Premier Miton’s Gervais Williams and Martin Turner have insured their portfolio against “a major downturn” in 2022, following a similar move that boosted returns in 2020’s coronavirus crisis. 
The managers have recently bought a FTSE Put for their £100m Miton UK MicroCap Trust. This put currently covers 38% of the trust’s portfolio, although the managers said they would consider adding more if such ‘insurance’ gets cheaper.
“We believe that it is a good time to buy stock market ‘insurance’. The principle is a bit like your car insurance. You buy it to cover a known period and at the end of the term it is worthless. In the case of stock market ‘insurance’ it can ‘pay out’ if stock market prices fall to a specified level,” Williams (pictured) and Turner said.
“Effectively, if there isn’t a claim, it ends up detracting from investment returns. Last year, during the uncertainty of the pandemic, stock market insurance was really expensive. Furthermore, stock market valuations were already depressed, so the downside risk wasn’t as high.”
Performance of Miton UK MicroCap Trust since start of 2020
Source: FE Analytics
The managers had put options on the FTSE in place on the trust and their Premier Miton UK Smaller Companies fund at the start of 2020, which paid off when the market tanked at the start of the Covid-19 pandemic.
This insurance helped to soften the blow of the initial crash, although the trust did fall further than its average IT UK Smaller Companies peer owing to its focus on more volatile micro-caps. Premier Miton UK Smaller Companies, on the other hand, held up better than its average peer.
The profits from the put option allowed the managers to add to holdings at depressed levels, aiding the strong outperformance shown in the chart above. Over the same period, Premier Miton UK Smaller Companies is up 120.8%, compared with 33.6% from the IA UK Smaller Companies sector.
This time around, the reason for applying the put option comes down to the managers thinking that there is limited upside remaining in the market and potential downside risk is growing.
Williams and Turner pointed out that the supply bottlenecks caused by the pandemic lockdown and efforts to stimulate the economy by boosting demand (through loose monetary policy and heavy fiscal spending) have combined to create high inflation.
In the UK, inflation as measured by the consumer prices index (CPI) is running at 2.4% – higher than the Bank of England’s 2% target – and is expected to hit 4% this year. In the US, CPI inflation stands at 5.4%.
While policymakers in the past could be expected to head off higher inflation by raising interest rates and taxes, they are unwilling to do this at the moment in case it chokes off the recovery from the pandemic.
All this has combined to make Williams and Turner buy portfolio insurance, as they consider either alternative – higher inflation or the withdrawal of stimulus – to be ultimately negative for the stock market over the medium term.
“In the short term, the extra demand can boost company profits. After the giant government spend following the pandemic, you may have noted the recent huge improvements in company profits. But the additional spend comes at the risk of higher inflation. And in time, extra inflation is reflected in lower stock markets valuations,” they explained.
“In effect, we have a dilemma. Either the authorities start withdrawing stimulus and actively slow demand, or there’s renewed inflation. Both outcomes are stock market unfriendly, because both policies are a challenge for corporates.”