16 September 2021 (pre-recorded 8 September 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.
[INTRODUCTION]
Ryan Lightfoot-Aminoff (RLA): Hello and welcome to the Investing on the go podcast brought to you by FundCalibre. I’m Ryan Lightfoot-Aminoff and today we’re joined by Jason Borbora-Sheen of the Ninety One Cautious Managed fund [renamed Ninety One Global Income Opportunities in October 2021], which is on FundCalibre’s Elite Radar. Jason, thank you very much for your time today.
Jason Borbora-Sheen (JBS): Thanks Ryan.
[INTERVIEW]
[0:16]
RLA: Now you took on this fund just 18 months ago. There’s a lot happened in that time, as we well know, so what sort of changes did you make to the fund and how have you done over that time?
JBS: Sure. So we delivered just over 20% since we took over the running of the strategy back in May 2020 and the fund’s up around 6.5% year to date. So we took on the fund having run the Diversified Income fund for the last nine years at Ninety One. And that’s a defensive strategy, which has delivered positive returns in each year since its inception. So the idea here was to take the core philosophy, which is basically that income is an undervalued source of total returns, that a portfolio should be built from the bottom up and that ultimately through managing downside, you can deliver some quite compelling risk-adjusted total returns. And we wanted to then do that with a greater risk budget.
So some of the changes that we made to the portfolio when we took it on included, I think first notably, managing bond exposure. So we actually took our developed market sovereign exposure down to zero, and we then went out right short gilt, bund and treasury markets for a length of time throughout this year. We’ve then actually reversed some of that. And then, more recently as treasury markets have rallied, we’ve gone shorter again. The second change I’ll probably note is that we added some credit exposure. And in particular that was during the second half of 2020, when there was a distortion in the price in the credit markets. And the third was that within equities, we went longer US stocks relative to UK stocks. And so when we put that together and look at the return profile of the fund, we see it offering an alternative to things such as credit or low illiquidity, higher income assets like infrastructure or property, or even higher risk absolute return type strategies.
And the fund’s name is actually going to change to the [Ninety One] Global Income Opportunities fund in October of this year, to align it with how it’s going about trying to achieve its objectives, which themselves won’t change.
[2:19]
RLA: And so, most of your holdings at the moment are in equities and bonds. Will you invest in any other assets to?
JBS: So the strengths, I think of the portfolio in how it achieves its objective, is the simplicity of its holdings. And so we focus on those cash, equity and bond holdings, we’re international in how we do that and we’re very single-minded in what we’re looking for. It’s basically a combination of above average levels of income with the resilience of cash flows backing that income stream and the potential for some capital upside or at least capital stability.
Where I think we make use of more complex instruments is when we’re managing risks in the portfolio. And that’s with regards both to equity and bond derivatives. So if you look for example, at developed market sovereign bond duration, we took that down to a negative level as I mentioned this year. And then more recently we took it back to above a year. And we then again, more recently have taken that back down to around zero. And that’s been through the use of those bond derivative instruments. We haven’t been so active…sorry?
RLA: I was just going to say, when you say you’ve gone sort of negative duration, just perhaps for our listeners, can you just explain what that does to the portfolio and what that does for an investor?
JBS: Sure. So duration is a measure of the portfolio sensitivity to interest rates. So if you have a duration for example of one year, that means that for a hundred basis point rise [1%] in interest rates, you would see a 1% loss in capital terms on the portfolio. So when we talk about managing bond risk, we use the duration term. So when we went negative in duration terms, that meant effectively that we were gaining from bonds seeing their yields rise. And so actually gaining from their price falls, which was something that was a hallmark of early in the year. The other area where we use derivatives is when managing equity risk. And we haven’t been so active in doing that. We’ve obviously seen markets perform strongly, but more recently we started to take some equity risk off using equity derivatives, which has taken our net exposure to equities now to just below 50% off its highs of around 60%. And we can talk maybe about some of the reasons for that later.
[4:31]
RLA: Sure. Actually maybe we can touch on that now, are there any sort of particular areas of equities where you are seeing high risk and you are sort of mitigating those risks with those, with those derivatives?
JBS: I think it’s less about there being significant areas of high risk. Although I would note that markets are being very narrow for the last two years really, in that we’ve seen a big crowd in, into growth stocks. You’ve seen a real, I think pessimisms towards value or income-based equities. So that has, I think created more of an opportunity on that side. If we look for example, at the, the valuation multiples of high dividend equities – they’re on a trailing basis around 19 times versus more than 30 times for the typical index. And we’re seeing those companies also deliver greater profitability than the index. So we think there’s certainly an opportunity there. I think there are risks starting to rise for equities more broadly, particularly as you go into 2022. And I think there, what we’re seeing is that growth data is starting to weaken across a number of nations now. So in China, it’s very weak already, in the US it’s starting to come off and in Europe, I think it’s starting also to flat line somewhat.
We’re then also going to see monetary policy becomes somewhat tighter, particularly with the Fed starting to discuss tapering, but that also is an international issue. We’re hearing about it from the Bank of England and from the European Central Bank too. I don’t therefore necessarily think that it’s a cause of a major correction, but I think that potentially some of the downside risks within equities come a bit more to the fore than they have done. I think for us to be particularly concerned about any one area we’d need to see complacency rise significantly. And so whilst you can often hear about particular small pockets of the US market, so-called meme stocks, looking very toppy. I think ultimately their significance to broader markets is quite muted.
