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Everything you need to know about Thomas Miller Investment’s model portfolios

12 April 2017

As part of its ongoing series, FE Trustnet looks under the bonnet of model portfolio providers – up next Thomas Miller Investment.

By Jonathan Jones,

Reporter, FE Trustnet

While the overall investment picture looks positive – at least for the next year – valuations mean a higher than normal weighting to cash is prudent, according to the team behind Thomas Miller Investment’s (TMI) model portfolios. 

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 – Andrew Herberts and Jordan Sriharan – about the firm’s process, current positioning, recent performance and outlook.

Originally developed for its in-house financial advisers, the TMI portfolios are now being rolled out to the wider adviser community.

The model portfolios are constructed so that over the long-term asset allocation should deliver cash plus a targeted risk-weighted return.

The firm runs its model portfolios with the aim of beating cash plus 2-5 per cent on a net of fees basis respectively, with a higher return target equating to higher risk appetite.

Herberts (pictured) said: “That helps IFAs because they need to know what returns the asset allocation will deliver and cashflow modelling is one of the strongest tools that IFAs have in the armoury and these portfolios were built to support that.”

Overall, TMI runs 12 portfolios, four that include alternatives, four excluding alternatives, two passive strategies and two ethical strategies.

 

“The team have asset allocation views and that is the first stage of our investment process, and then stage two is how we implement that particular view; that is where the collectives research team comes in,” head of collections research Sriharan said.

“We use a mix of passive and active managers in our portfolio. So, for example. in the US if we thought value would outperform growth in 2017 we would deliberately add an active manager with a value bias that would allow us to tilt the US equity bucket.”

As the model portfolios are designed for risk, they won’t catch as much on the upside but should protect on the downside relative to peers, the portfolio managers explain.


 

Key Overweights

The team’s current overweight positions at first seem to be a juxtaposition with riskier emerging market equities doubling up with cash.

Herberts said: “I suppose the key overweight across the portfolios is probably cash, though that sounds pretty dull.

“We’ve got other ones that we’re running but actually cash fits a little bit to the whole alternatives story as what we’ve seen is huge correlation of assets on the way up including most alternatives and what we’ve been thinking is, if all these drivers come off and are correlated on the way down, then where do we get our protection.

“I think a lot of managers are going fairly blindly into alternatives, looking at very historical relationships and ignoring what has happened in the last year or so.

“For us cash is a zero correlation asset but it’s never a strategic asset as much as a tactical asset. It’s the ultimate resilience asset.”

However, to achieve cash plus returns the team have to invest somewhere and they are currently overweight emerging market equities, taking some risk away from the UK in order to do so.

“In the model portfolios we’ve had an overweight to emerging market equities – certainly in the higher risk portfolios –for the best part of six or seven months now,” Sriharan said.

“I think people will badmouth and ‘trash talk’ emerging markets on the grounds that Donald Trump is going to do something abhorrent to them. But the reality is we try and look past the politics and focus on the fundamentals and there is a strong growth story in the emerging markets that has transpired in the last seven-to-eight months.

“We’re talking about the PMI numbers and the various economic data points that we look at and the emerging markets are starting to grow. So, that’s influenced our decision to come out of the UK a bit and be a bit more overweight emerging markets.”

The other area they are overweight is in the bond market favouring inflation-linked bonds over sovereign debt.

Sriharan said: “The UK index-linked market is naturally long-duration so whilst inflation has ticked up in the last six months. Prior to that, as inflation drifted off a bit, the long-duration element to our index-linked bond portfolio meant that our returns were above what we expected.

“As that happened we rotated into shorter duration inflation-linked bonds and there is a fund called the Standard Life Short Duration Inflation-Linked Bond fund which is one of the few active managers out there who can offer that strategy in the model portfolio world.”

However, he says the team like to look at relative value rather than take outright positions, meaning they wouldn’t be in a position where they had zero exposure to government bonds.

“This is because the long-term asset allocation tells us that some protection is required in the lower risk portfolios however can we improve our return profile by being slightly underweight government bonds and overweight to another part of the bond market,” the manager added.


 

Key Underweights

In terms of underweights, the team are staying clear of emerging market debt, despite a positive stance on the sector’s equities.

