Concern over central bank policy-making and historically high markets have prompted IBOSS Asset Management’ Chris Metcalfe to move to the most cautious positioning he has ever taken in the firm’s model portfolio range.
The IBOSS investment director said he has become increasingly concerned that central bankers have manipulated the market with lower-for-longer policies and that it needs to return to some sort of normality.
“Basically, we have been getting more and more cautious by the month and that culminated in the current positioning which is the most cautious ever,” he said.
“That was predicated on the backdrop that the markets were at their highest by most metrics – especially in the US.”
Indeed, during the period of ultra-low interest rates and unprecedented quantitative easing (QE) measures, markets have risen to new highs.
Performance of indices over 10yrs
Source: FE Analytics
As the above chart shows, the MSCI AC World index is up by 144.76 per cent over the last decade, while the S&P 500 – which has led the way – has returned 228.15 per cent in sterling terms.
“The thing we have been waiting seemingly forever for is central banks to let the markets find their own levels,” Metcalfe said.
However, he said that markets may now be nearing a turning point, with new Federal Reserve chair Jerome Powell an ‘unknown’ when it comes to how he will implement monetary policies.
Additionally, the manager said it is not yet known who will replace European Central Bank president Mario Draghi at the end of next year, though he may even come under pressure to reverse current policies before then if economic data remains strong and inflation expectations pick up.
Last month’s unexpected rise in inflation expectations led to the recent market correction, as the Federal Reserve was widely expected to raise interest rates more quickly than anticipated.
“This is all putting pressure on interest rates rises and questions whether central banks like the Fed and the ECB are behind the curve,” Metcalfe said.
However, it is for this reason that the manager is encouraged over the medium-to-long term, as improving economic data should be positive for markets.
“This is all good for the economy and the economy is what is meant to be driving the markets, as opposed to printing loads of money, because the system is on the verge of collapse and the markets going up because they think central banks have got their backs,” he said.
“The interest rate rises coming through are on the back of good economic data, that has to be a good thing,” Metcalfe explained.
“We have had the markets going up for years on the back of bad poor weak data, money printing and lower rates for longer. These things were ultimately negative for the economy and you can’t have it both ways.
“Now we have got stronger data from various economies in the world so we have higher interest rate expectations. I don’t see that as a bad thing.”
If markets are going to take faster rate hikes negatively, this should be positive for asset allocators and fund managers as corrections like the one seen last month lead to more opportunities.
“We have been saying that a correction was overdue and welcome for medium to long-term investors as parts of the world in our view have become virtually uninventable, with the US being the main one from a valuation standpoint,” he said.
“We would hope for a more sustained sell off over the coming weeks and months just to give asset allocators and active managers the opportunity to buy some stocks, bonds or whatever that look slightly more attractive relative to history.”
As such, with a base case scenario that central banks leave markets alone and volatility begins to pick up, the manager has moved to a more defensive positioning across his portfolios, with record levels of gold, cash and absolute return strategies.
One such strategy he is using is the $13.9bn Old Mutual Global Equity Absolute Return fund run by Amadeo Alentorn, Ian Heslop and Mike Servent.
Performance of fund vs MSCI World since launch
Source: FE Analytics
The fund has returned 74.32 per cent since its launch in 2009, underperforming the MSCI World by 133.7 percentage points over that period.
However, it has done so with much lower monthly volatility of 4.69 per cent, versus the index’s 11.1 per cent, and a maximum monthly drawdown – the most an investor could have lost by buying and selling at the worst possible times – of 5.43 per cent, more than half the index’s 14.06 per cent.
“Ian Heslop and his team have got a stellar track record over quite a few years. They have done it for quite a long time and have done it very well,” Metcalfe said.
One of the main attractions of the fund is its long/short nature, he said, though it is usually market neutral.
“The benefit, in theory at least, is that they are not hamstrung in the same way as a long-only fund where all of your assets are expensive relative to history,” he noted.
Another way the team are taking more caution is through diversification, with the Janus Henderson Emerging Markets Opportunities run by FE Alpha Manager Glen Finegan and Stephen Deane a surprising example of a defensive position in the portfolios.
As the below chart shows, over the past five years the fund’s one-year rolling r-squared ratio – which indicates how closely correlated a fund is to an index – versus the MSCI Emerging Markets benchmark is much lower than that of the average peer IA Global Emerging Market.
Rolling 1yr r-squared ratio of fund and sector vs benchmark over 5yrs
Source: FE Analytics
IBOSS senior investment analyst Chris Rush said: “One of the defensive positions we are taking is to make sure that everything isn’t pointed in the same direction.
“There has been a lot of talk around technology stocks and how they are becoming the dominant force within both developed and developing markets.
“So, one of the defensive plays we have put in there more recently across all of our portfolios is the Janus Henderson Emerging Markets Opportunities fund which has one of the lowest allocations to technology in the sector.”
Indeed, the fund is just 7.5 per cent weighted to the tech sector, while the MSCI Emerging Markets index has a 27.6 per cent weighting.
“It is very easy when picking up a passive fund in Asia or emerging markets to be accidentally overweight technology so we are trying to really make sure that what we do have is not pointing in the same direction,” he added.
Other funds the team have been using include JOHCM Global Opportunities and Rathbone Heritage, which have relatively high cash weightings of 17.7 and 26.34 per cent respectively.
Marlborough Global Bond meanwhile makes up a 3 per cent allocation, as the team believe its global nature should give it the best chance to outperform in the current environment.