Remaining cautious and taking bets against the market is how the Walker Crips’ Alpha: r² team is aiming to beat its benchmark in the coming years as lot of uncertainty still clouds markets.
As part of the series in which FE Trustnet looks at the model portfolios on offer to UK financial advisers, we spoke with the portfolio managers – Gary Waite and Andrew Morgan – about the firm’s process, current positioning, recent performance and outlook.
Alpha: r² was launched in July 2014 and took on its current form in 2015 with the aim of providing investors benchmark-beating returns.
Essentially, the team are targeting outperformance of somewhere around 3 per cent in a given year against the relevant WMA benchmark.
The firm runs five broad strategies from defensive to growth portfolios and three extra portfolios – two higher income variants and an ethical fund.
Chart showing the different portfolios
Source: Walker Crips
Waite said: “They are all benchmarked against the WMA except the defensive model which is benchmarked against the Bank of England base rate.
“From a top-down perspective the asset allocation is driven by the benchmark asset allocation – so we are taking active views versus the benchmark.
“So for example if UK equities are 30 per cent in the benchmark we will take a view on whether to be underweight, neutral or overweight that depending on our views of markets.
“We are entirely driven by our benchmark – not only by asset allocation but also by risk. What we are looking to achieve is returns of benchmark plus 2 or 3 per cent.”
It is this top-down allocation that drives the level of outperformance of the fund, Morgan adds, though it always has a correlation to the benchmark of more than 0.9 (with 1.0 being identical).
The firm has two offerings collectives – which invests solely in funds – and direct – which uses a mix of funds and stocks.
Unlike other portfolios studied previously, this range is not focused on risk as such, but more the targeted return above the benchmark.
“The IFA judges the clients’ capacity for risk. If you take a client directly you will meet the client, judge their risk tolerances and put them in a portfolio accordingly,” Morgan said.
“We don’t do that the IFA does that bit of the process and then communicates that to us.”
Key overweights
“Our key overweight is in the alternatives sector and that is mainly driven by a lack of enthusiasm for other sectors really where we see the equity market both here in the UK and in the US having risen so far so quickly we struggle to see value in both those areas,” Morgan said.
“Almost by default that leads us to alternatives as an area where we think there can be some return.”
The first fund the firm owns is Natixis’ £224m H2O MultiReturns run by Jeremy Touboul and Vincent Chailley.
The Paris-based fund, which aims to beat one month Libor rate by 4 per cent per year over a recommended investment horizon of three years, has returned 27.09 per cent over the past three years, though it has struggled since the start of 2016.
Performance of funds over 3yrs
Source: FE Analytics
The fund is contrarian in nature, adding more risk at times of market sell-offs and has made almost half of its returns from the currency market.
“We have the Natixis H2O fund which is a global macro fund that is heavily diversified and this helps with the aggregate risk analysis of our portfolio,” Waite said
“It sits quite nicely because it is a volatile fund which is quite uncorrelated to the portfolio and always seems to act quite different to anything else – which is what you want.”
The other alternative fund the managers are using is the First State Global Listed Infrastructure run by FE Alpha Managers Peter Meany and Andrew Greenup.
“Just like president Trump we like infrastructure,” said Waite.
“We have First State Global Infrastructure which we think is useful because we can think of it as a bond proxy. You have these contracts for long term projects that will kick off cashflow for the next 10 or 20 years so we have got that as a diversifier within the portfolio.”
The five crown-rated, £2.3bn infrastructure specialist fund has made 64.36 per cent over the last three years and received a tailwind thanks to the expansive infrastructure projects proposed by new US president Donald Trump.
The portfolio also takes advantage of smart beta tools and is looking to add structured products against the FTSE 100 – something we will look into further in an article later this morning.
Key underweights
Despite being moderately underweight both UK and US equities due to high valuations, the managers are generally positive on the sectors, but one area they are reducing exposure is Europe.
Morgan said: “We think there is major political risk in Europe as well and that will colour global stock markets. There’s a calendar of events that is happening this year where Europe is the single riskiest equity market.
