All four funds we look at in the Euro Cautious Balanced sector have distinguishing features that significantly affect their respective investment strategies and risk profiles. This is true even of our top-two funds over three years, both quantitative strategies (setting them apart from the Sarasin and JPMorgan funds) managed by Deka Investment Management.
Both Deka Stiftungen Balance and Deka Euroland Kommunal Balance are non-benchmarked. Instead, they target at least 99 per cent probability of capital preservation over five years and construct portfolios by passing proprietary quantitative market forecasts through a Black-Litterman model optimiser to arrive at an asset allocation. Bond selection is then largely top-down, while stock selection is bottom-up quantitative.
But the funds target different investors: as their names suggest Stiftungen is for endowment funds, while Kommunal is for Germany’s Bundesländer funds. On the bonds side, Kommunal is restricted to euroland-issued bonds, whereas Stiftungen can put up to 20 per cent into UK and US issues. The latter fund can also buy BBB issues, whereas Kommunal cannot go lower than AA-.
Both funds can put up to 30 per cent in equities and have a euroland focus, but Stiftungen has the option of investing in non-euro stocks that appear in sustainability indices. Kommunal adds an explicit lower market-capitalisation limit of €1 bn to meet its clients’ restriction to blue chips.
“The Kommunal fund’s equity portfolio follows a minimum-variance approach to get a lower-risk portfolio,” says Thorsten Rühl, portfolio manager and head of quantitative asset allocation at Deka. “Stiftungen Balance focuses on stocks with high dividend yields, which, alongside the coupon payments on the bonds side, means the fund has regular cashflows. This is designed to meet one of the key needs of the endowment-fund clients, which are not allowed to spend money from the fund, only from the distributions, paid four times a year.”
At Bank Sarasin, the Sarasin Fair-Invest Universal Fund has an asset allocation benchmark – the standard 75/25 split – but its security-selection process follows the house-wide, non-benchmarked, bottom-up style, with an environmental, social and governance (ESG) policy overlaying both equities and bonds. It can also complement its large-cap equities portfolio with up to 20 per cent in mid- or small-cap “pioneers” in environmental or social engagement.
JPMorgan Global Capital Preservation (JPMGCP) is perhaps the most distinctive of the four. A traditional balanced strategy benchmarked at 75/25 when it launched in 1995, it was converted to unconstrained total-return in October 2004. (The share class topping the 12-month league table launched in September 2006, and is the only one tracked by Morningstar: an equivalent euro share class with the requisite track record would place fourth in the 3-year table).
 | “We will go wherever we think there is a compelling risk-return trade-off to hit our target of cash+3 after fees,” says portfolio manager Talib Sheikh, who runs the fund with Neill Nuttall in the macro group at JPMorgan Asset Management. |
Equity delta
Like the Deka funds, JPMGCP determines its top-down asset allocation by starting with portfolio-level risk. But rather than an unwavering VaR metric, JPMGCP starts with the portfolio’s equity delta – and uses it dynamically, facilitated by the full scope of Ucits III’s derivatives capacity. The equity portfolio (including convertible bonds, which the fund can hold up to a 50 per cent limit), has a strict equity-delta range of 0.00 (the fund can net out its equity exposure or go 100 per cent bonds or cash) to 0.30.
“Look over the last year of the fund, and the delta has been at those extremes of zero and 30,” says Mr Sheikh. “We believe clients pay us to make aggressive asset allocation calls, and we have a rigorous process to do that.”
Despite the marked differences of approach, there is some consensus between the funds. The Deka and Sarasin funds look remarkably similar on the bonds side. All three have around 70 per cent allocated and shun corporate credit risk.
Sarasin Fair-Invest cannot go below A at all – and 60 per cent of its assets are currently in AAA. Twenty-nine per cent of its fixed income is in pure government bonds, but a further 24 per cent is from sovereign-like issuers such as the German state-owned development bank KfW or Spain’s Instituto de Crédito. Only 17 per cent is pure corporates.
“We do have 28 per cent of the bonds portfolio in mortgage-backed securities and Pfandbriefen,” says Gabriele Grewe, Sarasin’s head of bonds and balanced portfolio management. “We’ve seen rising spreads for high-quality AAA bonds, so we think that we can have a slight pick-up in yield without increasing the risk tremendously.”
