Insights

From the category archives: Market Views

Market Views

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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Allianz Gilt Yield to be managed in house

Allianz Global Investors have announced the appointment of Mike Riddell as UK Fixed Income Portfolio Manager. This will have an impact on one of the funds which we rate. The Allianz Gilt Yield fund, rated A by Square Mile, is currently managed by Mike Amey at PIMCO, a subsidiary of Allianz Global Investors.

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Short Term Manager Change For The Kames High Yield Bond and Kames Strategic Bond Funds

Kames Capital has today announced that Phil Milburn, co-manager on their High Yield Bond and Strategic Bond funds, is taking a short sabbatical. This will commence immediately and Kames expect Mr Milburn to return to full duties early in the New Year.

The Kames High Yield Bond fund will continue to be run by the highly experienced and well-regarded Claire McGuckin, with support from the wider fixed income team at Kames. In addition, Stephen Baines has been named as Support Manager for the fund. Mr Baines has already been assisting Mr Milburn and Miss McGuckin on the fund in a more informal capacity and we welcome this formalisation of his role.

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Differing Approaches to Absolute Return

The Investment Association Target Return sector is a real mixed bag. The IA defines funds in the sector as funds managed with the aim of delivering positive returns in any market conditions, but where returns are not guaranteed. The funds in the sector must clearly state the timeframe over which they aim to meet their stated objective; this must not be longer than three years. At first sight this may seem to be a fairly tight set of criteria but in practice it covers a wide range of funds with very different risk return profiles. Over the last three years, the best performing fund has virtually doubled while the worst performing fund has lost 10 per cent. The maximum drawdowns across the sector have ranged between -0.5 per cent and a sizeable -17 per cent. Fund volatilities have ranged from levels typically seen in near cash funds to funds that have been more volatile than equities. Few other IA sectors have such a diverse range of fund strategies and return profiles.

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Richard Buxton promoted to CEO

Richard Buxton, manager of Old Mutual UK Alpha fund, has been promoted to CEO at Old Mutual Global Investors (OMGI) with immediate effect. He will be supported by Warren Tonkinson, who has been appointed to the newly created position of Managing Director.

Mr Buxton joined Old Mutual as head of UK equities in June 2013. He was previously head of UK equities at Schroders, where he managed the Schroder UK Alpha Plus fund for more than ten years.

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