The great British summer has shaped up to be a good one, with sporting victories and some fantastic weather. This has coincided with improving economic data, suggesting the UK could finally be on the road to recovery. So far we have seen positive GDP data, far better manufacturing figures and the service sector is alive and kicking.
House prices have also been rising. Though, we should be wary this could mainly be good news for politicians who will be mindful of the impending 2015 election. However, on the whole everything in the garden is beginning to look a little rosier; there are now even calls from some quarters for an increase in interest rates.
At this stage I always feel it is good to speak to a fund manager with an opposing view. I could have immediately gone to someone like Neil Woodford, who does not own a single bank stock and as yet has no intention of doing so. That tells me much of what he thinks of the state of the British economy. James Harries, co-manager of the Newton Real Return fund, I suspect is even gloomier.
Newton’s house view is that we remain in a challenging world of excessive debt, experimental monetary policy and a misallocation of assets. Our problems have not gone away and they believe growth remains anaemic at best. Indeed, Newton believes we may yet see new lows on bond yields. James Harries envisages no sharp move in the yield curve and feels short-term interest rates are not going anywhere – a view I also share. This, though, is quite a contrarian view on bonds which most commentators believe are in a bubble.
We are now at an interesting juncture in the economy according to Mr Harries. He expects “there will be a shattering realisation at some point that QE does not work”. QE has undoubtedly distorted asset prices; precisely those in which we are supposed to be investing, yet instead have become a tool of government policy. Pricing distortions can lead to a misallocation of capital and potentially lower returns on equity – Mr Harries warns QE will have serious consequences.
This view explains well why the fund has underperformed the recent rally. Mr Harries accepts the conservative nature of the fund will make it look pedestrian if things are actually getting better. However, if the US does not recover as strongly as some believe and if China also disappoints, a better investment opportunity could arise at a later date.
“Boring”, well-financed equities are favoured, but Mr Harries dislikes unattractively-valued financial assets. The fund has some 58 per cent in equities, so you might expect the fund to have performed better than it has. This has been offset by a 17 per cent index option hedge. In addition, a further 25 per cent is invested in fixed interest – nearly half of this portion is held in Australian and Norwegian government bonds, with most of the remainder in high yield corporate bonds. Some 11 per cent is held in cash alongside a small amount in gold. While holding roughly 10 per cent in high yield corporate debt may look odd given his bearish stance, financial bonds and long duration has been avoided. Instead he is happy to take senior secured credit risk in industrial bonds, for example.
Mr Harries describes the fund as “robust to a variety of outcomes”. It is a relatively concentrated portfolio and perhaps should be looked at as an insurance policy for things going horribly wrong.
What are the countersignals to suggest Newton is wrong? Mr Harries lists what would knock down his case of an anaemic recovery: rising real wages in the US; increasing money supply; paying down debt; or signs the major economies can stand on their own two feet, which would mean the withdrawal of QE and rising interest rates. Presently, none of these looks likely to Mr Harries.
This is very much a fund for the cautious investor who is looking to shelter and limit the volatility of their capital wealth. We are currently undergoing the biggest experiment in history in terms of monetary and fiscal policy. In reality, no one can predict the final outcome. In my view, it is well worth having a fund such as this within your portfolio in the event things do take a turn for the worse.
Mark Dampier is head of research at Hargreaves Lansdown