Chief investment strategist Paul Wharton explores how Tacit Investment Management are managing lower risk strategies in a riskier world.
'How do you manage lower risk strategies in a world where yields on fundamental low risk assets are suppressed and in a time when duration risk has probably never been higher?
The reality of recovery in the real economy, and the transition away from central bank funded quantitative easing, is that the most important input into financial market pricing, the ‘risk-free’ rate, must rise. Capital values must then fall to yield levels that compete, for the first time in a decade, with yields available on growth assets.
From a regulatory perspective we have the paradox that lower risk assets are at ‘risky’ prices and assets that are likely to benefit from a return to a ‘normal’ business cycle are deemed ‘high risk’.
Clients do not typically pay us to hold cash, but as investors committed to avoiding ‘the permanent impairment of capital’ that Ben Graham identified as the cardinal sin of investment, we do not want to hold esoteric or illiquid assets that are subject to moments of Minsky evisceration.
Our real return portfolio attempts to provide clients with acceptable returns by mixing assets in different classes of relatively low duration, relative to their class.
As the recent volatility in markets is thought to be a function of higher US wages, higher implied US inflation and higher bond yields, despite our normal reluctance, we currently hold 22% of the portfolio in the shortest duration asset available: cash.
As the reasons for recent volatility are ‘good’ i.e, strengthening economic performance, we expect yield curves to steepen allowing us to deploy that cash in higher yields over the coming year.
Additionally, we hold 20% of the portfolio in short-duration gilts and short duration high yield, using the iShares 0-5 Gilt ETF and the AXA Short Duration High Yield Bond funds respectively.
We hedge inflation using a 10% allocation to the L&G Index Link Gilt Trust and with a 7.5% allocation to gold bullion in the ETFS Physical Gold ETF.
In respect of the growth element of the portfolio, which is currently at 50% of the portfolio, we allocate to value equities of lower duration than outright growth companies.
JO Hambro Equity Income and the Jupiter Financial Opportunities funds form 15% of the portfolio. The former because we value the visibility and compounding of a diversified dividend stream and the latter because financials should begin to benefit from rising net-interest margins, given our view of the yield curve and lower regulatory risk, as PPI and GFC scandals fade into the past.
We further allocate 15% of the portfolio to JO Hambro Capital Opportunities, where the managers have demonstrated clear stockpicking and allocation skills, and the M&G Recovery fund, in recognition that the UK has been a laggard and there is potential for some mean reversion.
Finally, we retain 10% in Japan via GLG Core Alpha, as a less correlated equity market to US than most, and on the basis of consistent official support from the Bank of Japan.
Since inception in September 2010, the portfolio has returned 78.58% relative to the ARC Balanced Index which has delivered 46.97%. Over one, three and five years, the portfolio strategy has delivered 2.88%, 21.52% and 44.14%, versus index returns of 6.3%, 15.8% and 30.4%, respectively.'
Source: Morningstar net of 0.77% AMC, net income reinvested.