October 2019 investment update

One of the most common questions I get in client meetings is ‘What makes Dolfin different’? Clients often feel that they want their investment manager to stand out from the crowd and to be delivering something ‘better’ than their peers – but without having any objective benchmark to rank and compare them, how can they objectively determine what is better?

One of the strange concepts in investment management is that the return objectives of just about every private client are focused on absolute returns. They have a target return in their head – a real return or a spread over inflation. A client very rarely expresses their return objective as a percentage of equity market returns combined with a percentage of fixed income market returns.

We aligned ourselves with our clients by developing three global multi-asset models when the return targets are all absolute return focused (they are all expressed as a CPI + X return

 

As logical as this may seem, this is at odds with a large component of the industry and something that makes us different. What makes us different is not that we use this concept of absolute returns – but that we actually adopt and incorporate it deeply into our portfolios. We don’t use any market related benchmarks because we don’t need to. It is refreshingly different because it puts us in the position where we only buy something if we want to own it. This works in both equity and fixed income. For an outsider this seems like a bizarre concept – surely every investment firm must work this way. Yet, if you look at most of our peers, they will have a ‘neutral’ equity position as determined by their benchmark, this might be neutral from an asset allocation perspective but also from a geographical perspective. The strange thing about neutral allocations is that these are the benchmark huggers. These are the allocations you hold in your portfolio if you don’t have a view.

To put that in context, if your ‘neutral Japanese equity allocation’ is 10%, because your benchmark has 10% Japanese equities, that means that if you have no view on Japan you own 10% of Japanese equities. Then you argue your way positively or negative away from that neutral allocation. At Dolfin, if we don’t have a view on something then we don’t buy it. The thought of owning 10% of Japanese equities when we have no expertise or no specific view is bizarre and one that we believe is incredibly outdated.

This links onto my second point this month – that the concept of balanced portfolios has fundamentally changed. It is not possible to get the historic return associated with fixed income holdings in a portfolio when we look forward at the next five years. Interest rates are too low and yields are too low.

For our clients this means that we either need to incorporate more duration risk or more credit risk into their portfolios – after ten years of economic growth.

I strongly believe that the concept of a balanced portfolio has changed permanently. This is especially evident for clients coming into money now and looking forward with a five year time horizon looking at how they can make four to five percent a year without incurring a substantial amount of risk. Having a stagnant allocation to equities is going to make this very challenging – this is why we are running with the concept of nimble beta timing using our internal MVST model combined with satellite investment opportunities.

Combining multiple time horizons within each asset class allows us to be nimble but responsive and also incorporate a client’s return objective. Most private clients are relative return focused when markets are positive, absolute return focused when markets are negative and have long term return targets until markets are choppy. Going back to what makes us different – we want to own equities only when we believe the risk/reward is in our favour. We want to own only the individual corporate bonds and stocks that we want to own. We only want to purchase the exposure that we believe in holding. Arguing exposure away from an arbitrary benchmark is an archaic approach and one that is not in the best interests of the client.

Between now and the end of the year I anticipate greater volatility in equity markets and fixed income volatility to remain elevated given some of the recent shifts that we have seen in yields. Our positioning remains very currency/yield curve specific with our US barbell approach and interest rate hedges helping to protect our clients when we saw the 10 year yield move from 1.46% to 1.90% in September. In our EUR denominated portfolios our Greek and Italian sovereign bonds helped performance in August and didn’t given that performance back in September which we were very happy about. Our UK fixed income positioning remains shorter dated and we utilise some government backed entities (like TFL) to get a little yield pick up.

On the equity side we remain with minimal equity exposure, only owning three single stock positions. Our risk adjusted returns remain very strong given our lack of equity exposure and we anticipate that equity exposure we incorporate into the portfolio as part of our core holdings will be when we trigger specific technical levels. All of our global multi asset models continue to hold Volkswagen, Tencent and EA. We took profits in September on Peugeot given the sharp rally that we witnessed in the share price. We would look to establish the position again at lower levels.