Markets have been a little less kind to the fund in January than the preceding few months. Equities have continued to move higher, which has clearly benefited our fund, as has the shift towards more cyclical equities. Our lack of exposure to banks clearly meant we have not participated to the same degree as some and sadly one of the larger positions, PZ Cussons, suffered a profits warning costing the fund nearly 10bps. It has since been sold.
To the downside we have seen some reversal in the sterling which has been a negative for the fund as has the recent weakness of gold. Certain of the fixed income positions have also been detractors. Clearly this has been a period where simply having equities and corporate bonds would have worked better. As I am sure most of you know, my opinion is that corporate bonds are simply a proxy for equity risk with a bit of government bond risk thrown in. Therefore, to have done well in the recent period we would have needed to run a fund with considerably more equity risk than I would ever be comfortable with.
To some degree I find the recent underperformance of the peers encouraging as it demonstrates that the fund is not solely exposed to a single view. The risk in the fund is clearly well diversified and the positions relatively uncorrelated. The net result has been that the fund has been flat against a rising market.
It pays to carefully consider each of the positions in the fund following a period of weak performance. I am very comfortable with the equity positions and I have been growing the exposure to many of more growth oriented names. In fact several new names have been added in this area such as Intercontinental Hotels, Starwood Hotels, BAE Systems and Ryanair.
In the bond portfolio I have allowed the inflows to shrink the size of the positions. I intend to write a longer piece in the next few weeks outlining the risk I see in being overly exposed to bonds at these exceptionally low yields. From a risk reward point of view the asset class looks very unattractive to me now.
Obviously we have to own some bonds and they still offer some diversification value but unlike in Japan we in the UK and Europe cannot rely on a vast pool of domestic savers to buy our bond market at any price. It is difficult to know when but at some point in the future bond yields must rise.
I still consider gold an attractive hedge on uncertainty, particularly following recent weakness and a recent patch of general optimism so I have again been building that position up again having seen it drift down to just 5% of the fund. Other commodities seem less attractive at the moment.
I remain positive on the dollar and negative on the Euro as I am convinced the US is recovering and the Euro crisis is still unresolved. Please see the new road show presentation on the US recovery.
In conclusion, I remain comfortable with the fund and see the recent period as an inevitable consequence of having had such a good recent run of performance.
David Jane 13th December 2011
All the UK press seem to be fixated on the prime minister’s use of his veto at the Eurozone summit rather than what he refused to sign the UK up to. Few details are available but it seems that the other EU members have agreed to hold referenda on fiscal integration (strict rules on deficits and tax policy), in exchange for the indebted nations paying the German banks back and the Euro being retained. In effect the Germans get their money back and the Euro is retained so long as the indebted nations go on a deep austerity program.
What seems astonishing is that all this commentary comes at the time of the shambolic state of the EU and the Eurozone. That the UK might feel it to be in their interest to stand aside while they Euro members sort their problems out, thus avoiding having to pay for the mess that has been created seems quite logical. Only a few months ago the government was being criticised for making a very modest contribution to Ireland’s bailout.
It also seems that ultimately the bankers won the argument, they get their money back and the tax payers pay. Which particular tax payers pay I expect will remain unsaid until after the treaty is signed but the evident anger at Britain’s refusal to join tells the story for me. The Germans are not happy as the removal of a large and rich nation from the picture shifts a large share of the burden back to them.
To conclude, the Europe is on the road to a solution and the path is now decided. The rich countries of Europe, ex UK, have agreed to save the Euro, in exchange for the power to set the poorer counties tax and budget policies.
Next steps will hopefully involve the ECB and IMF getting involved to bear some of the burden and the votes progressing through the relevant legislators. All this may happen too late for some of the peripheral countries.
From a market point we now have the outline of a solution and the will to implement it. In my view we will have a weak Euro as clearly the whole of Europe’s debt now needs to be set against the whole of the Eurozone’s tax collecting ability. Treaties in Europe seem to have different meanings depending on whether Italians are interpreting them or Germans. Why would the new treaty be any better than the Maastricht rules? Economically the focus can now shift from the uncertainty of Europe to what is going on more widely in the world which has to be positive.
