Hilary Coghill, founder and investment director at City Asset Management (AM), says she has been using structured products for clients for 12 years or more, and it’s a love affair that runs in the family.
Coghill’s son Nick, who is chief executive at City AM, is a former managing director in the equity division and co-head of the EMEA region for derivatives sales at Morgan Stanley.
Structured products gained a bad reputation during the financial crisis as many viewed them as opaque and expensive, so what’s the appeal? Coghill says some decent strategies can be thrown up by conducting thorough due diligence on the investment banks sitting behind these products.
The roster of banks that pass the test includes JP Morgan, Morgan Stanley, Royal Bank of Canada and Credit Suisse. HSBC used to be in the game but has taken a back seat more recently, she says. “We don’t do esoteric ones, they are very plain vanilla. We will use investment banks where we can check their stability and financial security.”
Synthetic equivalents
Coghill used to like zero dividend preference shares, which she describes as “old-fashioned loan stocks issued against investment trusts and treated as capital gains”.
She says investors could previously get quite high levels of return as interest rates were expected to go up and people thought the index was vulnerable; but these products fell by the wayside when interest rates fell to record lows after the financial crisis.
This has given way to synthetic equivalents, and Coghill highlights one of City AM’s structured holdings, the Morgan Stanley Daily Six-year Accrual, a synthetic structured product she invested in almost six years ago, which enables investors to take advantage of a range-bound market view of the FTSE 100.
Under the terms of the Morgan Stanley product, capital growth accrues daily when the FTSE 100 is within a range of 4,000 and 8,000, and capital is protected at maturity unless the index were to fall below 4,000. Coghill says the product is due to mature next June and is trading near the maturity price.
In addition to the predetermined income, these structures are liquid, as they can be sold back to the bank, and they can be cheap when dealing directly with the bank. Coghill says banks can make bespoke products when about £1m is raised.
“In our view, it gives you access to the FTSE 100 but unless you are really gloomy, we prefer the return to buying a FTSE tracker.” But she warns if the FTSE outperforms then “the tracker will smash you”.
Coghill also cautions that if these products go pear-shaped, responsibility falls on the discretionary manager, but she is clearly comfortable the firm has done its homework on all the counterparty investment banks.
She says the predetermined return is more consistent and superior than some of the daily traded absolute return funds in the market that have had a tough time of late.
In fact, Coghill believes the alternative sector in general has been a “nightmare”, based on poor returns. City AM sold out of Standard Life’s Global Absolute Return Strategies three years ago and has never held Invesco Targeted Return, another popular fund in the sector.
It does, however, own some global macro across the model portfolios, including JP Morgan Global Macro and Natixis H2O Multi-returns, both of which Coghill says are not for the faint-hearted, owing to their volatility and willingness to take strong directional views.
City Asset Management Real 2 and Real 5 model portfolios
As well as poor returns, Coghill has a problem with the fees attached to absolute return products. “I have a big issue when these are expensive. Many are looking to get a 4-5% return and there is a management fee and a performance fee on top. You are not getting much juice for your money.”
She also struggles with general fixed income in the current market because it is not generating a decent return.
According to Coghill, while this has driven the industry to focus on absolute return fixed income, she is concerned by the complexity of some of the products floating around the market.
“When you have such a small rate of return, they are taking higher risk and going short of the market. So many have been burnt by the expectation that rates were going to go up and haven’t.”
That said, Coghill singles out Twentyfour Asset Management Dynamic Bond as a standout fund, which features across the model portfolios.
Mission statement
According to City AM’s website, its mission is a simple one: to make its clients wealthier by growing wealth at a faster rate than the cost of living (inflation). As such, the majority of discretionary clients in its managed portfolio service are benchmarked against CPI plus 2%, 3% or 4% in its Real 2, Real 3 and Real 4 products, respectively, all over a five-year period.
Until recently, Real 5 was benchmarked against the WMA index but the firm is in the process of moving that to CPI plus 5%, which Coghill admits is a demanding target.
City AM’s bespoke portfolios are available to clients with more than £250,000 to invest, although that figure is flexible.
These can follow the same investment target above or fund CPI linked withdrawals of 4% a year for 50 years by outperforming CPI plus 4% pa, net of portfolio costs over the investment cycle.
Investment decisions are made using an asset allocation framework and a buylist of approved funds. City AM’s portfolio managers can deviate from the framework up until a 5% weighting in an asset class, at which point they must have some allocation.
Coghill says: “For example, if we have 4% in Japan and someone really didn’t like Japan, they could have a zero holding. But once it gets up to 5%, you have to hold something in it.” Typically, she says, weightings are about 3% or 4%.
For the bespoke portfolios, Coghill is also a fan of hedge funds and a preferred route is to access them through the RIT Capital Partners Investment Trust, a multi-asset vehicle that holds hedge funds in the underlying portfolio. These are hedge funds that are inaccessible to most investors as they are either closed, have limited access or breach Ucits rules around liquidity.
Indeed, Coghill says liquidity is her biggest concern right now. The 2008 crisis still haunts markets and investors need to be aware of the pitfalls, she says.
“What people thought were liquid bond funds in 2008 turned out not to be and we have just seen the issue with Gam, caught out mostly by illiquidity on some of the positions it held. We are very focused on liquidity.”
As such, City AM regularly discusses the subject with its managers to determine exactly how long it would take to liquidate their portfolios. Coghill cites the Ennismore European Smaller Companies Hedge Fund, which she describes as “a daily liquidity hedge fund closed to new investors”, and the Global Equity Fund as examples of funds with good liquidity.
Performance is good, too. “Ennismore European has one of the best track records of any European long/short fund. I have a client who invested in it 10 years ago and it is up 1,000%.”
Made to measure
One personal favourite investment trust of Coghill’s for bespoke portfolios is the Boussard & Gavaudan multi-strategy trust, launched by renowned former Goldman Sachs traders Emmanuel Boussard and Emmanuel Gavaudan. The fund aims to eke out a small return each month and while some equity positions have not gone well recently, Coghill admires the track record.
City AM has also been buying infrastructure investment trusts during the past few years. GCP Infrastructure and Sequoia Economic Infrastructure Income Fund both feature in portfolios but Coghill says they are high up the risk profile and trading at a premium to NAV, which is a concern.
Property is also accessed through investment trusts. When the Brexit vote occurred in June 2016 most of the exposure was through open-ended funds but the harrowing experience several of these went through after the referendum drove City AM to shift to closed-vehicles for the majority of exposure.
LXI Reit, Tritax funds and a previous holding in London Metric have featured in portfolios. As with the infrastructure trusts, Coghill says: “The problem has been when they are successful they tend to go to a big premium and we are uncomfortable holding something that has a 10% premium, so we have been more active in trading.”
Overall, Coghill believes it is a good time to be sitting on the fence when it comes to a risk on/off position. The debate within the walls at City AM rages over whether in an environment of low returns and so much uncertainty to hold a higher weighting in cash or commit to buying funds, which could produce flat returns once the fee is factored in.
“That is an ongoing debate in-house,” she says. “A lot of the managers are underweight fixed income and perhaps slightly overweight cash.”
