The world is at an inflection point both in terms of interest rates and quantitative easing, according to the team behind Waverton Investment Management’s managed portfolio service, although it remains fully invested: a strategy that has helped them outperform peers over the long term.
As part of an ongoing series in which FE Trustnet looks at the model and managed portfolios on offer to UK financial advisers, we spoke with Waverton managed portfolio service head John Bellamy and portfolio manager Luke Hyde-Smith about the firm’s process, current positioning, recent performance and outlook.
Waverton runs five mandates across its managed portfolio service – Growth, Balanced, Cautious, Defensive and Conservative – which have relevant ‘inflation plus’ benchmarks.
Bellamy said the team made the switch to inflation benchmarks to make it easier for clients to understand.
“Clients understand (and want to know) how much they are worth now, how much they were worth the last time we saw them and what inflation has done,” he said.
“That’s what’s important to them and we didn’t feel like we were getting much response when we said we had beaten the FTSE 100 or whatever it was all kind of meaningless to them.”
He said the portfolios are run with a very strong eye on risk and downside protection, meaning they have more in assets under management in their Balanced, Cautious and Defensive funds.
Each of the funds are made up of four Oeics – open-ended investment companies – run by different portfolio managers specifically for the managed service one each for fixed income and alternatives and two equity strategies.
The two equity funds include a core equity strategy, which is benchmark aware; the other is a tactical equity strategy, which implements the team’s top-down asset allocation views.
“Depending on which mandate you are in, it is made up of different weightings of those four Oeics,” Bellamy explained.
“There are a number of benefits – not least cost – but from our point of view the most important benefit is when we are constructing the portfolios we don’t care what is held on platform.
“So, it doesn’t matter if we want to buy the latest robo-ETF or if we want to put a structured note in there, it doesn’t have to be on platform because it is bought in our Oeic structure. The fact that those portfolios are identical in every single platform is quite a big factor.”
However, he said an adviser would not necessarily want to buy one of the Oeics separately, as they are managed from a top-down viewpoint meaning that each interacts with one another.
The top-down view is formed by Waverton's central asset allocation committee consisting of senior staff including chief executive Andrew Fleming, head of private clients Algernon Percy, head of fixed income Jeff Keen and Bill Dinning, head of investment strategy and communication.
“Everybody has the chance for input but the decisions are made by that committee of four,” Bellamy said. “When those decisions come out to overweight equities or bonds or whatever it might be, with the nuances of style and currency and geography… we implement them directly.
“So, for example, if we’re deciding within equities [that] we are going to increase Japan that then comes down to the manager of the tactical equity [strategy] to find the best manager or vehicle to populate that.”
Key overweights
Earlier this week, FE Trustnet considered some of the preferred equity areas the team have been adding in recent months, including UK smaller companies and emerging markets.
An area that the team is keen on outside of equities, however, is the alternative space, with a dedicated alternatives Oeic an integral part of the model portfolios.
“We are generally overweight alternatives. We view alternatives as the low-risk component of a client’s portfolio,” Bellamy said.
“We blend a range of different asset classes within there. None of them are without risk but the way we blend them together, because they are different risks, it does produce this moderate return with lower risk and lower correlation.
“I think over the last couple of years it has done a couple of per cent but the volatility is much lower than gilts.”
Indeed, as the below chart shows, so far this year the fund has returned 97 basis points, while 15-year UK government bonds (gilts) have fallen by 24 basis points, although gilts have also been much more volatile in 2017.
Performance of fund vs index YTD
Source: FE Analytics
Since launch, the fund has returned 2.01 per cent versus the 45.96 per cent return of the Bloomberg Barclays Sterling Gilt 15+ Years index.
The alternatives fund is made up of predominantly market neutral strategies alongside some global macro funds, Bellamy noted, but one area that it is less invested in is long/short strategies.
“We have historically used long/short but it has always disappointed us – not necessarily on the upside capture but it was the downside capture that we could no longer handle,” he said.
“One that we do hold is the Odey Odyssey – Tim Bond’s fund – which has been an extremely poor performer but Tim has probably the polar opposite view of markets that we currently have. As such it gives us a lower risk from a portfolio construction point of view as it negatively correlated.”
Also in the fund is a mixture of asset-backed companies, property funds, infrastructure funds specialist companies such as aircraft leasing.
“Wherever we own an asset class that is illiquid – such as property – we will not own it through an open-ended fund. So we won’t suffer from the problems that we saw most recently after Brexit where property funds closed their doors,” Bellamy noted.
“When we construct that area, the assets in there are not without risks but they have different risks and it is all about how we blend them to achieve the moderate return that we are after with as minimal correlation as we can muster.”
