Register to get unlimited access to Citywire’s fund manager database. Registration is free and only takes a minute.

Perfect blend: how seven DFMs mix active and passive strategies

We spoke to CIOs and heads of research to get an insight on their current positioning and how they blend passive and active strategies.

Jim Wood-Smith, CIO private clients & head of research, Hawksmoor Investment Management, Exeter

Active

The strong majority of our portfolios are avowedly active. Two philosophies underlie this. The first concerns our equity investments, where we believe there are responsibilities incumbent with being share-owners that are abrogated by passive investment. Share-owners should care about how a company behaves, in the interests of all its stakeholders. For passive investors, this is somebody else’s problem and we find that uncomfortable. Investment – and especially equity investment – is a long-term undertaking; the best long-term returns will come from company management teams that understand this and act responsibly and sustainably. Passive investment, in our view, shies away from these responsibilities.

The second issue is that we simply do not believe the myth that active mangers underperform. Our experience, which can be supported with hard data, is that good and genuinely active managers will create value, even after charges. In this regard, we welcome the increasing importance of passives and their indifference to the efficient allocation of capital, as these create inefficiencies that result in opportunities for active managers.

There is a third angle, which is shorter-term and is derived from the high valuation of both equities and bonds at present. In being inherently nervous that asset valuations are unsustainable, we are especially proactive in seeking what may be termed ‘independent alpha’: those funds that can drive their own returns, independent of the broader markets. These will almost always be actively managed.

We therefore allocate to managers, across asset classes and geographies, with coherent and transparent processes and with records of value creation. This holds good for both equity and bond allocations. Bond indices, based on levels of indebtedness, carry little logic and we have large allocations to strategic bond (and equivalent) funds, where the managers have proven that they can create value for their investors regardless of the direction of yields.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Jim Wood-Smith, CIO private clients & head of research, Hawksmoor Investment Management, Exeter

Active

The strong majority of our portfolios are avowedly active. Two philosophies underlie this. The first concerns our equity investments, where we believe there are responsibilities incumbent with being share-owners that are abrogated by passive investment. Share-owners should care about how a company behaves, in the interests of all its stakeholders. For passive investors, this is somebody else’s problem and we find that uncomfortable. Investment – and especially equity investment – is a long-term undertaking; the best long-term returns will come from company management teams that understand this and act responsibly and sustainably. Passive investment, in our view, shies away from these responsibilities.

The second issue is that we simply do not believe the myth that active mangers underperform. Our experience, which can be supported with hard data, is that good and genuinely active managers will create value, even after charges. In this regard, we welcome the increasing importance of passives and their indifference to the efficient allocation of capital, as these create inefficiencies that result in opportunities for active managers.

There is a third angle, which is shorter-term and is derived from the high valuation of both equities and bonds at present. In being inherently nervous that asset valuations are unsustainable, we are especially proactive in seeking what may be termed ‘independent alpha’: those funds that can drive their own returns, independent of the broader markets. These will almost always be actively managed.

We therefore allocate to managers, across asset classes and geographies, with coherent and transparent processes and with records of value creation. This holds good for both equity and bond allocations. Bond indices, based on levels of indebtedness, carry little logic and we have large allocations to strategic bond (and equivalent) funds, where the managers have proven that they can create value for their investors regardless of the direction of yields.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Jim Wood-Smith, CIO private clients & head of research, Hawksmoor Investment Management, Exeter

Passive

There are exceptions to our preference for active management. First, the persistent problems of active managers in outperforming the S&P 500 is well documented and we are not averse to having at least part of our US exposure in passives. Second, portfolio exposure to metals and commodities is best and most efficiently obtained by using passives. Our allocations to metals and commodities are currently small, but should this change later in the year then any increase would be via passives.

In addition, we find it easiest to keep our very small cash allocations in an ETF that tracks a very short-dated bond fund. This is a quirk of the low interest rate world, but it provides a positive return with daily liquidity, both of which we like.

Finally, we have passive exposure by default via our allocations to structured products. Structured products play an important role in our allocation to defined return and in our allocations in income portfolios, so in this regard we can be said to have passive exposure to a range of major global indices.

