The old adage ‘err on the side of caution’ is certainly prudent during times of economic and financial uncertainty, with the European sovereign debt crisis ongoing in the background and global equity markets still volatile.
A bias towards conservatism when selecting potential investment strategies is wise at the best of times, and even more so in this turbulent context.
This view of leaning towards the safer end of the investment scale is one used by Brewin Dolphin’s award winning research team, but as head of fund research Ben Gutteridge explains, this is blended with carefully selected growth opportunities.
‘We have a bias towards being conservative, but we have higher beta strategies and growth funds on the list,’ says Gutteridge.
Funds with a more defensive stance find favour on Gutteridge’s investment ideas list, including Neil Woodford’s Invesco Perpetual High Income fund and Angus Tulloch’s First State Asia Pacific fund. ‘Despite our preferences, strategies go in and out of favour.’
Gutteridge, who works with a team of experienced research professionals, has seen this change in strategic preferences evolve since he started at the firm in 2003. After studying maths at university, his first foray into the world of finance was at Barclays Global Investors on the sell-side, after which he decided to move to the buy-side.
‘I left for Brewin Dolphin, where I’ve been ever since, for eight years,’ says Gutteridge. Brewin Dolphin is one of the largest independent private client investment managers in the UK, managing around £25 billion on behalf of private clients, charities and pension funds from its 41 regional offices.
The firm provides a full investment management and financial planning service for private investors, charities and pension funds, and also has a corporate advisory as well as broking divisions.
Starting as a junior fund analyst at the firm, he has since worked his way up to look at not only the full universe of active fund managers, but also analyse the alternative space and rise of investment vehicles that have emerged more recently, such as exchange traded funds (ETFs).
‘In our research role, we serve our investment managers by providing a list of ideas accompanied by highly detailed levels of research, in order to help them build bespoke portfolios, tailored for their clients.’
Working with Gutteridge in research under team head Matthew Butcher are Rob Crawshaw, Victoria Hasler and Andrew Johnston, together with other analysts and quant specialists.
‘With our success we have grown to look at more esoteric areas, such as structured products, ETFs and hedge funds, for example,’ says Gutteridge.
The burgeoning ETF space has created a need for research experts such as Gutteridge to provide considered analysis as demand for the products has soared over the past few years. At the same time, the scrutiny by global regulators has compounded the requirement for comprehensive understanding and research in relation to them.
‘The ETF world has taken a share from active management,’ says Gutteridge. ‘We have had a lot more calls about ETFs, although this is partly because there has been a level of disappointment over active managers. ETFs also have lower fees and this is a cost-conscious world.’
Despite the hype thrown up by the regulatory attention, he does not think there is anything ‘revolutionary’ about these vehicles and is comfortable considering them alongside the core cautious strategies dominating his buy list. ‘The idea of clamping down on ETFs may not benefit our clients,’ he says. ‘They are a cost efficient means of accessing an asset class.’
Unlike those concerned by the term ‘swap’ in relation to synthetic ETFs, Gutteridge is of the view that close analysis is necessary, although he is not deterred by the derivative component. Nonetheless, he welcomes reports by those regulators such as the Financial Stability Board, as it only accelerates the drive to transparency being spearheaded by the ETF industry.
Although these ETFs may deliver performance via exposure to an investment bank, it is the collateral held in the ETF that investors are ultimately left with if the bank fails. As a result, Gutteridge wants to ensure collateral is robust and uses a range of assessments to check this is the case.
For example, the frequency with which collateral is topped up must be noted. Transparency over the type of collateral used, its liquidity and the extent to which a fund is over-collateralised are also important points.
‘If we see 107% collateralisation, for example, with collateral held by third parties, we are happier. The worry, though, is that there are aggressively marked instruments in the collateral pool, which turn out to be worth less than their market value.’
Equally, Gutteridge is able to analyse structured products, despite the view among some that they would not go near them with a barge pole. ‘We are by no means in that camp,’ he says. ‘The point I do read time and again, though, is to diversify counterparty exposure.’
Certainly, one prominent issue relating to structured products is counterparty risk, and some wealth advisers as well as industry proponents believe splitting their structured products exposure among different issuers will mitigate counterparty risk.
However, Gutteridge says: ‘We are not necessarily of that view. We think it better to reduce your structured products exposure and therefore counterparty risk, whereas by diversifying, you are more likely to catch something under stress. By being less diversified and cautious you are less likely to catch something severely impacted by the financial turmoil.’
Conversely, if used in the right way, moderate exposure to structured products can be advantageous, although Gutteridge warns they entail a lot more volatility than some investors may appreciate.
Having more of a conservative and cautious stance would have certainly been advantageous during 2008, especially after the demise of Lehman Brothers on 15 September, which he says was a learning curve.
‘Even if structured products have the term “defensive” in the name, they may not be that defensive in nature.’ He explains that although defensive products may provide a level of protection when markets decline, if markets were to fall sharply then the products would also fall substantially in value.
Many of the products on offer also appear correlated in terms of the markets to which they provide exposure. As a result, if equity markets drop, then many of these structured products are also in trouble. ‘So only use structured products in a prudent manner. They should probably not form the majority of your equity asset allocation.’
The same conservative bias runs through the research team’s fund selection. Even though absolute return funds, one of Gutteridge’s focus points, should have been in their element over the past few volatile months, a lot of fund performance has been underwhelming.
‘Even though they are absolute return in name, people have not appreciated that they will, most of the time, be net long the market. Although long/short funds have a role, generally they are correlated to equity markets and are not necessarily diversified.’
In terms of the firm’s house view on asset allocation, Brewin Dolphin is overweight the UK, despite being nervous about the UK economy. ‘But we like the look of the global nature of our company’s earnings, which is largely due to an independent central bank being able to buy back bonds. This has kept the debt costs down and is positive for corporate financing,’ says Gutteridge.
The firm is also overweight the US, as it does not think fiscal cuts will come in until 2013, and that the country has robust productivity levels and therefore profitability.
‘We are underweight Europe. It’s cheap, but it deserves to be, because it’s cyclical in nature and due to the sovereign debt crisis.’
The high yields seen on Italian and Spanish government bonds in particular are a cause for concern and compounds the view that a euro break-up is possible.
‘The probability has increased but this is not our core view. A Eurozone break-up would simply cost more than keeping it together. We predict a muddle-through process, but one that will continue to bring high levels of volatility.’
For Asia and the emerging markets, the firm is marginally underweight. Although Gutteridge says it would like to be more constructive on this region, with impending interest rate cuts, he is worried currencies might underperform.
As far as specific asset classes are concerned, he believes corporate bonds are attractive. ‘News flow has impacted on credit, but outside of financials, credit has been unfairly treated given the lack of defaults. Gilts look more unattractive, but offer negative correlation with equity markets.’
The firm as a whole has financially benefited from its views, with income for the third quarter 10.7% higher than the same period in 2010, according to Brewin Dolphin’s interim management statement at the end of June. Income in the period was £68.1 million, while recurring income from investment management represents 60% of total revenue.
In terms of funds under management, at 26 June the firm had £15.8 billion in discretionary funds under management and £9.1 billion in advisory funds under management.
For the nine months to 26 June, the firm saw net inflow of £1 billion of discretionary funds. In terms of group cash balances, Brewin Dolphin had £59.3 million excluding client balances, at 26 June.