Seneca Investment Managers has been adding to short duration high yield bonds and specialist assets within its portfolios after trimming equities in preparation for the end of the bull market.
The group has reduced the equity exposure of its £103.9m CF Seneca Diversified Income fund to 38 per cent while it has fallen to 56 per cent in the £117.7m CF Seneca Diversified Growth fund. Exposure in the £77.7m Seneca Global Income & Growth Trust has been taken to 58 per cent.
Equity markets have enjoyed a strong run since the global financial crisis bottomed out in March 2009. Central bank measures such as historically low interest rates and unprecedented quantitative easing have supported an eight-year bull market for stocks, with US equities leading the way for the bulk of the period.
However, many are starting to question when this run will come to an end. Fidelity International investment director Matthew Jennings recently warned that “winter is coming” for equities, for example, while Wermuth Asset Management’s head of macroeconomic research Dieter Wermuth argued that another crash gets likelier by the day.
Performance of indices since March 2009
Source: FE Analytics
Peter Elston, chief investment officer at Seneca Investment Managers, said: “There’s much talk about when the bull market in equities will end. We believe it will be around 2019, ahead of an economic downturn in 2020, but it’s vital to take action well in advance.
“Many investors are holding off from reducing risk, presumably waiting until the bull market has ended, but we don’t think that’s the right approach. To be protected when the markets turn, you need to taper your risk ahead of that change.”
That is why Seneca Investment Managers has already started trimming equities. Elston’s bearish outlook means changes to portfolios are needed now to avoid the need for drastic asset allocation changes as the market starts to turn.
“Our time frame is a very broad estimate and it’s likely that the market changes won’t occur when we expect them to. This is why we are taking action early: we feel in this situation it’s the ‘what’ that matters, not the ‘when’,” Elston continued.
“We’re now in a period of monetary tightening across the developed world, which could mean interest rate increases, tapering of asset purchases or balance sheet shrinkage. The US is ahead of other markets in this cycle, however the UK, eurozone and Japan are not too far behind. Given where markets are in the cycle, equity returns should remain positive but are falling.”
Proceeds from the reduction in equities have been channelled into short duration high yield bonds and specialist assets, which Seneca likes because of their inflation protection characteristics and relatively attractive yields.
Royal London Short Duration Global High Yield Bond has been the fund that has been mainly added to, although CF Seneca Diversified Income’s position in Muzinich Short Duration High Yield has also been increased.
Performance of funds over 5yrs
Source: FE Analytics
The Royal London fund is headed up by Azhar Hussain with Stephen Tapley as deputy manager. The portfolio, which is managed using RLAM’s value-orientated approach, seeks to exploit the inefficiencies found within global high yield credit markets and aims to be diversified by region and sector.
The offshore Muzinich Short Duration High Yield fund is run by David A. Bowen and tends to focus more on short maturity high yield bonds issued mainly in US dollars or by North American companies.
“I like these funds because they are very conservatively managed and both companies have very strong, well resourced, credit teams,” Elston said. “Neither have suffered any defaults in the history of their short duration high yield strategies. Both funds are very diversified with around 140 bond positions – reducing the idiosyncratic risks associated with bond investing.”
The chief investment officer added that reasons to like short duration bonds include the fact that they represent a lower volatility income strategy, protect against rising rates, should not be hurt by widening spreads, have default rates at historically very low levels and boast a high Sharpe ratio.
The Seneca team has also been adding to specialist assets while selling down equities. Areas added to include infrastructure, real estate investment trusts and direct lending.
Richard Parfect, who is part of the team managing the three portfolios, said: “We have increased the targeted allocations to International Public Partnerships and UK Mortgages Ltd as we believe both of these offer scope for low volatility of net asset value with little economic cyclicality.
“UK Mortgages Ltd has demonstrated a very low level of bad credit history in its portfolios of UK mortgages. In the case of International Public Partnerships there is the added benefit of an explicit high linkage in the underlying revenue stream from its infrastructure investments to inflation.”
Performance of fund vs sector over 10yrs
Source: FE Analytics
Furthermore, the team participated in the launch of PRS REIT plc, which raised equity to build a portfolio of modern purpose-built houses in the private rented sector. This trust aims to pay a dividend yield of 5 per cent and looks to increase this to 6 per cent by its third year.
The Seneca portfolios also have exposure to alternative finance through Funding Circle Income, which mainly lends to UK small- and medium-sized enterprises. A position in Ranger Direct Lending was recently exited, prior to them moving to a wide discount to NAV.
Finally, the funds participated in the further equity issuance of Greencoat UK Wind and the ‘C’ share issue of RM Direct Lending. “Both of these were existing holdings but where we were happy to increase their allocation,” Parfect added.