There is an implicit question over our planned use of smart beta, or factor investment products. We currently have no plans to introduce allocations of these. We do invest thematically and are likely only to do more so, but our means of so doing will be via our own researched funds and stocks.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Vince Hopkins, CIO, BRI Wealth Management, Meriden

Active

With markets that seem remarkably resilient and only capable of going in one direction, we are actively looking for opportunities to deploy capital in to absolute return strategies. With valuations looking stretched and earnings growth fairly anaemic it seems like ideal market conditions for experienced managers to make money from shorting stocks.

One recent addition to our portfolios is the Jupiter Absolute Return Fund which is run by the highly experienced James Clunie. The fund only has marginal net exposure to the equity market which is comprised of un-loved value stocks on the long side and expensive stocks with poor balance sheets on the short side. The fund has traditionally done well in choppy market conditions and we feel that having a holding in funds like this should provide a reasonable degree of insurance against volatile market conditions.

We consistently find that it is only active managers that can successfully offer these diversifying strategies and we do not mind paying slightly more than passive funds for, in our view, a higher quality offering. It reassures us to have seasoned fund managers in charge of our capital if we are entering a tricky period in the market rather than a ‘blackbox’.

Another area of interest for us (and many other wealth managers) is global infrastructure. Ever since President Trump entered office, it has been a strong area to invest towards. With global inflationary pressures picking up and coupled with heightened uncertainty we like having a steady stream of defensive dividends that can contribute to our overall total return.

The fund of particular interest to us is the newly launched Miton Global Infrastructure fund. Again, it is run by an experienced manager with a robust process which gives us comfort with how our capital is positioned.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Vince Hopkins, CIO, BRI Wealth Management, Meriden

Passive

The rise of passive investments in the asset management industry has been pretty remarkable over the last 10 years. Investors have come to the realisation that a significant number, but certainly not all active managers cannot outperform benchmarks so they are happy to pay lower fees to perform broadly in line with the market.

Our passive exposure changes during the course of a market cycle. We are very happy to own a significant amount of passives in most major equity markets when markets are low and we require ‘cheap beta’. However, markets are very high currently and we think owning every single company in an index is not a good use of capital. Our other issue with traditional passives is that capital gets allocated to every single company irrespective of whether they are successful companies or not.

We are currently looking at increasing our exposure to global equities with a bias towards value and income. One fund of particular interest is the Global High Equity Income index offered by First Trust. This filters stocks on high dividend yields relative to the universe, dividend growth, return on assets, levels of debt, pay-out ratios and free cash flow. The end result is a diversified portfolio of 266 companies that produce a dividend yield greater than 4% on about 10 times earnings.

Pleasingly for us, from a geographical weighting perspective it is far more diversified than most global funds which ties in with our recent underweight view on America. A high yield, lower company valuations, more diversification and a cheaper fee than active funds leads to an attractive investment offering for us.

There are a significant amount of firms offering passive products on the market and so you have to weigh up the pros and cons of each sort of strategy and the firms that offer them.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Ben Willis, head of research, Whitechurch Securities, Bristol

Active

Earlier in the year we decided to reintroduce what we call the ‘barbell’ approach to our US and European equity exposure within our portfolios. Quite simply this meant complementing our long-term core positions in these markets with satellite positions which we believe will add alpha over the next 12-18 months. The rationale also being that the core funds would prove defensive in times of market weakness whilst the new positions would outperform on any sustained market strength.

Both of these relatively new positions are value focused funds, which are looking to invest in companies that are either out of favour or being ignored by the broader market. Within Europe, we invested in Rob Burnett’s European Opportunities fund. Burnett’s big sector play within the fund is in the banking sector. The sector still has issues but this is reflected in prices. Negative interest rates in Europe had pushed these stocks back to crisis level valuations. However, with the economic data from Europe becoming more positive and the ECB showing indication of gradually tightening monetary policy, the outlook for recovery in Europe is promising.