David Jane 27th October 2011
Eurosolutions
Clearly we are all relieved that Eurozone leaders have finally come up with a plan to resolve the problems of the indebted nations of Europe.
As expected markets have rallied sharply with the end of the near term uncertainly. This is very positive for the fund, which as you know we have been getting more aggressively invested in equity in advance.
Longer term a less knee jerk and more balanced understanding is required. Clearly Greece needed to default, as it has, and other countries in Europe will also need help and the banks will need further financial support. The proposed solution apparently involves borrowing more money from China. I thought borrowing too much money from China caused the problem!
It follows that throwing ever more money at the problem may stoke inflation, but in the short run it helps halt the slide in confidence caused by the authorities inaction. For this reason we will retain our exposure to index linked and gold to cover the risk that inflation takes hold in the western nations. Our preference for fixed income exposure in the form of hard currency bonds and index linked remains.
Our near term conclusion is that the equity markets will continue to rally as attention moves away from Europe to a more rounded world view reflecting the fact that world growth remains relatively strong and European economies may continue to recover. At the same time we expect inflation to continue to remain a concern and that bond yields throughout the major economies will need at some point return to appropriate levels that reflect a positive yield above inflation.
Multi Asset Investing.pdf
DMAF Jan Factsheet.pdf
DMAF Reasons Why.docx
DMAF Jan Newsletter.pdf
TMDarwinMultiAssetFundPROSPECTUS 06 Feb 2012-r[1].pdf
Darwin Group.pdf
The keys to managing risk in any portfolio are diversity and flexibility. Well run multi asset portfolios are able to achieve a much higher level of diversity than traditional single asset class funds such as equity or bond funds. For this reason, although on simple volatility measures they may appear more risky than for example corporate bonds, multi asset funds should in fact deliver less volatile returns over time. This is because in any short term time period they will not be fully exposed to any poorly performing asset class.
The same is true of flexibility. However good a manager, he can only invest in the assets that his fund allows - if he is an equity manager he will have to have a portfolio that is largely composed of equities and may be further constrained to invest only in one country or region. A multi asset manager can move between asset classes where he feels the best risk reward profile is available and set an appropriate construction for the conditions that exist.
David Jane 13/09/2011.
Putting out the fire with gasoline:-
Policy makers still seem to believe the self-serving advice they are getting from the bankers that the way to solve the debt crisis is to borrow ever more money. The occasional individual has in the past experienced this in their personal finances- in order to pay their mortgage they borrow on their credit card and get further and further into debt. This is obviously not a solution to an individual’s debt problem and nor can it be for a country’s. Yet policy makers still seem to think that throwing ever more debt at the economy is going to solve the problem despite all the evidence to contradict this.
This is a common problem in economics, where theories are developed by academics as to how things should be but which bear absolutely no practical testing in the real world. A common problem with central bankers and politicians is that they feel they need to be doing something and believe that what happens is a consequence of what their action.
The effect of QE has been to put ever more money into the banking system and on into financial markets to the benefit of no-one bar the bankers. It may have had the effect of reducing yields across the curve but cannot make individuals and companies borrow more money if final demand is not there.
In my view the solution can really come only through time with the long term deleveraging of the consumer and governments, eased along by gradual inflation and currency devaluation. As the process progresses an improvement in consumer confidence will come only when individuals can feel their jobs are secure and their government is not going to be over taxing them or going on an austerity drive. Consumers are not blind to what is happening in the peripheral European economies. When final demand starts to improve companies may start to make investments and the growth cycle would start to work. This process will just take time.
However, we should all remember that world economic growth is expected to be 3% plus this year- which is hardly a poor number- but this is largely coming from outside Western Europe and the USA. The problems seem to be dominating markets attention at present but this should subside in time.
David Jane - 25/Aug/2011
It is tempting to say markets have been exceptionally volatile recently, but periods of market volatility are in fact the norm. Commentators have been suggesting reasons for the recent volatility such as Eurosclerosis or US debt fears but none of this is news. We have suggested for some time that economies would be flat to sideways, as I expect have most others, so nothing new has really occurred.
