Artemis shorts government bonds over debt concerns

William Littlewood manages the Artemis Strategic Assets fund. He joined Artemis in December 2005 to launch the firm’s Absolute Return hedge fund. Prior to this, he worked at Jupiter Asset Management from 1989 to 1999.

Q: When you launched the Artemis Strategic Assets fund in May, you said that the recession would last “a lot longer than people expect.” Do you stand by that forecast?

A: Yes. You would expect a normal recession to be followed by a V-shaped recovery, but this is a balance sheet recession and it will exert a strong pull backwards. Since the launch of the fund the economic numbers have come out stronger than I or the market expected. However, a lot of that has been driven by the end of destocking and that can not go on forever.

Secondly, we have seen enormous government stimulus packages which we will have to pay for one day. Countries will recover, but they will be below the level of economic activity of a few years ago and we will see below-normal growth.

Q: You began shorting American, British and Japanese government bonds last month. Do you have any concerns over near-term inflation in these economies?

A: There is no sign that inflation is beginning to pick up and I don’t see that happening for some time to come. Inflationary forces are building, but that is not the reason why I am shorting government bonds.

The reason is that I do not think governments can continue to finance their debts at this level. Also, in balance sheet recessions debt-to-GNP ratios go up as governments have to bail their countries out. I would argue that Japan cannot deflate itself, so the only way is to inflate its way out of debt. The UK and the US are drifting into a similar area. At some stage there will be a bomb strike in government bond markets – I do not know when this will happen.

At the moment, the fund is 30% short government bonds and that percentage will probably increase.

Q: Do you have any expectations on when inflation will re-emerge as a significant force?

A: If you believe that inflation will return one day it is extremely difficult to put a time-frame on it. It is possible that inflation has been brought nearer [by government stimulus measures] but there is no sign of it in the short-run. There will be a pick up because of higher oil prices, but that’s not the kind of inflation I am talking about.

Q: Strategic Assets has exposure to equities, bonds, commodities and currencies, in long and short positions, as well as cash. How else are you expressing your macro views in the fund’s asset allocation?

A: We are 59% long equities and short 8%, giving a net position of 51%. That is higher than I thought it would be at launch, and it is mostly in defensive shares – that cyclicals have gone up encouraged us to beef up our defensive positions. I am happy with a weighting of about 60%.

Commodities form 14% of the fund, with just under half of that in gold. Nearly 20% of the commodities allocation is in platinum and we have a tiny position in palladium. We also have exposure to agriculture but no exposure to oil. About 1% of the fund is in corporate bonds and the rest, 26%, is in cash.

Q: Has your corporate bond weighting fallen over the past four months?

A: Yes, but the only reason we had corporate bonds at launch was that valuations were extremely compelling. I am not an expert on corporate bonds but I could see that yields were high. However, those attractive valuations have unwound – corporate bonds are not necessarily expensive but they are not wildly cheap either. It was a slightly opportunistic move and I would not expect to have any exposure in two or three years’ time.

Q: Are you still focusing on British stocks within the fund’s equity portion?

A: Of the 59% equity allocation, 80% is UK and 20% is US. We can go elsewhere in the world if it is a global company that people are familiar with – Nestlé for example – but the UK and the US is where I expect to be.

In terms of cap size, I try to maintain liquidity. About 60% of the allocation is in FTSE 100 – or equivalent – stocks, 29% is in the Mid-250, and 11% is in small caps.

Q: What sorts of stock feature in your top 10 holdings?

A: Two of the largest holdings are drugs companies – GlaxoSmithKline and AstraZeneca – and about 14% of the long equity allocation is in pharma and healthcare stocks. P/Es [price/earnings ratios] are very low because people are worried about healthcare reform in the US, but the long-term demographic story is very strong.

H&T, a pawnbroker, is the only small cap stock in the top 10. One of the bigger Mid-250 positions is IG Group, which is involved in spread-betting. The firm has an entrenched position in the UK and it is going into other countries. It has enormous growth potential.

Q: Are you shorting any equity markets or sectors in particular?

A: We have one short position in the US and the rest are in the UK. I am not going to name names, but we are shorting non-food retailers in the UK and also companies involved in housebuilding. I think house prices are still too high – the average person can not afford the average house.

Q: The fund’s biggest short currency position [40.1%] at the end of August was sterling. Does this mean you are particularly bearish on the British economy?

A: Of course the other way round is to say that there are other currencies in which we choose to be invested. But we do have a deliberate policy not to be overly-exposed to sterling. Public finances in the UK are deteriorating and politicians do not seem to realise the extent of the problems they are storing up. The US has similar issues but it will grow more quickly than the UK – public spending has increased so far over the past 10 years that the UK economy is not as vibrant as it used to be.

Q: How does Strategic Assets compare with the Absolute Return hedge fund you ran for Artemis until last year?

A: The hedge fund had much more flexibility and we could take enormous positions. We could go 200% net long, whereas we can not use gearing with this fund. Some people might regard that as a weakness but I am happy with that. I can do most of the things I want to do – just not to such an extreme degree.