Within the US, we took our satellite position in Artemis US Smaller Companies. Unlike Burnett, manager Cormac Weldon is generally style agnostic but he is style aware, and is currently seeing opportunities within cyclical and economically sensitive areas, which are trading on relatively cheap valuations. Much of his sector positioning – infrastructure, regional banks – will be in favour if Trump is successful in implementing his pro-growth policies. Again, we are looking for that balance in our US exposure as mentioned: core, large cap positioning combined with higher risk but potential higher returns from our satellite position within the Artemis fund.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Ben Willis, head of research, Whitechurch Securities, Bristol

Passive

We have increased our passive exposure recently within our portfolios at the expense of two actively managed portfolio stalwarts. Within our cautious portfolios, we naturally limit the amount of equity exposure we can take. One of the funds we have held since its launch is Fundsmith Equity. This has served our clients incredibly well, indeed, above our expectations when we invested in the fund all those years ago. However, with the reflationary outlook and the prospect of a gradual shift in the economic cycle, we started to see the fund as a mature position and so decided to bank profits.

Proceeds were reinvested into Vanguard FTSE Developed World ex UK Equity Index. This position continues to provide a global, broad based exposure to equities within our cautious portfolios, with the added benefit that the fund’s OCF is extremely keen at 0.15%.

Our most recent investment switch involved seeding a new fund launch from Schroder. Once again, this involved selling a long-term actively managed position, JPM US Equity Income, within some of our income focused portfolios. We were one of the first wealth managers to invest in the JPM fund way back in February 2009 and it has been an excellent long-term holding.

We were informed of the imminent launch of the Schroder US Equity Income Maximiser recently. The fund is an expansion on Schroder’s high income focused ‘maximiser’ range. This fund is slightly different in that it will track the S&P 500 rather than making active stock selections, but will generate the target income of 5% using the same covered call strategy employed on the other funds within the range. The US is a low yielding, and efficient market, so this passive approach combined with a very high relative yield provides a low cost, efficient way of gaining exposure to US equities for our income portfolios.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

John Goodall, head of private client research, WH Ireland, Manchester

Active

We are focusing on markets and asset classes where active portfolio management can still add value. The US equity market stands out as a prime example. Although index funds have generally outperformed in recent months as the headline indices have run higher, we do not believe this will persist. Gains have largely been driven by a handful of large companies, predominantly in the tech sector. Valuations have now been driven to extreme levels, meaning that continued outperformance in the long term looks unlikely. However exciting a proposition the likes of Amazon, Google and Facebook may look, long term success cannot be guaranteed, especially in such a rapidly changing sector as technology. Yet continued cash flow growth in perpetuity is already priced in to valuations. As expectations change, we expect actively managed funds to outperform their index based peers. We favour the BNY Mellon US Equity Income Fund which we have recently added on to our recommended buy list. The manager utilises a value based approach, avoiding the overvalued sectors, which we believe will pay dividends to the patient investor in the long term.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

John Goodall, head of private client research, WH Ireland, Manchester

Passive

We continue to advocate a modest weighting in gold across all portfolios and believe that this is best represented by the use of a passive investment, the iShares Physical Gold ETC, which provides asset backed exposure to the precious metal at a low cost. Although active funds clearly have the potential to outperform passive investments in this sector (for example, the Charteris Gold & Precious Metals Fund returned 132% in 2016, helped by exposure to silver miners), we are typically using gold exposure to dampen overall portfolio volatility. Active funds do not generally achieve this because of the higher inherent volatility in equity markets. Gold has displayed a high level of inverse correlation to the equity markets, which we measure at -0.7 against the FTSE 100 over the last six years, and we believe this is best captured by investing in a simple passive ETC. Longer term, there is a strategic element to gold exposure. The ongoing “war on cash” is likely to heighten gold’s appeal and we believe it will prove a classic defensive vehicle which investors are likely to seek out in times of stress.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Haig Bathgate, joint chief executive and CIO, Tcam, Edinburgh

Active

It’s a tricky market in which to be finding new opportunities, active or passive. Not many asset classes look cheap at present and in many of the areas that we consider attractive – European equities and pockets of domestic equities – we are happy with current exposures. In both of these areas, we rotated into value in the second half of 2016, in line with our view that areas such as financials look attractive as rates begin to normalise.