The Deka portfolios are underweight Pfandbriefen, but Kommunal and Stiftungen have more than 99 per cent in AAA and AA, even though the latter is free to go down as far as BBB.
Risk-averse bonds
This is interesting, because according to Chris Traulsen, director of fund research at Morningstar UK Ltd, top quartile funds over the past 12 months have had more than 9 per cent invested at BBB or below while the bottom quartile have stuck at 1.4 per cent.
“Typically we have a risk-averse position in bonds because the drivers of added-value are asset allocation, duration positioning and yield-curve management,” says Dr Rühl. “Compared to this the additional value that can be achieved from extra credit risk is negligible.”
Although Sarasin Fair-Invest suffered over the past 12 months, losing 37 basis points, the two Deka funds came a respectable fourth and fifth in our league table, offering some justification of Dr Rühl’s observation.
Indeed, although JPMGCP looks to be well-diversified down the credit spectrum, with 13.3 per cent of its assets in BBB and even 2.1 per cent in high-yield, nearly all of that exposure is through convertible bonds – and pure corporates are at zero.
“Since we’ve been running this strategy we’ve felt that credit was the most overvalued asset class,” says Mr Sheikh. “We do have some credit risk in the convertibles – which we tend to keep at around 15 per cent, though we are looking to increase that to take advantage of more opportunities – but the real risk of those convertibles is in their equity sensitivity rather than their credit quality.”
The fund’s unusual emerging-market debt exposure is also a convertible bond – 0.7 per cent in a government-underwritten Malaysian security. It also has other non-European exposure (8.2 per cent US) which the Deka and Sarasin funds currently do not.
Within those other three funds the most notable geographical allocations are found in Sarasin Fair-Invest: one might expect Germany to top its exposures at 17.2 per cent, but the Netherlands and Austria in second and third place owe a lot to high scores on national sustainability – chiefly per-capita resource efficiency. The policy makes Sarasin’s bond portfolio more geographically diverse, with France underweighted against peers and Sweden making an unusual appearance.
In terms of duration, the Sarasin and Deka funds are similarly positioned, but differently managed. Deka Stiftungen and Kommunal have 5.6 and 5.9 years’ respectively, alongside 5.2 years for Sarasin Fair-Invest. This is relatively long compared to other balanced and global bond funds, and according to Mr Traulsen at Morningstar the top performers over 12 months have tended to be shorter, at 4.03 years, than the bottom-quartile managers at 4.34 years.
Expected rate cut
That may be changing as the ECB begins to sound less hawkish on inflation, but for Dr Rühl, the Deka funds’ position is more about his forecasting models showing “positive market dynamics” as investors become risk-averse, and the need to balance the portfolios’ 15 per cent equity allocations, than about the pure interest-rate views given by Ms Grewe.
“With the economy slowing, interest rates can still come down a bit between 10 and 20 years [on the maturity curve],” she says. “We are heavily invested there, where the yield curve is steep. We expect the ECB to start decreasing rates in the second quarter, and in the second half we expect a slight recovery in the US, with Europe lagging by one or two quarters, so we may be looking to go a bit shorter in the second half of the year.”
For JPMGCP fixed income positioning is almost entirely top-down, and in general that means the fund tends to stay at the front end of the European curve to offset the equity portfolio – often establishing derivative positions which are gradually converted to cash exposures. That has been exaggerated lately by the managers’ bearish take on credit – duration is currently just 1.4 years.
“Duration has been pretty low,” says Mr Sheikh. “I have a hard time seeing value at the back end of curves. We’ve seen much better opportunities for relative-value plays and we’ve been overweight steepening positions – so while duration is low there are some fairly hefty allocations on a market-value basis. We want to build a much more diverse portfolio than just taking an outright duration position.”
As such, this fund has been more dynamic in trading the lag between US and euroland economic and policy-loosening cycles: its 8.2 per cent US exposure, part of a general long-US short-Europe trade, reflects a long-held, very successful view that the Fed would be more pro-active than the ECB.
“The key question now is: when do you trade it back the other way? Ultimately we feel that the ECB will have to take a more pragmatic view. We are scaling into selling US duration and moving it into Europe, but I still think it’s a little bit early.”
