The Russell multi-asset growth fund range began reducing risk in portfolios at a fortuitous time in the scheme of the coronavirus outbreak and lockdown. In December, the five-strong range, also known by its acronym ‘Mags’, increased core fixed income from 12.9% to 15.6%, while a 3.2% position in emerging market debt was removed in its entirety.
The team was negative on the cycle, according to senior portfolio manager and head of multi-asset David Vickers, who says he “hadn’t heard of Covid-19 until early January”. Instead, non-pandemic factors prompted him to dial down risk from overweight to equilibrium levels.
“During 2019, we had that remarkable rally back up from the lows of 2018. We had a cycle that was looking late, and a negative or inverted yield curve that was telling us we were late cycle.” In terms of policy, Donald Trump’s trade war was making Vickers nervous and valuations in credit markets were “super tight”. Sentiment wasn’t over-optimistic “but it was heading towards that destination”.
“As you move towards late cycle it’s never about getting the timing dead on; it’s about starting to increase your defensiveness or reduce your risk positioning as you move through the cycle,” he says.
Dialling back risk several months before the pandemic hit markets worked out to be good timing, but Vickers admits without Covid the portfolios would have missed out on returns in the tail end of the cycle. “A good process means you notice when kindling is added to the fire. You don’t have to know what spark will ignite the fire but you can see the risks building.”
A three-pronged approach to asset allocation
Asset allocation in the Mags team at Russell Investments is examined through the lens of the macroeconomic cycle, valuation and sentiment.
A manager-of-manager approach is taken, with 38 analysts globally mostly covering segregated mandates but sometimes employing ETFs, third-party funds and derivatives for more niche or tactical exposure.
The equity book, for example, employs 23 different managers. The £95.1m Multi Asset Growth III Fund, which is the largest in the range and has a Synaptic risk rating of 3, utilises four active managers for UK equity exposure, with Baillie Gifford and JO Hambro the longest-standing Coupland Cardiff and Sompo are examples of managers that provide exposure to Japan, as is Oaktree for emerging markets. US equities are typically accessed through passives.
“We have begun to build a value tilt into our portfolios, given the huge discrepancy between value and growth, with more value-based managers being deployed,” says Vickers.
Within the fixed income portion of the portfolio, Mags opts for Hermes and Barings for high yield, and BlueBay and Insight for when it goes active for global aggregate exposure.
Vickers is particularly happy Mags moved out of its emerging market debt position when it did. “At that stage we thought the duration was still useful, but the risk premia you were getting in that particular asset class had greatly diminished and the liquidity premium also had disappeared.”
A segregated mandate made up of several managers was switched into a global aggregate bond ETF. In the alternative credit bucket there is a “very specific” mandate focused on BBB high yield. “That’s where we think the best Sharpe ratio is,” says Vickers.
Also in the bucket is a volatility and a mortgage repayment strategy. The latter faces a lot of mispricing because it is an esoteric asset, according to Vickers. He adds that it currently benefits from the fact people typically don’t repay their mortgages in a crisis.
Aussie bonds and convertibles help out during Covid
As part of a down-weighting of risk in late 2019, the Russell portfolios reduced equities and bought convertible bonds. “It’s really an all-you-can-eat buffet with only a quarter of the weight gain, because it has this convexity, the option gives it a really nice payoff profile.” Vickers says the third-party fund replicates a segregated mandate on the institutional side at Russell Investments, so he therefore has daily transparency on its holdings.
The BlueBay Convertible Bond was up by 4.6% in the year to 22 June, according to FE Analytics. A 4% tactical position in Australian bonds was introduced at the start of March as an additional hedge, says Vickers. “The Australian government had interest rate cuts to come – it’s not in the same situation as Europe – and the Aussie bond translated back into sterling has the best real yield available to us.”
The position has been reduced in the past month, particularly on the back of high retail figures that pointed to a stronger-than-expected recovery. “We plan to reduce it again once we are past the current period of uncertainty and concerns over a second wave of Covid infections.”
A quick reward once portfolios were positioned for a rebound
The team started to turn more positive on valuations during March, increasing equities from 51.8% on 16 March to 57% by 25 March. During the same period, core fixed income came down from 22.2% to 20.8%. “With drift our equity weightings had fallen, and so the first instinct was to rebalance back up to our equilibrium points. Then, through March, our sentiment indicators started to come alive and the valuations got cheaper. We added a second tranche, which pushed us back overweight.”
Vickers did not expect to be rewarded in the timeframe that followed. “I’m not patting myself on the back. This is just an unbelievable bounce-back.” Jumping to early June, he says valuations aren’t cheap anymore and risk has returned to neutral in portfolios. “There are definitely pockets of cheapness. The UK is still cheap, Europe still looks cheap, but the US has now gone back to well above fair value.
“It’s not nosebleed territory but definitely above fair value. Because the US market is 60% of the MSCI – and probably more in terms of its global buying power – you can’t ignore that weight on the global markets. So we now score valuations, at least in an equity space, closer to fair value in aggregate.”
At the end of May, the Russell Investments Multi Asset Growth III Fund had 17.8% in US equities, 16.7% in the UK and 10.2% in Europe ex UK.
Credit is still cheap in Vickers’ view “but nowhere near as cheap as it once was”. “In fact, high yield has sprung perhaps a little too far, too fast, to our minds. That’s because you’ve got a very determined central bank in the US buying fallen angels and junk bond ETFs.”
Fifty per cent of equity exposure is hedged back to sterling when risk is at equilibrium. “Some people don’t hedge any of their currency exposure, which since Brexit has been wonderful as a tailwind but, my goodness, if that reverses, and you lose on your currency and you lose on your assets, that’s a horrific double whammy.”
Vickers says they unhedged Japanese yen towards the end of 2019 in a defensive move “which helped us a little bit in the sell-off”. Japanese yen exposure was overweight at 6.3% as of the end of May, while sterling was 68.9%.
Russell Investments income fund contends with low yields and dividend cuts
Outside of the Mags range, Vickers also runs the Russell Investments Multi Asset Income Fund, which he says is on course to deliver its 4% target yield despite Covid. That’s in spite of the lion’s share of equity exposure being in the UK, which he says has been disproportionately affected by dividend cuts and suspensions.
“We benefited from an underweight to oil & gas and financials within our UK equity exposure, as our managers favoured high quality and more sustainable dividend names. As such, our yield here has been maintained.”
Companies that suspend dividends have been removed from global equity portfolios. Arguably, lower bond yields have been more challenging than dividend cuts during the coronavirus outbreak, he says.
The fund allocates a large weight to global high yield, emerging market debt, loans and preferred bonds. “We have been cognisant not to rely on property funds that we have always felt created a liquidity mismatch; nor have we considered esoteric assets like aircraft leasing funds to stretch for income.”
