Daring to be different

Sam Slator 10/07/2017 in UK, Equities

We talk about correlation a lot when it comes to investing, particularly when we are worried about markets. It’s part of the ‘diversification’ argument – being careful not to put all your investment eggs in one basket, in the hope that if one investment falls in value, another either won’t fall as far, or will even see a gain.

Correlation explained

Calculating correlation can get a bit complicated, but simply put, if the calculation throws up a number close to 1 there is a ‘perfect positive correlation’, which means the assets or funds are likely to move in exactly the same direction. If the number is close to -1, there is a ‘perfect negative correlation’ and the assets or funds will move in the exactly the opposite direction. A number close to zero means there is no correlation – or relationship – at all.

One fund that exhibits this close to zero correlation to its benchmark is Smith & Williamson Enterprise. It is a targeted absolute return fund that invests in UK equities and can make money by going ‘long’ (investing in companies it thinks are good and will do well), or also going ‘short’ (trying to make money when stock prices fall). Its correlation to the FTSE All Share index is 0.11¹ and this is one of the reasons we like this fund for diversification and to dampen volatility in a portfolio.

The long and short of it

The name of the game for the managers of this fund is capital protection. We caught up with Mark Boucher, one of the co-managers, to get an update on how they are positioning the fund in the current environment:

“Post-Brexit we have really focused on companies, as it is very hard to call macroeconomic and currency movements. But the past six months have come with an enormous amount of stock dispersion, which is good. It means we can really sift the wheat from the chaff and make money from both.

“A company we haven’t liked and have shorted in the past year is Pearson, which in our view has structural problems. It is a dollar earner so it benefited from sterling falling after the EU referendum, but since then it has had no fewer than four profit warnings and the share price has collapsed. People just don’t want to pay huge amounts for text books any more, and it has been slow to evolve to meet the changing environment.

“An example of a company we like and have invested in is Melrose. It has a very strong management team with a track record of buying, fixing and selling on the companies that they manage. This is not an oil price call or US macroeconomic improvement call, just a confidence in very good people.

“Overall the portfolio currently consists of 46 longs and 31 shorts². Shorts are more risky and hence we have fewer of them. We like to take things slow and steady and not take gambles. There is no point putting everything on black!”

¹Source: Smith & Williamson for the period 3 April 2006 to 31 May 2017 ²Source: Smith & Williamson as at 31 st May 2017

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions.Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice.Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.