Government bonds have been on a phenomenal run over the past year or so as concerns about equity valuations, falling inflation expectations and various other macroeconomic woes have driven yields back down to historic lows.
Performance of indices since Jan 2014
Source: FE Analytics
While bonds have historically acted as an effective hedge against equity market volatility, Scott – who heads up the PFS Hawksmoor Distribution and five crown-rated PFS Hawksmoor Vanbrugh funds – says this will no longer be the case.
Given that he is worried about the outlook for both bonds and equities, he has been rotating his portfolios towards less mainstream funds.
“We are concerned about the overall valuation levels of financial assets at the moment, and in particular the exceptionally low level of government bond yields,” Scott said.
“In terms of very negative scenarios I think investors need to be concerned that government bond yields have fallen to levels that mean they have limited scope to offer the negative correlation and diversification benefits to equities.”
“It is hard to build protection into portfolios, but things we are seeking to do is to have more exposure than usual to the US dollar – which should strengthen further if markets get more difficult – small weightings in a gold fund in appropriate mandates, and more exposure to absolute return funds than before – notably those pursuing a long/short strategy.”
With that in mind, he highlights three examples which he uses in his two funds of funds.
Henderson UK Absolute Return
First on the list is the five crown-rated Henderson UK Absolute Return fund, which is Scott’s fourth largest holding in his PFS Hawksmoor Vanbrugh fund accounting for 4 per cent of assets.
The £450m fund – which is run by the FE Alpha Manager duo of Ben Wallace and Luke Newman – is a long/short equity portfolio, but differs from the large majority of its peers as the managers don’t use their shorts as a hedge, but as a “profit centre” to generate alpha.
According to FE Analytics, Henderson UK Absolute Return has gained 43.8 per cent since it opened to retail investors in April 2009.
While those returns are far lower than that of the FTSE All Share over that time, the fund’s annualised volatility and its maximum drawdown – which measures the most an investor would have lost if they bought and sold at the worst possible times – have been three times less than that of the index.
Performance of fund versus index since April 2009
Source: FE Analytics
The fund has also delivered a positive return in every calendar year since its launch – apart from 2011 when it fell 0.44 per cent – including a 4.56 per cent gain during last year’s difficult market.
It features in the FE Select 100, with the FE Research team recommending the fund for investors who want to diversify their portfolios and want to protect their portfolio. It has an ongoing charges figure (OCF) of 1.07 per cent.
BH Macro
Sticking with the absolute return theme, Scott also uses the BH Macro Investment Trust – which sits in the IT Hedge Fund sector.
The portfolio, which is a firm favourite with investment trust analysts like Cantor Fitzgerald’s Charles Tan, has proven time and time again that it can protect investors during periods of increased volatility in financial markets.
This is largely down to its strategy, as instead of having just one manager, the portfolio is a combination of ideas from Brevan Howard’s 70-strong trading team, who are all looking to exploit inefficiencies across global equity rate, currency and bond markets.
Our data shows that since its launch in March 2007 BH Macro has returned 155.62 per cent. As a point of comparison, the FTSE All Share has returned 48.67 per cent while the Barclays Sterling Gilts index has gained 72.54 per cent.
Performance of trust versus indices since Mar 2007
Source: FE Analytics
Though the trust has historically struggled during strongly rising markets – as there are a lack of trades available causing investors to dump shares, resulting in a widening discount – BH Macro made 30 per cent in the crash year of 2008 and 25 per cent in 2011, when the European sovereign debt crisis intensified.
As a result of increased volatility last year, the trust performed well as its NAV rose and concerned investors caused the discount tighten.
BH Macro currently trades on a 5.48 per cent discount, which is still wider than its one and three-year average discount, according to the AIC. Its ongoing charges are 1.95 per cent, excluding a performance fee.
BlackRock Gold & General
Gold miners have had a terrible run over recent years as the fall in the gold price, changing inflation expectations and concerns about company management teams have all weighed on investors’ minds.
However, Scott says that valuations are now so cheap they offer good protection against other more mainstream asset classes which look expensive. He therefore holds a small proportion of his funds in Blackrock Gold & General.
The five crown-rated fund is headed up by Evy Hambro and has an AUM of £930m.
FE data shows the fund has lost 24.33 per cent since Hambro took charge in April 2009, outperforming its benchmark – the FTSE Gold Mines index – which has fallen 43.1 per cent over that time.
Performance of sector versus indices since April 2009
Source: FE Analytics
It has also outperformed both its benchmark and an equally weighted portfolio of all IA gold funds over three years. In 2014, it was the only gold fund to make money as it returned 2.19 per cent while the average fund lost 8 per cent and the index fell 14 per cent.
Blackrock Gold & General, which is a relatively concentrated portfolio as its top 10 accounts for 50 per cent of its assets, has an OCF of 1.17 per cent.