Key underweights
Somewhat unsurprisingly, with an overweight to equities and a structural overweight to alternatives the Waverton team are underweight fixed income assets.
“At the moment we are underweight fixed income. Within fixed income we are largely corporate with not too much government debt,” Bellamy said. “And within corporates we have a reasonable amount of exposure to financials which have done very well for us.”
Despite being an underweight position in the portfolios, the fixed income allocation has delivered a very strong return this year on a relative basis, he added.
Indeed, the Waverton Sterling Bond fund has returned 5.91 per cent, so far this year, beating the IA Sterling Bond sector by 1.8 percentage points and the FTSE Actuaries UK Conventional Gilts All Stocks index by 5.88 percentage points.
Performance of fund vs sector and benchmark YTD
Source: FE Analytics
“If you look at it against gilts it is up 5 to 6 per cent while gilts are relatively flat on the year and certainly with a higher volatility,” said Bellamy.
“So, we have made higher returns from lower volatility in an area which we don’t necessarily like, which is great.”
The other area the team are underweight is US equities, which they say have become too expensive when compared to other areas of the world. However, they still have a sizeable weighting in the fund.
The core equity product, which forms 60 per cent of a clients’ equity exposure, has a developed market core equity which is sector and country neutral but does have a fundamental bias, meaning that the weighting to the US market is neutral in this portfolio.
As such, it has a similar weighting to North American equities as its benchmark – the MSCI All Countries World index – of around 60 per cent.
In the tactical equity product, which makes up the remaining 40 per cent of the portfolios’ equity allocation, the team are “trying to get exposure to differentiated investments” Bellamy explained and are therefore running a small underweight position to the region.
Performance
Over the past five years the Waverton portfolios have consistently beaten their relevant inflation-plus target benchmarks.
Taking the Waverton Balanced portfolio, it has returned 46.12 per cent over the last five years and has paid out 21.7 per cent over three years. These returns are 15.68 and 5.68 percentage points ahead of its CPI+4 per cent target.
Performance of portfolio over 5yrs
Source: FE Analytics
“I think [what has helped our performance] is staying invested,” Bellamy explained.
“Our performance has been extremely consistent, so if you look at it over the five-year period against our competitors we are consistently in the top half on a rolling year basis and I think that is through staying invested.
“We have been in a six, seven, eight or nine-year bull market – whatever it is now – but it has not always felt like that and there have been periods within that where we might have headed for the hills.
“But the strength of our asset allocation has come through to allow us to participate and I suppose the fact that we are not trying to knock the ball out of the park has also helped].
“The chances of us really dropping the ball on a big bet is low so we have blended styles, geographies we have hedged currencies and the risk mitigation has always kicked in.”
Outlook
Bellamy said the world had arrived at an inflection point both in terms of rising interest rates and the withdrawal of quantitative easing, clouding the outlook for markets in the near-to-medium term.
“With that change of direction for interest rates specifically in mind if you have been invested for the past 30-35 years as a relatively defensive client at 40 per cent, or so, in bonds you have had a fantastic ride,” he noted.
“So, anyone who is managing money now that has used gilts as the anchor of their clients’ portfolio – perfect, what a great idea. You have ridden the interest rate curve down and have made great returns with a low level of risk.
Performance of index since Jan 1999
Source: FE Analytics
“Going forward it is probably a less good idea if interest rates are going to turn and even if they don’t turn and stay where they are the returns to be made certainly relative to the risks that are being taken is not what it was.
“So, we look to have another area of our portfolio that is very low volatility, has very little correlation to equities & bonds and can return cash plus two [per cent] and that is what we try to do within the alternatives space.”
On quantitative easing (QE), Bellamy said the extraordinary monetary policies of central banks globally have raised all asset classes over the past decade, but that this is now beginning to change.
“QE has pushed a wave of money into equity markets that has raised all boats which has probably meant that hunting in the passive space both in bonds and equities has been a very good place to be in the last six years,” he said.
“We think the removal of QE is going to make active stockpicking much more important than it has been and therefore we have greatly reduced our passive exposure and increased the exposure to active managers.”
As a result of both rising interest rates and the withdrawal of quantitative easing, Bellamy said he expects returns to be lower than they have been for much of the past decade.
“We have just finished a program over the last six months to our advisers and our clients that we are likely to be in a low return environment and as such we cut our CPI targets that we set five years ago by 1 percentage point across all of our portfolios,” he noted.
“With cash doing nothing, bonds poor and the current valuations of equities where we are now, it is quite clear from that the mathematics tells you we are in a lower return world so we thought it extremely important to talk about that.”