145. Investing in robotic arms and Nike destination stores

David Coombs, manager of Rathbone Strategic Growth Portfolio, talks to us about a range of alternative investments and how you can make money from the volatility in emerging market currencies and interest rate expectations. He also talks about the idiosyncratic risk in music royalties, using Taylor Swift as an example, and tells us about investing in the entire retail value chain and the companies fighting back against Amazon.

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The manager of Rathbone Strategic Growth Portfolio focuses not only on returns, but also on risk and correlation. He uses a disciplined asset-allocation framework and a forward-looking assessment of correlation, risk and return, as the cornerstone of the investment process. Asset classes are then divided into three distinct categories – liquidity (those that can be bought and sold easily), equity risk and diversified.

Read more about Rathbone Strategic Growth Portfolio

What’s covered in this podcast:

  • The outlook for equity markets in the second half of 2021 [0:11]
  • An explanation of an ‘emerging market FX momentum certificate’ and how it is used in a portfolio [3:05]
  • How Swiss pension fund buying creates pricing anomalies in the Swiss equity market [5:35]
  • How you can make money from the volatility in inflation rate expectations [6:22]
  • The manager’s views on alternative investments [7:02]
  • Why Taylor Swift’s re-recording of her first five albums highlights the idiosyncratic risk with music royalties [8:02]
  • Why the manager likes Nike and Shopify [9:51]

5 August 2021 (pre-recorded 4 August 2021)


Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.




Sam Slator (SS): I’m Sam Slator from FundCalibre and today I’ve been joined by David Coombs manager of the Rathbone Strategic Growth Portfolio. Hi David.


David Coombs (DC): Hi.





SS: So, crystal ball time, let’s start with markets, shall we? I think I’ve just seen that the S&P 500 is now almost double what it was at the low last March. So we’ve had some pretty amazing stock markets over the last year or so, what’s the outlook for equities, bonds and perhaps other asset classes for the rest of this year?


DC: So, thanks. What’s the outlook? Well, yeah, you’re right, the equity markets have recovered incredibly. We’ve been discussing this as a team this week actually, because it is quite worrying when you see valuations where they are. We’ve had just an earning season with, you know, vast majority of companies beating estimates, not that surprising because, you know, if you compare to 12 months ago where we were with COVID and, you know, companies were very reticent at giving detailed guidance for obvious reasons and frankly, totally realistic reasons. So I’ve no problem with that at all. And I guess estimates were probably on the, you know, analysts estimates were kind of on the more conservative/cautious side when there was very little to go on. So I guess not that surprising that companies have beaten… in some cases destroyed.


The thing to really highlight, however, is some companies are even back to sales pre-COVID which has just been phenomenal, you know, in some instances. Nevertheless, you know, it is, I think it is quite a good time to just take stock a little bit where we are, technology companies have recovered again, we’ve had these huge rotations as well in the last six months, sometimes on a daily basis. So yeah, we are a little bit nervous where equities are at the moment.


And of course the problem being nothing’s cheap anywhere else either. So it’s kind of the only game in town. We are rotating the portfolios a little bit, taking some profits from some of the companies that have gone up 200% actually in 12 months, you know, and just feel it’s time to trim a few of those names. And we’re kind of trying to look at, I hesitate to say value, but so you look at some sectors that may be, have been weaker over the last couple of months – more cyclical type ideas. So yeah, it’s tough. It’s really tough. I’d love to say yeah, we’re off another 20%, but I think that’s probably unlikely and bond markets, and this is the other strange thing, right? You’ve got the bond markets that are kind of telling you, you know what, there’s no real inflation around, there’s no real growth around and yields are really low and sort of grinding even lower. I mean the equity market highs, as you just pointed out, so who’s wrong? I’m backing the equity market overall.


SS: You are? Okay.


DC: At the moment, which is kind of dangerous because the bond market’s usually right. So I’m going against conventional wisdom.




SS: And you’ve got some sort of weird and wonderful things in your portfolio. I had a little look through the factsheet and I just wondered if you could explain what some of them are please. I think I found an emerging market FX momentum certificate. What’s that in layman’s terms and what does it do for the portfolio?


DC: Yeah. So back in the day, seven or eight years ago, when we were a fund to funds, we used to invest in hedge funds and one of the hedge fund styles, most people listening to this or watching this will know is CTA’s, [Commodity Trading Advisors, sometimes known as managed futures] you know, sort of quant funds, momentum funds, these sorts of funds. And we often used to joke that we wanted the CTA without equities because as the CTA funds got bigger and bigger and they needed liquidity, they started adding equity strategies into those funds that often correlated to equity markets. You lost that kind of diversification impact.


Since we’ve gone directly invested and as the funds have grown in size, it means that we can now go to those investment banks ourselves and recreate some of these CTA strategies. And the EMFX is one of those. It’s probably not the best example I might come to another couple in a minute, but what this one essentially is, is a momentum trade based on emerging market currencies. And it basically is long the carry, ie the interest rate differentials between emerging market currencies and US dollars. On a long-term basis we just want to be long of that carry. However, if volatility increases, it switches to becoming short EM and long US dollars. So it is, I think of it as a hedge fund that’s long/short emerging market currency, is the way to think about it, but we’re doing it within a structured note. Sort of direct if you like without any fund manager costs and everything else. It’s a much cheaper way of getting access to that kind of strategy.


SS: So it’s basically trying to make money out of emerging market currencies, because you think they’re going to rise versus the dollar. But if that doesn’t happen, actually,


DC: it switches


SS: the reverse trade kicks in.