“This year with French elections, German elections, major uncertainty in Italy with their banking system, I believe the Greece bailout and problems with the eurozone is not even remotely solved and will rear its head at some point again soon.”
In an upcoming article FE Trustnet will expand on the portfolio manager’s views on Europe and its impact on global markets.
The other area the managers are reducing exposure to relative to their benchmark is bonds, where they have a concern over liquidity.
“We’re constantly concerned about the bond market liquidity because if you think about the issues that we had in the property sector last year that will be magnified tenfold in bonds if bond funds started gating due to redemptions,” Waite said.
Global bonds have an extraordinarily good run of late, with global bonds up 29.64 per cent over the last three years – and much of that seen throughout 2016.
Performance of index over 3yrs
Source: FE Analytics
On the one hand, the low inflation and low interest rate environment seen globally has discouraged savers from holding cash with many moving into the bond market for ‘safe’ returns.
Additionally, with uncertainty abound and shock events including Brexit, Donald Trump becoming US president and the Italian referendum, even the more risk-hungry investors have been adding to bonds for security. As such bonds rose 21.77 per cent in 2016 alone.
The biggest change since then however, as well as the now inflated valuations of bonds, is in the interest rate environment, which the managers see rising at a faster pace than many expect.
Morgan said: “All the signs from what Trump is doing is that those interest rate rises will be a bit faster and a bit steeper than we might have assumed six months ago so that is the main reason for being negative on the bond market.”
Performance
Since the funds came took on their current form in September 2015, they have outperformed the WMA benchmark across the board.
As the below graph shows, the balanced portfolio has returned 22.5 per cent since September 2015 while the FTSE WMA Stock Market Balanced has returned 21.12 per cent.
Performance of fund vs benchmark since September 2015
Source: Walker Crips
Portfolio manager Waite said: “Since inception they are all above benchmark and as you would expect there is not too much volatility versus the benchmark.
“What we are aiming to do is to provide a greater degree of certainty to an IFA of what they are going to get.
“They won’t wake up one day and find that the portfolio is up 15 per cent overnight while the benchmark stayed still – because that’s not what we do – it’s a very much more gradual approach.
“I often say to the IFAs we work with that these are the most boring portfolios in the world in that it does what it says on the tin.”
The funds, which aim to provide a return of around 3 per cent ahead of the benchmark per year, have a platform fee of 0.3 per cent plus VAT and a direct fee of 0.7 per cent.
Morgan added: “Three per cent does involve taking a reasonable about of risk and having a reasonable tracking error. We are taking some reasonably significant positions in the portfolio but we are very conscious of the benchmark. “
Outlook
Overall the managers remain cautious heading into 2017, with European elections, Donald Trump’s presidency and inflation all among the areas investors need to watch out for.
“In these times we don’t believe that it’s time to take on massive amounts of risk because our conviction in markets are quite low across the board,” Waite said.
“From what’s happening in Europe to valuations in the UK and US now is not the time for us to say we have these massive conviction bets and we are going to massively deviate the benchmark.
“It is much more – we are very cautious and conservative about market expectations this year and then as soon as the economic news comes out that makes us more or less cautious we adjust the portfolio accordingly.”
He says while the next 12 months will likely be one with a lot of volatility, it is unlikely markets will end next year much higher – particularly in the UK.
“Markets will often trade sideways and there will be swings on everything from Europe to Brexit negotiations to Trump’s latest announcement but we don’t expect them to massively kick off,” Waite said.
In the UK, the FTSE 100 has continued its steady march higher, breaking the 7,000 ceiling in 2017 for the first time.
Performance of index over 5yrs
Source: FE Analytics
As the above graph shows the index has risen by 49.42 per cent over the past five years and is currently at an all-time-high, however, the managers are not convinced this will last.
“Due to where valuations are at the moment and these potential left of field events we don’t feel like we’ll be sitting here next year and the FTSE will be at 8,000 for example - that would be unlikely,” Waite said.
Morgan added: “It’s totally dependent really on whether one of these left field events happens and given the number that are in the mix there is a reasonable chance that one of them will happen.
“On the chance that none of them happen and we just plod on I would say that I wouldn’t be surprised if equity markets are around the same level this time next year.”