“If rates are increased too quickly, that has the potential to damage growth and hit bond markets,” he says. “If you withdraw the stimulus you have less money slopping around to invest in equities, bonds and property.”
A hawkish US Federal Reserve bumped rates by 25 basis points in June and hinted at a further two hikes before the end of the year. The European Central Bank, meanwhile, left rates alone but has finally committed to ending quantitative easing at the end of the year.
In the UK, the latest inflation figure came in slightly lower than expected, casting doubt on whether the Bank of England would raise rates this summer.
Scale and balance
Addressing this dilemma requires a balanced approach to asset allocation and fund selection, and one that Marchant, chief investment officer at Canada Life Investments, says necessarily involves spreading risk and exercising caution.
As a result, the team is moderately overweight equities, moving into short-duration bonds to avoid the impact of rising rates and using property as a diversifier. The team is currently 2-4% overweight equities relative to a neutral position for its multi-asset funds.
Within that, it is marginally overweight the UK and international markets except the US, where Marchant believes there are areas of excess driven by surging e-commerce, or ‘Fang’, stocks.
“If you plot the growth of the Dow Jones e-commerce index, it looks like the bull market to end all bull markets,” he says. “There we are pretty conservative and do not have significant exposure to them.”
That said, Marchant does not feel equities in aggregate are too expensive, saying the UK market remains “quite cheap” on the back of the Brexit vote and that equities are still the preferred asset class.
“That is a bit of a consensus call and it is a crowded investment view, so I am cognisant that risk is growing. In our underlying funds we do have more of a conservative position, particularly in the US, where returns have been stronger, yield is lower and valuations are higher.”
He adds: “If you arrived here from Mars and looked at equity markets, I think you would say they are not bad value.”
Marchant accepts we are in an extended bull market but believes there is no reason to turn negative on risk because the fundamentals – reasonable growth and low inflation – are still in place.
The team is cautious on bonds, especially government bonds, is heavily weighted in short-duration assets and prefers credit over government bonds.
He says: “I would rather buy short-duration credit than government bonds so I can get the increased yield by going into corporates and not have the risk of loss of capital because I am in longer bonds.”
Most of the fixed income is in UK assets and broadly split one-third short duration, one-third slightly longer-duration corporate bonds and a third government bonds. Exposure to the latter used to be nearer 50% but Marchant has reduced this, stating the risk in UK government bonds is asymmetric.
“Surely we can find something that is going to deliver more than 1.3% a year for the next 10 years,” he says. “You are going to lose out on real terms and you are dropping 2.7% against the yield on equities a year.”
Despite what Marchant terms the “moderate bullishness” on equities, he accepts that in the short- to medium-term the fallout from the Brexit vote and the transition to a post-EU membership world will mean a period of low growth for the domestic economy. The impact could be lessened if the UK remains part of the economic area and, longer term, he believes there could even be opportunities created from avoiding EU bureaucracy and opening up to other markets.
“But I would not want to bet on that,” he says. “Our fundamental case is that the UK will be a laggard in the global economy. But does that worry us? Look at the UK; it’s a very international market.”
Property has taken a beating since the Brexit vote but it makes up 5-10% of Canada Life’s risk target-managed portfolios and has a slightly higher weighting in the others.
“It adds diversification,” says Marchant, “but it is a much-disliked asset class. People think Brexit and property prices will fall out of bed. We don’t think it is an overly exciting market to be in but when you have a headline yield of about 5%, you don’t need a lot of capital growth to justify some exposure.”
Exposure is achieved through in-house property funds, which are part of the £2.25bn of direct property managed across Canada Life.
In terms of the global economy, Marchant believes Europe is “OK” but going through a bit of a purple patch as structural inefficiencies, high employment and too much debt still exist – not to mention Italy’s woes. But the bloc is generally supported by accelerating global growth.
As for the emerging markets, Marchant finds them attractive as the economies are growing faster. However, he stresses corporate governance is not as strong in these jurisdictions and that political risk is greater. He adds that economies tend to perform despite the best efforts of politicians to derail them, as exemplified by the US where the threat of a trade war is a worry and yet the stock market continues to hit new highs.
“If you look at political fears of the past five years, you’ve had Greece, Catalonia, Italy, North Korea. So, generally, it does not pay to worry about political developments.
“In this game there is limited benefit in trying to trade around short-term moves. People aren’t very good at it and making investment decisions involves trading and costs, so we take a long-term horizon.”
Summing up the global view, he says: “The global economy is in good shape. It is largely synchronised, inflationary pressures are still limited and global growth is generally firm.”
At Canada Life, Marchant overseas the asset allocation process and is ultimately responsible for the performance of the underlying portfolios in the multi-asset range, which is split into two groups.
The first is five risk-targeted funds, based on Dynamic Planner’s risk ratings three to seven. These have been available in life and pensions for 10 years and as an Oeic range for almost five years.
The second is a range of multi-asset funds over which Canada Life Investments has full autonomy when it comes to asset allocation. These are the LF Canlife Strategic Return Total Return, Balanced and 0-35% funds. Marchant is lead manager on the Managed and the 0-35% funds.
In terms of strategy, a formal quarterly review takes place where everyone gets the chance to air their views on how they see the world. That is followed up with a quarterly meeting involving a smaller group of decision makers – head of equities, fixed income, property and multi-asset – to decide how to implement their views within the portfolios. There is also a weekly review of asset allocation.
The team primarily uses in-house funds for the range but leans on third-party expertise for areas where it does not have adequate knowledge or resource. It also benefits from being able to leverage off other funds and asset managers that are part of the Great-West group of which Canada Life Investments is a part. This includes Setanta Asset Management in Ireland for global equities, Putnam for high yield, Mackenzie for global resources funds and GLC for infrastructure.
Elsewhere, passive ETFs are used for emerging markets and index-linked exposure, and the range uses the Blackrock Sterling Liquidity Fund for cash.
Why a passive approach to EMs? “It is not something we can do ourselves and [passive] is an economical way to do it with better returns,” Marchant explains. “We have had an active fund in the past and it wasn’t particularly successful.”
Although generally an advocate of active management, Marchant is wary that such funds often have an insufficient track record, which is why passive trumps active in certain cases. The challenge with active is in identifying good quality managers.
“If you put 100 people in a room tossing a coin, some will get 10 heads in a row. Does that make them good at tossing coins?”
Ticking all the boxes: Canlife Managed 0-35%
Marchant is eager to highlight the Canlife Managed 0-35% Fund, on which he is lead manager, as a good example of a drawdown fund for retirement.
He says a retirement fund should tick three boxes: low volatility, growth and yield.
“If you are 65 to 70 years old and you are taking money out over time, you don’t want volatility as it will kill your performance. You want some growth to be able to keep up with inflation and a yield you can live off.”
To further mitigate risk, the fund contains only sterling-denominated assets to avoid currency risk and minimise volatility. The portfolio is 26.5% UK equities; 18.9% in UK property; and the rest in cash and fixed income. The latter is split a third each in short duration, corporate bonds and UK government bonds.
Marchant says: “The fund focuses on corporate bonds for high yield and short duration because it gives a bit of protection and lower volatility, and UK equities through the LF Canlife UK Equity Income Fund. Income shares tend to be lower volatility and provide a yield.”
According to FE, the Oeic version of the LF Canlife Managed 0-35% Fund, which launched in January last year, has returned 2.85% and 2.58% over six months and one year, respectively, versus the IA Mixed Investment 0-35% Shares sector’s 0.5% and 0.9%.