1.38 per cent.
