Investing in large-cap growth stocks and avoiding fixed income assets are two ways in which Rathbones’ Managed Portfolio Service is gearing up for potential challenges on the horizon over the coming years. 
As part of the series in which FE Trustnet looks at the model or managed portfolios on offer to UK financial advisers, we spoke with Rathbones’ fund manager David Coombs about the firm’s process, current positioning, recent performance and outlook.
In contrast to regular model portfolio services, Rathbones launched its new, managed portfolio service in March this year for financial advisers. Overall there are six risk-rated strategies – ranging from low to high risk – which invest in the four Rathbone Multi-Asset Portfolio (RMAP) funds.
The strategies and service are run by Rathbones Investment Management (RIM) while the underlying RMAP funds are constructed and managed by colleagues at Rathbones Unit Trust Management (RUTM).
The Cautious strategy – the lowest risk strategy – invests solely in the RMAP Total Return fund, while the Balanced Plus and Income offerings invest in the RMAP Strategic Growth and RMAP Strategic Income funds respectively. The Equity Plus product invests in RMAP Enhanced Growth.
The Balanced offering, which sits between Cautious and Balanced Plus, invests in a combination of RMAP Total Return and RMAP Strategic Growth, while the Equity strategy – falling between Balanced Plus and Equity Plus on the risk scale – invests in a combination of RMAP Strategic Growth and RMAP Enhanced Growth, though the allocation split may be shifted depending on market conditions.
Portfolio construction
Source: Rathbones Investment Management
The firm already runs a unitised service in which it identifies the risk category, but the new service allows the IFA to conduct this: stripping out some of the cost.
“What the advisers wanted was direct access to a service, the bells and whistles – tax packs, look-through reporting, the client being able to access their portfolio online,” Coombs said.
He said there are intrinsic differences between a managed and model portfolio service, with the former allowing the manager more flexibility.
“I haven’t got to wait until the end of the month or the end of the quarter to make changes and that is massively important,” he said.
“We would argue that model portfolio services are restricted. I bought put warrants on the S&P 500 [recently]. We were able to react quickly – I couldn’t do that in a model portfolio set-up. I have more tools to protect to the downside by investing this way.
“We didn’t want to design an inferior investment solution just to satisfy market demand when that market has grown during a period of very easy monetary policy and strong bond and equity markets.
“We are now in a world with negative real yields, with huge dislocation going on, political risk is much higher across the developed world. Will your average model portfolio stack up in the next five years?”
Key overweights
Overall, the manager said he is more optimistic on the outlook for equities than any of the other major asset classes.
“We prefer equities to bonds but then who doesn’t? That’s not exactly a shock is it? So I think you can almost assume that,” Coombs said.
Within equities, rather than looking at geographies, he invests in themes, with a particular focus on large- and mega-cap names.
“When quantitative easing (QE) measures are unwinding and interest rates are rising that sucks out liquidity so I want to own liquidity which will become a scarcer resource,” he said.
“I want to own liquidity, mega-caps, growth, and low levels of debt, so it takes me away from the high yield bond market and poor quality cyclicals.
“Yes, they’ll rally at times, but I’m running a longer term strategy so I don’t care about short-term trash rallies.”
This, he said, takes him into technology, which is a big theme for the coming years, investing in the likes of Amazon and Google as well as Mastercard and Visa.
“Think Amazon, Google, Visa, Coca-Cola, Mastercard, the obvious big name ones where the barriers to entry are very high and competition is either dying, disappearing or non-existent,” he said.
This is a theme that has worked well over the last decade, with global growth stocks outperforming their value counterparts, as the below shows.
Performance of indices over 10yrs
Source: FE Analytics
Indeed, the MSCI AC World Growth index has outperformed the MSCI AC World Value index by 54.26 percentage points over the past 10 years.
But Coombs said with the potential for a reflationary environment – backed up by rising interest rates likely to keep growth low and squeeze liquidity – while technology companies disrupt long-established markets, growth companies will be the best way to invest for the long term.
Later this morning, FE Trustnet will look at these themes in more detail, as well as how Coombs is investing in the fixed income area.
Key underweights
As mentioned above, Coombs prefers equities to fixed income and is therefore, unsurprisingly, underweight in the latter asset class.
“I think from a UK [investor’s point of view] structurally you have to be underweight fixed income,” he said. “The maths is just totally against you.”
Indeed, the Barclays Global Aggregates index, has risen 124.75 per cent over the past decade forcing yields to historic lows, though it should be noted that some of the more recent movements have been caused by the fall in the value of sterling.
Performance of indices over 10yrs
Source: FE Analytics
“You would only be structurally overweight fixed income if you felt we were going into a global recession and, whilst I might not be overly optimistic, I don’t see evidence of a global slowdown,” Coombs added.