[6:24]
RLA: And in that you talked about some of those developed market debt looking quite struggling. I see that 9 of your 10 top bond holdings are from emerging market government bonds. Potentially obviously we’ve seen why you prefer them over things, but what’s so attractive about emerging market bonds at the moment and where are the best opportunities?
JBS: Sure. So I think, yeah, maybe to highlight why we think that developed market bonds like gilts are in a risky situation now, and then contrast that maybe with some of the emerging market ones. Ultimately we see the valuations on developed market bonds as displaying a degree of complacency. So yields are very, very low and there is now you think an increasing risk of both inflation and rate rises. So if you look at some of the inflationary signals, if you look at wage data, if we look at the reopening dynamic, that’s likely to play out as a Delta variant comes under control on an international basis. And then more I think sticky measures of inflation. So for example the cost of rent, all of those to us signal that inflation could become more of a problem. And that, and that is a typically a negative factor for fixed income markets. So that’s why we view developed market bonds as a risk. And that’s why, as I mentioned earlier, we’ve been taking down that duration or interest rate sensitivity in the fund and being so active with that.
I think the emerging market side of things is more interesting. So emerging market local currency bonds, that is the debt of emerging countries issued in their own currencies. And it’s one of the few asset classes that’s actually offering a high level of yield relative to its developed market counterparts than it did prior to 2008, prior to the GFC [great financial crisis], so it’s quite rare in that degree of value that’s being offered. When you buy those bonds unhedged, that means if you’re taking on the currency risk, you actually get a risk profile that looks very much like equities. So they’re prone to significant bouts of volatility and drawdown.
The difference though, is that when you take out that currency risk, when you actually buy the bonds as single issues as we do, and then manage the currency risk individually, you actually get a return profile that looks much more like treasuries or gilts, in that you have low volatility and low draw-down. And in fact, if you look at the performance of that strategy over the last 10 years, it’s performed better than treasuries for less volatility. So by taking out that unrewarded currency risk, you can get quite an attractive potential holding there. And as you mentioned, we’ve got number of positions in those. So we wouldn’t be concentrated in any one economy, but I think a broad range of exposures, currency hedged of low maturity, ie buying bonds that don’t have long until they mature, can actually deliver quite an attractive set of risk return characteristics.
[9:14]
RLA: That’s interesting. Thank you for that. And moving back to the equity side, what sort of stocks are you liking at the moment? Are there any particular themes you’re playing in the portfolio?
JBS: So the holdings are very equity income based. So the approach that we take is that sort of three criteria mix that I alluded to at the beginning, so it’s that blend of dividends, it’s how underpinned or how resilient are those yields, and then it’s what’s the potential capital upside, which is, you know, focused on valuations.
I think when you look at the style currently, it’s been so out of fashion that as a whole income equity looks pretty attractive and picking the point in which any one style will outperform is always very difficult. So I wouldn’t tie myself to when that might be. But what I would say is that historically it’s tended to come more to the fore during a market correction, you’ve tended to see better characteristics when the broader market is falling from those dividends stocks.
And two areas, I think that are particularly compelling now, one would be in financials, US banks in particular, where if you do see rate rises, actually these companies tend to benefit from that in terms of how they are profiting from lending versus deposits that they receive from individuals. The other actually would be within healthcare where there’s been a lot of controversy, a lot of pessimism around how the regulatory environment is going to change under the new administration that actually is seen so far to be quite benign. Companies are offering decent degrees of yields at pretty decent multiples relative to the market also, and that to us as quite a compelling area, to explore also.
[10:46]
RLA: And so putting all of that together, what’s your sort of outlook for equities and bonds over the next 12 to 24 months? Are you cautious, balanced, or perhaps with the new fund title you’re being opportunistic?
JBS: So I think, for equities and bonds, there’s a slightly different outlook. So for bonds, for traditional fixed income assets, the risks I think are starting to rise and they’re rising quite quickly. So inflation, I think, is going to potentially reassert itself somewhat more aggressively in 2022. A lot of people I think have got into the mindset that it was going to be a big issue this year. I think next year is actually when more sticky inflation dynamics might come to the fore and it’s in the US when it matters where it matters the most really, that drives sort of international inflation dynamics.
For equities, I think that in the shorter run that the risks to those are, are actually fairly modest. So whilst we think that growth data is decelerating, whilst we think that policy is probably going to tighten somewhat, I don’t necessarily see that in the imminent future as been a cause for a major correction in markets. What I do think though is that as we go further into 2022, those risks are going to rise. And so whilst currently we’re running around 50% or just under exposed to equity we are looking at how we can start to increase hedging in the portfolio. And I think that’s likely to be a theme probably going into late 2021 to mid 2022.
RLA: Well, Jason, that’s been really interesting. Thank you very much for your time today
JBS: Yeah, pleasure. Thank you.
RLA: And if you’d like to know more about the Ninety One Cautious Managed fund, which is on FundCalibre’s Elite Radar, please visit our website fundcalibre.com and for more from our Investing on the go podcast, please don’t forget to subscribe via your usual channels.
