Keiron Root examines the strategy of one of the stars of the Balanced Managed sector

In these turbulent times for investment markets, investors will be paying greater attention to the risk profile of their funds. Portfolios that seek to follow a flexible investment approach while limiting the overall level of risk should be particularly attractive, and it is just such a strategy that is followed by the CF Miton Special Situations Portfolio Fund, one of a range of distinctive investment funds run by Midas Capital Partners.

Martin Gray has run the fund since its launch at the end of 1997, and he has recently been joined by James Sullivan as co-manager. Gray explains that ‘In simple terms, it is a global balanced fund which sits comfortably within the Balanced Managed sector. But I am not constrained by benchmarks or sector weightings. The objective of the fund is to achieve a global balanced return, with as high a total return and as low a level of volatility as I can manage.’

Macro management
This objective has been achieved to a significant extent, with the fund close to the top of its sector over a range of periods. Martin Gray explains that ‘The asset allocation themes for the fund are based around those we set for another of our funds, the CF Miton Strategic Portfolio Fund, although that is much more cautiously managed. Special Situations follows the same asset allocation strategy, but with a bit more volatility factored in.’

The Strategic fund is also found within the Balanced Managed sector, but its more cautious nature is illustrated by the fact that it currently has over 60 per cent of its portfolio in cash and fixed interest, compared with less than 32 per cent for the Special Situations Portfolio.

Gray adds, ‘Asset allocation is totally macro driven. As a group, we buy in a lot of external research, which we use to help set the macro parameters, but the most important element of our approach is that we conduct a large amount of our own independent research as well. I do a lot of reading and the FT is a great source of information. We now have 12 fund managers in the group and we exchange a lot of views, which can also be very useful.’

He points out that ‘James has been on board for about a year, and he does a lot of the legwork. My job is to understand the macro view, looking at the global economy, to get a handle on what is going on and to use that as a basis to position the fund to the best advantage for our investors. There is no fixed management style, so, in that sense, it is an absolute sort of approach, but I should point out that we are not, in any way, an absolute return fund.’

Early movers
Sullivan states that ‘The cash weighting of the fund has been quite high over the past 18 months to two years – anywhere between 15 and 30 per cent. Initially, this was partly to do with getting bearish on the UK and US economies, but also there was an opportunity to take advantage of the fact that we felt we would see a recession.’

He adds, ‘As a result of this view, we were quite aggressive in late 2006 in moving money into non-sterling or non-US dollar assets, with the result that a lot of our cash or bond holdings were in euros or yen. Then, in early 2007, we were building up cash positions in yen and Swiss francs, in the belief that the carry trade would have to unravel at some point. This has happened and has been a big help to the fund. And all of the debt instruments in the fund are sovereign debt. We don’t hold any corporate debt.’

Martin Gray asserts, ‘I am quite happy to be early. I am a buyer on the downside and I wait for things to happen. Of course, if they don’t happen, you have to be prepared to admit that you made a mistake and get out. But the core strategy is to build up positions steadily in falling markets, then light the blue touch paper and wait.’

He adds, ‘There is still a reasonably sized pure equity weighting within the fund, around 40 per cent, but that is predominantly in large-caps. The cash weighting has been there for two years, and we went into that through doing primary research rather than waiting  for the external analysts to tell us to sell. That is a big advantage to conducting your own research.’

Gray reports that ‘There have been very few changes to the portfolio from the second half of 2007 through into 2008, although we have started to position things back towards a more “normal” market position now. We are moving the equity allocation back towards large-cap, particularly in the UK, and we are looking to buy the US and Japan, especially on bad days.’

Investing, not trading
In terms of overall strategy, Martin Gray says that ‘Generally speaking, the themes that I am following are on a one- to three-year basis. Some may be shorter term than that, but I am not a trader. Nor am I not a currency speculator. That was just a theme that ran its course and did very well for this fund. At the same time, we are not wedded to any particular benchmark or asset allocation model or sector strategy. I roam where I can to get the best return for the fund.’

The other key aspect of the portfolio is that it is primarily a fund of funds, although, as Martin Gray explains, this can cover a wide range of investments. ‘I use primarily open-ended and closed-ended funds, but we are not afraid of using structured products and ETFs [exchange-traded funds] from time to time. Indeed, I would also hold some direct equity investments if I wanted to get exposure to a specific sector.’

He adds, ‘For example, we are currently getting exposure to the property sector through REITs [real estate investment trusts]. I am prepared to buy early to get into a particular area and then wait for things to develop.’

Sullivan observes, ‘We are also looking at the property sector at the moment, looking for things that are on savage discounts but where you can be pretty sure there are some real assets. Certainly, there are some attractive discounts in the property sector, but you have to be careful of the debt structures of some of these vehicles, their banking covenants and so on.’

Relevant conditions
Gray explains, ‘I am trying to find managers who perform on the upside. For example, if I were looking at UK large-cap at the moment, I wouldn’t be interested in how a fund had done over the past 18 months. Rather, I would want to look at how the manager had performed under similar conditions in the past, and pick out those managers who can deliver on the upside in volatile markets.’

He adds, ‘We currently have 48 holdings. Typically, total holdings would be in the 45 to 55 range, because of the size of the fund. Currently, it is just shy of £150 million so we need to have a reasonable spread of investments. I also use some closed-ended funds in this portfolio so we need to keep some liquidity.’

Gray observes, ‘As to whether it is preferable to use open-ended or closed-ended funds, a lot depends on what is happening with discounts among the closed-ended funds, and also the liquidity of particular shares. Some closed-ended funds are just too small for me to consider.’