Current opportunities are primarily being driven by what we perceive to be the greatest risks facing global markets at present. Duration is one such risk as rate normalisation continues in the US and speculation grows that a first hike in Europe could come sooner rather than later. With this is mind, we’re continuing to move away from conventional fixed interest holdings, particularly with credit spreads having narrowed to pre-crisis levels. Our preference is for low duration exposures in those areas where fundamentals look more attractive.

One such area is European Financial Debt, where a changing regulatory regime creates potential for plenty of risk-adjusted upside. Underlying exposure focuses on “Additional Tier 1” bonds, where coupons can be suspended in the event that the issuing bank’s capital falls below the required level. Despite changes to relax the threshold and significantly better capitalisations post-Crisis, many investors remain inherently wary of financials and hence, the risk premia attached to these bonds is attractive. The asset class also offers a sustainable yield.

In a similar vein, we are also finding opportunities in direct securitised lending, with bank disintermediation a major theme in the current environment. A legacy of the Crisis, many banks remain limited in the types of opportunity to which they can provide early stage funding, with investors able to achieve attractive levels of return in exchange for the provision of bridge financing. Careful selection of opportunities allows for the mitigation of risks and it’s an area of the market that is broadly uncorrelated to equities and bonds.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Haig Bathgate, joint chief executive and CIO, Tcam, Edinburgh

Passive

Passives in the conventional sense are not an area to which we allocate. By their nature, traditional index-trackers are forced to buy-the-winners and sell the losers, which we consider a risky strategy as the current bull market continues to grow longer in the tooth. The funds will also inherently under-perform the index that they track by virtue of fees and transaction costs.

As one exception to this approach, we have exposure to an S&P 500 tracker with a covered call overlay. The call allows income to be generated, providing investors with yield and boosting return in sideways or falling markets. The strategy is also able to benefit from any pick-up in volatility as the level of premium increases.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Sophie Muller, head of research, EQ Investors, London

Active: Frontier markets

It is hard to deny the fastest growing countries on the planet are in Frontier Market economies. With that growth comes investment opportunity. There are, of course, considerable risks in each individual frontier economy, including the potential for political upheaval or capital controls. For this reason, we would never consider a passive approach to the region, or one which is not diversified across a number of countries. Having historically invested through HSBC Frontier Markets, the competitive landscape has shifted over the last few years, and as such we have recently switched into Charlemagne Magna New Frontiers. Top down considerations frame the research process, although this largely acts as a negative screen to discount countries, rather than idea generation. Holdings are identified through a bottom-up process, which seeks to identify well-run companies with standout management teams. The fund is concentrated, with 40-50 names, but forms a diversified portfolio by country, taking advantage of the low inter-market correlations.

UK Micro Cap

We see UK micro-cap as an interesting investment opportunity, given the lack of analyst coverage, significant growth prospects, and the current valuation opportunity relative to the rest of the UK market. There is also hard evidence that smaller companies have significantly outperformed their larger counterparts over the long term. However, unlike the majority of other asset classes that we invest in, there is no investable UK micro-cap index and therefore no passive alternative. Even if there were, the illiquidity would be a huge deterrent.

We recently took a position in the Downing Strategic Micro-Cap Investment Trust IPO, and while it is likely that the Trust itself will also be illiquid, we participated with the expectation to hold for the long term. The strategy applies private equity style due diligence to listed micro-caps in the UK, and the team will engage with the underlying management teams in an attempt to unlock an identified valuation catalyst. We believe this process to be true active management, and clearly not replicable in a passive product.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Sophie Muller, head of research, EQ Investors, London

Passive: US & Europe

While our overriding preference is to uncover active managers who are consistently able to generate alpha, this is often challenging in developed “efficient” markets. This, coupled with the well documented pressure on active managers to justify their fees has meant we have long gained our exposure to US equities through a position in the Vanguard US Equity Index. Perhaps more interestingly, we also hold Powershares FTSE RAFI US 1000 UCITS ETF, which tracks a value oriented fundamentally weighted index and which offers unhedged exposure to large-cap US stocks, as well as the stocks further down the market cap spectrum.

