Finding attractively valued and uncorrelated assets has never been harder than it is now, according to Hawsmoor’s Ben Conway.
The manager, who co-runs the top-performing Hawksmoor Vanbrugh and Distribution funds, says there is no one obvious asset that offers a margin of safety in terms of cheap valuation while also performing differently to mainstream financial markets.
This, combined with heightened levels of geopolitical uncertainty, a heavy global debt burden and slowing growth, means many investment professionals have positioned their portfolios more defensively over recent months.
“Our stock answer is always that the best defence is to construct a portfolio appropriately – which is to say, identify a variety of assets, all with a margin of safety, that will be uncorrelated to each other,” Conway explained.
“I think it is hard for us to point to any one asset that is guaranteed to be defensive since it’s hard to know what characteristics will be desirable in the next market set back.
“Indeed, this hints at one of the cornerstones of our investment philosophy – you can’t predict the future direction of markets or know which assets will perform strongest. The best you can do is have valuations on your side, and try to find uncorrelated assets.”
While he says this is challenging in the current environment, the senior fund manager talks through three areas of the market he finds attractive at the moment and the investment vehicles he is using to play them.
High-growth, specialist open-ended funds
First up, Conway likes Polar Capital Biotechnology, which has been managed by David Pinniger since launch in 2013.
The $181.5m fund is domiciled in Ireland and benchmarked against the NASDAQ Biotechnology index. While this is arguably a tough benchmark to beat, it has managed to do so by 41.53 percentage points since launch with a total return of 113.55 per cent.
Performance of fund vs benchmark since launch
Source: FE Analytics
“Polar Biotechnology is a very specialist and small fund in an area that continues to have superb fundamentals, has a great tailwind via a structural growth story in specialist drugs and is a sector temporarily out of favour while the US election circus goes on,” Conway said.
Another specialist area of the market the manager will play through open-ended funds is UK micro-caps, given its high growth potential and their relative immunity from wider UK market behaviour.
In this space, he likes Judith MacKenzie’s £23.5m Downing UK Micro-Cap Growth fund, which has five FE Crowns and aims to generate growth through a concentrated portfolio of between 25 and 30 holdings. These holdings will typically have market caps between £20m and £150m.
Conway likes this fund in particular because the manager will close it to new money when it hits £100m in size, which will help to keep it liquid and nimble.
Conway also has exposure to UK micro-caps through closed-ended vehicles for liquidity reasons. In this space, he holds River and Mercantile UK Micro Cap, which was launched in 2014 and has an AUM of £75.9m.
“Micro-caps are still very cheap and companies accessed by these funds should fare well regardless of macroeconomic headwinds,” the manager added.
Niche property investment trusts
Conway likes this area of the market as he believes it is attractively valued so valuation risk is therefore minimal.
One trust he holds in this sector is Target Healthcare REIT, which aims to provide both growth and income through high-quality care home assets with attractive financial characteristics.
While it is currently trading on a sizeable 10.9 per cent premium, the senior fund manager points out that it has a dividend yield of 5.6 per cent and 100 per cent of its income is inked to inflation.
Since its launch in 2013, the £282.4m trust has returned 32.12 per cent, underperforming its sector average (which consists of only five trusts) by 9.63 percentage points.
Performance of trust vs sector since launch
Source: FE Analytics
Had an investor placed £10,000 into the trust at launch, they would have received £1,968.65 in income.
Another niche property investment trust Conway likes is AEW UK REIT, which is trading on a 6.7 per cent premium and is also yielding 5.6 per cent.
Manager Alex Short aims to exploit pricing inefficiencies in smaller commercial properties which are let on short occupational leases in strong commercial locations.
Since its launch last year, the trust has more than doubled the returns of its average peer. It has also achieved a lower maximum drawdown and annualised volatility than its sector average over the same time frame.
‘Traditionally’ defensive plays
The two most significant, typically ‘defensive’ positions the Hawksmoor team holds are Phoenix Spree Deutschland and Royal London Short Duration Global High Yield, according to Conway.
“The former is a trust we have mentioned many times and is entirely focused on German, mainly Berlin, residential property,” he said.
“The underlying growth in rents here is very strong and supported by structural demand and a very supportive policy backdrop (NB this is 100 per cent euro exposure).”
The £212m trust is managed by the team at PMM Partners and has a portfolio of 120 properties containing 2,344 residential units, 197 commercial units, three commercial buildings and 513 garages and car parking spaces.
Since its launch last year, the trust has returned 58.31 per cent compared to its sector average’s return of 32.02 per cent.
Performance of trust vs sector since launch
Source: FE Analytics
The second typically defensive play Hawksmoor has in its portfolios is the open-ended Royal London Short Duration Global High Yield fund, which is headed up by Azhar Hussain.
“The manager can identify smaller issue sizes that are mispriced by the market and ratings agencies, who don’t realise that the probability of default falls the closer to maturity the bond gets,” Conway continued.
“Typically bonds that are closer to maturity are mispriced as they are rated the same as longer duration bonds from the issuer.”
The three crown-rated fund predominantly aims to provide income while also outperforming the 3 Month LIBOR by 2 per cent per annum over rolling three-year periods.
If an investor had placed £10,000 into the fund at its launch in 2013, they would have received £2,143.64 in income. It has also outperformed its benchmark every year over the same time frame.