A positive outlook on the global economy but a negative view on the UK are two key calls the team behind the Standard Life managed portfolio service is making in the current market environment.

As part of an ongoing series in which FE Trustnet looks at the model and managed portfolios on offer to UK financial advisers, we spoke with Standard Life Wealth senior investment managers Jason Day and Eric Louw about their process, current positioning, recent performance and outlook.

Standard Life Wealth runs 10 managed portfolios with five having an absolute return target and five offering a more traditional relative return profile.

The ‘conventional’ products start with models one and two, which are focused on income, while four and five target growth. Model three is a combination of the two.

The range is risk-targeted and each portfolio has a volatility band in which they aim to make their returns, with model one being the lowest risk and five being the highest.

Day, who runs the conventional products, said the team start with strategic asset allocation, using ratings agency Moody’s who provide the risk and return profile outline as well as asset class data.

There is also a tactical element, which the team determines with help from the multi-asset investment team behind the Standard Life Investments Global Absolute Return Strategies (GARS) fund.

“We work with them monthly and go through the asset classes where, as a house, we are overweight, underweight and neutral. Then we take that output and shape the portfolios accordingly,” Day (pictured) said.

At a fund selection level, the team garners assistance from the Aberdeen Standard fund research team for access to third-party managers and models three to five also utilise the Standard Life Wealth Falcon fund.

The Falcon fund makes up a large weighting in the higher risk portfolios and is a selection of the team’s best stock ideas. Alongside this they add satellite funds to move over- and underweight certain areas of the market.

“With these portfolios IFAs get access to our best stock ideas and the multi-asset element to dampen the volatility,” Day added.

On the absolute return side, run by Louw, there are also five portfolios with target returns ranging from cash+1 to cash+4 per cent. 

In terms of process, the team follow the same asset allocation as the global absolute return strategy, with the key difference being that it has the ability to flex their central asset allocation up and down based on the level of risk.

“For lower risk clients we don’t need the level of returns and dial down the risk return profile by adding to low-risk asset classes,” Louw (pictured) said. “The higher risk portfolios drill into the same tactical allocation but we tweak the fund selection.

“For most of the portfolios we are looking for funds with quite modest tracking errors [of] 3-6 per cent but with the high-risk portfolio we flex that a little bit to give us more leeway and are looking for higher risk funds.”

Within these funds, one-third of the portfolios are invested in the Standard Life Strategic Investment Allocation fund which reduces some of the risks in the traditional part of the portfolio and it gives access to institutional investment techniques which aren’t traditionally available in the private client portfolios.

Key overweight

One key overweight position within the portfolios is infrastructure – a still relatively underused asset class within model and managed portfolios, the team said.

“We’ve reduced our bricks and mortar and our UK commercial property but we still want something that is a diversifier to mainstream equities and we still want something that has got inflation proofing with fairly low volatility compared to equites – so infrastructure fits the bill,” Day said.

The yields on offer within the sector have come down in recent years as the asset class has grown in popularity, pushing prices higher, but remain attractive in the low growth environment, he added.

“To us it is a reasonable yield but being a diversifier is the key thing and inflation proofing [is also important],” the manager noted.

Inflation has been a relative afterthought for portfolios in recent years, with deflation a more prominent threat, but with it creeping back into markets – particularly in the UK and US – inflation-proofing has become more important.

“There hasn’t been any inflation for years but we are starting to see a pickup within the eurozone, in the US and clearly in the UK,” Day said.

“If you have companies that are able to benefit from that – and infrastructure companies are linked straight into it – then that gives you a good pick up in the earnings of those companies.”

Louw added: “It also depends which geography you are looking to. We can probably agree that UK inflation has really been driven by some technical reasons – the sterling depreciation and to a certain extent the energy prices as well.

“So we wouldn’t say we are expecting inflation to pick up dramatically here in the UK but looking more globally it is picking up in quite a lot of places like the US and Europe.”

As such, the team owns First State Global Listed Infrastructure, a fund that has been a strong performer over the last five years, returning 114.19 per cent.

Performance of fund vs sector and benchmark over 5yrs

Source: FE Analytics

“It has a very strong pedigree with a well-resourced team. It has very dependable returns, is well diversified and offers good upside capture and downside protection,” Day said.

The five crown-rated, £2.5bn fund has been run by FE Alpha Manager Peter Meany since its launch with fellow FE Alpha Manager Andrew Greenup joining him in 2011.

The fund has a yield of 2.67 per cent and a clean ongoing charges figure of 0.82 per cent.

The team is also overweight the emerging markets on both a debt and equity level – an area we will look at in more detail in an upcoming article.

Key underweight

Turning to the underweight positions, the team remains wary of the UK as the Brexit negotiations continue to cloud the market.

“In terms of our outlook I wouldn’t say we are very negative on the UK economy but I think we have to recognise that the overhanging uncertainty of Brexit negotiations, and what that means for our future relationship with Europe, is a material risk and we’d probably prefer to take UK exposure elsewhere (away from the domestic economy),” Louw said.

