At the start of 2019, Fidelity International revealed it was merging its fettered fund of funds into the unfettered range and adopting lower fees via a manager-of-managers structure. This was the culmination of a two-year project for the $380bn asset manager, as it followed in the footsteps of Brewin Dolphin (which adopted a similar approach in its managed portfolio service in Q1 ’18), Quilter Investors and St James’s Place.
Bill McQuaker (pictured), who oversees the £2.8bn multi-asset range, says the investment team became involved in the transition in late 2017, when it was time to populate the Common Contractual Funds domiciled in Ireland with strategies.
According to McQuaker, while the shift to mandates from third-party funds has “clear benefits”, including access to a wider array of managers, the leverage to negotiate keener fees and room to more precisely map mandates on to the investment team’s aims, “it doesn’t really change what I do”.
There are nine portfolios, two of which are fixed income, one alternatives and five equities, covering the UK, North America, Europe ex UK, emerging markets, Asia ex Japan and Japan. “We are looking to add between 150 and 200 basis points of outperformance over a rolling three-year window. We want to design portfolios that deliver that outperformance in a wide variety of different market conditions,” he says.
McQuaker is the primary manager on Open World, the largest fund in the range, at £1.3bn. He also co-manages the remainder of the range – Defensive, Strategic, Growth and Adventurous – with Ayesha Akbar. Strategic asset allocation broadly happens within the sub-funds while tactical asset allocation occurs outside, he explains. Using the Fidelity Multi Asset Open Strategic Fund as an example, McQuaker says asset allocation is 41.09% equities, 31.38% fixed income, 19.76% diversified alternatives and 7.7% cash.
‘Sometimes it’s so bad it’s good’
McQuaker’s equity and fixed income positions are slightly underweight compared with his peers, and he differentiates the range through alternatives exposure. The construction of the portfolio is broken down into three elements: return-seeking growth assets, typically equities; mid-risk assets such as high yield and emerging markets debt; and hedging assets he believes will perform in difficult conditions.
“At the beginning of December last year I had a more negative view on equity than I do now,” he says, a view that was fully priced in by Christmas. “Through December and into the earliest part of January, the hedges were in technology, Korean equities, broad US equity and Japanese equities, short positions in a variety of different areas.
“I closed those shorts because of a rule of thumb, or maxim, that has stood me in good stead during my career: the notion that sometimes it’s so bad it’s good.”
Within the first week of January, chair of the US Federal Reserve, Jerome Powell, vindicated McQuaker’s positioning in a speech that made it “crystal clear” the central bank was pivoting on policy. The view was reiterated later in the month at the Federal Open Markets Committee. “They said they’d done enough on rates, that the balance sheet might not shrink as far as people had anticipated and that a more neutral stance was appropriate.”
A more reassuring tone on the US-China trade discord also helped stabilise markets, he says. “As the quarter unfolded, I’d been inclined to bank some profit on that decision. The central banks have done a lot to stabilise markets – and this pivot towards a more dovish stance has been quite effective – but the evidence we’re seeing from the real economy is not consistent with a turnaround in growth that would justify pushing prices further.
“In fact, it’s interesting to see how indicators of growth have unfolded so far this year: in almost every region the surprise has been to the downside rather than the upside.”
This year could still be “pretty decent” for investors if equity markets do nothing but go sideways between now and December, he points out.
Populating a sub-fund
Within equities, McQuaker uses the Japanese sub-fund, whittled down to four managers from a long-list compiled by the team’s analyst in Tokyo, to highlight how the team diversifies exposure.
Michael Lindsell is the manager in the portfolio best known to UK retail investors. Lindsell runs the Japanese Equity Portfolio with the same approach as Lindsell Train’s UK and global equity funds. “It’s about identifying businesses that have long-term compounding ability, wide moats, high and sustainable rates of return.” The Lindsell Train manager is joined by US boutique managers Pinebridge, Brandes and Mitsubishi UFJ Kokusai Asset Management (Mukam), a subsidiary of the eponymous Japanese bank that offers a contrarian strategy McQuaker compares to Man GLG Japan CoreAlpha.
While Pinebridge has an Irish-domiciled Ucits fund, Brandes and Mukam are not available to the average UK investor, he says. “If Lindsell Train provides good downside protection during more difficult times, then the Pinebridge strategy offers upside capture when things are going well in the Japanese stockmarket.”
