Anthony Willis and Scott Spencer confidently predict stockpickers will thrive during the next 18 to 24 months, as the end of quantitative easing exposes poor companies that have relied on a decade of cheap money to refinance.
The pair believes QE has enabled a raft of companies to refinance at lower rates but as the Federal Reserve puts an end to the glut of cheap money and hikes rates, the difference between companies that have been blagging it and those that are genuinely good businesses will be highlighted.
While this will not necessarily come out in the wash over the next 18 to 24 months, the BMO Global Asset Management team is already positioning itself by increasing exposure to active managers across its Navigator and Lifestyle ranges.
“Markets always look forward, so maybe we will start to price that in a bit sooner,” says Willis (pictured above, right). “Given we favour stockpickers over passive managers, that is a pretty good backdrop. A lot of the managers we speak to didn’t really like 2017 because it was such a dull year and everything went up.”
The duo believes US tightening on the back of a growing economy and low unemployment will reintroduce volatility to markets, especially if it prompts more aggressive rate hikes. The Fed has indicated four raises this year but if investors believe it will raise quicker and further then risk assets will suffer, which again will provide opportunities for good active managers.
Willis explains: “For the moment the US is managing to extend that cycle further through various policies generated by the government, not least tax cuts. But you have to offset the potential overheating in the US with the potential reaction from the Fed.
“We need to be aware that though the economic backdrop is good, it is likely already priced into a lot of market valuations.”
Higher ground
For now, the pair believes the US stockmarket can continue its march higher as companies buy back shares at a “phenomenal rate” and the economy remains favourable. However, from a regional perspective, the US is still in an underweight position.
They accept that most US returns of late have come from so-called ‘Fang’ stocks but the managers are switching their US exposure to value stocks.
Spencer says: “I like Amazon as much as the next person but at some point valuation becomes important in what you pay for a share price, so we are leaning more towards value in the US.
“Our value managers have some compelling stats showing their portfolios have never been as cheap relative to the S&P, even going back to 2008. We are there in terms of value versus growth.”
As for US funds, BMO GAM has exposure to growth via the Edgewood US Select Growth Fund but is reducing this in favour of Conventum Lyrical for its value attributes. Both funds have focused portfolios. Edgewood has 22 names while Conventum has 33.
Willis and Spencer say it is difficult to find genuine value managers in this space as many have exhibited style drift after shifting their focus towards quality growth or some form of quality.
Spencer cites another US boutique, Hamlin Capital Management, on the income side of the fence and Pzena Investment Management as their other preferred positions.
The range is overweight Japan on the back of prime minister Shinzō Abe’s increasing popularity and slightly overweight Asia and emerging markets, despite the threat posed by elections and a rising US dollar.
“In Japan we still have more of a growth bias,” says Spencer. “It is genuinely in a different stage in its corporate restructuring argument and growth names have more room to run.”
For Asia and emerging markets, the team is drawn to managers with smaller AUM that can move their book around in these less liquid markets into opportunities away from the likes of Samsung, Alibaba and Tencent.
“There are more opportunities further down the cap scale but you can’t access them if you are a large Asian manager because liquidity is not your friend,” explains Spencer.
The team owns TT International’s Asia Pacific ex Japan and Emerging Market Unconstrained funds. The two funds have different managers but the same team feeding into the process. Spencer believes the managers, Duncan Robertson for Asia and Rob James for emerging markets, have a thorough macro and stock selection process but above all have strict control over capacity.
“Both funds are at £1bn and that is all they want to run,” Spencer continues, “but they will move up and down the cap scale into interesting names that have been completely overlooked by the market.
“Big GEM managers all buy the same things. The other stuff that is compelling, with cheaper valuations and higher growth, is being ignored.”
Boutique browsing
The team has a neutral stance on the UK and Europe, describing the former’s political and economic backdrop as “uninspiring at best”. That said, they do identify opportunities at a stock level as sterling weakness continues to favour international earners.
There has been a return of political risk in Europe, with recent episodes in key players Spain, Italy and Germany, but Willis believes economic growth remains strong.
The team prefers managers who stick to their knitting and this tends to result in boutique firms being handed mandates.
Spencer says: “The selection of managers tends to be genuine boutiques because a lot of the larger caps have had some style drift. We have always focused on boutiques.”
This focus runs right through everything the multi-manager team looks at for the portfolios. To identify these firms, they assess whether its ‘ABCs’ are in order: its alignment of interests, benchmark unconstrained and capacity and control.
Spencer says if a manager is incentivised to perform and has money in their own product, that focuses the mind more than running a large amount of assets. They are also more willing to buy funds early in their life.
What about track record? “If you just focus on track record you wait for the fund to hit a good three-year track record and pile it in,” Spencer says. “I think of it like driving your car. You spend most of your time looking forward and only occasionally look in the rear-view mirror. If you look at track record there could be style bias in it; it could be an analyst creating the outperformance, not the named manager.”
Describing the overall positioning as “relatively cautious” the team is broadly neutral in equities and underweight fixed income, with the balance in cash and absolute return.
In terms of fixed income, the pair believes there are still opportunities but that careful credit selection is paramount, given the potential risk of a breakout in inflation and a surprising response from central banks.
As a result, the team has developed a penchant for strategic bond funds that can be flexible and nimble.
Names the pair like include the Janus Henderson Strategic Bond Fund, run by Jenna Barnard and John Pattullo, as well as the 1167 Capital Global High Income Bond Fund and the strategic bond fund team at Liontrust, led by former Kames duo Phil Milburn and David Roberts. BMO GAM is a seed investor in the Liontrust Strategic Bond Fund.
The team sold out of its dedicated high-yield funds a couple of years ago and has struggled to find a reason to return to the asset class. The range still has exposure to high yield via the Schroder Strategic Credit Fund run by Peter Harvey.
According to Willis, the team looks to alternatives for yield, particularly for its flagship Distribution portfolio, but does not believe it is necessary to venture up the risk spectrum to achieve it.
Perfect pitch
The team has long held the Darwin Leisure Property Fund, which invests in UK caravan parks, for its lack of correlation with most indices and its typical yield of 6%.
“That has worked out well since we invested in 2009 and it does not have a lot of the issues you would face with a mainstream UK commercial property fund,” says Willis.
“You only have to look out of the window to see that we could have an oversupply of property in the market within the next couple of years.”
However, Spencer cautions against people following the herd and blindly investing in these strategies simply on the “concept story” of yield generation.
“You have to have a strong belief that it is a quality underlying asset that will generate a yield throughout the cycle,” he says.
The team has exposure to absolute return funds, preferring market-neutral or long/ short strategies that produce genuine alpha rather than just beta.
It recently added the Man GLG UK Absolute Value Fund, run by a team Spencer feels has a strong capacity discipline. He also mentions Majedie Tortoise, a long-term holding that has had a bad past year, but Spencer says the portfolio can take that “because everything else did really well”.
The team has also taken advantage of low volatility by buying cheap put options on the portfolio to protect on the downside. The strategy, put in place by BMO GAM’s in-house dedicated dealing desk, did well during the return of volatility in February but the team removed it when it subsided again, only to ramp it back up more recently.
“Given how cheap they are compared with the norm, that is a price we are willing to pay,” says Willis. “You are talking 10 basis points and that should be your maximum loss, where in the past it could have cost you 1%.”
Summing up the strategy, Spencer says the team is currently more willing to take fund risk than asset class risk. It would rather gamble on style, cap size or manager than have to make bold calls on Europe or the US.
“Because volatility is on the rise, we think that is a better way to generate returns.”