As such, while the products did contain dedicated small-cap exposure in the form of FE Alpha Manager Harry Nimmo’s Standard Life Investments UK Smaller Companies fund, the team switched out of this two years ago.

Performance of fund vs sector and benchmark over 10yrs

Source: FE Analytics

“It is a very good fund but having had an extremely strong run and generated a lot of alpha we took the decision to shift back up into large-caps about two years ago,” the manager noted.

“In hindsight that has been quite patchy. Initially mid-caps did outperform, then underperformed quite a lot post-Brexit, and as the dust has settled have performed very strongly again.”

In terms of the data, Louw said he is most concerned about the household savings ratio, which is currently much lower than he would like.

“With inflation quite high and wage inflation much lower, it is putting the squeeze on consumer spending power,” he said.

“I think a lot of UK consumers have been spending above their means, and you can see that in the savings ratio which has really dropped to the lowest it has been since the 1960s.

“As such we think a lot of consumers are not in a great place to deal with higher interest rates and higher mortgage rates as there is not a lot of savings to fall back on.”

Despite this, the UK has held up much better than many (including the Standard Life team) were expecting. “We have been surprised by how resilient it has been but we still remain quite concerned,” Louw noted.

Instead, the team has switched its smaller companies focus to Europe by investing in the four FE Crown-rated Baring Europe Select fund run by Nicholas Williams, Colin Riddles and Rosie Simmonds.

“We took a view that the euro was strengthening significantly, so while that could be a drag for exporters the domestic economy continues to be very strong,” Day noted. “It has done well for us for a long time and we have actually added to recently.”

Performance

Since its launch in 2014, the conventional model three portfolio – which has both an income and growth mandate – has returned 23.53 per cent, while models one and two – the income focused portfolios – have returned 10.61 and 14.08 per cent respectively.

Meanwhile, models four and five have outperformed the FTSE All Share benchmark, returning 36.12 and 31.87 per cent respectively, as the below chart shows.

Performance of portfolios vs benchmark since launch

Source: FE Analytics

Importantly for this type of portfolio, model five – the most risky – has experienced less volatility than the FTSE All Share, with all models experiencing less volatility than expected.

“There are two reasons for this. One is that the volatility at an asset class level has been historically low,” Day said.

“We are looking at 10-year forward assumptions but things have been so different recently because of quantitative easing (QE) – we have never seen this amount of monetary stimulus before.

“Secondly, I would say the active funds we have been using have typically had lower volatility than their benchmark through either the style composition of the portfolio or the cash in there.

“So you put those two together and it dampens the volatility but it certainly hasn’t hampered our returns.”

Meanwhile, the absolute return strategies launched in May 2011 have had a more difficult time after being hit in the first half of 2016 – suffering a 5 per cent drawdown in some portfolios.

As such, while all funds have made positive returns ranging from 26.53 per cent to 17.15 per cent, the model three is outperforming the higher risk models four and five.

Performance of portfolios since launch

Source: FE Analytics

“On the target return side we have been running portfolios for longer and the performance is pretty good but obviously it is not a relative return portfolio,” Louw said.

“The elephant in the room is that we had our most challenging period of performance through the first half of last year and amassed quite a big drawdown of 5 per cent, which is a lot for us.”

While the portfolios only fell by around half the amount of overall equities, Louw said they are currently short of their own three-year rolling period expectations due to the underperformance during that period.

“Performance has improved since then as we have been recovering, but we have not made back the money we lost,” he noted.

“At the beginning of last year we were positioned for the US economic recovery to continue and for that to lead to steadier growth and allow the Federal Reserve to raise interest rates,” he said.

“At the same time we were expecting loose monetary policy in Europe and Japan – so we were short US duration and had quite a number of currency positions where we were favouring the US dollar.

“Meanwhile our equity selection was tilted towards Europe and Japan as we expected the currencies to weaken and drive export prices. What happened in Q1 was almost the direct opposite to what we expected.”

Outlook

Overall, the team remains positive on the outlook for the global economy, although it is wary of the UK as highlighted above.

Louw noted that for the first time in a long time there is synchronised economic growth and as such equity markets have all benefited, as the below chart shows.

Performance of indices over 2yrs

Source: FE Analytics

“Much of the post-financial crisis gains have been driven primarily by the US. The UK had been following a similar trajectory but had been lagging behind and Brexit has been a pretty major speedbump for the UK,” he said.

“Looking outside of the UK, the US has continued to do pretty well on both the hard and soft data and Europe, having been in crisis three or four years ago, is pretty much firing on all cylinders and now growth is stronger than the US.”

Additionally, the region is coming from a low base compared to the US, meaning that it could have further to run in the long-term. “We think that European cyclical recovery has got quite a lot of legs,” he noted.

Another area the team is getting more bullish on is the emerging markets and Asia, where they have moved from an underweight to neutral position.

“I think one of the things we have to acknowledge we got wrong is we have been overly bearish on China,” he said.

“I wouldn’t say we have been expecting a hard landing but we thought the cyclical slowdown would be more pronounced.

“While Chinese growth is decelerating it appears to be nice and steady so we have got synchronised growth across the three major areas. All that is positive for global trade and that supports a number of asset classes.”