Insights

From the category archives: Market Views

Market Views

Risk Targeted Funds - A look at the market

A significant growth area among multi asset funds over the last few years has been a group of solutions often referred to as risk targeted funds. Inflows of assets into risk targeted funds over the last five years has been substantial and the market is now estimated at over £35bn with around 250 different funds to choose from.

The definition of a risk targeted fund can vary but generally refers to any fund which targets a defined level of risk as its primary objective. This contrasts with traditional funds which generally have return as the principal focus. Risk targeted and risk profiled funds are often confused and wrongly thought of as being one and the same. Any fund can be risk profiled but not every fund will be risk targeted. A risk profiled funds is designated to fit within a particular risk profile based on current portfolio and performance characteristics which may change over time whereas a risk targeted fund is specifically designed to expose investors to a predefined level of risk, which is often directly aligned to a risk profile.

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The similarities between Marathon runners and Fund Managers

With the London Marathon only days away, people across the country will be adding an extra bowl of pasta to their dinners in order to get the energy needed for the big race. The many attributes that these runners require in order to take on the mammoth task of running 26 miles and 385 yards are also required by fund managers across the city in order to deliver the required outcomes for their investors.

The point that all marathon runners fear is the dreaded 'wall', where sudden fatigue and loss of energy hits the body making any movement let alone running difficult. Many runners aren't able to deal with this pain and give up, while others fight through the pain and make it to the finish line. Similarly no fund manager is immune from difficult periods, however unlike other mangers, which have fallen by the way side, the fund managers mentioned in this article have survived their 'wall' and bounced back stronger.

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Square Mile: four funds to meet investor expectations

The FCA has castigated the asset management industry for promoting closet-trackers as actively managed funds. Elsewhere, it shames companies offering investment vehicles which do not deliver the outcomes to investors that their marketing literature promises.

Against this backdrop, investors could be forgiven for shying away from investment funds altogether. However, Square Mile Investment Consulting and Research stresses that there are examples of best-of-breed practice and highlights four funds which do not reference benchmarks, preferring to construct portfolios to meet specific investor objectives.

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Rerunning the Widow Maker

There have been a number of investment opportunities that have stood out over the last twenty years but few, at the time, seemed as compelling as shorting Japanese Government Bonds (JGBs) once yields slipped below 2% eighteen years ago. Fortunately I did not have the wherewithal to do much about this, so I escaped devastating losses as yields halved, halved and halved again. Anecdotally, this was a popular trade for the more sophisticated types in the hedge fund world. Eventually, the trade rather darkly earned the moniker 'the widow maker'. Following the financial crisis, JGB yields have continued to spiral lower until, almost with a resigned inevitably, the 10 year note finally sunk into negative territory in February. This article covers some thoughts as to whether gilts are investable for retail clients on current yields or whether buyers should be institutionalised (in either sense of the word).

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Evaluating Open-Ended Passive Funds

In theory, selecting passive funds for investment should be quite straightforward. This is certainly true when compared to the work required to identify suitable active funds but still challenges remain. The range of options for passive investment has broadened enormously over recent years as the ETF industry has developed and if systematic smart beta options are included, the options become boggling. During the summer, Square Mile initiated a ratings coverage of passive funds. This article highlights some of the issues that we came across in analysing passives and how we set about overcoming some of these difficulties.

Firstly, we restricted ourselves to mainstream open ended vehicles. There are well over 1,000 listed ETFs available to investors with many following a smart beta approach. However, there are questions as to whether smart beta approaches should be considered passive or active management. For instance, value indices can be defined by a price to book, price to earnings, price to cash flow or through a combination of these factors. Since a subjective judgement is required to identify the most appropriate metric I believe that smart beta approaches require a due diligence approach more in keeping with active funds and were excluded from our review of passive funds.

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The Power of Compounding

It's difficult to begin to write about compound interest without being tempted into hackneyed quotes from Albert Einstein. Since this article is only partially about compound interest, I shall resist with some enthusiasm. Even investment professionals, myself included, can lose sight of the power of compounding, and the impact that it can have over time is nothing short of staggering. Let me illustrate with an example which appears a little abstruse to begin with but the reasons for it will become clear as I move on to the main theme of the article.

Let's begin by going back to Ancient Egyptian times, say 2,000 BC. Imagine that we have a 1 metre cubed block. Now this block is added to each year and grows at a 2% rate. My question is how big will the block be today?

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Philosophically Speaking

Investment philosophy is possibly the most overlooked of the five P's. I think a lot of fund buyers can underestimate the benefits gained by identifying a sound philosophy that underpin an investment strategy. Perhaps therefore, it is not surprising to find occasionally fund managers who struggle to articulate, or indeed, identify what their underlying investment philosophy is. It is quite possible to successfully manage investments without a clear underlying investment philosophy but it is very helpful to consider what might be driving this success. Car drivers don't need to understand how an internal combustion engine works, but if it suddenly comes to a juddering halt, a knowledge of the principles behind what makes an engine tick can act as a solid foundation on which to base the repairs.

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Looking Beyond the Marketing ‘Gloss’

The power of presentation is arguably at its most potent in modern politics. The first televised presidential debate between a sickly Vice President Richard Nixon and calm, confident Senator John Kennedy in 1960 - still one of the most watched programs in US broadcast history - is surely testament to that. Whether in the US or closer to home here in the UK, nowadays the electorate tends to favour politicians they 'like' and 'trust' over those that appear 'able' and 'skilled', making the personality of the politician even more important.

But perhaps the best example of the art of spin is the lesser known tale of Mexico's motorways. It all started with a bright idea from the country's Ministry of Transport sometime around the 1960s or 1970s. At the time Mexico was planning to expand its motorway capacity but faced the familiar conundrum of having plentiful political capital and not enough financial. With the upcoming election front of mind, the Ministry of Transport set about re-marking the two lane highways as three lanes, in an attempt to create a speedy - and cheap - solution. The impact was immediate but in no way wholly positive. Road capacity increased by 50% and with it the accident rate soared to the extent that the roads actually had to be returned to their original state. However none of this was enough to put off the incumbent politician from leading his re-election campaign with the line that he had successfully increased the road network by a net 17% during his time in power. This was achieved through increasing capacity by 50% less a decrease of 33%.

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First State makes name changes to four Square Mile rated funds

Following the decision made by First State in March of this year to split their equity team into two investment teams (Stewart Investors and First State Stewart Asia). They have decided to change the name of the following funds:

First State Asia Pacific Leaders Fund to Stewart Investors Asia Pacific Leaders Fund

First State Asia Pacific Sustainability Fund to Stewart Investors Asia Pacific Sustainability Fund

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Outlook for Equities

Following the Swiss National Bank's surprise decision to remove the franc currency floor in January, most of the major markets settled into an eerie quiet through much of the first half of the year, despite the ongoing calamity in Greece.

Warning signs showed in June as the first cracks appeared in the Chinese stockmarket bubble. Yet, developed market stockmarkets only began to stir once the People's Bank of China devalued the renminbi on 11 August. In the final two weeks of August, equity markets erupted in some extremely violent moves that were disturbingly reminiscent of 2008. Daily fluctuations of up to 5 per cent became the norm. The Vix index leapt from 15 to 53 within three days, leaving many options prices too volatile to quote. This proved unsettling even for hardened market veterans.

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