When a fund manager has held 25 per cent of their portfolio in cash for the last two-and-a-half years, the natural assumption is that they are extremely bearish about the prospects of global stock markets. 
But Schroders head of multi-manager Marcus Brookes said such an assumption about him would be incorrect, even though he has no plans to soon to put to work the quarter of his £853m Schroder MM Diversity fund that is in cash.
Instead Brookes, who joined Schroders in 2013 after the acquisition of Cazenove Capital, said the high cash weighting reflects the team’s longstanding caution regarding the bond markets.
Given how well some areas of the bond market have performed in the time period since the global financial crisis, it’s a call that would have tested the nerve of many – but he says it is one he is sticking to.
“We made the call based on the evidence we had at the time,” explained Brookes.
“Our caution stemmed from the fact that we could perceive a much rosier outcome for the global economy than the bond market was predicting. A 10-year government bond yielding about 2 per cent simply didn’t look good value given the predicted pathway of inflation getting back to 2 per cent that both the Bank of England and the Federal Reserve were predicting.”
Performance of Schroder MM Diversity under Brookes and McDonald
Source: FE Analytics
On the back of this, Brookes halved Schroder MM Diversity’s 20 per cent weighting in bonds to 10 per cent and upped the cash weighting from 10 per cent to 25 per cent. Given that in the time since the Fed has raised interest rate three times, twice in the last four months, and inflation everywhere at about 2 per cent on paper it seems a good call.
“What has been frustrating is that the European slowdown in late 2014/early 2015 and the quality sell-off which followed has artificially depressed some of the statistics,” he added. “However, we are now seeing both of these things start to unwind and bond yields are start to rise slightly.”
So how easy has it been for the manager to stand by his convictions when performance is sliding as result? Brookes said the key thing is to stick with your process.
“You have to keep going,” he said.
“If you start deviating from your process it can become even worse for you and you end up in no man’s land. If we had given up on this stance in the middle of last year, we would have had a much tougher time, but the honest truth is that we are always looking at it.”
The fund is ranked fourth quartile in the IA Mixed Investment 20%-60% Shares over three and five years, but Brookes said the fact it returned nearly 9 per cent in 2016 is “a comfort”.
“The performance target of Schroder MM Diversity is CPI plus 4 per cent and if you average it out over the last five years the fund has done well,” he said. “If you look at performance versus the sector it doesn’t look great, but you have to bear in mind that we cannot do what the sector can.”
This is because the fund is designed to be one-third invested in fixed income and cash, one-third in equities and one-third in alternatives. The peer group, on the other hand, is 60 per cent equity and 40 per cent fixed income. As a result, the manager says, the performance profile is not going to be the same.
“Philosophically we know we will not outperform every quarter, but we have a process we have used for a long time which we are very comfortable with,” he said.
“We also do moderate our positions, so while we don’t like bonds we did buy back in to them at the end of 2015, before selling them quickly after they rallied. However, as a team we are always willing to admit to when we are wrong.”
Risk/return of Schroder MM Diversity range over 5yrs
Source: FE Analytics
Brookes and co-manager Robin McDonald have worked together for 16 years and he describes their investment process as based around the top-down and implemented using funds.
“It’s all about asset allocation and finding the right fund manager for the right environment,” he said.
“You have to have views in your portfolio, not blend away all the risk by investing across a broad range of managers. Asset allocation is incredibly important to funds of funds, but viewing it as a separate discipline to fund selection is wrong. It is part of the same thing.”
For example, if you are bullish on the UK and think it is in a cyclical upswing being led by the large-caps, being overweight towards Majedie UK Equity (a large-cap manager) would be more appropriate to Brookes than a UK small-cap manager, such as his favoured small-cap fund Franklin UK Smaller Companies.
“We think Richard Bullas, who runs the Franklin UK Smaller Companies fund, is a very good manager but he is likely to struggle in a scenario of the FTSE 100 generating strong performance, so in essence you might be using great managers but you are getting the wrong exposure,” he said.
“The point is that once you put together the ideas of where you want to go, it strongly indicates what sort of factors you want in the portfolio and the appropriate managers.”
While marginally underweight in equities overall, Brookes said his overweight positions in Europe, Japan and emerging markets should go some way to disprove the theory that he is a “perma-bear”.
“To say we are cautious on everything is wrong,” he said.
“How did we make 9 per cent last year? It was not by having zero risk in the portfolio. We had the BlackRock Gold & General fund, which was up over 85 per cent in 2016, while we started buying back into value funds over the last year.”
The question Brookes says he gets asked most by clients is when will he put the cash back to work?
“It would be one of two things,” he answered.
“Firstly, it would be that it turns out we are wrong and the growth profile we thought we were seeing in the global economy turns out to be incorrect. In this instance, with inflation falling back to zero, a bond yielding 1.2 per cent suddenly looks good value and we would buy the life out of them.
“The second way is that it proves we were right all along. Bonds turn out to be disastrous value for clients and go into a bear market. Not only would we be avoiding losses in this scenario, but we would also have cash on the sidelines ready and waiting to pick them up at much better valuations.”
This, in essence, is how Brookes’ whole approach works: he is either correct about the macro backdrop and takes profits on the cash positions and buys bonds (after they have fallen in value), or he is wrong, recognises that fact and gets invested.
“However, in this instance if we are wrong because the world is not looking a good place to be, I will be more worried about my bullish call on equities than anything else, so it would not be the only decision I have to make,” he added.
It all comes back to one of his golden rules of investing: opinions can change but principles cannot.
“We live in a dynamic world that doesn’t move in a straight line, so if new data comes in that is contrary to your view, you must be able to change your mind,” he said. “However your principles – don’t lie, don’t cheat etc – must always remain the same.”
This article originally appeared in FE Professional.