One of these consequences he points to is overleveraging in US companies, which are buying back their own shares to prop up prices. “Here is an example of something that started off as balance sheet optimisation turning into straight financial engineering,” he says.
“In the past few years, companies that have been run conservatively for a long time have been beginning to build up quite big debt levels. But the interest rate burden is barely visible because rates are so low.”
The team is operating a number of longer-term themes, particularly in equities. For example, while acknowledging that the strong-performing ‘high-quality’ end of global equity markets is progressively becoming more expensive, Spence runs a small portfolio of companies with high franchise value and strong market share within the TM Cerno Select Fund.
Baillie Gifford Global Discovery, run by Douglas Brodie, is another fund holding, while equity risk is balanced with some more defensive positions, including in Treasury Inflation Protected Securities (Tips).
Spence says: “If we tip back into a disinflationary environment, Tips are going to behave pretty similarly to nominal bonds. But if inflation rides up, they are going to do better than their nominal cousins.
“If inflation rides up quickly, with a sudden change in inflation expectations, then there will be a cramming effect and they are going to be the assets of choice.”
Cerno does hold some hedge fund managers, though few in the global macro space because of the challenges currently affecting these strategies.
Heroes and zeroes
“The central strategy for many of these managers is trading bond curves, and when they become so flat the opportunity set is vastly diminished,” says Spence.
“Once you strip this away, the most obvious thing you are left with is currency pair trading, which is a devilishly difficult game; last year’s hero, this year’s clown. Currency markets owe nobody a living.
“While we would argue that currencies are the sharp end of regional and country differences, turning that idea into a systematic way to create profit is a challenge for all macro managers. As a group, I now think they are facing significant challenges in managing their investors’ expectations.”
Gold is an asset class that became more interesting to Cerno last year, after it had been “washed out” of most portfolios following the peak allocation in 2011 and 2012.
Spence says: “Gold offers two-way payoffs but on more violent changes in the rate of inflation, up or down. Although we do not think that either hyperinflation or deflation are high probability outcomes, there is a possibility, which allows an argument for owning gold.”
A seasoned traveller, Spence suggests he is now very much settled and there is no place like home. He believes London is the best location for the business as it is in the centre of the major time zones.
“One of the things I brought back from Asia was a sense of what I call a cross-pacific view of the world,” he says.
“It was so often the case that what defined whether a given Asian market was in a bull period or not, had a great deal to do with capital flows. Trade flows are very relevant in that part of the world, with the economies being so mercantile, defined by trade.
“You became very aware of the sheer power and economic mass of America and its radiation across the Pacific to the so-called ‘workshop of the world’.”
