There is a tension to holding cash when one is paid to manage money. After all, the unspoken argument goes, if I am paying you to invest on my behalf, it should not really be sitting on the sidelines.
For Heartwood Investment Management, however, cash is a very strategic asset, and one that speaks to the philosophy at the core of the firm.
Michael Stanes, one of three investment directors on the firm’s tactical asset allocation committee, elaborates: “When you invest cash, the return is attributed to the thing that was bought, not the fact that you had the cash with which to buy it.
“Volatility is rising and will continue to rise. One of our jobs is to understand that and figure out how to manage money against that background. You can hold cash for as long as you want to, as long as you do something with it profitably at some point.
“In a sense there is no timeline on that; it is much better to sit on cash and invest in something when you feel it is appropriate than think I have to invest because I will be fired for holding cash.
“We are in business to preserve and grow our clients’ money. In order to do so, you need to play both offence and defence. Some places are very much about offence; we take defence very seriously and are happy to forego some return to do that.”
The heart of the matter
To fully appreciate this view, it helps to understand where Heartwood came from and how it operates. The firm spent much of the ’90s and ’00s building up a client base of highly sophisticated financial services executives.
Head of Heartwood Investment Management Noland Carter explains: “These are people that have given over management of money they have sweated hard to earn, and which they have paid taxes on. Our proposition is built around looking after that money and making it perform in line with the level of risk that is sold.
“There is a distinctive bias toward risk management and understanding the asymmetric opportunity between risk and return,” he says.
The firm has grown significantly since then. It has two distinct divisions: the first is a private client wealth manager and the second is Heartwood IM, which is a dedicated multi-asset investment business.
Heartwood IM manages all the client assets raised by the private client business and, for the past four years, has been distributing its offering to third parties.
In 2013, it was bought by Handelsbanken – a deal Carter says has given the firm both an influx of capital and access to much wider distribution, while at the same time meeting its initial sale requirements of allowing the business to carry on in the same manner in which it started.
Simplicity squared
This distribution has helped to grow the group’s third-party assets, from zero a few years ago to roughly 25% of its £2.3bn in assets under management today.
But while the mix of client demands and demographics has changed somewhat, especially since the Handelsbanken deal, the group continues to offer the same, simple proposition it did at the beginning.
Says Carter: “We have five core strategies, into which 90% of our clients fit, and every client in each strategy is treated exactly the same – the only difference is the access point.”
Clients can access the portfolios through the firm’s multi-asset funds, through a segregated portfolio or via model portfolios on platforms, but all are promised the same outcome. Putting that simplicity into context,
Carter says: “Fewer than 100 holdings make up just shy of 97% of AUM, and 47 or 48 holdings make up more than 90% of that 97%.”
Asked his view of the criticism often levelled at such portfolios – that this level of ‘industrialisation’ conflicts with the notion that each client should be treated as an individual – Carter replies:
“Treating all clients with the same outlook and aspiration in the same way focuses our investment team in a much greater fashion on the outcome. This is because we have much more at stake if it goes wrong as a result of the contamination effect.
“It also gets rid of an enormous amount of frictional activity for investment managers. The process of managing every account separately and interpreting house views and research separately for each account, I regard as frictional activity.
“It takes an exceptionally talented investment professional away from what you are paying them for, which is ultimately research and making investment decisions.”
Collective conviction
Stock decisions are currently made by a team of investment directors. Stanes, Martin Perry and David Absolon make up the group’s tactical asset allocation team, while each of the four main asset classes have a sector lead.
For fixed income, the leaders are Absolon and Scott Ingham, Stanes is the leader on equities and Alan Sippetts for alternative investments including property, private equity and hedge funds. Each strategy has a starting allocation to the various asset classes, based on long-term views.
“Our day job is to assess financial markets and all of the stresses, strains, risks and consensus, and work out where we think asset classes are going. Depending on those views and the strength of conviction about them, we will then shift the asset allocation, sometimes meaningfully, to reflect those views,” according to Stanes.
Adding that the views are represented consistently across the portfolios, he says: “We think this gives us enough room to express our views in such a way that it can make a difference to performance without losing the sense of what each strategy is trying to do.
“We analyse the risk of our positioning today, or the positioning we might go to tomorrow, against the central view and against our starting point. We do that in a sophisticated way. It is not about saying that if one strategy has a starting point of 20% in bonds we can be 40% or 10% – that is naive. It is about building the risk of your entire holdings and comparing it with the whole combined risk of the starting point.”
Strange days
A good example of this in practice is the firm’s bond position, which Stanes says is lower than the starting allocation. It does have a reasonable allocation to conventional government bonds, he says, but duration is on the short side.
“Were this a normal environment, you would say there is no value in government bonds, but I spent five years in a country where the ‘normal’ disappeared 25 years ago (Japan) and while bond yields are significantly lower than the market has expected them to be, it is not obvious to us that the fall in yields is yet complete,” he says.
