What are senior bonds and their defensive attributes with Brooks Macdonald
Darius McDermott catches up with Jon Gumpel, manager of Elite Rated Brooks Macdonald Defensive...
Targeted Absolute Return funds have become ‘this season’s must-have’ in investors’ portfolios, attracting the most money from UK investors last month.
Having been the top pick for investors throughout 2015 – when then Chinese stock market crashed and causing others to tumble with it – and again in 2016 on the back of uncertainty caused by the EU referendum vote, the sector was somewhat of a cast-off in 2017.
So why the return to favour now?
Here at FundCalibre, we see targeted absolute return funds as a bit of a ‘timeless’ portfolio staple. If you select the right funds, they can provide some of the best diversification around and better preserve capital when stock markets fall. This is especially important now that volatility has started picking up and both equities and bonds are looking expensive.
I spoke to three managers who run Elite Rated targeted absolute return funds about why they think the sector is back en vogue and how they are navigating today’s tricky backdrop.
James Mahon and Jerry Wharton, who head up Church House Tenax Absolute Return Strategies, said investors are at a difficult juncture at the moment because, while markets continue to rise, valuations of most assets are looking expensive. Almost 10 years into a bull market, active managers are starting to show more caution and take risk out of portfolios, but investors still want to enjoy the late-cycle ‘euphoria’.
“It’s all rather reminiscent of late 1999 and 2007, when the more perceptive and client-focussed fund managers left the party early and struggled to retain clients, as investors gorged themselves on vastly over-priced assets believing the good times would continue for ever,” they warned.
“We’re not saying there will be a crash – we don’t know when a downturn will come, and we don’t know what the catalyst would be. But we do feel it is right at this moment to maintain a very cautious stance and remain patient until volatility in financial markets increases, when the price of assets fall and present irresistible opportunities for us to exploit”
Church House Tenax Absolute Return Strategies has its lowest allocation to equities since 31 March 2008 at 7.9%**. In contrast, its biggest asset allocation is a 35%** weighting in floating rate notes, which are essentially bonds with interest rates that aren’t fixed.
Jonathan Gumpel, who runs the Brooks Macdonald Defensive Capital fund, told me: “Cash is not paying much of a return, while expensive bond valuations are not taking into account the underlying growth of the global economy – they also remain at risk of further falls if interest rates rise.
“Then, at the same time, equity markets have not priced in the risk of a global trade war, a Chinese slowdown or a Eurozone meltdown. Meanwhile, the underlying bull market keeps getting older, paler and staler. An absolute return fund should shield you from the worst of any corrections and should provide positive returns over the next few years, something that might be difficult for some of the other asset classes.”
Due to these high levels of uncertainty, Jonathan warned there is scope for both negative and positive sharp price movements for a wide range of equities and sectors. He said today’s environment works very well for convertibles – bonds which can be converted into equities at an agreed price – so he has recently increased his exposure to the asset class.
“Our convertibles all benefit from high levels of convexity – which means they offer an asymmetric return – so we have more scope to gain from our winners and less scope to be hurt by our losers,” he added.
Ben Wallace, who manages the Janus Henderson UK Absolute Return fund, reasoned that we are in a low-growth and volatile world, which is why a fund which can deliver a steady stream of income has become more highly-valued by investors.
He said: “Since the financial crisis we have seen a prolonged bull run in both equity and bond markets. However, a fragile geopolitical backdrop – with US-China trade relations and the direction of Brexit negotiations being key concerns – combined with uncertainty around rising interest rates, means investors are looking to diversify their portfolios with funds lowly correlated to capital markets.”
“Equity funds capable of taking long and short positions – shorting is when you can bet against a stock, so can therefore also benefit from falling prices as well as rising prices – may be able to provide this steady stream of absolute returns, irrespective of how the wider markets are performing.”
In terms of the fund’s positioning, Janus Henderson UK Absolute Return has a number of new short positions in US industrial companies because of their high share prices combined with their dependence on imported commodities such as steel, which could be impacted by US trade tariffs.
*Source: The Investment Association. 5 July 2018