The removal of liquidity from the market proved to be as big a challenge as anyone had anticipated but there is one issue that Brooks Macdonald’s Jon Gumpel believes many investors are overlooking.
Gumpel, manager of the five FE Crown-rated Brooks Macdonald Defensive Capital fund, said – while he had been able to accurately predict what the big challenges of 2018 were – the portfolio had been caught out by the sharp and rapid fall in markets during the final month of the year.
Last year the Brooks Macdonald Defensive Capital fund lost 1.48 per cent, although until the fourth quarter the fund had been in positive territory with a gain of 1.48 per cent.
Performance of fund vs sector in 2018
Source: FE Analytics
Gumpel said December’s sell-off had taken its toll on what had otherwise been a positive year for the fund, as the Federal Reserve waived market concerns and pressed on with its rate-hiking programme.
“We got the big calls right and the only surprise is that the Fed didn’t necessary take as much action as it might have done at the end of last year,” he said.
“Basically, the market was proving to the Fed after 21 December that they made the wrong call and that, actually, the pressure is getting too great for them to continue talking about raising rates.”
Now, he said, the Fed is starting to think about damage limitation rather than central bank orthodoxy.
One curious aspect of the December correction, said the Brooks Macdonald manager, was that while most asset classes sold off one started to move in a different direction.
“Everything sold off at that time apart from, strangely, the one defensive asset that has been pretty poor all year: bonds,” said Gumpel. “Bonds suddenly started to come back into their own.”
Performance of indices in December
Source: FE Analytics
The December sell-off also highlighted another issue for markets: the withdrawal of liquidity.
Central banks have to move away from the ultra-loose monetary policy introduced after the global financial crisis, which has helped boost risk assets for much of the past decade.
“A lot of the people during the course of in 2018 were sitting there scratching their heads going ‘why are markets going down? I don’t really get it’,” said Gumpel. “The reality was an unprecedented liquidity shortfall.”
Combined with a 4 per cent governmental budget deficit in the US and Fed’s rate-hiking programme, the withdrawal of liquidity (or quantitative tightening) has proved a lot for markets to cope with, said the manager, who said there is now a “big black hole” of funding in markets.
“Last year we had the liquidity shortfall and, as a result, valuations have come back; they’re better in equity markets but is that liquidity drain going away? I don’t think it is,” said Gumpel.
“It’s a negative for markets that we’re looking at quantitative tightening carrying on while the US is requiring to be funded at the level it is.”
One of the big issues of 2018 and something likely to challenge investors again this year, Gumpel said, is politics. This is often discounted by investors as irrelevant.
“During the course of the year, and this is a problem going forward, is that we’ve looked at the amount – number and size – of the political issue that have taken place,” he said. “In a sense they haven’t really been factored in.
“A lot of investors have been trained to say ‘politics doesn’t really matter – it’s all about markets and fundamentals and economics’,” Gumpel said. “In reality, yes, that is true most of the time. But every so often politics really does rear its head. I think we have that now.”
Gumpel said there were three big geopolitical challenges facing markets were political divisions in the US, the US-China relationship, and major insurrections within the EU, including Brexit and a stand-off with the Italian government.
(FE Trustnet will look at these issues in more detail in a future article.)
Given the scale of the challenges facing markets, the Brooks Macdonald Defensive Capital manager said that he has already begun to change the fund's positioning to reflect opportunities.
“We’re not a super-defensive. We’re a defensive fund but we’re all about trying to find the right sources to make money,” the manager explained.
“We said last year it wasn’t [going to be] a great year to make money and we were going to be relatively defensive. Most of our peers are down 3-6 per cent.
“The point of our fund is buying the right assets to be correctly positioned for the next 24-to-36 months.”
He added: “There’s been a lot of focus on the absolute return sector saying ‘actually, there’s too much volatility’ and that there are some good funds in there, but some are down 10 per cent or up 30 per cent. The problem is you never know when it’s a good time to buy into those funds.
“Whereas with our fund because of consistency of returns over time almost whenever people started [investing] it’s never been a bad time to buy the fund.”
Performance of fund vs sector since fund strategy change
Source: FE Analytics
Since the fund's strategy was changed in March 2010, Brooks Macdonald Defensive Capital has made a total return of 60.01 per cent compared with a 19.73 per cent gain for the average IA Targeted Absolute Return peer, although it should be noted that the sector is home to a wide range of strategies.
The fund has an ongoing charges figure (OCF) of 0.81 per cent.