James Beck joined James Hambro & Partners in 2017. Beyond his Partner and portfolio management roles, he has a specialist remit to identify and monitor alternative investment strategies designed to provide diversification and opportunity in client portfolios.
The bull market has just entered its tenth year. Is now an important time to be considering alternatives?
James: For the last few years one of the best places to be invested has been equities, but as the economic cycle matures and interest rates begin to rise, investors are likely to be increasingly attracted to the uncorrelated and defensive characteristics of alternatives. We’ll be looking to add to our holdings, but we’re being very selective. One area that has seen a lot of growth is quoted alternatives – illiquid investments wrapped in investment trust wrappers. A lot of money has flowed into investments in this area, many of which are very credible. However, within the quoted space many investments have traded at a premium to the underlying assets’ value. If there is a turn in markets and liquidity dries up, these supposedly protected assets can quickly de-rate from 15-20% premiums to 20% discounts. They also tend to be slower to bounce back than conventional equity when they do. So whilst the underlying assets may be fine, investors may have lost 35% to 40%. This is a good illustration of how challenging the alternatives arena is and why we have to be so careful.
Isn’t one of the problems with alternative investments that they don’t actually generate very good returns?
James: Many investors are simply looking for a quick fix. As a result, they often end up investing in things they don’t understand and which don’t achieve the returns they are aiming for. For example, they may invest in something that underperforms equities when the market goes up but still loses money when everything else is going down, which is when you really need alternatives. We’ll certainly be considering more structured and bespoke solutions for our clients. However, we want alternatives that really contribute something different to the core of our clients’ portfolios, which are invested in high-quality equities and fixed interest.
Are you finding anything of interest?
I spend a lot of time meeting managers and there are lots of very clever and persuasive people who are trying to offer something different. The difficult question for us is whether their solutions will work in the context of our portfolios and if they are suitable for our clients. I’m happy to kiss a lot of frogs and I’m always talking to other managers, seeing who they rate in the absolute return space. We are not too proud to follow others who we respect. You have to remember too that we don’t have to invest in alternatives – we aren’t afraid to retreat to cash if markets dictate that it’s the prudent thing to do to protect client portfolios. If we’re going to invest and pay an underlying manager, they should be out there trying to generate a return, not seeking to generate cash-like returns with a fee. I think that would be an abrogation of responsibility on our part.
I’ve seen a number of very interesting and very different funds recently. I met the team managing an Asian macro fund, for example, who take a view on macroeconomics and express that view through a range of different instruments – not equities and bonds, but focusing on areas such as interest rates and currencies. These are areas where we don’t necessarily have specific expertise and which offer diversification from our core holdings. One of the things that attracted me to this team is that they are based in Asia. Their contention is that Western investors fundamentally misunderstand Asian investment intentions, particularly those of China.
They also make the point that although China represents a quarter of global GDP, the average investor might only have about 5% exposure in their portfolio. That’s despite the fact that China is one of the world’s fastest-growing economies and may soon be its largest. They suggested that were Western investors to increase exposure to China only modestly, to say an average of 7.5%, that could lead to a 50% increase in flows into China, which would have a material impact on asset prices. That was very thought-provoking.
I happen to be in Hong Kong soon and I’ll meet that fund team to learn more about their structure and do some further due diligence.
What differentiates James Hambro & Partners is our willingness to think independently. We are a good size boutique but not one of the industry behemoths who are constrained by their size. That gives us an advantage – it means we are able to be dynamic and invest in smaller specialist funds.
What characteristics do you look for in absolute return funds?
The key with absolute returns is to look for things that are genuinely differentiated from the core of what we are doing already and not to see it just as a bucket that has to be filled within our asset allocation. I’d rather hold cash than hold something we don’t have conviction in.
What sort of funds do you hold now?
We have one fund that I brought in when I first joined last summer. It’s a well-known macroeconomic trading fund that focuses on things like interest rate differentials and currencies. It’s been very flat in a period of low volatility but these are funds that thrive on uncertainty and volatility in markets – on the fact that there can be outcomes that other investors do not appreciate. You’ve seen that recently, with Wall Street forecasting, until not long ago, just two interest rate rises in 2018. It’s amazing how quickly expectations can shift – now they’re predicting three or four. The Fed has gone from being ahead of the market to behind in just two months, all on one inflation report in January. These things can move very fast. As volatility picks up these types of funds can make good money for clients and they are completely agnostic about, for example, whether equities or bonds are going up or down. It’s down to small movements in perception and their ability to create asymmetric trades that mean if they’re right they generate a strong return and if they’re wrong they give up very little.
The other thing we’re looking to do is increase investments within equity strategies that are either market neutral – so have no market exposure – or that incorporate some element that reduces exposure to human bias and error.
Does that mean ‘robo’ wealth management?
No. There is always going to be an important human element in investing. I don’t think we ever want to hand responsibility over to the machines. They are only as good as the inputs and so they are equally subject to programming bias. I wouldn’t go down the route of pure systematic investing but I do think that the use of algorithms to enhance the execution of a fundamental approach can improve a good investment strategy.
Another area we’re looking at and where we already have some exposure is renewable energy funds; where you are invested in either solar or wind farms which are operational and pay you a good dividend. Some of our peers have suffered recently from the impact of Carillion on PFI and faltering confidence in social infrastructure, but renewable energy has already had the rug pulled from underneath it in terms of government cuts to subsidies and feed-in tariff rates. This is a sector that’s survived the reduction in government support as it matured and is now strong enough to succeed without external influence.
Do you enjoy the job?
It’s such a varied space – you have to turn a lot of stones and kiss a lot of frogs just to come up with a small handful of really good ideas. I think that’s what enthuses me about it, but it’s also devilishly difficult! From a client’s perspective, a 15% loss from equities is often acceptable; a 5% loss from a hedge fund or alternative investment strategy is often terminal.
Should investors be prepared for absolute return strategies to lose money sometimes?
I think too much of the expectation around hedge funds is that they’ll never lose you money. In order to make a return you have to take some risk and inevitably that means at some points you might suffer on a short-term basis. What you want is not to lose money on these strategies at the same point when you’re losing money on core positions. That’s where we’re focusing our time and energy – finding strategies that can deliver returns when traditional assets are failing.
Posted 11 April 2018
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