A preference for Japanese equities over European, buying investment-grade bonds over government and tilting towards infrastructure assets are some of the stances that Thesis Asset Management has taken in its model portfolios against the uncertain market backdrop.
As part of new series in which FE Trustnet will be taking a closer look at the model portfolios on offer to UK financial advisers, we spoke with Thesis model portfolio manager Gaurav Gupta about the firm’s process, current positioning, recent performance and outlook.
Thesis Asset Management has been investing on behalf of clients for more than 40 years, focusing on the long term regardless of occasional economic upheavals and short-term market turbulence.
The firm uses seven different risk mandates serving those with a low/moderate tolerance to a relatively high tolerance, split across three model portfolio ranges. The group moved to a more centralised process around four years ago to make its offerings more accessible to investors.
Essentially, this means a dedicated research team is focused on making sure these risk mandates suit the different criteria set in each of the portfolios.
Thesis’ 7 risk mandates
Source: Thesis Asset Management
As well as its model portfolio service, which will be looked at in more detail throughout this article, the company also offers personalised investment portfolios – a bespoke service for financial advisers – and a fund-of-funds range called Optima, which offers lower, middle and higher risk portfolios.
However, its main offering is the model portfolio service which is split into three different products: collectives, securities and passive portfolios.
The collectives range will only hold mutual funds, securities can use listed assets such as investment trusts and equities as well as mutual funds, and the passive portfolios are a low-cost solution using ETFs or index funds.
Gupta said: “The long-term performance is fantastic on all our products and that’s really what we focus on. It’s the driver of how we allocate.”
Theis’ flagship offering – the Securities 4 portfolio run by Steven Richards – is built around mutual funds and listed vehicles but will also own individual stocks to maximise opportunities. Gupta notes that the inclusion of individual securities help to bring down the portfolio’s fees, as they do not levy management or performance charges.
He says this has given Thesis a “nearly unique” approach in the model portfolio space: “All the other model portfolio services we see in the market are just fully loaded with collectives but this one mixes the two to try and get a cost advantage and where adds our expertise for a performance advantage too.”
So how is this reflected in Thesis’ model portfolios at the moment? FE Trustnet looks at the Securities 4 portfolio in more detail.
Key underweights
Digging into the portfolio, the Securities 4 model portfolio is underweight equities and has been for much of 2016.
The portfolio currently 39.88 per cent in equities, below the FTSE WMA Stock Market Income index’s 52.5 per cent; it is 7.19 percentage points underweight UK equities and 5.43 percentage points underweight international equities.
Gupta said: “This year we have been underweight equities for the majority of the time because we took a very risk-off approach when it came to the Brexit announcement and the US elections.
“We didn’t feel like it was the best place for us to increase the risk when there were two big macro uncertainties looming in 2016.”
Of particular note is Europe, where Gupta says the portfolio is underweight given the political uncertainty expected over the next 12 months caused by Brexit as well as general elections in Germany, France and Holland.
He sees Japanese and European equities as similar trades, but says the latter looks much more risky than the former.
“Europe and Japan are very similar trades in how we perceive them,” he said. “They’ve both got very supportive central banks and loose monetary policy so quantitative easing is still very prevalent there. They have low interest rates as well.”
Performance of indices in 2016
Source: FE Analytics
As the above graph shows, Japanese equities have returned 22.04 per cent to investors over the last year while their European counterparts have returned 10.30 per cent.
Gupta added: “We use hedged share classes for both Europe and Japan exposure because we believe that both currencies are likely to be weak in the longer-term.”
Key overweights
On the other side of the coin then, it is unsurprising that while the portfolio remains underweight equities on the whole, it is overweight Japanese equities. As noted, the country maintains loose monetary policy while a reform package from prime minister Shinzo Abe has been launched to kick-start the economy.
Gupta said: “We’re overweight versus the benchmark slightly. Essentially we’ve chosen to invest more into Japan than in Europe.”
A coming article will look at Thesis’ reasons for preferring Japan as well as the funds that it is using to take exposure to the world’s third largest economy.
Another area the portfolio is overweight is fixed income, with 32.49 per cent allocate to the asset class versus the benchmark’s 27.5 per cent weighting.
