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Jane: How I’m protecting my fund against an equity/bond sell-off

22 August 2013

The manager of the TM Darwin Multi Asset fund says investors now need to look beyond fixed income for low-risk assets with diversification properties.

By Alex Paget,

Reporter, FE Trustnet

Equities and bonds will continue to be highly correlated for the foreseeable future, according to Darwin’s David Jane, who says investors must look further afield to protect their capital.

As FE Trustnet recently highlighted, equities, bonds and commodities were all hit in the aftermath of the Fed’s QE-tapering announcement in May this year. As a result, multi-asset managers have had a tough time making sure they can defend their clients’ cash, as many asset classes have moved in unison – both up and down.

Jane (pictured), who manages the TM Darwin Multi Asset fund, says this correlation is a real cause for concern as traditional asset allocation models are no longer a feasible option for risk-averse investors – particularly those approaching retirement.

ALT_TAG "With equities and bonds both becoming more volatile and positively correlated with each other, we have been searching ever harder for assets which might offer both attractive returns and help better diversify the portfolio," he said.

"Over the past few months, volatility of both equities and bonds has been increasing and the asset classes have become strongly positively correlated. We expect this to continue as markets come to terms with the end of QE."

"UK equities and UK government bonds have moved almost in lockstep since the tapering speech in May, reversing a long period of negative correlation."

"This provides a significant challenge from a portfolio-construction point of view, as it means one of the major sources of diversification, bonds, is now both expensive and correlated with equity," Jane added.

Many market commentators have highlighted this risk recently, saying that current market movements are being dictated by central bankers instead of fundamentals.

Jane’s £35m TM Darwin Multi Asset fund is a top-quartile performer in the IMA Mixed Investment 40%-85% Shares sector so far this year. However, as the graph shows, his portfolio was hit harder than most by the sell-off.

Performance of fund vs sector year to date


Source: FE Analytics

Jane told FE Trustnet a few months ago that he was chopping down his exposure to the so-called “QE beneficiaries” to protect his fund.

In particular he has significantly reduced his emerging markets, corporate bond and Asian property holdings as he expects them to continue to struggle as the market becomes jittery over a reduction in the Fed’s stimulus package.

However, Jane says that building a portfolio that is protected by further correlation is no easy task.

"We have embarked on a search for attractive but uncorrelated assets; however, a caveat is required here," Jane explained.

"To one degree or another, all assets are valued as a function of interest rates, inflation and the economy, so it is only the degree to which they are exposed, and in what way they are exposed, that we can manage."

"A further caveat, which comes from experience, is that where an asset appears low risk or uncorrelated, it is often simply because it is exchanging one form of risk for another."

"In particular, many seemingly low-risk alternative assets appear this way because they are not priced daily on volatile stock markets and, therefore, you are exchanging price volatility for illiquidity."

"With many alternative assets, it is this risk which is ignored," he added.

Because of those risks, the manager says he is adding a number of niche holdings to his portfolio.

"With the above caveats in mind, we have been seeking out alternative, less equity-like assets. Clearly our Japanese REITS and defensive equity do not correlate very much with Japanese equity and the rest of the portfolio, hence these remain attractive," he said.

"Our gold position may prove to be attractive again if investors start to worry about how QE may end. We have recently added a number of new holdings in investment companies that invest in variable rate corporate loans, which offer credit exposure without interest rate exposure."

"A further recent addition has been a company investing in legal claims, clearly relatively uncorrelated, but also relatively illiquid," he added.

Jane has managed his TM Darwin Multi Asset fund since its launch in June 2011, having previously been head of equities at M&G.

According to FE Analytics, the fund has returned 12.78 per cent since then, slightly bettering the returns of the average fund in the sector.

Performance of fund vs sector since June 2011


Source: FE Analytics

Jane currently holds 54.9 per cent of his portfolio in equities. He is very negative on the outlook for the fixed income market and only has 19.7 per cent in bonds and to meet sector constraints he holds nearly 20 per cent in cash.

The manager says that the key to future success and capital protection will be to keep a constant watch on changing macro conditions.

"Our search for more diversification will continue, but not for diversification's sake. We must identify assets which offer attractive real returns over time, where we understand the risks and can manage them in the context of the overall portfolio."

"As we expect rising bond yields and equity volatility to be a continuing trend, we expect to have to work hard to keep the overall portfolio risk in line with client expectations," he added.

TM Darwin Multi Asset has an ongoing charges figure (OCF) of 1.84 per cent and requires a minimum investment of £1,000.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.