DC: Yeah, so it doesn’t happen overnight, it’s a trend follower. So, you know, it takes a few days of emerging market weakness for it to start, you know, like a seesaw, it starts to rebalance. That’s the way to think about it. You know, it’s not a diversifier for a kind of a collapsed market overnight type thing. It’s not there to do that job. It’s a long-term uncorrelated trade if you like to equity markets, but it is a risk on trade to a certain extent.


I guess the other investments in that space that we own probably better examples of diversifiers. We have a stock dispersion note, which is based on a Swiss equity index. That’s basically your long volatility of the equities and short volatility to the index. So think about it, the more volatility you get in individual stock names, it makes a positive return. Again, it’s got nothing to do with the direction of the stock market, it’s purely long the volatility and there’s lots of reasons why you’d want to do that in Switzerland, due to the pension fund buying of the index, there’s all sorts of sort of price anomalies, where it makes sense to take a stock dispersion note on that index. Also it’s made up of banks and pharmaceuticals dominated and then Nestle of course.


And then finally one which we’re doing at the moment, which I can’t talk too much about, but it’s basically where we’re putting long volatility on interest rates. So again, directionless – doesn’t matter if interest rates go up or down – but as we think inflation fears will come and go a lot over the next year or so, we think there will be more volatility in rates expectations. And we want to be long that volatility. And again, there are institutional, reasons for institutional buyers in pricing anomalies, and forward interest rates that we can take advantage of by again, working with an investment bank to put together that strategy. So it’s a really efficient way of kind of creating our own mini CTA, if you like.




SS: And you’ve already mentioned that you think equities are quite expensive, bonds as well. The alternative space is quite interesting, sort of it used to be just sort of perhaps property and commodities, but it’s grown and grown, and a lot of these alternatives are becoming quite mainstream now, you hear a lot about music royalties, shipping, that type of thing.


DC: Yep.


SS: Can you give us a few thoughts maybe on how the alternative space has grown and where you’re finding opportunities at the moment?


DC: Yeah. So I would question some of those as being alternatives, to be honest, I know that’s some people’s definition. They certainly don’t meet my definition. So when I think about alternatives, those three trades I just talked about sit in our alternatives bucket. We do own and have been increasing exposure to commodity baskets for the last few years, because we were… as a kind of inflation hedge, and also a Brexit hedge actually. So we still think commodities ex-gold play a big part in the strategy at the moment.


I have real problems with some of these other alternatives, like you mentioned, the music ones, for example, I don’t think they’re fully tested. I think, you look what’s happening with Taylor Swift with the re-recording of master tapes, you know, trying to understand how secure your rights are and whether there be government intervention and antitrust laws. I still think, you know, there’s lots of potential idiosyncratic risk. Are they alternative? I guess there they are in the sense that they’re probably uncorrelated versus equities per se. Although that’s, again, it’s still to be tested, to be honest.


If you think back, you know, in the 35 years or so I’ve been working, you know, people were very excited by vintage car funds and art funds years ago, 20 years ago. And that, and the reality was they were highly correlated to equities during market corrections because, you know, when the wealth effect turns negative people look to sell what they can and you tend to find those things you thought were alternative, were not quite as alternative as you think. So we’re very cautious about these new alternatives. A lot of them are very illiquid as well. And if you got a liquidity squeeze, they’re probably not going to do very well. Even the renewable energy we question, you know, how alternative is renewable energy really, as it becomes more mainstream?


So yeah, for us, alternatives are still pretty traditional, apart from, as I say, you know, trying to recreate these kind of quant-based strategies, we think that’s a much better way, more transparent way and visible, and you have greater visibility over the future return profiles in those types of strategies.




SS: And within your equity holdings, you have a couple of stocks that our listeners will know very well, you’ve got Nike and you’ve got Shopify. What is it about those two that you like in particular?


DC: Well, when we look at any sector or industry, we try to understand what are the tailwinds for that industry or sector? Because if you’ve got structural tailwinds, it kind of is a less risky way to invest. You know, if you’ve got structural headwind, you can be the best company in that sector,  but if the industry, if that sector or industry is contracting, you know, you’ve got a headwind. So we like to invest with companies that are in sectors that have a tailwind. And when we look at retail, you might find that a strange thing, thinking: well how can retail have a tailwind? Well clearly e-commerce retail does have a tailwind. And so when we look at who the likely competitors to Amazon, we think Nike, is you know, it’s focused now more on selling direct to consumer through its own online presence, through digital marketing, but also coupling that with their destination stores, their proper customer experience type bricks and mortar, they’re combining bricks and mortar with a very sophisticated digital online channel. We think that’s really compelling and it’s a model that many tried to meet, but you’ve got to, you need the capital to do it.


Shopify clearly allows many brands to retain their brand value and sell direct to consumer rather than becoming a third-party supplier to Amazon and losing your brand value. So we think it really plays into the future of retail, as companies start to think about how do we offset the Amazon effect and impact?


We also like Kion for example, which is a company that makes kind of the robotic arms and autonomous vehicles in the big distribution centres within retail. Think the Amazon distribution centre, Next distribution et cetera, et. So we’re looking at playing retail throughout the value chain where you’ve got this very sophisticated, omni-channel. Omni-channel is not just website and shop. It has to be much more brought together and sophisticated, and that’s kind of where we want to invest.


SS: That’s really interesting, thank you. And if you like find out more about Rathbone Strategic Growth Portfolio please visit fundcalibre.com and don’t forget to subscribe to our podcast via your usual channel.

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