He said there were certain factors that could change the investment environment, including a credit crunch in China or a crisis in Russia or Asia.
Coombs said he works on probabilities rather than attempting to predict unlikely outcomes and currently the probability of this kind of shock is not enough to warrant any portfolio moves.
“So, fixed income has to be underweight,” he explained.
However, that doesn’t mean he doesn’t have any exposure to the asset class. “I own some foreign currency fixed income and some very short-duration fixed income, just quasi-cash really,” the manager said.
The other area he remains underweight is in property, selling out of his last commercial property holding in March 2016.
“I don’t own any commercial property or bricks & mortar: I haven’t for some time, over a year now,” Coombs said.
He added: “I see no chance of me buying any in the foreseeable future. The UK commercial property market is set for at best flat moves for the next couple of years.
“There will be pockets – there always are. The West End will probably recover at some stage but ultimately the outlook for retail – both malls and retail – is negative structurally.
“Similarly, if we are losing financial firms from London to Frankfurt, Paris Hong Kong and Tokyo then office space in the City doesn’t look like a massively great investment to me.
“And forget the second level like student accommodation, that doesn’t look very well as I think it highly correlated to the housing market.”
Performance
All four funds run by Coombs - RMAP Total Return, Strategic Growth, Strategic Income and Enhanced Growth sit in the new IA Volatility Managed sector.
The £23m RMAP Strategic Income fund, launched in October 2015 has the shortest track record, but over the last year has returned 17.23 per cent.
The other strategies all have longer track records, as the below shows, with the lowest-risk Total Return fund, which aims to outperform a target of the London Interbank Offered Rate (LIBOR) +2% up 31.84 per cent over the last five years.
Performance of funds over 5yrs
Source: FE Analytics
The medium-risk Strategic Growth, which aims to beat the Consumer Price Index (CPI) plus 3-5% has returned 59.67 per cent while the higher risk Enhanced Growth, which aims to outperform CPI+5%, has paid out 76.26 per cent over the period.
The five crown-rated, £214m Total Return fund is also targeting one third of the volatility of global equities. Over the past five years it has experienced 3.58 per cent volatility, compared to the MSCI World’s 9.51 per cent.
In its latest review of the fund, Square Mile Research noted: “The lead manager David Coombs is an experienced investor and through his career has managed equity, fixed income and multi asset portfolios.
“The flexible approach to portfolio construction means the manager has the freedom to invest in the most appropriate investment vehicles and securities in order to implement his investment views.
“We believe that Mr Coombs key strengths of asset allocation and risk management are to the fore in the running of this fund and that the environment which has been created is ideally set up to allow his skills to flourish.”
The four crown-rated, £293m Strategic Growth fund targets volatility of two thirds the index. It has experienced 5.41 per cent volatility over the last five years.
Finally, the three crown-rated, £31m Enhanced Growth portfolio aims to have a similar level of volatility to the index. It has experienced 9.26 per cent volatility over the period.
Outlook
Overall, Coombs remains cautious on the outlook for global growth, highlighting that inflation remains the biggest risk to markets over the coming years.
“From a multi asset perspective it is very difficult because, of the major asset classes – and I count property, equities and bonds as the major asset classes – two of them are almost uninvestable and if you think inflation is rising then they are really uninvestable.
“My strategy is very low if not zero duration fixed income but with currency exposure as portfolio insurance, no commercial property and the equity I own is part of the inflationary trade,” he said.
“The outlook overall is that the global economy will continue to grow albeit pretty underwhelming. If it grows better then that’s a plus but my scenario is that it grows around 2-2.5 per cent per annum which is not great actually for indices.
“I think that in that scenario growth will be quite hard to find [outperformance] – unlike since 2008 with money being thrown at investment assets.
“I think we go back to fundamentals and companies that can grow their bottom line and top line, market share and good old fashioned good performance will do well.
“The outlook is quite difficult and therefore one needs to focus on growth. Buy-and-hold probably doesn’t work so well in that strategy and you’re going to be more active.”
Additionally, the manager said investors need to use the UK as a trading market, not as one to be structurally overweight to.
Performance of index since EU referendum
Source: FE Analytics
“The UK is a trading market. When Brexit risk is high you buy the market and when it is perceived to be low you sell the market. That’s what we’ve done since the referendum,” Coombs said.
“Strategically, I think the UK is insignificant to a certain extent from an outlook perspective. You have to have a view on the UK economy but for me with a global strategy the UK is just one market.”
Indeed, he highlighted that in his Strategic Growth fund, he is now down to a 3 per cent allocation to UK earnings overall.
He concluded that investors need to be more focused than ever before and may have to take on less diversified strategies than in the past.
“I don’t think the world is coming to an end, but I think animal spirits will be somewhat subdued and that is the environment I am trying to navigate through.”