In equity sectors, the Deka funds’ bottom-up process aims to neutralise exposures; JPMGCP, by contrast, selects stocks bottom-up within well-defined macro themes, the strongest of which most recently have included Hong Kong property and stocks related to the soft-commodities boom, such as fertiliser producers.
Sarasin Fair-Invest has the most concentrated equity portfolio – it is strictly limited to just 50 names – partly because it is non-benchmarked approach with a very fundamentals-driven, bottom-up strategy, and partly because of its ESG policy.
That results in some underweighted sub-sectors which have enjoyed good performance – utilities, mining, oil and gas – but also some interesting and unusual stocks for a balanced fund. Obvious examples would include renewable energy companies, and stocks in energy-efficiency services and inspection services which are part of energy or industrial materials stories: Vestas, the Danish wind-turbine producer, ticks all the right boxes and returned 131 per cent for the fund last year, for example.
Vestas also exemplifies how the ESG focus diversifies the portfolio geographically, bringing in much more Northern European exposure than the fund’s peers. Switzerland, at 3.5 per cent the fund’s third biggest country exposure, is not only a home bias, but a sustainability bias, taking in firms like engineering giant ABB and sanitary-tech group Geberit.
The Deka funds’ euroland country weightings come via top-down views, with non-euroland exposures in Stiftungen Balance coming from Deka analysts’ bottom-up picks. Over recent months, the only non-European exposure has been a single stock – “an established international player which just happens to be based in Argentina,” says Dr Rühl. They have nothing in the UK or US, and Morningstar data suggests that this may be one reason why they (and Sarasin Fair-Invest, which has 3.8 per cent in the UK but is restricted to Europe) sit at the top of the 3-year table, where the top quartile have averaged 8.2 per cent US exposure against the bottom quartile’s 14.2 per cent.
But JPMGCP seriously bucks that trend, which is even more stark over 12 months, when the bottom quartile has gone up to 18.2 per cent US exposure while the top quartile has fallen to 5.1 per cent.
Creating synthetic shorts with Eurostoxx futures, the fund has been implementing a “very negative” view on Europe (-5 per cent) against longs in North America and Asia ex-Japan.
“Over the last three months we’ve been trimming our aggregate European equity weight and moving that across to the US,” says Mr Sheikh. “The macro thinking behind that is the same as what we spoke about on the bonds side. The next trade we’ll look at is when to take Japan – which is at -2 per cent now - up to neutral or long.”
Using the full power of Ucits III certainly appears to open up opportunities in uncertain markets which are not playable in the long-only asset-allocation world.
“Over the last three years, the top and bottom quartiles are both at 25 per cent equity exposure,” observes Morningstar’s Mr Traulsen. “If you look at the one-year, it’s a different picture: the top quartile had 15.6 per cent and the bottom quartile 24.1 per cent. So you can see that shift as losses mounted across equity markets and the more conservative funds performed better.”
JPMGCP has certainly been the most conservative of our four funds – derivatives around its core 25-30 per cent cash equity position bring net exposure down to 8 per cent (versus 15 per cent in the Deka funds and 25 per cent in Sarasin Fair-Invest, which both managers describe as quasi-neutral). But it has also been the most dynamic. All three managers see value emerging in oversold equities – “Stockpicking will be very, very important this year,” says Ms Grewe – but JPMGCP is arguably the best equipped for choppy waters.
“We don’t think this is the year you get paid for making big asset allocation calls with a 6- or 12-month view,” says Mr Sheikh. “There are small relative value and tactical allocation opportunities which we will definitely be pursuing, and we are certainly expecting to see pockets of value emerge towards year-end. But there is the serious possibility of a short squeeze – so we are looking at options structures that protect us from that and allow us to be very quick to trade the first half of it.
“Total return is relatively new for the non-hedge fund client. There are several different ways of doing it, but we think our multi-asset approach has legs because it opens up very diverse alpha streams.”
As an allocator, if you think that the current environment is a blip in an ongoing equity bull market, keep looking at the 3-year table. If you think the game might have changed, the 12-month table may offer a better clue as to who will outperform in the coming months.
