Although there are times when investors can benefit from active management to tweak exposures, Tatton Investment Management chief investment officer Lothar Mentel believes portfolio construction should start with trackers.
“First and foremost, the starting position for any active asset allocator should be to go through trackers unless there is some really good evidence that by paying more you are going to get a higher return potential to come through,” he said.
As such, during the times when he thinks there is not much potential for alpha to be generated in markets, Mentel will increase the passive exposures even in Tatton’s managed fund ranges.
“We just don't see the point of paying for active management when we don't think it's going to add particularly much,” he added.
“I was always very much of the view that if in the lower risk profiles your risk premium is only pretty much 2 per cent above the rate of inflation, if you erode that down by charges there's literally nothing left for the client.
“So, costs and charges, even if they weren't that dominant a factor in the past 10 years because returns both for equities and bonds were so good, it was an issue.”
This is one reason why its £123m VT Tatton Blended Balanced fund, for example, has kept its ongoing charges figure (OCF) at 0.58 per cent – which places it in the top quartile in terms of low costs of all funds in the IA Mixed Investment 20-60% Shares sector.
Like many managed funds offered by Tatton Investment Management, a large chunk of the portfolio’s equity and bond exposure is through passive index tracker funds. Some of these include the £11.9bn Vanguard US Equity Index and BlackRock’s £11.2bn iShares UK Equity Index trackers.
Its biggest bond exposures are through the £4.5bn Vanguard UK Government Bond Index and the $22bn Vanguard Global Bond Index offerings.
Mentel explained why a passive bond exposure was particularly important from not just a cost perspective, but an asset allocation perspective: “There was a time in fixed interest where we had a specific view on fixed interest, and sometimes active managers just take them the contrary position to what your view is.”
If the team at Tatton had a particular view on yields and which direction they are headed or what level of duration risk it is comfortable with, the whole positioning of portfolios can be upended if the active bond manager takes a different view.
“The one way of really making sure that we get the duration that we want in the portfolio is just by going for passive instruments. Then we know what we've got,” Mentel said.
“Then if it goes wrong - well that’s our fault. But if it goes right then at least there wasn't an investment manager who just contradicted our own position.”
However, Mentel also revealed how an active exposure can be useful in avoiding what he perceives to be limited upside in a broader stock market dominated by a few companies.
One portfolio change it made earlier in the year was adding the £3.6bn JPM US Equity Income and £2.6bn Artemis US Select funds to its portfolios.
Mentel likes these two funds because they gave Tatton’s portfolios less exposure to what he labelled “particularly highly valued” tech giants.
He is bullish on the US in general because of the economic momentum that is “gripping the country”, paired with the fiscal support and initiatives being pushed by the Biden administration.
“But we think it's perhaps run a bit too far on the mega techs,” he said. “We're just wary of them. We always try to stay away for our clients from those things that have already gone quite a long way.”
In contrast to the S&P 500 index where Facebook, Amazon, Alphabet, Apple and Microsoft make up the bulk of its top positions, JPM US Equity Income has its biggest positions in companies such as Comcast, Bank of America and BlackRock.
Mentel said the fund was particularly appealing because of the way it has managed to avoid the big US tech giants: “At the moment, we prefer the JPM US Equity Income fund more because it's less growthy.”
He revealed that Cormac Weldon’s Artemis US Select fund was initially added mostly due to increasing demand from Tatton clients who wanted more exposure to global companies.
“If you do that, then the US exposure just does go up by quite a few percentage points and therefore we just wanted to have more active funds in the US,” Mentel said.
“Cormac has been known to us for a long time from previous work when he was at Threadneedle, and so we’ve followed him a long time, know him very well and like his approach.
“Cormac will be a bit more growthy - even though he manages that really well – we have a slight preference for the JPMorgan fund.”
Performance of the fund versus sector & benchmark
Source: FE Analytics
The VT Tatton Blended Balanced fund has delivered a total return of 23.23 per cent since inception in January of 2018, compared to 15.10 per cent from the average IA Mixed Investment 20-60% Shares fund.