The UK equity market has made strong gains since the period after the financial crash, with the past year in particular seeing increasing confidence among retail investors.
Performance of index over 5yrs
Source: FE Analytics
The vast majority of fund managers seem to be bullish, with the likes of Fidelity’s Trevor Greetham expecting the FTSE All Share to repeat last year's returns of 20 per cent again in 2014.
However, Stewart (pictured) – manager of the £8.6bn Newton Real Return fund – thinks investors are overlooking the dependence of the apparent recovery on central bank support.“The consensus is that there are no risks out there, and that continues to worry us,” he said.
Stewart’s views are similar to those of FE Alpha Manager Marcus Brookes, who recently told FE Trustnet that investors need to revise down their expectations and resist being swept away by euphoria.
“People are saying ‘well if you adjust for this and you adjust for that, there are plenty of reasons to be bullish’.”
“Effectively what they are saying is if you ignore all the bad news, then everything looks good,” he said.
Stewart, who has managed open-ended funds for more than 25 years, says investors are playing with fire if they think the world’s central banks will continue to bail out markets if they show signs of weakness.
“We do think there is complacency in the market,” he said.
“There is that general feeling that the authorities have got our back and though the central banks don’t want speculation, that’s what has been happening as people think ‘why not take higher risk?’”
“People have seen a green light to buy equities because they think there isn’t much downside risk because the central banks will step in if there is trouble. I think that is a dangerous assumption and history shows it is a misplaced one.”
Stewart is also concerned about the state of the UK economy. While UK GDP figures have been steadily improving over recent months, with the housing market strengthening and corporate confidence returning, the manager says that the economic pick-up is still built on shaky fundamentals.
“There has been a pick-up in the economy and there are even signs that Europe is not getting worse. However, while UK growth has accelerated, the main drivers of that are similar to that of the last cycle.”
“Consumers are running down their savings and credit growth is running up again. We are basically moving into the next cycle still carrying the baggage from the last one.”
“My thoughts are that we are probably not going to get the levels of growth that most are expecting,” he added.
However, unlike his fellow long-serving FE Alpha Manager Martin Gray, who also has a very bearish outlook, Stewart sees little value in holding a high proportion of cash in his portfolio to mitigate risk.
The manager says avoiding equities altogether would also be a mistake, so as a result he is currently happy to hold 58 per cent in shares.
“It has been wrong to be too cautious as 2013 was a spectacular year for risk assets,” he said.
“That has largely been driven by policy as it has been so supportive. Investors just can’t afford to stand in the way of the juggernaut; they may as well take part.”
“There are still a lot of risks out there, however, as shown by the fact that profits growth seems to be stalling but markets have moved upwards.”
However, Stewart only focuses on what he describes as quality companies.
These are companies that, he says, are in control of their own destiny and can perform well no matter what the economy is doing.
He looks for companies with a strong balance sheet and that repay shareholders via a reliable dividend.
For instance, the manager has a large weighting to large cap pharmaceutical stocks, with GlaxoSmithKline, Bayer, Novartis and Sanofi all featuring in his top-10 holdings.
Stewart has managed Newton Real Return – which is a member of the IMA Targeted Absolute Return sector – since March 2004.
According to FE Analytics, it has made a positive return in every discrete calendar year since he took over, except in 2011 when it posted a loss of 0.75 per cent.
Cumulatively, that means the fund has delivered a return of more than 125 per cent over 10 years.
Performance of fund vs index over 10yrs
Source: FE Analytics
The manager has a very large investable universe.
His high equity weighting, along with a relatively large exposure to high yield bonds, makes up the core growth element of his portfolio.
However, he also has a hedge “bucket” which includes gold bullion, gold mining equities, government bonds and derivative instruments such as put options and futures.
Stewart’s thoughts are similar to those of fellow FE Alpha Manager Hugh Hendry, who recently told investors that he had given up on his bearish positioning because risk assets could continue to perform well for the next three years thanks to the irrationalities in the market.
The Newton manager doesn’t dismiss Hendry’s argument, and says that while some sort of bubble will eventually emerge given the huge amount of central bank intervention and the over-hyped equity market, it is difficult to see when and where it will burst.
“What he has been saying makes a lot of sense, but with respect, he is an example of a bear that has capitulated,” he said.
“You do need that to happen, however, as looking at the history of things, this is just the next credit-driven boom and bust cycle.”
“But this time it is much bigger: the scale of it is just enormous. You could, therefore, conclude that the inflation of asset prices could continue for a lot longer, but will become more of a bubble than anyone could have envisaged. Also, with policy distorting the market, who knows what will happen?”
Newton Real Return has an ongoing charges figure (OCF) of 1.12 per cent and requires a minimum investment of £1,000.
