Odey 'devastating' warning: how fearful are others?

Crispin Odey has warned that global markets will be ‘devastated’ in a downturn that will be ‘remembered in a hundred years’. And while his stark prediction may have the ring of Société Générale’s perma-bear strategist Albert Edwards about it, a growing number of ‘mainstream’ managers are increasingly looking at ways of protecting their portfolios.

This is arguably of little surprise in the face of several key macro risks, ranging from slowing Chinese growth to a eurozone collapse or the US bull-run ending.

Whether through holding elevated cash levels, buying put options or other financial instruments, we looked at how and why many fund managers are looking to safeguard their clients’ money.

Gervais Williams, Diverse Income Trust: Put option on the FTSE 100

Although the Diverse Income Trust is run predominantly as a small and mid cap vehicle, manager Gervais Williams has a long-standing put option on the FTSE 100 to provide protection for his portfolio.

He initially took out the position in November 2013 at a cost of 1.6% of the trust’s net asset value. It covers about a third of the company’s assets, has a strike price of 5,800 and expires on June 19 this year.

‘The company has little need to hold precautionary cash with a put option, so if the markets remain buoyant then the portfolio remains well positioned to fully participate in that market rise,’ Williams said. ‘Conversely, if markets were to fall back, then the value of the put option would rise and could become significant in the context of the whole company. At those times, its rise in value might offset the reduction in the regular portfolio to some degree.

‘Better still, the put option could then be sold so the scale of the portfolio could be increased at a time when market prices were depressed.’

Marcus Brookes, Schroder Multi-Manager Diversity: 31% cash, zero bonds

Schroders’ head of multi-manager Marcus Brookes has stuck with his bearish stance on fixed income for over a year. His flagship MM Diversity fund has been running with a cash position of over 30%, which has been painful in the short term as government bonds confounded expectations with their strength in 2014.

‘Diversity is meant to be one third fixed income but we are basically in cash because we don’t think bonds represent any value at all. We have maintained that and a very large cash position, which proved wrong in 2014 as bonds rallied hard,’ he said.

However, despite the fund sliding into the fourth quarter over 12 months, after last year’s rally, Brookes said fixed income is now less attractive than ever. He believes the risks of relative performance suffering due to the large cash weighting are far outweighed by the threat of being exposed to a hefty bond correction. Also reflecting his current caution, he has 29.2% allocated to alternatives, the fund’s highest single weighting.

Steve Russell, Ruffer Investment Company: 37% index-linked bonds

Ruffer has long been wary of the risk of inflation due to quantitative easing (QE). To guard against this, the trust has a chunky 37% weighting in a combination of index-linked gilts and international bonds. While he admits this scenario is some way off, despite UK inflation falling to a multi-year low last month, the fund’s positions in long-dated linkers have still proved beneficial as the longest duration gilt rose 50% in 2014.

‘It’s a learning experience for all of us,’ he said. ‘But it appears that linkers also offer disinflationary protection. These can move all over themselves independently of each other and when bond yields fall without a corresponding move in inflation, you can get a sharp appreciation.’ He adds index-linkers also have massively long duration, with the bulk of the payment towards the end. ‘The key to the way we invest is to take timing out of the equation. So we may be wrong about one aspect of the portfolio but hopefully we will be right about enough else that we won’t lose money.’

Tineke Frikkee, Smith & Williamson UK Equity Income: 10% cash

Frikkee is expecting elevated levels of volatility in the run up to the general election but said this will present buying opportunities.

‘I am cautious on the UK market in the short term, which is reflected in the 10% cash level of the trust. The trust will remain focused on downside protection by using cash levels strategically, keeping the portfolio beta below one but being alert to attractive opportunities as they emerge during falling markets.’

Richard Scott, Hawksmoor Vanbrugh: 8.6% cash

Scott and co-manager Dan Lockyer positioned the fund more cautiously last year, warning that government bonds and other income-generating assets ‘are more vulnerable than many realise’. He remains cautious, saying this reflects his wariness of ‘the diminishing upside potential for most investments compared with downside risks’.

Sebastian Lyon, Trojan fund: 19% cash

Although cash and gilt allocation is quoted as a single figure, the size of the position underlines Lyon’s caution. He warns of the ‘growing dread that financial assets have become disconnected from reality’, and questions whether equities can continue to rise when the QE-driven liquidity starts to dry up.

‘The realists recognise that the economic fundamentals are not improving,’ he said, adding the question is how long can equities and bonds continue to ‘muddle through’.