Alex Brandreth, deputy chief investment officer at Brown Shipley, explains how they are rotating for more volatile times.
'We believe that macroeconomic indicators are all pointing to a change in policy in the not too distant future. UK government bond yields have fallen to their lowest level to date this year, inflation is finally starting to fall to the Bank of England’s target of 2%, and the UK economy remains robust in the face of Brexit-related uncertainty.
What’s more, with interest rates still at emergency levels, the Bank of England would lack the necessary firepower in the event of an economic slowdown. With less than 12 months of governor Mark Carney’s tenure remaining, those in line for succession will want to know whether or not they have some levers left to pull should they find themselves in the hot seat.
Against this backdrop, it is difficult to see how fixed income can deliver returns to our investors from the current low yields. As such, we have begun to reduce our exposure to the asset class, as demonstrated by our recent sale of a global fixed income fund from our Model Portfolio Four.
Another reason for doing this was to reduce our exposure to the dollar. While dollar strength (versus sterling) has been a significant contributor for UK-based investors post-Brexit, the risk/return trade-off no longer looks attractive, with a significant degree of volatility for limited upside potential.
For these reasons, we have added the Muzinich Enhanced Yield fund to our portfolio, demonstrating our preference for credit over duration within fixed income. The fund is a good blend of investment grade bonds with carefully selected high yield names, and its focus on avoiding capital losses fits with our desired risk/return profile in the current market conditions.
On the flipside, we are increasingly confident that the absolute return funds we have selected will deliver returns in excess of those on offer in fixed income markets. More recently, we added the Old Mutual Global Equity Absolute Return fund as our third largest holding in the portfolio to complement our existing holdings in Ruffer Total Return and Troy Trojan.
The challenge of increasing exposure to alternatives is delivering adequate diversification without compromising total returns. However, diversification is becoming more important than ever as the traditional inverse relationship between stocks and bonds, a cornerstone of portfolio diversification, is increasingly being challenged. A low correlation to markets too often translates into low returns.
This dynamic has focused our research into market neutral funds with sophisticated risk management processes and solid growth prospects. The quantitative team at Old Mutual fits the brief perfectly.
More broadly, we are maintaining our existing equity positioning. The relative outperformance of the US compared with Europe was generally positive for the portfolio, but the poor returns from emerging markets have been more of a headwind to performance. As a result, we continue to favour low-cost passive exposure within the highly efficient US markets and more active propositions elsewhere.
In total, we have £140 million in the Brown Shipley model portfolio service across five different platforms. We are pleased with our latest quarterly performance – in Q2, Model Portfolio Four gained 4.63% versus the IA 20-60% shares sector average of 2.92%.
Nonetheless, we remain alert to the increasing volatility in the markets and to the risks and opportunities that this can present, both in terms of asset allocation and manager selection.'