MAY 2012 Funds weather the storm
Identifying the right assets in which to invest is the best way to protect funds in volatile markets and flexibility and adaptability are key to a successful asset allocation strategy.
ANDREW COLE Fund manager, Barings Multi Asset Fund
In this time of turmoil, it is clear the investment strategies that worked over the past 10 years are those that had the flexibility to change their asset alloca- tion as markets discounted an overly optimistic outcome for the economy, only then to discount complete despair. Flexibility and adaptability are likely to continue to prove crucial over the next decade for generating returns in a volatile, but largely directionless market environment. Asset allocation will will continue to be a more impor- tant driver of returns.
Multi asset may be the new game in town for retail investors but Barings has a lengthy track record in successful top- down analysis.
Andrew Cole, manager of the Baring Multi Asset Fund, has been with the group for 25 years and since 2002 has been building multi asset portfolios for institutional clients where the approach has proved increasingly popular. Cole explains the rationale behind a multi asset discipline. “The past 10 years have not been unusual,” he says. “Mar- kets have been volatile but if we look back over history, we find that is the norm. The 1980s and 1990s are the anom- aly, when investors generated good returns consistently from bonds and equities with very few down years. During those times, the key determinant of performance was how much was held in equities and how well those equities performed.
“Prior to that, the key determinant of performance was the asset you were in – and that wasn’t always equities. We believe that for the next 10 years, the key to consistent good performance will be identifying those assets that are going to do well above all others.”
In identifying those assets, Cole’s view is that understanding the economy and how it influences the pricing of assets is the key. The group builds its view of economies through Barings’ monthly research cycle.
He says: “We review all of the eco- nomic data for each country round the globe and ask ourselves whether this is consistent with recession, recovery,
slowdown or boom. We look at whether a country is beating or missing consen- sus estimates and also whether returns are consistent with our expectations of how an economy will develop.” The macroeconomic analysis is aligned to the group’s strategic work on the potential outcome for individual economies over the next decade. This gives the group a benchmark from which they can assess whether growth is consistent with the expected path. It also provides a basis from which to judge valuations of different asset classes. If everyone is bullish, risk pre- mia tend to be low, so investors may not be compensated for a lesser outcome. Cole says: “The cornerstone of our process is what we think the economy will look like in 12 to 18 months and what risk premia we are being offered.” In judging whether they are being sufficiently compensated for the volatil- ity of an asset class, the Multi Asset team will assess each part of the capital struc- ture. For a bond with a fixed coupon, the provider of capital knows it has the first call on assets if the business goes wrong. Further down the capital structure, an unsecured borrower knows when they will get their money back and their coup - on, but if the business goes wrong, they are second in line and need to be paid a higher interest rate to compensate. For equity risk capital, the investor knows they may get a dividend, but not when they will get their capital back. Like unsecured bond borrowers, if the company goes bust, there are two people ahead of him. Equity investors therefore need to expect a higher rate of return than the other two. For Cole, this must be reflected in market valuations. With the exception of collectibles such as wine, vintage cars or stamps, no asset is off limits, though the open-ended structure does impose some constraints on very illiquid assets. The asset alloca- tion shifts are made “meaningfully”. In 2008, for example, the fund held less than 15% in equities and could have gone to zero had Cole deemed it prudent. Cole also builds in an analysis of shifting correlations between asset classes. He points out that the rela - tionships between assets are not stable. Investors might have assumed prior to the credit crisis that if they had equities and government bonds, the combination would provide better risk- adjusted returns.
Most of the time this will be true, but
correlation may break down quickly at times of market stress. A Greek investor, for example, will have found his portfo- lio of government bonds suddenly dis- playing equity-like characteristics. “This is an extreme example, but 2008 also highlighted the problem. Investors had diversified into private equity, hedge funds or commercial property, only to find that they all relied on the ability to borrow money cheaply to gen- erate returns.
“When there was less cheap borrow- ing available, all these assets suffered. Gold was a good diversifier at the time because people don’t tend to borrow to buy gold, but more recently it has moved up and down with the equity market.” Cole describes himself as “prag- matic” in implementing the asset allo- cation. They will use Barings funds where appropriate, but will also use third-party managers and passive funds. They have an in-house research team that helps to source the best ideas. Cole adds: “Our first decision is whether we want to be active or passive and we always bear in mind that using third-party active managers comes at a cost. As recent years have demon- strated, there can be good and bad years for stockpickers.
“In the macro-driven markets such as 2008, the average stock picker will struggle. As it is, in 2012, we believe that stockpickers have got something of a tailwind, so we are more inclined to be active.”
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Multi asset may be the new game in town for retail investors but Barings has a lengthy track record in successful top-down analysis
The result is an “all-weather” strat- egy that has delivered strong risk- adjusted returns over the last 10 years. The retail vehicle, the Baring Multi Asset Fund, has produced positive per- formance in every calendar year since launch three years ago. Overall, the aim of the fund is to beat inflation as mea- sured by the Retail Price Index by 4%. Cole has been managing money this way for over 10 years and the team now runs more than £6 billion across the firm’s various multi asset mandates as the strategy has found increasing reso- nance with investors of all types, is con- fident it can deliver consistent, risk-adjusted returns for investors. Cole is confident he can work to deliver consistent, risk-adjusted returns for investors. He says: “At the heart of our philosophy is the view that one dis- astrous year can destroy years of good growth and this approach delivers a much smoother return.”
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