2016 is likely to remain a volatile market, and as such absolute return investment vehicles look particularly appealing over the medium term, according to Santander’s Toby Vaughan and Tom Caddick (pictured).
Vaughan, who is head of global multi-asset solutions, and Caddick, who is head of fund management, say the extreme market conditions driven by monetary policy, Chinese growth and the drop in commodity prices mean investors may wish to consider repositioning their asset allocation to provide greater protection.
“We are generally constructive on absolute return and we’re currently above where we’d normally be in terms of weighting, and we are managing our equity position with a bias towards actually being quite constructive over the medium term,” Vaughan said.
“Our view is that you need to be managing the size of positions in portfolios and there are some things that we’ve done to make sure that risks are not too skewed. But our view is also that markets have moved away from fundamentals and that’s a sign that markets are panicking and risk assets are moving into oversold territory.”
While Santander manages a total of 23 funds across various asset classes and sectors, six of these – the Santander Atlas Portfolios 1-6 – are risk-adjusted multi-asset funds and of course have varying weightings across the market depending on where they sit on the risk spectrum.
Generally though, Vaughan and Caddick have reduced their “risk limit” which blankets the entire range of Atlas portfolios and currently stands towards the lower end of the volatility range.
“That’s to reflect that, even though we might be constructive medium term on certain areas, our view on the overall portfolio strategy is that it needs to be quite balanced and managed in the short term as well,” Caddick said.
In light of this, both managers offer FE Trustnet their insights on three major asset classes, their feelings towards them and which funds they’re buying in that market area.
Equities
The managers are constructive on developed market equities from a medium-term perspective, although they point out this is case-specific.
“We like Europe and we like Japan because they have a better earnings environment, more accommodative policy and more attractive valuations versus the US. We’re more cautious on emerging markets and the US,” Caddick said.
In terms of earnings, the managers believe that Europe and Japan have less pressure on their margins than the US, as they think US profit margins are highly extended and, as such, companies are far more reliant on top-line growth to generate earnings. Because margins are less extended in Europe and Japan, they point out there is more potential to improving earnings through expanding them.
“In terms of policy, Japan recently took interest rates negative [and] Draghi has recently opened up room to do further quantitative easing, so we think the policy environment in both of these markets is more supportive for both growth and also currency depreciation, and that should benefit them medium term,” Vaughan said.
Caddick and Vaughan are unable to discuss their exact Japan positioning due to recent portfolio changes.
One position they’re using to play their preference for European equities is BlackRock European Dynamic, which has been managed by FE Alpha Manager Alister Hibbert since March 2008. The four crown-rated fund is £1.9bn in size and invests in stocks the manager deems to be under-valued or able to demonstrate high growth potential.
Over five years (the length of time Sandander has held the fund), it has provided a total return of 46.41 per cent, outperforming its sector average and FTSE World Europe ex UK benchmark by 17.8 and 25.66 percentage points respectively.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
“We like the team, the company and the infrastructure – the good thing about the team is it’s been a stable, growing team with a lot of resources that has been able to deliver a risk-controlled track record over quite a number of different product ranges, which is always a good sign,” Vaughan said.
Blackrock European Dynamic has a clean ongoing charges figure (OCF) of 0.93 per cent.
Fixed income
Vaughan and Caddick are generally cautious on fixed income and have lowered their weighting because they deem it to be overvalued. However, they point out that fixed interest assets play a vital role in multi-asset portfolios because they potentially reduce drawdown and volatility, as well as add asset class diversification.
“It’s part of the role of a multi-asset portfolio. Historically, the bulk of what would be deemed to be low risk or low volatility would tend to be higher weightings to some of those traditional asset classes,” Caddick said.
The managers are fairly constructive towards high yield bonds because spreads have widened significantly, providing investors with attractive yields. However, because of the high level of risk they say it is important to balance these with sovereign bonds, which smooth returns but don’t provide much return potential.
“The way we think about fixed income at the moment is that you have traditional diversifiers such as government and corporate bonds, and you need them in the portfolio to manage your risk factors,” Vaughan said.
“We’re prioritising the asset class and what that brings. We don’t want the manager taking lots of other risks because then we don’t get the diversification that we need.”
In terms of corporate bonds, though, the team is allocating to more “flexibly-managed” funds such as FE Alpha Manager Ariel Bezalel’s Jupiter Strategic Bond as a means of generating alpha.
Since its launch in 2008, it has provided a total return of 87.73 per cent, outperforming its benchmark and sector average by more than 20 and 40 percentage points respectively.
Performance of fund vs benchmark and sector since launch
Source: FE Analytics
The manager is able to invest in high yield bonds, investment grade bonds, convertible bonds, preference shares and others, in order to achieve its aim of providing both high income and growth.
The fund has a clean OCF of 0.73 per cent and yields 5.1 per cent.
Absolute return
This is the area that the managers are most constructive towards at the moment. Within the Atlas portfolio range, the weighting to absolute return exposure has increased to almost 15 per cent since the start of 2016.
“We’re in this environment where we have moderate returns in traditional asset classes with elevated levels of volatility, so that’s why we continue to like absolute return strategies. We’ve been building a position in liquid, UCITs absolute return vehicles for the past year and a half,” Vaughan said.
“We expect these vehicles to outperform bond markets with lower drawdown and lower volatility over the next couple of years and that’s starting to happen now.”
Three examples of funds that the Santander managers like are the five crown-rated Old Mutual Global Equity Absolute Return fund, the £2bn BNY Mellon Absolute Return Equity fund and FE Alpha Manager duo Luke Newman and Ben Wallace’s Henderson UK Absolute Return fund.
“BNY and Old Mutual are market neutral to a certain extent,” Caddick said. “If you can find true market neutrality within that portfolio – so your correlations are close to zero versus the equity markets – that gives you great diversification within your portfolio.”
“This is not necessarily offering any kind of protection in your portfolio, which is traditionally what sovereign debt has done in certain markets and arguably won’t do going forwards, but if you can find true market neutrality within that, that gives you a nice building block in your portfolio to help control some of your risk.”
The managers say that Henderson UK Absolute Return is slightly more directional and higher-risk, but investors could be rewarded well over the medium term.
Old Mutual Global Equity Absolute Return has a clean OCF of 0.85 per cent, BNY Mellon Absolute Return Equity has a clean OCF of 0.96 per cent and Henderson UK Absolute Return has a clean OCF of 1.06 per cent.
