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Everything you need to know about Old Mutual Wealth’s model portfolios

17 May 2017

As part of its ongoing series, FE Trustnet looks under the bonnet of model portfolio providers. Up next: Old Mutual Wealth.

By Jonathan Jones,

Reporter, FE Trustnet

With several political and macroeconomic market headwinds yet to play out, Old Mutual Wealth’s model portfolios have been cautiously positioned for the remainder of 2017 to mitigate any further shocks. 

As part of the series in which FE Trustnet looks at the model portfolios on offer to UK financial advisers, we spoke with portfolio manager Stuart Clark about the firm’s process, current positioning, recent performance and outlook.

In total Clark (pictured) runs some 64 models at Old Mutual with eight different risk bands in four different tax wrappers though currently each tax wrapper is similarly positioned. He notes that potential regulatory changes make it prudent to keep all options open.

At the moment there is very little difference between the tax wrappers but that would not have always been the case during the past 15 years, says Clark.

The portfolio manager runs one set of portfolios that are fully active but another set which introduces some passive holdings to keep the costs under a set clean ongoing charges figure (OCF).

Clark runs the portfolios, which went live in 2014, from risk level three through to 10 – with level three the most cautious and 10 an all-equity strategy.

He said: “When we look to drive the maximum return we can for the given risk level. When you get below risk level three you’re getting to that point where it is hard to drive enough return to offset all the costs associated with a client holding the model portfolio.

“Risk level one would effectively be a cash portfolio and there is not much you can do to drive outperformance so we don’t bother running that for clients. [At] risk level two by the time you put on an adviser fee and the OCF of the portfolios, as well as inflation, it is hard to drive enough return to make it a valid portfolio. That is why we start at risk level three.”

The composition of the portfolios is determined firstly by a long-term strategic asset allocation which it collaborates on with consultancy firm Willis Towers Watson who provide the manager with forward looking risk/return correlation assumptions.

“We use those inputs across six high level asset classes – alternatives, cash, international equity, UK equity, international fixed income and UK fixed – and then optimise those asset classes to give us a notional strategic asset allocation for each risk level,” he said.

“That is our starting point. Each quarter we update our set of assumptions and ask ‘if you were to hold this portfolio for 10 years from this date what would be a notionally optimal portfolio to maximise your return for that given level of risk’.

“Over and above that, I have to contemplate where we are in the cycle, any additional risk or less risk we want to take in and then overlay a tactical asset allocation decision around the models.

“This comes in the form of taking overweight and underweight positions in the broader asset classes mentioned above.

“Finally we have manager selection and blending so we have our building blocks – the approved list of funds which are provided by the research team – and I get to choose between those approved funds which is the best combination of managers for the current point in the cycle.”


 

Key Overweights

One area Clark is seeing real potential is in the emerging markets and Asia-Pacific regions, which he says offer investors true value in the current climate.

“If we start at the high level asset classes and say we don’t see much value in fixed interest [but] we have a risk target for the portfolio, so we do have to own some risk assets and our preferred asset would be equity,” he explained.

“Within equities, it strikes me that there are some areas of the market which are priced for optimism and that would be the US. Even still today I think they are being optimistic in the deliverance of the Trump reflation trade.

“Whereas in emerging markets, Asia and, to a degree, Europe, there has been this cap on the equity markets as people have concerns around trade wars & tariffs or slowing GDP growth in China, for example, which have meant that they look cheap; not only relative to other markets but to their own history as well.”

Performance of indices over 5yrs

 

Source: FE Analytics

As the above graph shows, the MSCI World index – more than half of which is made up of US stocks – has strongly outperformed both the MSCI Emerging Markets and Asia ex Japan indices over the past five years.

“Within equity I would much rather skew towards those areas that look relatively cheap rather than either fair value or overpriced compared to their history,” Clark said.

“Not only that, [but] I think we have managed to identify some good managers in those areas who can outperform the benchmark as well.

“If we have a situation where we can skew the portfolio to an area that is cheap and is less efficient, active managers have tended historically to add more value, then that can give us a bit of a double whammy.”

Within his portfolio, Clark uses Henderson China Opportunities, Aberdeen Asia Pacific, Invesco Perpetual Asian and at the last rebalance he introduced Old Mutual Asia Pacific.

Overall, in his risk level seven portfolio – the most balanced model with 65 per cent weighting to equities – Clark has a 5.02 per cent weighting to emerging markets and 10.63 in Asia Pacific giving a total of 15.65 per cent overall.

“My understanding is that this weighting puts us in the ‘healthily overweight’ value/emerging market risk bucket,” he said.


