Stocktake: Thesis explains why it sees a long term case for gilts

Michael Lally specialises in managing charity money, and has a particular focus on fixed interest markets, where he is lead manager of the Optima Bond fund. As CIO of Thesis, he chairs its asset allocation committee and heads the research department  

Positioning

A bullish 70% of Lally’s balanced risk portfolio is in equities, with weightings in fixed interest at 20%. Alternative investments make up 8.5% of the portfolio, covering infrastructure, gold and hedge funds, because Lally believes the speculation required in commodities investing is too risky for clients seeking a balanced approach. Instead, he uses the Sarasin AgriSar fund for commodity exposure. ‘It’s a better way into the soft commodity process without the extreme volatility risk of actual commodities themselves,’ he said.

A further 1.5% of the portfolio is in cash, because in the current low interest environment Lally prefers to gain yield through bond exposure. Although inflation is higher than many bond yields, he believes it is not certain bond yields have to rise, because inflation could fall. ‘People are used to gilts yielding 5% or 6% over the past few years and assume there has to be mean reversion, but why should there be? We could be entering 10 years of really low growth,’ he said. 

Performance

Over one year, Lally’s portfolio has returned 15.24% compared with 13.74% by the average Apcims balanced. He cut his weighting in US equities last summer, then increased it and finally moved funds elsewhere about one month ago to place money in to the Sarasin AgriSar fund.

‘We think it will take years to get out of this mess,’ he said. The major change over the past year is the drop in alternative investments, almost halved from 16.5%, but with equities bumped up by 7.5% during the year and fixed interest weighted exactly the same, changes to the investment focus have not been dramatic.

All Thesis clients bought a position in a dollar-denominated exchange traded fund last year, which was halved within the past month over worries about rising prices. Lally has been overweight Japan for over a year, but he closed the position not long before the earthquake as he felt the yen was too strong. ‘We’re now back in,’ he said, but he has now hedged out the currency risk. ‘Government bonds did very well last year,’ he added.

Outlook

‘The biggest call going forward is going to be gilts. We’ve stuck our neck out and stayed in,’ said Lally. ‘A third of our fixed-income exposure is in gilts.’ He plans to invest in emerging market commercial property as an inflation hedge, and by doing so hopes to avoid some of the volatility of investing in equity funds in the same markets.