Rare equal-weight portfolios struggle to impress

The art of portfolio construction taken away from managers adopting equal-weighted funds

Geffen

There are plenty of passive funds on the market that offer equal-weighted portfolios but finding active managers running these strategies is a difficult task, which could be why fund selectors give them a lukewarm response.

Two of the better known are both income funds: the Neptune Income fund, run by Robin Geffen (pictured), and the Guinness Global Equity Income fund, managed by Matthew Page and Ian Mortimer.

Geffen’s £202m fund has a high conviction portfolio of 33 equally-weighted holdings, while the £526m Guinness fund is similarly high conviction, holding about 35 names in equal weights. Both funds have done relatively well given recent market volatility.

Last year, the Neptune fund returned -3.37% versus the IA UK Equity Income sector’s -10.55% and the FTSE All-Share’s -9.47%, while the Guinness fund returned investors 0.73% during the year, beating the IA Global Equity Income sector’s -5.83% and the MSCI World’s -3.04%.

Stock-specific risk

For Geffen, equal weighted makes sense because many other income managers have too much stock-specific risk in their top 10 holdings. He told Portfolio Adviser it is not uncommon to see 7-8% positions in certain income funds managers’ top 10 holdings, which he believes is because they chase yields of 5-6% from certain companies.

This “dividend risk”, as he terms it, poses a risk not just to capital but also income because if some of these companies yielding 6-8% see their share price cut then their dividend will also suffer.

“Not only do you have a big loss to capital, you have not had it compensated for the apparently higher dividend being paid,” says Geffen. “In an income fund you have a responsibility for managing both the capital and income and therefore one has to be very careful about having high weightings in income stocks.”

Geffen adds it has taken a negative year in returns like 2018 for people to begin to question the fact that having a lot of money in a few holdings that have a high yield is a risky strategy.

Similarly, Page says reducing stock-specific risk is a big part of the rationale for equally weighting the Guinness Global Equity Income fund, but it is also because there are too many unpredictable factors affecting markets to guess how they will impact companies.

He explains: “I can’t hand on heart order my portfolio from one to 35 companies and say ‘I think this one is going to generate a larger total return in the next six to 12 months than the other 34’,” he says. “Let’s equally weight these positions the market will decide when it will re-rate individual companies and we can then rebalance the portfolio.”

If a company does well, Page says the team can rebalance it down and bank some of that profit while if a company’s stock price goes south, they can step in a buy more.

Non-equal weighted

Neil Woodford runs a less concentrated portfolio of 107 names for his Equity Income fund and the top 10 accounts for 44.37% of the portfolio, making it a candidate for Geffen’s stock-specific risk category. According to the firm’s website, the largest holding, Imperial Brands, is 7.02% of the portfolio, followed by Barratt Developments at 6.35% and Burford Capital at 5.76%. Woodford declined to comment on his strategy when contacted by Portfolio Adviser.

The Gam UK Equity Income fund invests in a portfolio of about 50 stocks and does not follow an equally-weighted approach. The portfolio is not as concentrated as the Neptune and Guinness funds with the top 10 holdings making up 32.4% of the portfolio.

Adrian Gosden, investment director and manager of the fund, says there are three reasons the portfolio is not equally weighted.

First, dependable businesses are dividend favourites but cyclical companies also play a part. “As cycles come and go, weightings need to evolve in the portfolio,” he says. “Those companies that have the potential to ‘surprise’ generally would have a lower weighting in order to manage the risk.”

Second is the issue of liquidity because as a fund grows in size, it may not be possible to have the same weight in all shares, if those share have very different market capitalisations.

Finally, Gosden says while equal-weighted portfolios are easy to set up and there is no need to discuss weights, there is the need to manage ‘weighting drift’ as not all shares perform in the same way.

Lukewarm response from fund pickers

Fund selectors Portfolio Adviser spoke with are not convinced by the merits of the approach.

AJ Bell fund manager Simon Molica says it is not a surprise that not many fund managers offer the strategy because portfolio construction is such an important part of their toolkit.

“When we meet fund managers we always focus on portfolio construction. That is important as it is another way of controlling risk and from a conviction point of view. If you are equally weighted you are expecting someone to have the same conviction in each idea and I think that is unrealistic.

“You do expect people to have different conviction levels at different times. I would insinuate you are unnecessarily constraining yourself and actually you want the ability to put a smaller or larger weight in something.”

Molica says it is helpful for portfolio managers to be able to assign different weights to stocks at different times so they can slowly build a position in a stock that is falling and the catalyst for buying more isn’t clear yet.

“Giving yourself smaller size positions, you can find stocks that are growing into their income that could be paying later on,” he says. “You could be mitigating the growth part of the income just to ensure you are getting today’s income.”

Jonathan Moyes, head of research at Whitechurch Securities, describes equal weighted as “just not an important approach”.

“To my mind the challenge is keeping to an equal weight – it just means you’re constantly fighting against volatility to maintain a set weighting,” he says. “I find it hard to believe that in itself adds value.”

Rebalancing costs

Moyes also notes that in the spirit of Mifid II and disclosing transaction costs these equal weight approaches may come under pressure as the cost of trading to maintain those equal weights starts to appear in the cost line.

However, both Geffen and Page are quick to note that trading costs are no different to other funds.

Geffen says: “I am not obsessive, and I don’t rebalance every day but I do use the cash that is coming in to top up the holdings below 3%. I have cash coming into the fund every day. My turnover is low anyway, but my dealing costs are no more than anyone else because I’m investing the cash that gets put in the fund.”

Geffen argues this is a good discipline because it is much easier to top up your favourite stock than it is to top up a holding that has fallen below 3%.

Page says it is reasonable to assume his fund rebalances about four times a year as it is not perfectly in line with the model weight because that would mean trading every day.

“Costs are pretty low,” he adds. “I would have thought the costs would be higher if you are constantly fiddling with position sizes and moving them up and down.”

 

Tags: | | |

Recent News

Leave a Reply