Performance of indices over 1yr

 

Source: FE Analytics

As the above graph shows, emerging market debt index in local currency terms has risen 5.17 per cent, 2.04 percentage points ahead of the global corporates average.

“One place that we have been nervous about allocating to with a high level of conviction is emerging market debt, particularly the local currency side,” Sriharan said.

“Yes, hard currency emerging market debt has done fantastically well – that is a function of yields and the treasury market more than anything else – but emerging market debt local has been one space that we not understood entirely the dynamics at play there.

“The growing debt pile that is happening is a more recent phenomenon than just post-QE, this is in the last two or three years with more access to cheap credit in that part of the world.”

However, he says that understanding the risk drivers of why local emerging market debt local should behave in the volatile nature that it does is key to the region, something they are not completely comfortable with.

“We have thought about looking at total return emerging market debt funds – so funds that play a mixture of local, hard and corporate credit – and just getting the beta from emerging market debt more generally but in our asset allocation we have been underweight for a good couple of years.

“We have to understand what our fixed income is doing in the portfolio and to make a bet against the benchmark you have to understand that it will behave as you want it to do.”

The fund’s most significant underweight in the equity space is in the UK, despite being broadly positive on the region, something we will look at in more detail in an article later this morning.


 

Performance

Since its launch in 2008, the balanced portfolio (risk level four) is up 81.83 per cent, 18.75 percentage points ahead of its ARC peer group – consisting of other discretionary fund managers –and 49.35 percentage points ahead of its cash plus 3 per cent benchmark.

Performance of portfolio vs peers and benchmark since 2008

 

Source: Thomas Miller Investment

“Over three years and one year we are up there with peers and again since inception and over those time periods we are ahead of our cash plus benchmarks in all portfolios,” Herberts said.

“The one thing that we had last year along with anyone that employed active managers we lagged our benchmark – our long-term asset allocation figures – but we were helped by the passives we have employed.”

Performance of portfolio vs peers and benchmark since 2008

 

Source: Thomas Miller Investment

Indeed, last year the portfolio returned 11.95 per cent, 3.36 and 8.54 percentage points ahead of its peers and benchmark respectively.

“Year-to-date we are pretty much there with benchmarks and peers as it has been a relatively flat start to the year.

“We outperformed peers because we weren’t taking money off the table before Brexit or Trump we were looking past the politics and focusing on the fundamentals which generally last year were robust. By not being too driven by political noise we had a good year relative to peers.”


 

Outlook

Overall, the team at Thomas Miller Investment are constructive on the economic prospects over the next 12 months and towards the medium-term, with economic growth coming back across the board.

“Leading indicators look healthy, Trump is unlikely to be particularly fiscally disciplined, and it looks like the UK fiscal purse strings may loosen,” Herberts said. “It’s actually quite positive.”

“It looks as though Europe is turning around as well so another positive there as the big economic bloc is looking pretty healthy.”

Performance of indices over 1yr

 

Source: FE Analytics

“There are going to be idiosyncratic risks and there are still flashpoints but all other things being equal it looks okay,” he added.

“The interest rate environment may change in tone but not fundamentally as the American, UK and European central banks are not going to risk another recession by ramping up interest rates and we know if they do the indicators will turn pretty sharply.”

This has translated over the last year into the equity markets where despite the Brexit vote and Donald Trump’s surprise election victory, markets globally have been pushing steadily higher.

Herberts notes that he expects this to continue for at least the next 12 months, which could be elongated further under the right circumstances but that this upward trend in the equity space has caused a new set of challenges for investors.

 “All other things being equal you would be really aggressive in real assets, but the trouble is valuations look stretched in fixed income and equities so in the near term that doesn’t matter.

“You could probably stretch it and say for the rest of the year valuations don’t matter but in the long-term they absolutely do.

“So while we are constructive on markets this year we’d expect to move neutral later in the year as there are a few technical reasons why a pullback isn’t out of the realms of possibility – not a full-blown bear market but a correction.

“Longer term is much more interesting and it will depend on valuations. If we get anywhere near normality in interest rates then equities are far too expensive and that’s a real concern but it’s not a bet that you can take in the short-term.”

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