 

Key Underweights

One asset class the manager has shied away from is fixed income, although Clark still maintains some exposure within the portfolios – particularly the more cautious models – for its diversification benefits.

This underweight position dragged on performance for much of last year before reversing in November.

Performance of index in 2016

 

Source: FE Analytics

Clark said: “On the one hand we meet advisors now who note we were underweight fixed income last year which has been a drag on performance – and of course it was.”

The portfolio manager says many advisers would have failed to foresee the reversal in government bond yields over the course of the year. Meanwhile, some advisers have questioned why he now bothers to hold any fixed income assets at all.

He said: “I actually find that an easier argument to make rather than the ‘you should have more fixed income at this point of the cycle’ argument. Why we hold fixed income is obviously diversification.”

Of the fixed income assets he does own, the manager says he has skewed the portfolio more towards corporate bonds with a small position in local currency emerging market debt.

At risk level seven, Clark holds 1.9 per cent in gilts and a further 4.45 per cent in sterling investment grade or strategic bond funds. “A relatively small position,” Clark noted.

He added: “It does still – although the correlation to other markets has picked up – offer diversification benefit and in a risk-targeted portfolio that smooths the risk-return profile for clients.”

Clark says the firm takes a holistic view of the portfolio and tries to optimise returns for the given risk level through investment of its six headline asset classes, including fixed income.

The manager says the forward return expectations projected through their analysis suggest potential returns of around 1.5 per cent per annum for the next 10 years with a volatility level of 6 or 7 per cent.

“Compared to cash that is an inefficient asset class,” he said, but with inflation expected to rise, he is aware that returns need to come from somewhere.

In an article later this morning FE Trustnet will look at the alternatives Clark is using in place of his fixed income allocation.


 

Performance

Since its launch in February 2014, the risk level seven portfolio has outperformed the IA Flexible Investment sector by 5.56 percentage points. As the most balanced portfolio, this is the one we have chosen for comparison purposes.

Performance of fund vs benchmark since launch

 

Source: FE Analytics

The portfolio is ahead over three years, however, it is slightly behind the sector average over one year, in part due to the lack of fixed income exposure mentioned previously as well as a high weighting to cash (12 per cent).

The largest holding in the portfolio is Old Mutual Global Equity Absolute Return run by Ian Heslop, Mike Servent and Amadeo Alentorn at 6.4 per cent.

The portfolio is matched to a risk profile which targets a specific range of volatility and will invest around 60-80 per cent in equities, with the remainder held in fixed interest, property and cash.

It has a volatility target of between 12.9 and 14.66 per cent and has an OCF of 0.68 per cent.

For reference, portfolio 10 – the highest risk – has a volatility target of between 18.07 and 19.76 per cent while the risk level three – the most cautious model – is targeting 5.61 to 7.85 per cent volatility.

Risk level 10 has outperformed its IA Global benchmark since launch, returning 51.06 per cent (versus 44.02 per cent) while the risk level three portfolio is slightly behind its IA Mixed Investment 20%-60% Shares benchmark by 29 basis points.


 

Outlook

Looking ahead, Clark says he is concentrating on two things: performance until the next portfolio rebalancing and long-term returns.

“At each rebalance you’ve got to not just think about the next three months,” he explained. “Of course you want the best possible combination of assets for the next three-month period but I am trying to think longer term in nature.

“It does seem to be a bit of a lost art in fund management to look through the noise and think longer term.

“Overall, I would say the portfolios are still cautiously positioned and so whilst we saw – ahead of the Trump election – positive US growth, inflation coming back into the system, I think being cautious in the current environment is the right thing to do.”

He added: “We are not past all the geopolitical risk be it further European elections, be it US intervention in the Middle East and North Korea – there are plenty of potential hotspots out there.

“And at the same time we are later through the cycle, every month that goes by we are further down that road.”

If he sees stronger economic growth coming through the manager will be willing to put some money to work but he says analysts seem relatively optimistic – particularly in the US – for earnings strength in 2017, making it hard for these factors to surprise on the upside.

Also, valuations look stretched in certain parts of the world, says Clark, who prefers not to chase that momentum. The manager is instead taking a more prudent approach by looking for opportunities to take profits from alternatives and reinvest those into assets as and when they suffer a more sustained sell-off.

One of the biggest risks to markets is US president Donald Trump and his pro-growth policies. Says Clark, which could provide very strong but short-lived US GDP growth and lead to a final push for already costly US equities.

Performance of index over 10yrs

 

Source: FE Analytics

“If Trump doesn’t derail global growth by being too protectionist then the rest of the world may be able to catch up with the valuation levels in the US but my base case scenario is to be slightly cautious,” he added.

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