Meanwhile, the Brandes offering “emphasises value alongside fundamental considerations such as quality of balance sheet and reliability of earnings”, he says.
Specialist selection Looking to manager selection in the global aggregate fixed-income portfolio, McQuaker combines Colchester, a specialist in the “quite dull” asset class of government bonds, with Pimco, a $1.7trn fund house.
“Pimco is a very different beast. It does everything, which is an important reason for us including it in the strategy. They have research teams that allow them to look in some of the more esoteric parts of the financial markets, including Cocos, AT1s and mortgage bank securities in the US. These are the areas that not every firm has got the bandwidth to really look at in-depth.” The other fixed-income sub-fund is sub-investment grade credit. However, gold, at 10%, is currently at one of its highest ever levels in the portfolios as low rates limit the upside potential of government bonds in McQuaker’s view.
“In previous recessions you’d get 5% off rates on average and that might add 15-25% to the price of a 10-year bond that starts with a yield of 5-6%. Today, the same 10-year bond in the US had a starting yield of 3% last year. In Europe it was 1%.”
Tactical allocation happens outside the sub-funds
While manager of managers can negotiate keener fees, McQuaker acknowledges the assets can become stickier. “We’ve made a greater commitment to these managers because we expect them to continue to look after these pools of money for longer than they would a fund of funds,” he says. “In that sense the exposures are more firmly set than they would be with a fund-of-funds structure.”
He points out that 25-35% of exposure is held outside the sub-funds. “I don’t feel I’m more inhibited as a portfolio manager with this structure.”
Outside the sub-funds, US utilities index exposure generated positive returns through volatility at the end of last year and the portfolios have exposure to US housebuilders as a play on the shift in Fed policy. “With the benefit of hindsight, I should have bought more; they performed very well,” he says of the rate-sensitive sector. “That’s one of the hazards of this business, you either wish you’d never got involved in something or wish you’d done more.”
Shorts are employed in the portfolio via CFDs or index positions. “We currently have a short in the FTSE 100, which is reducing the overall position to UK equities, and last year that position was in the FTSE 250.”
Speaking in mid-March, when the UK parliament was voting a second time on Theresa May’s Brexit deal, he said progress was being made in negotiations with the EU. “The 250 is not a perfect proxy for domestics but it’s more exposed to the domestic economy than the FTSE 100. Conversely, the FTSE 100 is more sterling sensitive, and I think if we get a resolution and sterling goes up, it will be bad news for the FTSE 100.”
However, McQuaker is not pinning his hopes on a sustained rebound in UK equities. “If the withdrawal agreement is signed then there will be a period of relief for the markets. However, I think that would be short-lived because the next stage of the negotiations would follow hot on the heels, and that’s where things could become even more difficult still.”
Aircraft leasing and infrastructure
Closed-ended funds make up the bulk of McQuaker’s exposure to diversified alternatives. Aircraft leasing investment trusts sold off a couple of percentage points in February following Airbus’s decision to cease production of the A380. “It’s a sentiment-related thing. They also are quite tightly owned, so if anyone changes their mind for any reason the share price can react quite quickly.”
McQuaker also holds 3I Infrastructure and Sequoia Economic Infrastructure Income. He says the sector was also hit as a result of shifting sentiments when Carillion collapsed and Labour proposed state privatisation policies in the first part of 2018. “I am not saying we’re guaranteed to see something similar in aircraft leasing but sentiment does ebb and flow and it’s characteristic of this part of the portfolio.”
The flexibility of unfettered funds
McQuaker estimates that 70% of the managers survived the transition to the manager-of-managers approach. He will not be drawn on which were removed during the change, but says: “In one or two instances, the wider search threw up managers we were less familiar with and which we thought had real quality to them.” Some managers did not want to participate in the new structure.
“Sometimes capacity is limited or the business model is focused on a very limited pool of assets. Some managers want to offer the funds and that’s it; they don’t want the additional complexity of running mandates alongside them.”
In the UK retail marketplace, Fidelity International no longer offers a fettered fund of-funds product. Special Situations manager Alex Wright, American Special Situations manager Angel Agudo and Emerging Markets manager Alex Duffy represent Fidelity International in the multi-asset range. “Other asset management companies are going in the opposite direction and moving things in-house. Our view is that we can deliver a stronger product to clients if we’ve got the flexibility to use the best active managers we can find, and clearly we can find some people in Fidelity that fit the bill.”