“There is an old saying that you haven’t been a fund manager in Japan until you have lost money shorting Japanese government bonds. That saying has now broadened to the rest of the world,” he says.
However, Stanes is not convinced the Japanese experience is one that is likely to be completely mirrored in the West. Japan’s primary problem was that it failed to grow the absolute size of its economy for 20 years, in nominal terms – a failure that is very difficult to escape.
However, Stanes points out, unlike the Japanese experience, while growth is slow in much of the West, and becoming slower in some parts, there is still growth.
That said, Stanes admits the world currently finds itself saddled with a rather unusual set of circumstances.
“This experiment has been going on for five years, and it is a bit early to tell what the ultimate course will be; after all, it was only two years ago that investors worried that inflation was about to shoot up.”
However, the world is suffering from an excess of savings – a problem that is exacerbated by the fact a large proportion of global financial assets are not designed to take risk, he says.
“They were designed to be in ultra-safe government bonds, cash or cash equivalents, to give a return somewhere around the rate of inflation and, in some cases, explicitly linked to inflation.”
He explains the difficulty is that much of the goal of QE is to push money out of such instruments, which, combined with the search for yield, is helping to continue to grind yields down.
“We do not expect global savings to decline in the shorter term, and thus yields are likely to stay low by historical standards.”
That is not to say, however, that circumspection is not required, especially with asset prices having risen as much as they have in the past five years, but the argument is more nuanced than merely saying that buying bonds at a yield of under 2% is extremely risky.
“I would just play back the fact that global growth is not accelerating, there are excess savings in the world economy and there is disinflationary pulse everywhere.”
Reality checks
On the equity side of things, Stanes says the group may occasionally use baskets of individual stocks to express a specific thematic view, but does not necessarily spend a lot of time researching individual stocks.
While the overall equity starting point weight for each strategy is different, the starting point for regional allocations are half UK and half overseas.
At the moment, says Stanes, Heartwood is somewhat negative on the UK and positive on Europe, Asia and Japan, and neutral or negative on everywhere else.
Stanes believes equity market valuations tell you “absolutely nothing” about short-term returns but a lot about medium-term returns. Looking over the medium term, few markets appear cheap, especially after deconstructing the various markets and examining their exposure to different industries.
On the whole, he says the group is concerned about equities in the shorter term because there is a fight going on between what Stanes refers to as “the forces of liquidity” and “the forces of reality”.
“The forces of liquidity are highly supportive for equity valuations but the forces of reality are that profit margins are high, valuations are not particularly cheap and, at the margin, there is some slowing in some of the momentum behind corporate earnings.
“When you balance those two things out we are pretty neutral in our equity allocation. We have been quite significantly overweight and we might go back to that but, in the medium term, we continue to think that this environment of low growth, low inflation and very supportive central banks is quite good news for equity markets.”
Regionally, Stanes says the US looks pretty well placed. “Most Europeans think the US market is expensive, and it generally is, but despite that it continues to perform.”
The firm also remains moderately overweight Europe, although the outlook is slightly different.
While there has been a lot of excitement as a result of the European Central Bank’s QE programme, the region remains unloved by swathes of investors. But while the underlying data has been bad, it is not as bad as some believe.
Cheap tricks
The group has also been building an overweight position in Japan during the past 12 months, from a zero starting point.
But Stanes says: “Abenomics is an illusion – it is just a cheap yen game and they will continue to play that game.”
As a result, the group has hedged some of its Japanese exposure, although it tends to leave its equity exposure unhedged as there is often a natural hedge to be found where stocks derive their revenues.
That said, Stanes agrees that the position taken on currency is becoming more important than it has been in the past.
“Some of the pressures that have been building in the financial system are expressing themselves through currency, the Swiss National Bank being the most recent and Bank of Japan another obvious one. Markets are moving currencies around quite meaningfully after having been relatively stable for a period, and we think that is likely to continue.
“The world is devaluing – or trying to – and we have not seen the end of currency volatility.”
However, Stanes is quick to add that Heartwood Investment Management has no plans to drive client portfolios on the back of a single view on a single currency.
“It is very dangerous to do that and it goes against building a diversified portfolio. Currency markets are notoriously difficult, and while trends can be established, reversals can be quick and significant.”
Cautious on commodities
In terms of alternative assets, the firm says while it has had exposure to commodities in the past, it has avoided the space for the past two years. However, it has very recently been beginning to reallocate, albeit in a modest fashion, taking a small position in corn and exposure to broad commodity indices.
Says Stanes: “The last investment of any real size we had in commodities was in gold, which was sold in early 2013, but it wasn’t really a complicated decision. Historically, gold has not liked the perception of rising real rates. We saw a tougher environment coming for gold, and so we thought we should get out.”