The recent weakness has also thrown up a number of opportunities particularly in defensive high yielding stocks so much of our recent activity has focused on building these holdings.
UK gilts now yield as little 2.4% over ten years which is a remarkable figure and debate rages as to whether the gilt yield is wrong- reflecting quantitative easing and investor fear- or equity valuations. On balance we feel equities offer good value, although we are cognizant of the argument that on a very long term view equity yields are still not offering exceptional value.
Such academic arguments are of little value to us as we must invest our clients somewhere. Bonds still offer a good diversifier of equity volatility so we continue to seek out what value we can find in this area, equities in many companies offer great value, with attractive yields. We remain committed to our gold holdings as another good diversifier and the ultimate risk hedge.
At the margin we have reduced our exposure to the economy although judging by the data from Baltic Freight Index there is little evidence to suggest that the world is weakening any further, in fact it seems things are strengthening. On balance however, we see no reason to change our basic construction.
David Jane - 08/Aug/2011
What a difficult week that was.
The immediate cause was that markets had been ignoring the reality of the economic situation in the US and Europe for too long. Simply borrowing more money is not going to solve a debt problem. In many ways you could argue the fund was positioned to avoid this problem with no exposure to banks or consumer stocks in the Europe or the US and only holding government bonds in countries unexposed to the crisis. What has been difficult of course is that the markets when they come to recognise a problem generally sell equity first and ask questions later.
Much of the time we would be unconcerned but on this occasion the bond positions and particularly the currencies which underly them worked against the fund not in favour of it. This reflected a concerted effort by central banks in the unexposed countries to offset some of the strength of their currencies. In the medium term we remain convinced that it is more sensible to hold the debt of countries which are able to repay.
Over the week we have taken some corrective action, particularly by reducing some of the more volatile equity positions and replacing them with high yielding defensives, such as Glaxo and BATS, while letting the overall equity weight decline with the inflows.
We try not manage the portfolio against a strong view of the future and therefore we wont try to predict when the market will begin to recover. What we do know however is that there is substantial real value in many companies, particularly those exposed to the strong areas of the economy. We also know that economies outside those over-indebted ones continue to perform well, the focus of Asia growth is now within Asia, in particular to Chinese domestic growth. We also know know that those countries with huge debt burdens will not be able to repay their debts in real terms, something the Chinese authorities are seeming to be becoming increasingly concerned about, which is why it is ironic that despite all the worries US treasuries rose on the week.
Our challenge as ever is to put together a portfolio able to benefit from the value in markets which is not as exposed to the volatility as a pure equity portfolio. With this in mind we will continue to monitor the positions with a particular view to finding effective ways to maintain a portfolio of real assets where the diversifying positions are effective at reducing volatility.
I am confident that the recent equity volatility will be relatively short lived compared to the 2008 period as on this occasion we are coming from a position of much reduced expectations and valuations rather than over-exuberance and inflated expectations but I am not of the view it pays to run the portfolio with a strong bias to that view.
David Jane - 01/Aug/2011
Market concern seems to have moved on from Europe’s continued failure to address its structural weakness to the USA’s debt problems. As I rewrite this politicians have agreed a compromise on the debt ceiling although it remains my view that the country’s debt is at levels which in the long term are unsustainable. Therefore the only realistic solution is a slow inflation and currency driven default whereby the overseas creditors receive the payment in dollars at a much reduced value. Economists might argue the fairness of this solution as the debt was built up against the background of an artificially strong dollar versus the renmimbi and therefore repaying Chinese creditors in devalued dollar reverses the unfairness of the earlier terms of trade.
In the meantime Greece has defaulted partially on its debts through a very typical European style solution to the crisis and this seems to set the tone for future partial defaults elsewhere in the Eurozone which the markets are surely now discounting. Perhaps now that the US crisis is settled near term the focus will return to Europe.
