Strategies such as value investing, alternative assets and gold could help to protect investors’ capital if the current market cycles turns over and we head into a bear market, according to Schroders’ Marcus Brookes.
In an article yesterday, Brookes - head of multi-manager at Schroder Investment Management – argued that now is an appropriate time for investors to concentrate on preserving capital as the current market cycle looks close to drawing to an end.
He noted that the current US equity bull market has lasted 98 months and led to a return of around 300 per cent. This makes it 50 per cent longer than the 64 months a bull market has tended to last in the post-war period and almost twice as profitable than the typical gain of 163 per cent.
Performance of indices over 10yrs
Source: FE Analytics
“In the later stages of a cycle our approach has always been to gradually shift emphasis from capital growth to capital preservation over a period of time as market risks build – the objective being to carry less risk as the market hits its peak, than we do as the market hits its bottom,” Brookes said.
“This transition phase (which is gradually underway) is invariably frustrating and requires discipline and patience, as while momentum pushes prices higher in the short term it feels as though almost every single thing you do is wrong. From a full-cycle perspective though, it’s perfectly rational, even if it does risk sacrificing some short-term relative performance.”
The multi-manager has highlighted four strategies that he is running across his portfolios that he believes could protect capital if markets start to turn south.
Equities in relatively depressed markets
Brookes is a big fan of value managers, holding the likes of GLG Japan Core Alpha in Schroder MM Diversity and Investec UK Special Situations in Schroder MM Diversity Balanced.
“Value investing, which is the art of buying stocks which trade at a significant discount to their true value, has been in the doldrums, relatively speaking, for about a decade now,” he said.
“Below is a chart showing a ratio of US growth stocks against the MSCI World Value index, which recently surpassed its ‘tech bubble’ highs. Although of course past performance is not a guide to future performance, you’ll note from the chart that from a similar extreme in 2000, value went on to radically outperform for many years. What equity exposure we have remains tilted in favour of the value style, in part for this reason.”
Performance of US growth stocks relative to global value
Source: BofA Merrill Lynch Global Investment Strategy, Bloomberg
Alternative strategies
Despite a bias towards value, Brookes argues that from a full-cycle perspective, it’s probably the case that there is more risk to the growth style than there is absolute upside to the value style.
“We think a good way to supplement this bias is therefore in strategies that have the ability to generate positive returns when markets are falling,” he said. “It is however important to note that such strategies involve additional risk as should markets rise instead of fall, large losses may be incurred.”
The flagship Schroder MM Diversity fund, which Brookes runs with Robin McDonald, has around one-third of its £865.7m portfolio in alternative strategies. Funds such as Majedie Tortoise and Morgan Stanley Diversified Alpha Plus are top 10 holdings that focus on alternatives.
Gold
Schroder MM Diversity also has exposure to gold, with a 3.8 per cent allocation to iShares Physical Gold ETC.
Gold reached a record highs of $1,900 per ounce in September 2011 during the eurozone sovereign debt crisis but has endured more challenging conditions more recently.
Investors have lost money on the yellow metal over the past five years (the S&P GSCI Gold Spot index is down 4.4 per cent) but it has risen by close to 25 per cent over the last three years.
Performance of gold over 3yrs
Source: FE Analytics
Brookes said: “During the phase of an economic expansion when earnings and profit margins are expanding, you’d expect assets with growing cashflows to outperform gold.
“But in an environment where profit margins are already very high, bond yields are close to all-time lows and the dollar is close to its peaking, we think gold becomes a more interesting proposition as part of a diversified proposition, with potentially good upside.”
Cash
The multi-manager also maintained that cash can help to preserve capital should markets start to enter a prolonged downturn. The Schroder MM Diversity fund currently has 24.3 per cent in cash.
“Otherwise known as ‘dry powder’, cash has considerable value here, not because of the return it currently generates, but because of the opportunity it affords investors to establish more constructive positions as forward-looking returns improve,” he said.
“Being fully-invested in a bull market feels great. Being fully-invested in a bear market feels awful. For now, cash could be one way of lowering portfolio risk.”