Last year required a deft hand from asset allocators. They needed to ensure their clients didn’t take the full force of the downturn in markets, while also participating in the market recovery when it came. However, they also needed to be sufficiently agile to shift the portfolio to more economically sensitive areas to participate in the reflation trade from November onwards.
Waverton’s multi-asset team had strategies in place to deal with each element. James Mee (pictured), lead fund manager of Waverton Multi-Asset Income and fund manager on the broader multi-asset team, says the group’s first line of defence was an allocation to an internally managed strategy, designed to give a strong return when equity markets are weak. This protection strategy performed in line with expectations, rising significantly as equity markets collapsed.
The team also took out put options on the iTraxx Crossover Index, which had been trading at record lows. They also marginally lowered their equity weighting, taking it down from around 48% to 42% in the group’s Waverton Multi-Asset Income Fund. This pushed the cash position higher.
Solving the puzzle
This completed the first task of ensuring investors didn’t take the full force of the downturn. It also meant they had cash on the sidelines to start re-allocating back to the market when valuations appeared sufficiently compelling. They started doing this on 20 March. The final piece of the jigsaw puzzle – participating in the significant rotation in markets – came from the group’s bottom-up research.
“We don’t make big asset allocation calls,” Mee states. “We wouldn’t look at interest rates rising and say ‘we should be investing in cyclicals’, for example. However, in reality, it was our bottom-up research that guided us to the early signs of a rotation. By the time the rotation began in earnest, we were already transitioning from long-duration to more pro-cyclical areas.”
For Waverton, this is true-multi-asset investing, incorporating sophisticated use of alternative and hedging strategies to deliver client objectives through different environments. The approach is fully global, diversified across regions, asset classes and currency, with its key objective “compounding returns through the cycle”.
The funds are around 90% invested in individual securities across equity, fixed income and alternatives. “This allows us much more control and gives us the ability to control allocation when we want to play a particular theme,” Mee explains. “For example, we’ve had around a third of our exposure in the ‘reopening’ trade. We wouldn’t have the ability to do that using a passive strategy.”
There are a range of funds built from the multi-asset process alongside Multi-Asset Income. The group also has the Portfolio, Real Assets and Absolute Return funds. The group also runs a model portfolio service on platform with five investment options, all with a CPI-plus objective over specific time horizons, plus a managed portfolio service and bespoke portfolios.
While some of their portfolios have volatility targets, this is not Waverton’s primary focus when considering risk. Mee says, for them, it is far more important that a portfolio outperforms inflation. That means investing in equity and real assets.
The second key risk is drawdown, defined as permanent loss of capital. Mee believes that growing the real value of capital over the long term requires that portfolios do not suffer signifcant losses at any point in the market cycle.
“While some protection is provided by investing in best-in-class businesses, and more from our allocation to absolute return alternatives, the importance of hedging portfolios against the most deleterious outcomes cannot be overstated. By protecting against drawdown risk, we are able to smooth the return profile over the cycle and enable portfolios to compound from a higher base.”
For the equity portion, the group is looking for durable businesses with a focus on free cashflow generation. These businesses compound over time, using sustainable competitive advantages to deliver high and/or rising returns. In the Multi-Asset Income Fund, this includes businesses such as Coca-Cola, Deutsche Post or CME Group. The equity team has around 1,000 meetings every year.
The group has also sought to build out its expertise in alternatives over the past decade, including areas such as property, infrastructure and commodities. Mee says they consider it an important differentiator, capturing new risk premia, such as liquidity or complexity. The multi-asset team divides its alternatives allocation into real assets (return-seeking) and absolute return (capital protecting).
The ability to manage across hedging strategies and alternatives alongside conventional equities and bonds requires a team with some depth. The investment team is currently 22-strong and the multi-asset team is 10 – with specialists in equity, alternatives, fixed income and multi-asset. The equity team is broken up into regional responsibilities.
The final element is asset allocation. Mee says they don’t aim to move the asset allocation around significantly, believing, “the world is far too complex to forecast”. As such, they work with in an established macroeconomic framework.
“Formally we have an asset allocation meeting every six weeks. The asset allocation committee thinks about how we can adjust portfolio construction. That said, we have very short lines of communication, with most of us sitting on the same floor. We tend to walk over and have a conversation when we believe there’s a need to change things.”
Feeling the force
Today, the key focus is on inflation and whether it is structural or cyclical. There are still secular disinflationary forces, including debt, demographics and digitisation. The Chinese working age population peaked last year, for example. However, globalisation, once a deflationary force, may now become inflationary. Mee points out there has been a reshoring of supply chains as countries and companies seek to ensure continuity and reliability of supply. This could raise prices. Equally, he says, investors need to be mindful of the inflationary impact of a potential change in tax rates.
“Tax rates have been coming down since the pre-Reagan/Thatcher era, but now we are looking at a global minimum tax rate. While disinflationary forces remain dominant, there are some changes.”
In the short term, however, inflationary pressures are likely to continue. There are bottlenecks in areas such as commodities and semiconductors. Strong consumer demand is bumping up against constrained supply and conspiring to put up prices.
“This should be transitory,” says Mee. “I think the opportunity is to trade against that. The current expectations of the market are that inflation trends to 2% by the end of this year. Next year there should be fewer cyclical inflationary pressures. There are currently 3.5 million more unemployed in the US versus the end of 2015. That’s a lot of people coming back into the job market.”
This should be disinflationary. The group’s portfolios are generally short-duration in their fixed-income exposure. Mee says that with interest rates still low it is going to continue to be difficult for bonds. Equally, he has seen some of the diversification advantages of government bonds relative to equities diminish as inflation fears mount. They currently make up only 20% of the Multi-Asset Income Fund.
“We don’t need to be bullish on inflation and rates to see that the outlook for bonds is poor. Even if inflation were to remain subdued, and the US, UK and Europe all to follow in Japan’s ‘lower-for longer’ footsteps, bond mathematics imply a lower total return from the asset class.”
The group still has a significant weighting in equities. Multi-Asset Income sits in the Mixed Investment 20-60% Shares sector and currently has a 54% weighting in equities. This is substantially geared to the reopening trade, where Mee continues to see value.
The portfolios also have a significant weighting in alternatives, around 20% for the Multi-Asset Income Fund. This provides diversification and inflation protection and includes holdings such as infrastructure group GCP Asset Backed Income. The group also continues to hedge against a ‘doomsday’ scenario where equities and bonds decline in tandem.
Performance on Multi-Asset Income has been strong. After a tough 2018, the fund significantly outperformed its benchmark (CPI + 2.5%) in 2019 and 2020, leaving it top-quartile in its sector over three and five years.
If 2020 required a deft hand, navigating the post-pandemic era is also likely to need an agile approach. The Waverton approach is multi-asset in its truest sense, making full use of a broad toolkit to ensure consistency of returns over the long term.