Despite all the noise surrounding the month’s events the fund has been relatively steady during the month. The hard currency bonds in your portfolio have been good contributors. With UK ten-year benchmark gilts now yielding less than 3%, and inflation and default fears dominating the headlines, it is difficult to understand the attractions of mainstream bond markets. Even when credit spreads on corporates are taken into account yields remain paltry. A notable example would be our holding in Glaxo, which yields more than its own corporate bond. This phenomenon is widespread and serves to reinforce the long-term value of Equity versus bonds at these levels. Of course we need to own some bonds so we concentrate on hard currency governments where we assess default risk to be very low such as Norway and Singapore.
The effect of weak agricultural commodities was mitigated by a much reduced exposure and Gold continues to be very strong against the background of dollar worries.
In equities the generally strong performance of the funds holdings was frustrated by a profit surprise and 20% decline in price of Vallourec (a producer of pipes for the oil industry), at the end of the month. The stock has subsequently been sold. Given our equity is largely exposed to industrial exporters, oil and consumer defensives we had up until then been avoiding the disappointments coming from consumer cyclicals and financials but any significant loss hurts. Overall equity markets, particularly overseas, were quite weak with the most major markets down more than 5% in the period.
We have added a number of new holdings over the month in order to build up our equity exposure against the weaker background. In particular we have built our exposure to Japan up to 7% of the fund through introducing a number of individual holdings. Japan continues to recover from the effect of the Tsunami and the large industrial companies appear good value.
While near term fears around the US debt and budget have been allayed the long-term position remains the same. The underlying cause is that many countries have levels of government debt that are above the levels that their populations will be prepared to service. We are therefore set on a path of long drawn out default whether actual or through currency devaluation and inflation which makes the risks of owning mainstream government or corporate bonds too high for our fund. A better risk reward seems to come from our well diversified equity positions, combined with peripheral government bonds and inflation hedges in the form of index linked and gold. The only recent change has been to build up the equity at the expense of agricultural commodities.
At Darwin we run funds with a focus on outcomes- we seek to put together portfolios which will deliver a particular return profile over time. This is in contrast to traditional products which tend to focus on inputs – such as equity, corporate bonds or property. The particular the fund I run (TM Darwin Multi Asset Fund), aims to limit losses in difficult times while earning a satisfactory total return over time
Over the past fifty years there has been a trend to apply mathematical and statistical techniques to gain a better understanding of financial markets. This at first glance seems to offer a sophisticated way to earn better returns. Unfortunately the vast majority of the techniques used are completely without validity in the real world.
These techniques are based generally on a number of very basic errors. Firstly, basing the model on some belief in the way the world should behave rather than as it actually does behave. A good example of this is the widely used assumption that people are rational individuals with perfect knowledge and no dealing costs. The majority of financial market players are anything but, they are generally using a third party’s money and their risk and reward profiles are completely out of line.
Another example is the use of risk models based on past data or construction techniques using long term historic returns. These can only succeed if the future is a mirror of the past and nothing happens that hasn’t happened in the past. It only takes a moment’s reflection to realise that trying to deal with uncertainty by presuming that it doesn’t exist is a little foolish.
A final very simple but important error is the assumption of what in statistics is known as normality, this very basic problem is the cause of huge losses to investors. By assuming normality rare but possible occurrences are presumed to occur much less frequently than is the case in practice. We have all heard market professionals talk of thousand year and six sigma events too often to believe that such models have any use in reality.
In practice financial markets are highly complex and often unstable systems where the use of simplistic mathematics is extremely dangerous- they have more similarity to the weather than they do to machines and this makes long term predictions based on simplistic assumptions highly dangerous.
So how can I deal with risk and uncertainty? In my previous role at M&G I used to encourage managers to consider the real world rather than staring at screens full of data. It is in the real world that risk arises and the real world where it hurts you. I cannot, of course, know the future but I can see where it comes from- the present.
I can also know that risk can arise from sources outside the traditional focus of financial markets- earthquakes, oil spills and politics are good examples here but they don’t appear anywhere in the models and I need to allow for them.
When constructing portfolios in a highly uncertain environment it is very important to build in what is known as redundancy- the ability to withstand shocks. I cannot know where the next event is coming from so I must have a sufficiently broad range of exposures such that no one event can really hurt: this is the old diversification principle. Redundancy need not be inefficient if each position also has a positive benefit to the portfolio in addition to its role in withstanding shocks.