In addition, we have recently become more positive on the outlook in Europe, based on evidence of a stronger economy, improving growth outlook and strong momentum. This has led to an increased allocation, not just in our active European managers who have certain sector specific focus to more defensive parts of the market, but also in the Vanguard FTSE Developed Europe ex UK UCITS ETF. This passive provides us with diversified exposure to large and mid-sized companies in developed Europe, ex UK, across all sectors, including those which are more cyclically sensitive to improving European economics, such as financials.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Michel Perera, CIO, Canaccord Genuity Wealth Management, London

Indian equities: active investment

India’s stock market is now expensive compared to its history, but fundamentally, we like it for the following reasons:

The growth in India is real, secular and healthy: millions of needy people become middle class and spend on basics as well as aspirational needs

Poor infrastructure, corruption and stifling bureaucracy have not prevented India from becoming the 7th largest world economy. The next 20 years may see India grow to 3rd largest.

The current political leadership and programme of reforms (such as demonetisation) should transform India and may help it leapfrog other emerging markets.

India is an idiosyncratic story, which does not depend on the US, China or Europe for its success.

Should we go active or passive?

Entrepreneurs have arisen everywhere, creating businesses that have grown 100, even 1,000 times. As they list on the stock market, they create fantastic opportunities for investors.

Investment managers can choose growth companies that provide basic needs or sophisticated IT services, an option you don’t have in advanced markets.

Understanding the families behind most listed companies is crucial to pinpointing the strengths and weaknesses of each company. Investment managers on the ground can get colour on the families and management. If some stocks multiply by 100 whereas others lose 95% of their value (in the same sector), you need to understand why.

The top quoted sectors are not necessarily representative of the attractive economic sectors: you want to buy the 60% of the market that is geared to domestic demand and capex, not the 40% that is utilities, global cyclicals or export companies. The bottom line is you should not buy the index, but select an active manager instead. Our preferred manager is Reliance Capital.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.

Michel Perera, Chief Investment Officer, Canaccord Genuity Wealth Management

Euro-zone banks: passive investment

We like the Euro-zone banks (the SX7E index). They are finally recovering, together with the Euro-zone economy. They have been one of the worst stock market performers since 2009 due to a number of reasons: (1) increased capital requirements, (2) weak corporate lending and (3) political risk in Europe. These issues are getting resolved because European banks have Tier 1 ratios of 13.9% vs. 13.2% for US banks, due to the fact that corporate lending has recovered and also because political risk is progressively abating.

Bund yields should rise if the ECB starts signalling a change in monetary policy. European banks are tightly correlated with Bund yields and should benefit from their rise.

The EUR/USD rate has started recovering after a long bottoming process since 2015 and should benefit from further reduction in political risk and any change in ECB rhetoric

European bank financial situation: S&P recently upgraded the 4 largest German banks, Santander hiked its dividend, ING and UniCredit delivered an upside earnings surprise, all pointing in the direction of “healing” for this downtrodden sector.

Valuations: European banks are not as profitable, well run or advanced in their restructuring as US banks, but US banks are trading at a large premium on Price/Book . In addition, non-performing loans in European banks benefit from steadily falling unemployment in the Euro-zone.

Technicals: the SX7E index has gone through a double bottom and hence its recovery is sounder now than in 2012-2013. The improvement we foresee in Euro-zone banks should “lift all boats”, both the quality banks and those with a less pristine balance sheet. The few banks which may still suffer are too small to matter and should not stop us from preferring passive access. Why pay a manager when we like all the components of an index?

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.
Your Business: Cover Star Club

Profile: a Williams de Broe vet on striking out from Investec

Profile: a Williams de Broe vet on striking out from Investec

Laurence Boyle and his team became ‘somewhat of an oddity’ within Investec after joining via its acquisition of Williams de Broë

Wealth Manager on Twitter