Brompton Asset Management's chief investment officer, Gill Lakin, explains why it is time to look to alternatives as rates and inflation rise.
The asset allocation of the Brompton Global Balanced fund reflects Brompton Asset Management’s current approach to investing according to a balanced mandate.
The fund’s B shares returned 31.41% net of costs from their 9 January 2014 launch to 28 February 2018 against 24.59% for the IA’s Mixed Investment 20-60% shares peer group.
Increased investment in alternative funds
As interest rates and inflation rise, longer-duration assets such as long-dated bonds and commercial property may prove vulnerable.
The Balanced portfolio currently has no investments in funds focused on these asset classes. I have, however, increased investment in alternative funds to provide diversification and potentially some protection in the event that inflation expectations and interest rates rise more rapidly than anticipated.
The term ‘alternatives’ encompasses a wide variety of funds. Brompton’s investments are in daily-traded long/short equity funds such as Man GLG UK Absolute Value and F&C Real Estate Equity Long/Short, which have a low correlation to bond and equity markets. A rise in equity market volatility should increase the opportunities for managers with proven stock-picking skills and the flexibility to take both positive and negative views on stocks.
Growing preference for ‘value’ managers
For a long time after the credit crisis, investors preferred high quality growth companies with relatively predictable cash flows, the so-called ‘bond proxies’.
Fast-moving consumer goods companies figured prominently among such businesses. Recently, some of these companies have experienced significant cost pressures, which have proved difficult to pass on to consumers, and their share prices have been punished with sharp falls when earnings have disappointed. As a result, ‘value’ managers may outperform and I have bought funds managed in accordance with this investment style, such as Schroder UK Recovery and Aberforth UK Smaller Companies.
Focus on short-dated bond funds
Lower risk multi-asset portfolios typically have big weightings in bond funds. Some bond funds may not, however, prove to be ‘low risk’ if they invest in longer-dated bonds that may fall should inflation and interest rates rise. The Brompton Global Balanced fund currently holds no longer-duration bond funds. It does, however, hold funds such as M&G Global Inflation-Linked Bond, which invests in short-dated securities and should provide some protection from rising inflation. It also has a sterling hedged holding in Templeton Emerging Market Bond, which holds local currency emerging market sovereign bonds.
Selective use of tracker funds
Brompton uses tracker funds and exchange-traded funds (ETFs) as well as actively managed open-ended funds and investment trusts to deliver the best risk-adjusted returns for clients as cost effectively as possible. In recent years, the growth in the number of ETFs and competition between providers has been a significant benefit to multi-managers. Brompton only invests, however, in tracker funds backed by underlying assets and not those that are leveraged or secured bank guarantees.
Currently, the Brompton Global Balanced Fund holds a small number of ETFs.
It does not hold bond trackers because active managers are likely to prove more defensive should bond markets fall. One reason is that bond trackers may inherently hold larger investments in more highly indebted companies because these businesses typically have more bonds in issue than lowly geared companies. This may mean trackers have big weightings in companies that present a greater risk of default when interest rates rise.
By contrast, the portfolio holds an ETF that tracks the US financial sector because many larger US financial companies enjoy significant economies of scale in the highly competitive and relatively commoditised sectors of financial services.