Within this, the Thesis team is low on UK gilts and instead is looking towards short-duration corporate bonds for their exposure to fixed income.
“We’ve had the exposure to corporate bonds rather than gilts for quite a while now and one of the benefits to that is you are going to get the yield,” Gupta said.
However, he says that “you are not going to make as much as gilts” in terms of capital appreciation as has been seen in the recent past, when government bonds rose strongly.
“I think we would have got punished more by IFAs for not being in gilts if it was always going to be lower rates for longer,” he said.
“But because there has been such an expectation over the last three years that interest rates were going to rise, we could have been punished a lot more due to the loss that would have resulted by an aggressive rate hike in the UK.”
He adds that with 10-year yields having gone as low as 1.1 per cent and the base rate at 0.25 per cent, the potential for gains versus losses appears “vastly skewed to the latter”.
“[Losses] would have been a lot tougher to stomach than potentially not making as much in gains. So we have a high allocation to investment grade.”
The portfolio is also overweight infrastructure for a similar reason – yield – as many companies and funds are offering attractive pay-outs, while many of the projects they invest into are partially government backed.
“The yield we are getting off them are very attractive versus government bonds for instance,” Gupta said.
Additionally, with the new US president-elect having pledged to embark on bold infrastructure projects during the campaign trail and the UK government announcing infrastructure plans at the Autumn Statement last week, the asset class could be in line for a boost.
“We are structurally overweight against our benchmark and I think we are going to maintain that overweight until the yield becomes less attractive,” he explained.
Recent performance
The model portfolio has struggled this year compared to its FTSE WMA Stock Market Income benchmark in part due to the surprise rise in equities following both the Brexit and US presidential election votes, as well as the continued gains in gilts.
As the below graph shows, both gilts and equities, two areas as already mentioned that the portfolio is underweight, have performed well this year.
Performance of indices over 1yr
Source: FE Analytics
UK gilts have gained 7.34 per cent while the FTSE All Share has risen 12.09 per cent so far this year despite a sharp fall following the EU referendum in June.
As a result, the portfolio has underperformed over the last 12 months, returning 4.84 per cent – around 8.07 percentage points lower than the benchmark.
However in the previous four years, the portfolio outperformed in every year and despites its struggles over the last 12 months, remains significantly ahead on three- and five-year views.
Performance of portfolio over 3yrs
Source: Thesis Asset Management
Broadening out to a five-year period, the portfolio is much more robust, returning 61.78 per cent to investors compared with the benchmark’s 49.65 per cent.
Gupta says the long-term performance of the portfolio is “excellent”, adding that the goal is to make sure investors get better returns at lower risk.
“We don’t want a massively bumpy journey. We really want to make sure we are protecting client assets and if we’re avoiding risk, over the long term we will achieve our goals,” he said.
Investment outlook
Moving forward, Gupta says the portfolio will be looking to reduce its cash position with potential landing spots including short-duration bonds and US equities.
The portfolio currently has 6.53 per cent in cash, but with the key events in 2016 already behind us, he says it is safer to reduce this position.
“We didn’t feel like it was the best place for us to increase the risk when there were two big macro uncertainties looming in 2016 [Brexit and the US elections],” he said. “Now those macro risks are over there’s more opportunities for us to deploy cash.”
He says while there may be potential European surprises and Japanese issues remain unsolved, “we can now invest more certainly in some of our high conviction ideas”.
Additionally, the expectation of rising inflation has had an impact, with the Bank of England now expecting inflation to hit 2.7 per cent next year, up from the current rate of 1 per cent.
Bank of England’s inflation projections
Source: Bank of England
“The other reason we want to actively get cash off our portfolios because we’re seeing a spike in inflation in the UK,” he said.
“If inflation is predicted to be over the next 10 years an average of 3 per cent – and we’re getting that forecast from the 10-year breakeven rate – and in our cash accounts we’re getting zero per cent interest, we’re effectively losing 3 per cent each year.
“We’re looking to get that cash invested and where we’re going into is short-dated corporate bonds as a way of gaining interest in a low-risk vehicle.”
He says zero-to-three year or zero-to-five year duration bonds look most attractive while offering some risk protection.
“Being shorter-duration protects us much more, whilst other defensive measures taken by the strategic bond managers with whom we invest should also benefit our portfolios,” he said.