FE Alpha Managers Algy Smith-Maxwell and Peter Lawery (pictured) say that preserving wealth against inflation is still the central problem for investors in the current environment, warning that nothing fundamental has changed in the world economy despite the recent rally in markets and renewed optimism in some circles. They say inflation-linked bonds are useless to that end, given the unreliability of official statistics, and that they are maintaining their weighting to gold despite the recent sell-off in the metal.
Smith-Maxwell said: "We don’t hold any more bonds than we have to in the bond component."
"Equities are the least bad place to hedge the risks of inflation in the future."
Lawery added: "With such an expensive bond market, it’s an easy decision not to be overweight that market."
"If you are wrong about not holding a lot of bonds there’s not much upside because they are so expensive, so it pushes you into relatively cheap areas, which is equities and emerging market corporate debt."
"We have let the bond weighting come down to its absolute minimum and equity to its maximum," he added.
Lawery poured scorn on the notion that index-linked bonds offer protection.
"Index-linked offer inflation protection against official figures, which are Alice in Wonderland numbers," he said. "Do they protect against the real rise in the cost of living?"
"I would rather own predictable, dependable large cap companies that can pass on cash to customers than government issues of index-linked bonds."
The team is also hanging on to its gold exposure despite the sudden fall in its price over the weekend.
Performance of gold in 2013
Source: FE Analytics
"We had 10 per cent in it on our funds a few years ago. John [Chatfeild-Roberts] sold 20 per cent of it and since then we have had strong inflows and now gold is between 2 and 5 per cent of our portfolios," said Algy Smith-Maxwell.
"To have a currency that cannot be printed is a sensible holding in a portfolio."
"Gold has a long history of moving from the hands of the weak to the hands of the strong," he added.
"I’m not sure what has caused the gold price to sell off. It seems to me that there have been some forced sellers that have been taken out and shot by the market."
There are five funds of funds in the Jupiter Merlin range, all of which have a strong track record.
The five crown-rated Jupiter Merlin Income fund is the most popular, according to data from FE Analytics, having attracted £660m over the past year; the fund is now £3.5bn in size.
The portfolio sits in the IMA Mixed Investment 20%-60% Shares sector and is in the top quartile over one, three, five and 10 years.
Over three years it has made 25.12 per cent while the sector has returned 15.92 per cent.
Performance of fund vs sector over 3yrs
Source: FE Analytics
The fund is currently yielding 3.1 per cent, according to FE Analytics, and the managers say it is difficult to find investments with a good yield that meet their criteria.
"Income is harder to come by and we have to look for alternative ways to generate it," said Lawery.
One new asset the managers are considering is property, which has been out of favour for many years.
Yields of 7 and 8 per cent are available on the market, which has made it appealing to the managers.
"We have not worked out how to play property yet. It’s like a lobster pot, so you have to be sure you want to get into it," said Smith-Maxwell (pictured). "But 7 to 8 per cent is attractive and maybe we have got to start to look at a way of getting exposure."
"I don’t know the way yet but we are starting to do some digging."
The team has slightly increased its exposure to Japan during the recent stock-market surge, but remains wary on the medium-term outlook for the country.
"Turnover has been low but we have trickled more money into Japan," said Lawery. "Markets are giving Japan the benefit of the doubt, but what we have done is hedged the yen back to sterling."
"That’s probably the biggest asset allocation we have made in Merlin."
The most recent launch in the range came in September of last year: the Jupiter Merlin Conservative fund.
The £17.7m portfolio has made 6.95 per cent since launch, compared with 5.73 per cent from the IMA Mixed Investment 0%-35% Shares sector average.
Smith-Maxwell says that half his pension is in the fund, which is intended to be Jupiter Merlin Income with half the risk.
He adds that the fund is intended to appeal to clients with a lower risk appetite.
"We had a large amount of advisers saying they wanted to get clients out of cash but couldn’t get them into equities," he said.
"It’s a first step out of cash into risk assets, which it seems clients are starting to take."
Lawery says that holding money in cash is even more unappealing after the Cyprus bail-out plan that saw large deposits taxed by the authorities.
"Do you want cash in the bank in a banking crisis? I think it’s an interesting precedent that has been set now in Cyprus," he said.
He adds that the euro crisis as a whole is far from over, with the choice facing the continent of either Germany transferring its wealth to the poorer nations or the latter devaluing internally, which he thinks is a course of action that democratic nations will find it hard to take.
UK investors should also be preparing themselves for the possibility that government subsidies they are expecting to receive in the future will not be honoured, he says.
"The country can’t afford a lot of those public sector pensions. I just cannot see how they can be honoured," he said.
"The other hot potato is the NHS. The politicians don’t want to tackle it but it’s a very expensive thing to provide because it’s such a large part of the budget and it’s growing astronomically."