Fairstone Private Wealth’s ‘core’ model portfolio service is constructed around a relative valuation framework that seeks to identify overvalued and undervalued regions, asset classes or styles in order to take advantage of them over the medium term.
We are operating in an increasingly complex and changeable market environment distorted by extraordinary central bank policies still trying to cure the hangover of the global financial crisis. Against this backdrop, we believe that valuation is critically important, and that robust, fundamental analysis grounded in decades of precedent should lead to good client outcomes.
Building in a valuation-based margin of safety across the portfolios is the foundation on which we can look to deliver the downside protection and strong risk adjusted returns our target client segment seeks from this range.
However, it is still critical to maintain an element of pragmatism within the portfolio construction framework.
For example, while we may see little value in having a purely passive exposure to negatively yielding (in nominal or real terms) developed world government bonds, or richly valued and poor quality credit at this time, we recognise that a strategic bond team such as Janus Henderson’s is able to exploit shorter-term trading opportunities in the same asset classes through active management to add risk-adjusted value.
At the higher risk end of the portfolios, this pragmatism lends itself to diversification by manager style. In US equities, we have been buyers of Natixis’ US Equity Leaders fund for a number of years – a concentrated, mega cap growth portfolio – but have diversified this holding with Fidelity’s American Special Situations fund – the polar opposite in style to Natixis as a value-biased offering.
This was in recognition of the historic widening between growth and value style performance over the past 10 years, which, historically, has been strongly mean reverting.
Despite this, we intend to continue holding both managers. We retain conviction in Natixis and believe there are still scenarios under which the trend could persist to even greater extremes. Though value outperformed growth for a period last year, this has unwound to a large extent in recent months.
So, while we are drawn to ‘cheap’ or ‘cheaper’ assets, we must balance this with a wider view of market dynamics in thinking of forward risk mitigation.
As part of our latest quarterly review, we are increasing the portfolios’ weightings to emerging market (EM) assets through broad EM equity funds and a small diversifying holding in Latin American equity, of between 0.5% and 2.5%, to be funded by a reduction in US equities.
We see EM equities as generally cheap versus other regions looking at current valuations versus long-term averages, with cheap currencies providing an additional potential boost. This gives us an in-built margin of safety versus the US where valuations are well above long-term averages and monetary and fiscal policy trends could see the US Dollar weakening.
Our Latin American equity position will be taken through Brown Advisory’s Latin American fund. This has a bias towards mid cap growth companies with high quality balance sheets across the region and is benchmark unconstrained, focusing away from the large state-owned incumbents that dominate the broad index.
The managers focus on the burgeoning middle class, investing in domestic industries they feel are set to structurally outperform. Their portfolio contains companies growing their earnings quickly without accumulating debt and is seeking to take advantage of Latin America’s relative weakness in recent years, driven by domestic cyclical issues that are now easing.
We do not seek to be different for different’s sake, but see this region as being under-represented by investors in EM, which speaks to our contrarian nature.
While volatile in absolute terms, it has a low correlation to other global regions. We see it working well within portfolios to increase diversification and upside return potential.