With markets not yet able to stand on their own two feet, the team behind IBOSS’s model portfolios is holding more cash and gold than ever before in the expectation of interest rates remaining low. 
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 IBOSS portfolio manager Chris Metcalfe (pictured) about the firm’s process, current positioning, recent performance and outlook.
Metcalfe’s team run seven risk-rated core strategies across two platforms, as well as an income portfolio and an ethical portfolio which are based on model four – the median and most balanced portfolio.
“When we first started running the models in March 2006, originally one of the differentiators for us – which is hard to believe now because things have changed so much – was that we used multiple funds in a sector,” Metcalfe said.
“Back then the standard number of funds in a portfolio would have been under 10 and we immediately brought in a system which was using somewhere between 30 and 40.”
While this practice is accepted as the norm nowadays, the track record the team has built up over the last decade using this philosophy sets them apart, the manager added.
“That we have the best part of a decade’s worth of data we can see that having multiple funds does take out some of the risk that’s hard to quantify and not captured in risk metrics,” he said.
The funds are benchmark-aware but unconstrained and can therefore look very different to peers, as evidenced by the 0 per cent weighting to North American equities it currently employs.
Metcalfe and the IBOSS team use a tactical overlay to determine asset allocation before then using quantitative and qualitative processes to aid in choosing individual funds.
Ideally, he said that they are looking for managers with an unconstrained mandate that move their funds across multiple market sectors and styles in order to drive outperformance.
“We are looking for managers who are flexible and successful – so it is no good thrashing around if your track record doesn’t warrant it,” the manager noted.
However, he said finding these managers is “more difficult than it should be,” and as such where they cannot be found he uses a blend of funds with different styles that have proven to be consistent in their process throughout the cycle.
Key overweight
The IBOSS team do not have many overweight positions in the portfolio. Indeed, the team’s “least bearish” position is towards Asia equities, which we explored earlier this week.
One of the few areas the team has built a record weighting towards is cash. Metcalfe said while it offers “paltry” returns it does provide some downside protection.
While many may dismiss cash, however, sometimes it can be the best option for investors, he explained.
“In a 14-year period ending in 2008 you would have been as well-off investing in cash as investing in the IA UK All Companies sector or bonds,” the manager said.
Indeed, as the below chart shows, on a relative basis the average IA UK All Companies fund would have underperformed cash from 1995 to March 2009 by 2.73 percentage points.
Performance of fund vs sector since launch
Source: FE Analytics
“You had extreme circumstances leading to the financial crisis and we would argue you have got potentially– pretty extreme conditions now – though we’re not trying to say that the market falls over tomorrow,” said Metcalfe.
“The market globally is setting a new record high pretty much every 24 hours at the same time as volatility, if you go by the Vix as a measure, is the lowest it has been since the index was launched.”
The only other times this has happened, he said, was in the lead-up to the technology bubble of the early 2000s and in the lead-up to the 1929 crash.
Metcalfe said volatility has been low due to support from central banks, which have “rigged” the market through extreme measures such as quantitative easing and extremely low interest rates.
“The bottom line is the [European Central Bank president Mario] Draghi, [Federal Reserve chair Janet] Yellen and [governor of the Bank of England Mark] Carney put has been in place for quite a while and markets have quite rightly worked out that the central banks have got their back,” Metcalfe noted.
“That is all fine and dandy except we appear to be coming to the end of that period and one way or another there is going to have to be a new chapter written.”
Overall, he said it comes down to the “least worst risk-return profile” for investors in this environment, with central banks potentially taking away their stimulus.
“We think that cash is there and you also want some ammunition for if markets do sell off then we would be looking to reposition some of that cash in relatively short order,” he added.
Key underweight
One area where the manager is extremely cautious is the property sector, with valuations reaching new highs and yields potentially coming under pressure if interest rates do rise.
“It is the lowest property holding that we have held in our history in any version,” Metcalfe said, noting that historically the Model Four has held between 8 and 12 per cent in the asset class but it currently stands at 6 per cent.
However, there remains a case to hold the asset class on diversification grounds, despite the unappealing valuations and fears for the UK property market with ongoing Brexit negotiations clouding the outlook for the sector.
