From Seneca Investment Managers' public marketing material. Seneca is now part of Momentum Global Investment Management.
My attention was drawn during the month to an article in FT Adviser, Multi-asset pledge should set off alarm bells. “Investors should be wary of multi-asset funds promising 5 per cent income that could be taking a “gamble” with capital, experts warn” says the piece. Sensationalist tosh in my humble opinion.
"How do we deliver a gross total real return of 7%?"
Any fund that is investing outside of risk free assets could be said to be ta king a gamble with capital, not just those targeting a high yield. What matters is whether any loss of capital that will always occur when investing in risky assets is temporary (tolerable) or permanent (not tolerable).
I can’t speak for all funds seeking to deliver a 5% yield but I can speak for ours. We have done extensive modelling on our CF Seneca Diversified Income Fund and we believe we can deliver this yield without putting real capital at risk over the longer term (I would agree that o ne cannot seek to protect capital over the short term, markets don’t work that way).
In order to achieve our investment performance objective, we need to deliver a gross total real return of just shy of 7% per annum over the longer term. After costs, this would come down to closer to 5%, which would be split between income of 5% and real capital of 0%.
So, the question then becomes, how do we deliver a gross total real return of 7%? The answer is that it comes from a combination of strategic asset allocation plus value added from tactical asset allocation and security/fund selection.
We think we will get around 4.5% from strategic asset allocation without taking undue risk. Our strategic asset allocation to equities is fairly low at 40% (our fund sits in the IA 20-60% Shares sector) and we think equities will deliver us around 6% real, in line with long-term historic averages.
Adding in bonds and alternatives, which we think will provide 2% and 5% real over the long term, and you get to a total of around 4.5% (our strategic asset allocations to bonds and alternatives are 35% and 25% respectively).
As for value added, we are looking to add 2.5 percentage points per annum from tactical asset allocation and security/fund selection. Whether we can do this depends on two things. First, is the ex ante tracking error of our fund in relation to its strategic asset allocation giving it the potential to produce 2.5 percentage points of value added? Our risk models tell us that the answer to this question is ‘yes.’
Second, do we have an investment process that is able to deliver this potential? Again, the work we have done tells us that the answer to this question too is ‘yes.’ Our tactical asset allocation process draws on well-regarded academic work that finds strong links between yields of equities and bonds and future returns.
Within UK equities, where we invest directly, we focus on mid-caps where there are higher systematic returns as well as greater stock picking opportunities that exist because of thinner broker research coverage. We also think that we’re able to spot third party managers of overseas equities funds who have strong, value oriented approaches that produce good returns over time.
So, while we would agree there may be funds out there promising 5% that don’t know what they’re doing, ours does.
Published in Investment Letter, September 2015
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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