View from America: ‘Sell Britain’

While Mike Trudel, of BlackRock in America, says Britain’s economy is too dependent on its financial sector, his firm’s Global Allocation fund may hold lessons for British fund managers.

The New York Times reported last week on how Europeans are elbowing aside the wealthy of the Upper East Side as they snap up luxury goods up and down Fifth Avenue. The euro has doubled in value against the dollar since 2002, and even sterling is still 25% ahead. The article was headlined “We’ll take Manhattan, for cash”.

But when American investment managers look across the pond – and at Britain in particular – they are not exactly envious. What they see is an economy with many of the same characteristics as America’s – just worse.

Mike Trudel is research vice-president for BlackRock in Princeton, New Jersey. He works on the Global Allocation fund, a retail fund with £25 billion under management – that is four times the size of the biggest retail fund in Britain. “In our opinion, of all the major economies, the one we have the least confidence in over the near term is the UK,” says Trudel. In other words, there’s a great big “Sell” recommendation on Britain, if that’s what BlackRock and other American managers think.

“The UK is much more dependent on the financial sector than any other major economy. Around 20% of private sector jobs in the UK are in the financial sector, which is far more than in the US. Those jobs must be at risk as the financial sector restructures. We believe that financials will remain under pressure, and we’re more comfortable buying UK gilts than equities.”

Not that Trudel is saluting the Stars and Stripes. The Global Allocation fund is deeply underweight American equities as well. It is also light on mainland European equities. The overweights are in Asia and Latin America.

The fund has a mixed bonds and equity portfolio of the style that has fallen out of favour with British investors, who prefer narrower mandates. But its performance suggests that maybe we should be rethinking our prejudices.

Over the past year the sterling class of the Luxembourgbased Sicav is up 5.7%, and since it was launched in December 2005 it is up 25%. The dollar sub-fund, which dates back to 1997, has enjoyed an average annualised gain of 12.2%.

Those are not spectacular figures, but they’ve been achieved within a narrow risk range. “We have done a really good job protecting on the downside,” says Trudel. “Returns on the fund have been higher than the MSCI [index of world stocks] but with about one-third less volatility.”

The big calls have been to go underweight America and Britain and avoid financials almost completely. The fund has also kept a persistently high weighting in cash, which is about 14% of the total assets.

It’s good to see a fund manager regard cash as an important allocation asset class. Too often managers claim that their mandate is to invest and that if investors had wanted to keep their money in cash they would simply have left it in the bank. It’s an argument I’ve never quite bought. Sometimes – such as over the past year – cash is the best place to be and managers should raise their cash weightings accordingly. The same goes for hedging, an area the fund also has a responsibility for to investors.

The fund is 29% in American equities (against a benchmark 37%), 8% in European equities (benchmark 13%) 14% in Asia including Japan (benchmark 8%) and 3% in Latin America (benchmark 1%). The bond exposure is about 32% of the fund, chiefly American and European government debt. Not only is this fund unfashionably broad in its asset base, it also has an unfashionably large number of holdings – 750 stocks – and nothing is more than 1.2% of the total fund.

But neither is it a closet index fund. It takes some big active bets and frequently moves a long way from its benchmark. One of its more interesting bets is American railroads. Burlington Northern Santa Fe and Union Pacific are both in the fund’s top 10 holdings.

Burlington Northern Santa Fe operates in the mid and western states. It started out freighting oriental silk from Seattle’s port to America’s eastern cities. Now it hauls grain and wheat. In an era of rising commodity prices, it’s a great time to be the main transport conduit – with much of the traffic heading back west and across the Pacific to China.

In January the shares were trading at about $77 (£40). They are now at about the $100 mark, and have been as high as $110. Five years ago they were languishing at $25. The Union Pacific story is, if anything, stronger – with its share price up from $55 a year ago to a recent peak of $84. “The railroads have been enjoying a new era of profitability and now have pricing power,” says Trudel.

The fund is neutral on commodities and oil. “Our outlook remains cautious,” says Trudel. “We are close to benchmark on oil, and if the global economy slows, then we could see the price of crude fall further. But in the medium term you have to consider underlying demand from China and India.” The fund prefers to play oil through stocks such as Petrobras, another top 10 holding, and Exxon Mobil.

Financials are entirely absent from the top 10. “Only 3% of the fund is in US financials – and that’s very specifically custody banks such as Bank of New York and State Street.” BlackRock says that out of the credit crunch a much tougher regulatory regime will emerge and that growth rates enjoyed by financials in the past decade won’t be achievable in the next.

This is not a fund that will appear at the top of the performance tables. But its structure may have lessons for other investment groups now that with-profits has collapsed as a concept in Britain. Investors want safe, sleep-at-night funds. Over the past five years they have been sold UK Equity Income – and not done too badly – but maybe that is too narrow, and a global world demands a more global approach. A Luxembourg Sicav may not appeal to core British investors, but this fund’s model has much to recommend it.