Investors should focus their portfolio on areas of the market that offer value in the current environment which is fraught with risk, according to Hawksmoor’s Ben Conway and Richard Scott, who say more mainstream assets will come under increasing pressure in 2016 due to various concerns. 
Though equity markets have made a slight gain in 2016, that masks a huge degree of volatility and some large drawdowns as investors have been very wary of China’s economic woes and fears over the future of central bank policy.
Scott and Conway, whose Hawksmoor Distribution and Hawksmoor Vanbrugh funds are both top decile in their respective sectors since launch, believe that the remainder of 2016 will be an increasingly difficult time for investors seeking to build a diversified portfolio.
Performance of funds versus sectors since respective launch dates
Source: FE Analytics
“The margin of safety in markets has diminished somewhat in recent weeks because earnings forecasts have generally been coming down at the same time that share prices have been rallying,” Scott (pictured) said.
“Although you can find pockets of value, we don’t think we are faced with markets that are cheap in aggregate terms. There are also things that are causing uncertainty, like in the UK with a potential Brexit and in the US with an upcoming presidential election.”
“Also, there is a lot of uncertainty about the outlook for US Federal Reserve policy which has the potential to create quite sharp movements in currencies and bond markets.”
This unnerving backdrop hasn’t meant Scott and Conway, along with fellow co-manager Daniel Lockyer, have fled to highly defensive assets, though. Indeed, they say the best way to construct a portfolio at this point in time is to focus on areas that offer value – which has led them to sell down their exposure to mainstream equity markets and avoid traditional ‘safe haven’ bonds.
“As a result of that, we wouldn’t say that anybody (including ourselves) has any conviction whether markets will be higher or lower and whether the economy will be better or worse over the coming months ahead,” Scott said.
“With that in mind, I think it is much, much more profitable to look beneath the market to find those pockets of value where there is a margin of safety and build your portfolio on those.”
In this article, they highlight three areas of the market that they think offer good value going forward and talk through the funds they have been buying to access that exposure.
Credit – Baillie Gifford High Yield Bond
First and foremost, Conway says they have been buying high yield bonds as the significant sell-off in the asset class over the last year – due to falling commodity prices and fears of a global recession – has led to very attractive valuations.
“We have increased credit exposure for the two funds and this was primarily done via high yield bonds,” Scott said.
“High yield bonds generally have a higher margin of safety in the fact that they price in a higher probability of recession than perhaps any other asset class. When you look at the performance of high yield bonds versus equities over the past six to nine months you can clearly see that, with equities trading not far off their highs but high yield bonds having sold off significantly.”
He added: “They do represent value to us.”
The team at Hawksmoor do hold a number of funds in the space, but one of their most recent acquisitions has been Baillie Gifford High Yield Bond.
The five crown-rated fund has been managed by Donald Phillips and Robert Baltzer since June 2010 and, according to FE Analytics, it has been a top quartile performer in the IA Sterling High Yield sector over that time with gains of 53.31 per cent.
Performance of fund versus sector under Phillips and Baltzer
Source: FE Analytics
It has outperformed over one, three and five years as well. The £720m fund has a yield of 4.1 per cent and has a clean ongoing charges (OCF) of 0.38 per cent.
Gold – CF Ruffer Gold
Gold has had a barnstorming 2016 so far with the price of the precious metal soaring by 21 per cent in sterling terms.
There have been a number of drivers for this, such as a general loss of faith in central bankers and equity market volatility, but many would be forgiven for thinking the best is now over for gold given various false dawns in the asset class over the last few years.
Hawksmoor, on the other hand, have added even more gold to their portfolio but have decided to take higher beta exposure via the CF Ruffer Gold fund, which focuses on mining companies.
“We topped up gold in February when it became clear that central bank credibility was becoming increasingly undermined,” Conway said.
Scott adds that it has been the best first quarter for gold in 30 years, which is very telling.
“I think that is an important message as it shows the degree to which people, including ourselves, are becoming worried about whether the policy we have seen from central banks is reaching the limits of its ability to be affective in changing short-term economic trends,” Scott said.
Paul Kennedy has managed the £550m CF Ruffer Gold fund since February last year.
While that is only a short timeframe, it has returned a hefty 53.62 per cent under Kennedy putting it some 30 percentage points ahead of its FTSE Gold Mines benchmark. On top of that, it has more than doubled the returns of the average IA Gold fund over that time.
Performance of fund versus sector and index under Kennedy
Source: FE Analytics
However, Kennedy says investors shouldn’t get carried away with that performance.
“Whilst we believe it is likely that the shift in investor sentiment towards gold is structural, there remains plenty of scope for this to be challenged in the year ahead, given the solidity of the US economy.”
Kennedy added: “In this context, we are continuing to manage our exposure to stocks which offer only generic beta to the gold price and tilting the portfolio slightly further towards special situations, as these offer a better risk/reward balance.”
The fund’s OCF is 1.33 per cent.
Emerging market debt – Ashmore Emerging Markets Short Duration
Another area Hawksmoor have been buying is emerging market debt, an asset class they shied away from for a number of years.
Though investors have tended to dislike all things emerging markets for some time due to China’s woes, Conway says the valuations on offer mean it would be foolish not to have some exposure to developing world debt within a portfolio at this point in time.
“We’ve started to see evidence of what we would call dislocation and that is when an asset class sells off and that sell-off bares absolutely no relation at all to the underlying performance of the fundamentals,” Conway said.
“Those are the types of opportunities that we are really keen to find in periods of volatility.”
For their exposure, Conway and co have recently bought Ashmore Emerging Markets Short Duration fund, which was only launched in September 2014 and stands at $305m in size.
According to FE Analytics, the offshore fund delivered a returns of 20.55 per cent since its launch – an impressive feat given the average fund in the equivalent IA Global Emerging Market Bond sector has made just 4.56 per cent over that time with significantly larger drawdowns.
Performance of fund versus sector since launch
Source: FE Analytics
“It is a dollar-denominated, very benchmark-agnostic, very high yield emerging market corporate debt fund,” Conway added.
“That to you might scream risk and volatility and you are probably right on the second point, this is likely to be a volatile fund but not incredibly so, but the point here is that yields available on dollar-denominated emerging market corporate debt are substantially higher today than they were in 2006.”
“That is simply not something you can say about other debt instruments.”
Indeed, Ashmore Emerging Markets Short Duration has a yield of 8 per cent at the moment but has a high OCF of 1.49 per cent.