Keiron Root’s monthly review of developments in the investment fund markets

It may come as a surprise, but some funds have actually made money over the past six torrid months. Sixty-seven of them, to be precise (excluding institutional funds), after charges have been deducted, according to the Lipper data, which, admittedly, is not many out of a total universe of over 1,900, but goes to show that it can be done.

How it is done, of course, is by investing in either bonds or cash. As the tables below indicate, nearly all of the funds in positive territory over the six months to 28 November were either Money Market funds or funds investing in some form of fixed-interest security. Indeed, the picture is even more skewed towards these asset classes than it appears, since the three Absolute Return funds and the three Unclassified funds on the list are all bond funds of one shape or form.

International security
As the table of the top 20 funds over the past six months (on page 34) shows, some of these returns have been extremely impressive, but the best have almost exclusively generated their performance from a combination of international bond holdings and currency movements. The weakness of sterling has proved to be a significant boon to
UK-based investors holding international bond portfolios.

Indeed, even the apparent anomaly of Neptune Japan Opportunities, up more than 40 per cent over the period, is due to the defensive stance adopted by its manager, Chris Taylor, with a relatively high (18.5 per cent) cash position, the effect of a strengthening yen relative to sterling and some judicious hedging of the portfolio through selling TOPIX Index futures.

Certainly, defensive stances seem to be the order of the day among fund managers at present, with most equity fund managers simply going as liquid as they possibly can to ride out the storm until the markets return to something approaching normality.

Rob Burdett, co-head of Thames River Multi-Manager, reflects the prevalent attitude when he confirms that ‘Macro factors continue to influence our portfolio construction and we are retaining cash at higher levels than normal. We have successfully managed our cash levels tactically and managed to participate in the recent rally before correctly reverting to our strategically defensive stance. At some point we recognise that it will be necessary to take a more fully invested position, but do not believe it is right to do so just yet.’

He points out that ‘All of our five funds continue to be positioned defensively, which has led to outperformance across the range since launch. At present we have a strategy of holding cash and market-neutral funds, such as Cazenove UK Absolute Target, alongside flexible, experienced fund managers, such as Odey in Europe, which has served us relatively well. In other words, we have stuck to good-quality “vanilla ice cream” at a time when this has proved to be the right strategy.’

Applying caution
In terms of asset allocation, Burdett reports that in Thames River Multi-Manager’s income portfolios, ‘we have relatively low weightings in corporate bond funds and no pure high-yield holdings. This has proved helpful to performance given recent falls in these asset classes. We are reluctant to add too much in this area for the time being, but acknowledge that good value is starting to appear for the long-term investor. However, we continue to review this position daily, looking for improvements in liquidity conditions, which will be an important consideration in our taking a more optimistic view.’

He points out that ‘Specific property and commodity exposure continues to remain absent from our portfolios, as it has since the inception of our funds in 2007. The commodity bubble that emerged in the first half of 2008 is well on the way to being deflated, but we believe there is still some way further to go. It still appears too early to get involved with property given the poor economic outlook. In equity markets, small- and mid-cap stocks will also offer interesting opportunities at some point in 2009 or 2010, but again, in our opinion it is too early to rush in.’

Interestingly, Burdett observes that ‘In order for us to change our cautious view permanently, which we fully recognise we may need to do at some point next year, we are looking for signs that the de-leveraging that is currently punishing markets is coming to an end, coupled with some stability in the developed housing markets. At this point, however, markets may not necessarily move up dramatically in the short term, but it will mean that more fully invested portfolios will be more appropriate, while we wait for the excellent long-term prospects to be realised. We need to be braced for further volatility in markets in the meantime, but markets are discounting a pretty terrible outcome for companies and for economies, and historically these have rallied well ahead of the bottoming out of recessionary conditions.’

A game of two halves
So what funds should investors be considering amid the current market chaos? Tony Yousefian, CIO at fund of funds specialist OPM Fund Management, confirms that ‘2009 is one of the most difficult years to call for some time as far as markets are concerned. To use a famous footballing analogy, it is likely to be ‘a year of two halves – the first half typified by defensive, capital preservation mode play, the second half, in particular towards the end of the third quarter, the opposite.’

He adds, ‘In the first half we expect the managers with defensive, quality stocks – with minimal exposure or no exposure to the consumer-facing companies – to outperform the market. Names that we favour in this category are John Wood, who runs the UK Opportunities Fund at JO Hambro, and Messrs Bailey and Luthman, who share stewardship of the Walker Crips UK High Alpha Fund.

‘In the Equity Income sector, Karen Robertson of Standard Life Investments and Adrian Frost and Adrian Gosden, who jointly run the Artemis Income Fund, would be our picks. In general terms, Large Cap, Utilities, Pharmaceuticals, Telecommunications, Infrastructure and Exporters would be among our favoured sector plays. We would expect the equity markets to start to look forward to better earnings prospects for 2010, and for this to begin to be reflected during the second half of 2009.’

Anticipating the cycle
Yousefian asserts that ‘It is at this point that we anticipate the badly beaten up early cyclical stocks will begin to outperform. It is this leg of the market movement that stands a better chance of being sustained than any other bounce in the markets through to the middle of next year.

‘In the international markets, we remain very much overweight in North America. In this region, the Neptune US Opportunities Fund, run by Felix Wintle, and Legg Mason US Smaller Companies, managed by Royce & Associates are our top picks. The second half of 2009 should also see a healthy return from Emerging Markets, and James Donald, who runs the Lazard Emerging Markets Fund, is our main recommendation.’

And he concludes, ‘As far as the equity markets are concerned, 2009 should prove to be quite fruitful, but it will be a choppy ride, so all those who get sea-sick easily should perhaps turn to Corporate Bonds, where a less choppy but nonetheless good positive return is expected as current valuations are discounting a depression, never mind a deep recession.

‘The quality end of the market is likely to give a healthier return, and the current valuations should be used as a major buying opportunity. In this asset class, for defensive plays and for the more cautious investor, we favour John Anderson at Rensburgs (Rensburg Corporate Bond Fund). For a bank recovery play, we like the Artemis Strategic Bond Fund, run by James Foster and Alex Ralph. This should prove to be a very profitable investment.’