The world is not rosy right now, and it’s not going to be any time soon, is the view of Franklin Templeton’s Toby Hayes.
The manager of the Franklin Diversified Income and Franklin Diversified Growth funds is very bearish on his outlook for the world, and has put his funds into defensive mode.
Hayes had predicted this gloomy outlook for some time and has spent some months gradually making asset allocation changes to these funds to shore them up for rocky times ahead. He completed the transition two weeks ahead of what has been dubbed ‘Black Monday’, when on 24 August China’s markets fell and took many other markets across the globe with them.
Hayes says: “Equity markets had not responded to the macro hurricanes flowing through other asset classes.
“Commodities are in a structural bear market, bond yields are ever decreasing and the dollar is rising. All these asset classes are not unrelated and they are huge strong signals that the equity market has not been noticing.”
It’s the dollar’s strength that he thinks is particularly key to all markets, describing it as the “critical driving force” behind many sectors. However, hedging out that exposure from his funds is no easy task.
“It’s just a question of which dollar bet you take, which currency you take the dollar versus. Not all dollar bets are good bets,” he says.
Going into last month Hayes was short the dollar versus the yen and the euro, believing that there are pockets of growth in Europe and Japan when compared to other nations.
Franklin Templeton launched the Diversified Income and Diversified Growth funds last summer, meaning they now have just over a year of track record under their belts. They are both absolute return funds, pegged to the Bank of England base rate, with the income version aiming for 3 per cent over Libor while the growth fund targets 5 per cent over Libor.
The income fund has £11m of assets under management, while the growth version has around £7.3m. The total expense ratio of the income and growth funds are 75 basis points and 85 basis points, respectively.
Hayes is hopeful of growing the fund assets soon. He is caught in the fund manager circle of not having enough assets for many investors, but being unable to build assets significantly for that reason. However, he is expecting an additional block of £13m in inflows for the income fund, although is cagey about details.
“We need to get investors lined up at the same time, but we have got good inflows coming in that will hopefully spur existing clients that have only put a bit in as they don’t want to own too much of the fund,” he says.
The funds are not run like usual multi-asset funds and do not follow an asset allocation model. Instead, Hayes puts assets into different risk buckets – growth, defensive, stable and opportunistic – and varies the allocation to each depending on his outlook.
Currently the growth bucket of the income fund is 58 per cent of the fund, while opportunistic is 17 per cent, stable is 14 per cent and defensive is 10 per cent.
The fund also uses derivatives to gain its risk exposures, making it more complex to decipher than the average multi-asset fund. It means the fund can short assets as well as go long.
In the income version of the fund the use of derivatives means that he does not have to rely on the usual assets for income, such as high-yield debt, dividend-paying equities and emerging market debt.
While Hayes did have a high-yield position of around 6 or 7 per cent until January this year, he has gradually phased it out, selling the final 0.5 per cent two weeks before the August events.
Rather than rates being the main concern for Hayes with high-yield, he thinks liquidity is the big issue should we experience another significant event. “There are very few brokers willing to warehouse risk, so if there is any significant rush to the exit there will not be anyone on the other side,” he says.
Instead, Hayes trades volatility using derivatives to generate income. “Where we are getting the majority of our income is from volatility. With options you can generate income by selling the upside on markets, such as equities and the commodities space, so we sell the upside we don’t think will materialise,” he says.
This strategy is delivering more than half of the income for the fund, and has the added benefit of taking equity risk off the table too, says Hayes.
The big issue most managers are trying to predict at the moment is when Janet Yellen and the Federal Reserve will take the jump and raise interest rates in the US. But Hayes thinks they have backed themselves into a corner, with no good way out.
The Fed has talked about being “data dependent” but also heavily hinted at a rate rise shortly. With core inflation nowhere near rising and likely to start falling, says Hayes, a rise now doesn’t make sense.
“If they don’t [raise rates] they will be seen to be pandering to markets but they lose credibility by not raising rates. Either way I see it being negative for markets,” he says.
“A rate rise going into very fickle markets will be considered negative. But not raising rates means markets will think even the Fed thinks something is wrong with the global economy,” he says. “All news is now bad news, which adds to our very defensive positioning.”