Jordan Sriharan, head of fund research at Thomas Miller Investment discusses knitting together MPS portfolios for the long term.
'Thomas Miller’s multi-asset team manages £1.1 billion in assets, benchmarked against real return performance targets. Of that, just under £0.5 billion is managed within the parameters of our model portfolio service (MPS). There are four portfolios, each of an increasing risk profile that has been constructed using an efficient frontier, which is itself constructed upon our own long-term capital market assumptions.
In many ways, that all-encompassing word ‘long term’ is at the heart of what the MPS is trying to achieve. The efficient frontier helps in the construction of a strategic asset allocation for each risk profile, which provides the building blocks upon which the real return portfolios are expected to generate their performance targets.
For the lowest risk portfolio, we would expect the strategic asset allocation to produce the return of cash plus 2%. For the highest risk portfolio, we expect cash plus 5%, all on a net of fees basis.
Tactical asset allocation is an important tool in protecting downside and, more broadly, for managing portfolio risk; however, our view is that alpha generation is limited when a portfolio constantly changes asset allocation to time markets.
Model portfolios do not lend themselves to a high frequency trading approach, certainly not from an operational perspective. It is difficult to apply dynamic currency hedging strategies, and utilising derivatives for efficient portfolio management purposes is virtually impossible. MPS managers should naturally have a focused, long-term approach to portfolio management.
We focus on portfolio construction and how the underlying funds in the portfolio knit together; bottom up selection is fundamental to generating alpha. The top-down analysis is no less important. Indeed, it focuses our research efforts and ensures we are capturing the various return streams and relative value opportunities. Our MPS blends passive with active funds. In order to do so, it is imperative to understand the idiosyncrasies of benchmarks and how our active managers complement them.'
'Our allocation to UK equities has turned more defensive over the last year and we expect to move underweight in the coming quarters. This is not driven by a negative post-Brexit view of the country, as everybody knows the statistics around how much FTSE 100 revenue is derived from outside the UK. The global nature of the FTSE 100 means that as global growth peaks, plateaus and falls away, the UK equity market will broadly follow.
For us, being defensive meant switching from passives (with their sectoral imbalances) to active managers. As a house, we utilise L&G’s passive range and have moved away from the L&G UK Index Trust, and more into our current stable of active managers, which includes Evenlode Income and Investec UK Alpha, amongst others. Their ability to protect the downside in 2018 has supported portfolio returns – Artemis Income is a great example of this. As a strategy, the team have avoided bond proxy stocks, including some of the larger tobacco names, but have also built a significant position in UK financials, which performed well in the first quarter.
At this later stage of the global economic cycle, portfolios remain overweight equities. We are not trying to time precisely when the cycle ends – as volatility increases, the opportunity to take profit and recycle it into underperforming equity regions also increases. Behavioural biases play a huge part in determining investor appetite and our long-term discipline tries to ensure that we do not become hostage to them.
Emerging markets are currently going through an ‘unloved’ phase, both equity and debt. As the fast money dumps anything EM related in their portfolios, the narrative has changed to make sense of it – stronger dollar, higher rates – but these factors have been in play for some time.
We added to our two largest active managers in the EM equity space, Somerset Dividend Growth and Hermes Emerging Markets, which reflects our view on where we are in the cycle.
This behavioural assessment is not dissimilar to what happened to the high yield market in 2015; the end of an asset class was the narrative that time. The following year produced exceptional returns for high yield; for the long-term investor with an informed view of the macro environment, there was a huge opportunity.'