The risk that central bankers are behind the curve, uncertainty around sterling and the potential for a new credit crisis are the three risks that will be keeping Rathbones’ David Coombs up at night for the foreseeable future. 
At the start of each year, the head of multi-asset investments at Rathbones highlights the three market risks that he is keeping an eye on. In 2015, he was concerned by oil price movements, the UK’s Brexit referendum and the US election while last year he was worried by rising inflation perceptions, European politics and market liquidity.
For 2018, Coombs – who runs the Rathbone Strategic Growth Portfolio, Rathbone Total Return Portfolio, Rathbone Enhanced Growth Portfolio and Rathbone Strategic Income Portfolio funds – has three new things to prevent him from getting a good night’s sleep.
Central banks behind the curve
Global stock markets recently sold off after better-than-expected wage inflation indicators sparked panic among investors that the central banks would be forced to lift interest rates faster than anticipated. From being fearful of deflation sweeping across the globe, markets are now watching inflation tick up from previous lows.
Performance of indices over 2018
Source: FE Analytics
Coombs said: “One of the perceived risks this year is that central banks are behind the curve and we had this ‘taper tantrum 2.0’ over the past few weeks where good news was bad news. That’s kind of bizarre really.
“I think it was just a lot of stupid people who were short volatility, picking up pennies in front of a steamroller. They all got caught out and had to quickly buy volatility.”
However, this view of the underlying cause of the recent correction does not mean the multi-asset manager is unconcerned by central banks this year.
While new Federal Reserve chair Jerome Powell is widely expected to be of the same mould as previous chair Janet Yellen, the possibility that this might not be the case makes Coombs “slightly nervous”. And while he is not overly concerned by likelihood of the European Central Bank tapering its asset purchases, the manager added that he is “always a bit nervous about everything [Bank of England governor] Mark Carney does or says”.
“No doubt about it, the cock-up potential with central bankers is extremely high at the moment and the markets are going to be pretty volatile this year because they are really struggling to discount where yield curves are going to be,” he finished.
Sterling
One of the biggest consequences of the UK’s decision to leave the EU was a drop in the value of sterling and the currency is still under pressure today. The Bank of America Merrill Lynch Global Fund Manager Survey showed that asset allocators have been underweight sterling for some time, despite some arguing that it now appears significantly undervalued.
“Sterling really keeps us awake at night. I have no idea where sterling is going this year, to be honest. It really is so unpredictable at the moment,” Coombs said. “It is clearly moving on Brexit concerns; when we’re looking at ‘hard’ Brexit sterling falls, when we’re looking at ‘soft’ Brexit sterling rises and [when] Mr Carney speaks it can go in either direction.”
Against this backdrop, the manager has been active in hedging his currency exposure across his portfolios.
When UK prime minister Theresa May attended the Brexit talks in Brussels in December 2017, Coombs predicted that the market would take this positively so hedged out euro, dollar and yen completely to sterling. In the past week or so the manager has started to reduce his dollar hedge, around 60 per cent of dollars are now hedged to sterling; this made his funds resilient over the recent period of dollar weakness, when sterling rallied back to $1.41.
Performance of sterling vs dollar over 3yrs
Source: FE Analytics
“Typically I am not one for strategically hedging and I very rarely tactically hedge on equity positions, but we are in extreme market conditions and sterling is very undervalued,” he added. “Therefore, sterling strength is a risk for us so we will continue to be very active tactically with the hedging strategy.”
A credit crisis
The final risk that Coombs is concerned about is the potential for problems within credit markets, given how challenging conditions appear to be here. The Rathbone multi-asset funds are underweight this part of the market.
“It might not be as alarming as a Lehman Brothers but certainly credit markets look very stretched to me with very little value. The returns that you’re picking up now from credit – 3, 4, 5 per cent – is not really compensating you for the risk you’re taking in those markets,” he said.
“I do worry that credit has been stretched again and that lending requirements are being eased again. We could potentially see something in the auto or credit card markets; that is something which is keeping us out credit really.”
When combined with inflation and interest rate concerns, this means that the manager sees income as “a pretty scary place to be right now”. He points out that if inflation and interest rates do rise faster than expected, then all duration assets look vulnerable.
With this in mind, Coombs is worried about alternative income assets – such as aircraft leasing, peer-to-peer lending, student property and caravan parks – that have grown in popularity in recent years as yields declined in more mainstream areas.
“I put this slide in [see chart below] to say ‘I told you so’. They’ve all had a really tough time but I don’t think the end is nigh on this and it could get worse,” he said.
“Any asset that has a high level of income, or even an equity that’s paying most of its profits out as income, is vulnerable to inflation and interest rate risks. That’s why even the income strategy we’re running has quite a low yield at the moment, because higher yield strategies will lose a lot of money if central banks do make a policy error.”
Coombs noted that some US-based peer-to-peer lending funds have suffered falls of up to 90 per cent recently, as alternative income came under pressure. He thinks the outlook for the whole asset class looks clouded from here.
Performance of alternative income trusts over 12 months to Nov 2017
Source: FE Analytics
“We’re not playing alternative income strategies in the main,” he said. “I still think they are vulnerable to further losses and yes at lot look like they’re quite low on volatility, but the chart shows that it’s not volatility that hurts you – it’s the drawdowns when the faith in those strategies suddenly disappears.”
Coombs’ largest fund is Rathbone Strategic Growth Portfolio, which he has managed since its launch in June 2009 and has assets under management of £401.8m.
FE Analytics shows that the four FE Crown-rated fund has posted a 103.17 per cent total return since inception, beating the 96.90 per cent gain made by the average member of the IA Volatility Managed sector and the 84.47 per cent rise in its UK CPI plus 5 per cent benchmark.
The portfolio currently has 64.40 per cent exposure to equities through the likes of Roche, Sampo and RELX, while 20.57 per cent is held in government bonds and cash. It also has 14.03 per cent in diversifiers, through funds such as M&G Global Macro Bond, Henderson UK Absolute Return and Aspect Diversified Trends.
Rathbone Strategic Growth Portfolio has an ongoing charges figure (OCF) of 0.80 per cent.