The biggest challenge investors face at the moment is negative sentiment sparked by the belief that we’re entering a deflationary world, according to John Husselbee (pictured). 
The head of multi-asset at Liontrust says that underlying fundamentals are actually supporting a more reflationary-type world, although he warns that sentiment can eventually impact these foundations.
To minimise such risks while maintaining a value strategy, Husselbee and his team adopt a multi-layered approach to selecting assets for the portfolio to ensure they are attractively valued, likely to boost returns and are also reliable.
“Our tactical asset allocation determines whether we’re going to be overweight or underweight. Within that, the next layer of value is style. We’re trying to look at investment style and we break that up very simply between value and growth and large cap and small cap,” he explained.
“In doing so, we want to find managers that we believe consistently stay true to their investment style. If you want to do that you’re then drawn towards managers who have longer track records.”
However, the manager says that the team isn’t trying to drive performance through fund selection, and explains that it aims to do this through instead multiple plays to maximise diversification.
“It’s about making sure that, not only that we have the right strategic asset allocation but the right tactics, then the right style, and we’re looking to add value from the manager’s alpha as well. But we’re not trying to dominate the portfolio through one aspect or another,” he pointed out.
To provide FE Trustnet with a taste of his selection process, Husselbee talks through the four areas of the market he is seeing the best opportunities in at the moment:
Smaller companies
“An area we do like is smaller companies. There is still solid growth there even though it can hardly be described as fast,” he said.
“In some economies, particularly in the US and the UK, smaller companies are favoured. In the US we might not like the whole market for valuation reasons but we do like the smaller companies.”
Usually, the manager will use a combination of both active and passive plays to utilise regions of the market he likes, as he explained in an FE Trustnet article last week.
For the small-cap space, though, he says that it is more difficult to invest in passives and as such uses different mandates in this area of the market.
In Europe, for instance, he uses Nicholas Williams’ Barings Europe Select fund within the smaller companies space as opposed to a combination of Jupiter European, JO Hambro Continental European and Fidelity Europe ex UK, which is what he uses for larger stocks.
For his UK small-cap exposure he uses the £129m Henderson UK Smaller Companies fund, which has been managed by Neil Hermon since 2002. Over this time frame, it has provided a total return of 417.09 per cent, compared to its benchmark’s return of 383.82 per cent and its sector average’s return of 335.02 per cent.
Performance of fund vs sector and benchmark under Hermon
Source: FE Analytics
The fund has a clean ongoing charges figure (OCF) of 0.84 per cent and yields 1.2 per cent. Among the other small-cap funds he uses that invest in his preferred regions are Eytan Shapiro’s JP Morgan US Smaller Companies and Johan du Preez’s M&G Japan Smaller Companies fund.
Emerging markets and Asia
A more contrarian stance now as Husselbee began to see a wealth of value opportunities in both Asia and emerging markets 12 months ago and has since increased these positions twice – once in June and once in December last year.
“In terms of Asia, if we look at our fund selection it’s fairly defensive - we don’t have high beta plays in that and we don’t have high beta plays in emerging markets either,” he said.
“It shows you that while we’re happy to build our position, we’re doing it on a cautious basis.”
For his Asia exposure, Husselbee is using Stewart Investors Asia Pacific Leaders, which has five FE crowns and is £7.7bn in size.
It has been managed by FE Alpha Manager Angus Tulloch since 2003 and co-managed by fellow FE Alpha Manager David Gait since last year. It aims to grow returns through investing in companies with a market cap of more than $1bn and has a concentrated portfolio of 50 holdings.
Over Tulloch’s tenure, the fund has achieved a top-decile annualised volatility, Sharpe ratio, which measures risk-adjusted returns, and maximum drawdown, which measures the most an investor would have lost if they’d bought and sold at the worst times.
It has also significantly outperformed its benchmark and peer average over the same time frame and currently yields 1.44 per cent. Asia Pacific Leaders has a clean OCF of 0.9 per cent but is closed to new investors.
Performance of fund vs sector and benchmark under Tulloch
Source: FE Analytics
The other fund that Husselbee uses in this market area is Schroder ISF Asian Total Return, which aims to grow returns and income and also seeks capital preservation through the use of derivatives.
Currently, the $2bn fund has a substantial 14.56 per cent cash weighting and has outperformed its MSCI Asia Pacific ex Japan benchmark more than six times over since its launch in 2007.
Schroder ISF Asia Total Return has a clean OCF of 1.33 per cent and yields 3.93 per cent.
Alternatives
Husselbee is currently overweight alternatives through holdings in hedge funds and absolute return funds.
“To provide our definition, because that’s something that changes from one person to another, I would say an alternative asset is something that should display low or no correlation to traditional asset classes,” he explained.
“What we use hedge funds for is enhancing, so trying to get a different path of return, and with absolute return funds we use them as risk reducers and diversifiers in our portfolio.”
However, the manager warns that choosing alternatives requires a vast amount of time and resources, as their performance is more reliant on the skill of the individual managers than the behaviour of the market.
“What’s very noticeable from the indices is that since 2008, if you just take a typical hedge fund index or an absolute return index, most of them are fairly flat over 2008 this period,” he pointed out.
“However, if you do your homework, the dispersion of returns is fairly wide. You need to do your research to make sure you’re in the right fund that can consistently deliver.”
The absolute fund that Husselbee uses is the offshore Pyrford Global Total Return fund, which is three crown-rated and is £2.3bn in size. However, it is unavailable on most investment platforms.
Commodities
Commodities is an area of the market that the manager is looking to increase active exposure to following the continuing drop in the prices of raw materials.
Performance of index over 1yr
Source: FE Analytics
However, he says that it is an area of the market in which value investors must tread carefully so as not to put capital at high levels of risk.
“Commodities are more challenging. There are two approaches – you can take an index approach which is what we’ve taken. Is it the most efficient vehicle? Probably not, but it does give you exposure to commodities,” he admitted.
“The other way to do it is to use some of these out-of-favour natural resource and global resource funds. Then, you’re not only getting the commodity play, you’re also getting the equity play as well.”
“There will be a point in the cycle in the future where we’d be more willing to use that type of thing, but at the moment we’re just using a plain ETF which tracks the Dow Jones commodity index.”
Since Husselbee founded North in 2001, which was later bought by Liontrust, he has outperformed his peer group composite by 12.28 percentage points with a return of 105.99 per cent.
