Two transformative forces have dominated my lengthy career in the
investment industry: regulation and technology. Both have always been important
prevailing factors, but the question is, how have they re-defined the role of
an investment manager?
Technology has removed a good deal of the manual work for a professional
investor, by hugely improving data consumption and analysis. I remember when
first starting out as an investment analyst in 1986, I was tasked with updating
a wall chart tracking movements in the markets, manually updating price sheets
for our portfolios, and sending off company reports and accounts – all of which
are now instantaneous.
This leaves portfolio managers with more time to look under the
bonnet of a business –understanding its competitive edge and relationships with
customers, employers and wider supply chain. It also allows us to spend more on
the road engaging with our investee companies – seeing first hand their
business models in action.
Meanwhile, the ever-increasing prevalence of regulation has been
both a good and a bad thing. MiFID II and other regulatory initiatives have
focused on protecting the small or individual investor, tackling bad behaviour
and poor ethics, which many view as synonymous with the financial
However, having navigated my way through several of the most
challenging periods in financial services history – from the Asian financial
crisis in 1997 to the global financial crisis of 2008 – it’s clear that regulation
has its limits. The greatest lesson for any aspiring fund manager is
understanding the permanency of crises.
The reality is, no overarching piece of regulation has managed to
halt the boom and bust nature of the financial markets. As an active fund
manager, it’s important to appreciate that while crises can be immensely turbulent,
they also present unique opportunities to drive long-term alpha generation.
IMPORTANCE OF INACTION
Despite the landscape of investment changing drastically in the
last 30 years, my investment philosophy has remained constant. I believe
markets are efficient most of the time, and therefore often the best course of
action is inaction. Investment is one of the few areas in life where the
correlation between effort and reward is often negative. Hence, adopting a
long-term view is imperative.
However, as a manager of a multi-asset fund, it is important to
flex the asset allocation muscle of the fund over time, to adapt to changing
market dynamics. The chart below illustrates how I have done this, shifting the
Higher Income Fund’s asset allocation between equities, fixed interest and cash
over the years.
During the 2008 global financial crisis, my bond allocation rose
to around 70% of the fund, as at the time investment grade bonds appeared to
offer outstanding value with yields of 8%. However, since then bond prices have
risen significantly and consistently. Consequently, my reduction in exposure to
bonds has gone hand-in-hand with their steady reduction in yields over the past
decade. Though I have sympathy for the bond market’s more pessimistic view of
the world, I nevertheless have reduced my bond weightings to 17% - the lowest
in the fund’s 24-year history.
So, what’s the rationale for my record low bond exposure?
Inflation is the chief adversary of the fixed interest markets and I have
concerns that inflationary pressures will continue to rise. These concerns are
compounded by record high employment and wage growth levels in the UK, and
indeed around most of the world. I believe current yields on 10-year gilts of
0.9% provide very little cushion against these inflationary threats. Given the current outlook, index linked gilt
yields seem to me an accident waiting to happen. A 2068 0.125% linked gilt with
a price of 262p on 25 May has a yield of -1.9% and if held until maturity, would
guarantee real terms losses of over 50%.
I like to compare this to the biggest stock market bubble I have personally
experienced – Japan in 1989, which rose over 230% in 5 years and traded on a PE
of x85. If you had bought in at that peak and held until today, you would have
lost 43% over the last 29 years – a terrible outcome but still considerably
better than the guaranteed 52% loss over 50 years for the 2068 index linked
gilt. Investors need to tread lightly, but I am still finding value in the
fixed interest markets in certain niche areas, with Preference Shares and PIBs
still looking attractive with yields of 5.5%.
Time has shown that global financial markets are constantly in a state of flux.
The active manager’s remit is to navigate investors through the perpetual
cycles of crises. This is best done by avoiding overblown markets while paying
careful attention to areas of the market which the herd have decided to ignore.