Ultra-loose monetary policy has led to worrying levels of household debt and eye-watering valuations across developed markets, warns Pyrford’s Tony Cousins, who describes his current view on markets as “unashamedly bearish”.
Performance of indices over 5yrs
Source: FE Analytics
As such, his £2.4bn Pyrford Global Total Return fund – a top pick for Hargreaves Lansdown research director Mark Dampier and Liontrust portfolio manager John Husselbee – is the most defensively positioned it has ever been over the course of the last 23 years.
Given the portfolio’s absolute return mandate, its investable universe consists of developed market equities, very low-risk emerging market equities and global sovereign debt that has a minimum quality rating of ‘AA’.
Even so, the manager says it is still far more defensively positioned than it usually is, which is significant given it has only suffered one negative calendar year since inception – in 2002 when it lost 2.1 per cent.
“This is the most defensive portfolio we have ever put together. We are very much in ‘hiding in the cave’ mode at the moment, we have our tin hats on. Money printing around the world has made financial assets exceptionally expensive,” Cousins explained.
“Everybody has chased yield and chased it down, so you end up with financial assets which are eye-wateringly overvalued.
“Given our commitment as a value manager, it has never been smart to go and buy at these levels. We are unashamedly bearish.”
The manager is keen to point out that he isn’t a ‘perma-bear’ and that today’s environment warrants particularly drastic measures.
In the throes of the financial crisis, for instance, he bought badly-bruised stocks and even returned 12.8 per cent including dividends during 2008, while the FTSE 100 and FTSE All Share indices lost 28.3 and 29.9 per cent respectively.
Now, though, he has a hefty 57 per cent in short-dated UK gilts with a modified duration of 1.8 years.
“We own a lot of bonds because we think equities are horrendously expensive. The duration of those bonds is exceptionally short because we think long-duration bonds are even more expensive than equities,” Cousins said.
“Yields need to rise 150-200 basis points depending on where you are in the world. If you own a long-duration bond – a 30-year gilt has a duration of a little over 20 – and yields rise 2 percentage points, you will lose around 35 per cent of your money, which is a disaster. You don’t want to own those things if you think yields will rise, which we do.
“However, if you own very short duration bonds you can’t lose the money because duration sensitivity to yield change is so low. These are akin to cash, they just have a slightly better yield than cash – that’s why we own them.”
The manager says the fact they are sterling assets is also a significant factor in his positioning.
In the run-up to the EU referendum, 38 per cent of Pyrford Global Total Return’s portfolio was exposed to non-sterling currency. However, Cousins reduced this significantly as he believed sterling had to fall regardless of the outcome. He says the fact the UK was running a 5.5 per cent GDP current account deficit meant sterling at that point in time was expensive.
Performance of currency vs US dollar since 2016
Source: FE Analytics
As such, the manager sold all of his exposure to US dollar bonds and replaced them with sterling.
“We’ve never had more money in gilts than we have today. These are not equities, they’re in sterling and they’re very short,” he continued.
“What we have done additionally is hedge away the currency exposure to the Canadian dollar, Australian dollar and Swiss franc. We have gone from 38 per cent unhedged foreign exposure to about 10 per cent. In our 22-year history, we have never been lower than that. We need to protect our clients.”
The fund currently has a 15.6 per cent weighting to UK equities, which is predominantly held in high-quality dividend-paying stocks such as British American Tobacco, the National Grid and GlaxoSmithKline.
While Cousins says this is because of his focus on stocks with high ROE (return on equity) ratios and their ability to compound, he also says it is the product of his concerns about growth in the UK.
While many investors are concerned about the ongoing Brexit negotiations, he says the headwinds are far more deep-rooted and longer-term as they predominantly revolve around the leverage in the UK housing sector.
“Two years ago, the government needed to get elected. To get elected, you need to get the economy moving and they were faced with a situation where real wages had been in decline ever since the financial crisis. That’s not an easy environment in which to get the economy moving when 70 per cent of the UK economy is consumption,” the manager reasoned.
“So how do you do it? Well the way you do it in the UK is to get house prices up. George Osborne realised that, if you get house prices up, then people spend the equity.
“So, in an environment where borrowing is very cheap because of QE and ultra-low interest rates, the environment was right to get this to happen and so schemes such as ‘Help to Buy’ were rolled out.
“Guaranteeing the top 20 per cent of a first-time buyer’s mortgage encourages them to borrow and also encourages lenders to lend because they know the government’s on the hook for the first 20 per cent of the loss.”
Cousins says average UK house prices are significantly higher than they were at the pre-crisis peak, which he says has partially been engineered to encourage spending and bolster the economy.
However, he warns it has left the population incredibly leveraged and warns that the UK essentially operates a floating rate mortgage market compared to the likes of the US, where homebuyers can lock in 25- to 30-year fixed mortgages.
“You can go out and borrow from someone like Barclays bank or a building society at 1 per cent. The Help to Buy scheme has now been terminated but you would have been able to get a 95 per cent loan-to-value at 1 per cent,” Cousins said.
“The problem is though, if base rates went up just 50 basis points, your interest payments would go up 50 per cent. It’s just simple mathematics. As someone who lived through the late 1980s where interest rates got to double digits, you can see this happening again.
“Mark Carney knows this and he is far more hamstrung than the Fed in terms of what he could do but, when inflation starts to rear its head, [the Bank of England] has to react and that’s the real concern here. When base rates are at 25 basis points, they’re not going any lower.”
The manager says this is the primary reason he does not hold any domestic-facing stocks, UK banks or value plays. He also won’t hold any UK retail stocks that are linked to personal consumption.
Elsewhere across developed markets, he says US equities are “mind-blowingly expensive” as a result of excess liquidity and warns that southern European countries such as Spain and Italy are facing their own headwinds.
“The euro has been a catastrophe for these countries and a human catastrophe at that. The Italian GDP sits where it sat more than 15 years ago in real terms – its 11 per cent per capita is actually below where it was 15 years ago. The only thing they have buckets of is debt and youth unemployment. Frankly, it’s a disgrace,” Cousins continued.
“Europe is going to squeak through 2017 without electing a populist government. Italy might in the first quarter of 2018 and Italy is the big problem here. We don’t want to be part of this.
“On the other side of the coin, you can find some fantastic companies in Europe that are in knowledge-based industries. From a stock-picking view, it is our job to scour the continent for these.”
While the fund’s strategy has an institutional client track record dating back to April 1994, Pyrford Global Total Return was launched as a Ucits fund in December 2015. Over this time frame, it has returned 14.34 per cent with a maximum drawdown (which measures the most money lost if bought and sold at the worst possible times) of 1.31 per cent.
Performance of fund since launch
Source: FE Analytics
It has a clean ongoing charges figure of 0.81 per cent.