The contrarians in a world lacking conviction

Fearful investors urged to take on calculated risk as volatility returns

The fear factor has prevented investors showing any real conviction in their portfolios, but most fund selectors say there are contrarian opportunities to be found if one looks hard enough.

Portfolio Adviser asked fund buyers at its recent Spring Congress whether it is difficult to find contrarian ideas in the current environment, 68% said no and 32% said yes. However, when PA asked certain individuals to name the areas they have particular conviction in, there was a mixed response (see video).

A combination of the Federal Reserve adopting a more dovish stance and ongoing geopolitical uncertainty, including Brexit and a US-China trade war, has spooked investors and the Q4 downturn was evidence of these events influencing markets. According to Last Word Research, UK investor sentiment towards the macroeconomic environment deteriorated in Q4 (see chart below).

Source: Last Word Research

But markets have bounced back since the start of the year, offsetting much of the Q4 losses. The S&P 500 returned 10.9% in sterling terms over Q1 while despite Brexit, the FTSE 100 was one of the best performing developed markets in March rising by 2.83%. Does that mean fund selectors are more positive?

Fear factor

According to BMO GAM co-head of multi-manager Gary Potter (pictured), people are afraid of taking risk which naturally leads them to seek safety in areas like trackers or fixed income. He believes taking calculated risk is the only way to make a decent return, but warns investors to be very careful about which areas they invest in.

“One of the observations I feel in the market place is people are not taking enough risk and that may be partly driven by the regulator,” he says. “We seem to be in an investment world where people want to take all the risk away… but the ones who are going to stand out are the ones who are prepared to take measured risk.”

But Potter adds investors have to be very careful about “a lot of stuff coming to the listed market that really shouldn’t be coming to the market at all”, especially as central bank policy shifts and volatility returns.

“After 10 years of QE, and whether we have the pause of the Fed or not, we are clearly entering a different zone in markets. Beta one is over and volatility is going to be back… so be a bit more careful and circumspect, but remember you have to take some risk to make a decent return, just be careful what you choose.”

Where’s the conviction? 

Gibbs Denley investment manager Tom Sparke says his strongest conviction is in “one of the most boring areas possible”, namely sovereign bonds.

Typically, when assessing sovereign bonds the first thing to think about is their sensitivity to interest rates, says Sparke, but with the US Fed reining back its stance on hiking rates and the Bank of England and European Central Bank showing little sign of raising them, that risk is taken out of the equation.

“What we’ve got left is a really good inverse correlator and in times when market volatility is high, like we saw in the last quarter of last year, it is extremely useful to have that duration power to offset the equity falls in portfolios,” he says.

“So, while it is normally a fairly dull asset, we are pretty excited about that.”

Sparke is not alone in having this view. Last Word Research found European fund selector sentiment towards developed market government bonds based on a 12-month forward view surged by 22 percentage points in Q4 2018.

The UK seems to be splitting investors at the moment. Many are waiting for the Brexit dust to settle while others see it as so beaten up that now is the time to buy.

The majority of fund selectors polled at Spring Congress (76%) said they were looking to increase their allocation to UK assets over the next 12 months. Only 6% said they would decrease their exposure, while 18% said it was likely to stay the same.

Source: Last Word

Similarly, Last Word Research from Q4 found a net 29.8% of UK fund buyers looking to buy UK equity and UK equity income over the next year. One of them is AJ Bell head of active portfolios Ryan Hughes, who says UK equities is arguably his biggest conviction stance. 

“[I’m a] big fan of areas people really dislike,” he says. “We tend to look at areas that are totally out of favour and it seems to be the UK can’t get any more hated, so right now it looks attractive; the yields are high. We obviously have lots of uncertainties but if we get those cleared out the way there is a good chance UK equities could do very well.”

On the fence

Others, however, are yet to be convinced the UK is the place to be. City Asset management founder and investment director Hilary Coghill says her strongest conviction is in having no conviction.

“We have reduced European equities and we are sitting on the fence with the potential of increasing our exposure to UK,” she says. “We have moved more into global equities, and are looking very much more at active managers and long/short managers.”

Canaccord Genuity deputy chief investment officer Justin Oliver is even less convinced currently about the UK. He told Portfolio Adviser the firm’s strongest conviction is underweight UK because there is so little clarity on the country’s future, but he concedes that at some stage this sentiment is likely to shift.

“We are in the camp of UK looks to be good value and we see some opportunities, but we don’t want to close the underweight.”

Given the uncertainty, he finds it difficult to pinpoint which area of the UK market to buy. A softer Brexit could benefit FTSE 250 names but a harder separation and a subsequent devaluation in sterling could see the larger cap FTSE 100 do well, he says.

“Maybe it doesn’t matter what the [Brexit] result will be. It is more about having a result.”

Oliver says Canaccord is moderately overweight risk pointing out Japan as a slight overweight but he notes the US as the firm’s greatest positive conviction.

“Despite what you may think of Trump, he is equity market friendly and he will want to make sure the economy is firing on all cylinders by the election in 2020.”

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