A final aspect of risk management is I am not forced to own anything because it is in a benchmark. I try to remember a simple adage that you cannot lose money in what you do not own. If something is in a benchmark or someone’s theoretically idealised model it does not follow that I am taking risk by not having it.
At Darwin our understanding of risk in financial markets leads us to leave behind the traditional benchmarks and models and to be committed to an unconstrained and outcome driven approach to asset allocation which we believe will better satisfy our clients goals over time.
David Jane 3/10/2011
When Doves Cry
Policy makers in Europe continue to struggle to agree on the obvious. Clearly Greece and others are unable to meet their obligations and therefore the choices are fairly simple- default or some-one else pays. In fact the choices amount pretty much to the same thing. In the event of default the holders of the debt- the banks- will need to be bailed out by tax payers again. The governments of France and Germany and as a consequence their tax payers will need to accept the money as lost.
Applying ever more pressure on the people of Greece to find ways of repaying the debt is getting ever more ridiculous as plainly the size of the underlying economy is not sufficient to support such a level of debt and austerity measures, while helping the political process, are serving merely to make the debt more unsustainable by shrinking the economy further.
The error was to lend such a small economy so much money in the first place. This error was made by bankers who lent them the money in the first place and the governments who accepted the advice. To create misery for the population in order to ensure the banks do not have to recognise their error is morally repugnant.
All the uncertainty continues to weigh on markets and the self-evident lack of political leadership in Europe offer financial markets the opportunity to dictate events. This is a situation that should never be allowed.
Going forward the impact is largely sentiment rather than substance. The effect of Greek default is quite containable as the numbers are not huge but the effect on sentiment for consumers and businesses is material. Hence the ECB appears to be the brink of reversing its recent rate rises at its next meeting. When doves cry indeed.
David Jane 19th October 2011
Free Money
The market remains obsessed with the Greek crisis, which still remains unresolved although there are rumours today that France and Germany have come to an agreement on the mechanism of a bailout. The problem of lack of effective leadership for the Eurozone remains but it is inevitable that a bailout of some sort will take place. For this reason markets have been moving cautiously higher in anticipation.
In the background however there seem to be more important events taking place outside of the markets main focus.
We are seeing the real burden of consumers; governments and businesses debt continue to be eroded by the effect on inflation. UK inflation recently topped 5%. This is important as it brings an eventual end to the debt crisis closer and hence the possibility of faster economic growth in the UK and US more likely.
There is a relatively obscure school of economic thought in the US that believes in nominal GDP targeting as the focus of monetary policy. This is in stark contrast to the recent focus on targeting an upper band for inflation and setting interest rates to reflect this. Bill Gross of Pimco appears to believe that the Fed is embracing this policy.
This is perhaps the biggest risk factor which markets are not focussing on. Inflation linked bonds are only discounting 2% inflation over ten years- which given current inflation in the UK of 5% seems frankly absurd as even a couple of years at current levels would mean inflation over the rest of the period needs to be near zero.
It seems to me that there is not a lot of money to be made from inflation moving lower but a lot could be made or lost if it remains high or moves higher.
A real risk we have worried about is a sudden upward shift in bond yields across the curve as markets discount higher short term rates to offset higher inflation. For this reason the Feds apparent change of heart is a material event. It implies that short rates will remain low despite relatively high inflation while the real economy recovers and therefore bond markets may not suffer the disorderly sell off feared.
We are therefore committed to our strategy of hedging the risk of inflation staying high through index linked bonds, hard currency bonds and gold while maintaining exposure to an economic recovery in our increased equity positions and we have become significantly less worried about the nightmare scenario of a disorderly sell off in bond markets leading to worse sell off in equities as it seems the Fed is committed to monetising the debt through continual easing.
Darwin Property Investment Management Ltd Company, Reg No. 06189407. Registered Office: Stanmore House, 29/30 St James's St, London SW1A 1HB. Authorised & Regulated by The Financial Services Authority © Darwin PIM 2011 www.darwin-investment.com ©Copyright Darwinim 2011. All rights reserved.