“There is still a case and reasons for holding property: the yield. If interest rates don’t go up very high from here because the global economy isn’t that strong then you are back to a supportive reason for holding property just for the yield alone,” the manager said.
“We are holding less [property] than we have been holding [previously] but if we are going to hold any we think that Guy Morrell is the best person to do it.”
The FE Alpha Manager runs the £310m HSBC Global Property fund, which invests in other property funds across multiple geographic locations.
The fund has been a consistent performer in the IA Property sector, returning 77.56 per cent since its launch in 2007 against the sector average’s return of 33.5 per cent.
Performance of fund vs sector since launch
Source: FE Analytics
The unique approach Morrell adopts starts with analysing data and meeting fund managers to predict the direction of global markets before the best 10 to 15 funds within their preferred markets.
“Morrel is the only person who runs a fund like this and is completely objective because he can invest in pretty much anything property related,” Metcalfe said.
“He has got a good track record and did a very good job of manoeuvring the fund around the point of Brexit so he managed to dial down his UK bricks & mortar exposure almost to the hour.”
The fund is a 4 per cent weighting in the model portfolio – the capped maximum position – with the other two per cent invested in the F&C UK Property fund.
The manager said: “It is newer than a lot of the UK bricks & mortar funds so it has got less of the legacy properties that were potentially bought when there were massive flows into the sector a couple of years ago.”
Performance
The Model Four portfolio is benchmarked against the IA Mixed Investment 40-85% Shares sector and since launch has beaten the sector by 14.23 percentage points, as the below chart shows.
Performance of model portfolio vs benchmark since launch
Source: FE Analytics
“The reason we like relative charts is [that] you cannot hide in a relative chart while you can in a cumulative,” said Metcalfe. “We have seen plenty of examples over the years of somebody who has knocked it out of the park for 12-18 months and then hidden in the benchmark and that is no good to us because if we are paying active fees we want people to be actively trying.”
The portfolio has done this with volatility of 7.97 – the seventh best in the sector – top quartile Sharpe ratio (which measures risk-adjusted returns) and maximum drawdown (the most an investor could have lost if buying and selling at the worst possible moment).
The portfolio also has a top quartile information ratio, which assesses the degree to which a manager uses skill and knowledge to enhance the fund returns.
“Overall, I think one of the things that we have got is very high information ratios across the board and that for us is important,” Metcalfe said.
“It doesn’t help the product fly off the page because information ratio is not the most glamorous statistic but for us it is important because it is all about consistency.
“We outperform in more cases than not and are one of the most consistent fund of fund model portfolio offerings out there from our low risk to our high risk – we outperform consistently across the board.”
He added: “There are odd periods where we have underperformed but I think our approach means that we don’t get individual funds take a sector out for us.
“That’s the reason we capped our exposure at 4 per cent because we didn’t want any one manager to have too big an impact.”
Outlook
Overall, Metcalfe said he has positioned the portfolios for the eventuality that central banks will be unwilling to raise interest rates consistently.
“Our base case is that central banks do not back off to any large degree and that is based on the evidence of they haven’t backed off so far,” the manager said.
“I am not sure the market could stand on its own two feet if central banks cleared off out of the way so if that is the case then we would expect interest rates to not go very far.”
While he admits that the Fed in the US are the most likely to raise interest rates more consistently than the European Central Bank (ECB) and Bank of England, he does not envisage more than one interest rate hike this year and one next year.
“I am not sure markets can take it,” he noted, adding: “One of the reasons the markets are buoyed as they are is that they don’t really believe that the Fed is going to keep hiking if the data doesn’t justify it.”
Separately, while the ECB might cut down on the amount of money printing and bond buying it has implemented in recent years, it is still a long way from raising interest rates.
However, the danger to markets is that something happens outside of central bank control that is currently unknown, be it geopolitical, macroeconomic or any other number of factors.
“On the assumption that central banks can stay involved then we would expect interest rates and yields bonds to pretty much keep drifting around where they are which is why we think it is going to be difficult for the bond managers to make too much progress,” Metcalfe said.
When it comes to equities, he added that he does not think it will be too much of a struggle for the asset class to make progress though investors need to be selective on which markets they buy.