AJ Bell’s latest managed portfolio launch is very much an active strategy but it allows experienced fund manager, Ryan Hughes, to add passives in order to protect capital amid a fluctuating market.
With the launch of AJ Bell Investments’ active managed portfolio service (MPS) in February, the firm’s head of fund selection Ryan Hughes was given the title of head of active portfolios.
For Hughes, taking the reins of the six actively managed, risk-profiled funds is a return to his roots, having run active multi-asset funds at Apollo Multi-Asset and Old Mutual before moving to AJ Bell in 2016.
Hughes was given the task of launching AJ Bell’s first funds and managing its passive MPS, which launched in August 2016, but he always knew an active version was on the cards. “The passive MPS allowed us to form a bedrock from which we could later create an active strategy,” says Hughes. With this in mind, in November last year Simon Molica joined AJ Bell from Morningstar to work with Hughes as a fund manager on the team.
From the ground up
With more than 30 years’ investing experience between them, Hughes says the pair has been witness to pretty much every investment cycle. “In the time we have been running money we have seen crashes, corrections and the near capitulation of the entire financial system,” says Hughes. “You name is, we have seen it, and this new MPS puts our collective knowledge to the fore.”
“Typically, when you join a group you inherit an old fund and an existing process but with these six portfolios we are starting from scratch, which is a nice challenge.”
Being risk-rated solutions, Hughes must remain within certain parameters in terms of asset allocation, meaning the strategy underpinning the active MPS is the same as passive portfolios.
“As with the passive MPS, we are taking a long-term approach with the active strategy. It is just the route to implementation that differs,” he says. “Philosophically, as a house we are neither active nor passive, we are agnostic in the debate and have committed to give advisers the choice of both.”
“In the new strategy we will only use those active managers we believe are able to outperform after fees. We will not just use active funds for the sake of it.”
Fit for purpose
The six portfolios, benchmarked against risk portfolios three to eight in Distribution Technology’s Dynamic Risk Planner risk ratings, predominately hold active funds but Hughes is able to select passive funds if he sees fit. At launch for MPS 3, which is the closest to what would be considered a balanced offering, Hughes has opted for two passive funds to gain US and gilt exposure.
“While these funds are long term in nature we are sensitive to the current market environment and can look for opportunities to add value or protect capital on a one to three-year basis, meaning there is an element of tactical asset allocation,” he says.
“One place where we have diverged from our strategic allocation is in our exposure to UK gilts. The strategic allocation would mean us taking a neutral-duration position at 12 years but our view is that interest rates will rise faster than is being priced into the market. As a result we moved all our gilt duration from normal to short-dated.”
At launch, 33% of MPS 3 assets were in fixed income, of which 7% was allocated to UK gilts. However, with few options to choose from in the active funds space, to get exposure to shorter-dated gilts Hughes opted to go down the passive route, using the Lyxor FTSE Actuaries UK Gilts 0-5yr ETF.
“We are taking a one to three-year view on gilts, depending on the direction of rates and how the economy pans out after Brexit.”
Active Managed Portfolio Service 1 & 2
Source: AJ Bell
Active Managed Portfolio Service 3 & 4
Source: AJ Bell
On a longer-term view, Hughes describes the world as “fundamentally OK”. While developed markets face challenges regarding interest rates and the end of quantitative easing, he believes markets are now entering a phase of “normalisation”.
“We are moving into the third phase of market conditions since the global financial crisis in 2008,” says Hughes. “The first of these phases, between 2008 and 2012, was survival, from 2012 to 2017 was the recovery and from 2017 onwards we have moved into what I would call ‘onward normalisation’.”
“Post-quantitative easing is unchartered territory for everyone and it presents challenges to both equities and fixed-interest investing. When it comes to fixed interest, it has pushed us to having more long-term diversification than we would traditionally.”
One example of this is Hughes’ strategic allocation to emerging market debt as the portfolio launched with a 5% weighting to the asset class.
“Historically many would have used global emerging market debt on a tactical basis, either having a zero weight or a small amount at certain times,” he says. “However, in the long term an allocation to this asset class is a great diversifier because these economies are on a different cycle to many of the developed markets.”
To further diversify, Hughes has adopted a strategic allocation to global bonds on an unhedged basis.
“Allocating to these two asset classes on a long-term basis means the fixed-interest element of the portfolio offers protection against what could be a challenging environment in the next few years as rates normalise in developed markets,” he says.
The balanced portfolio has a 57% allocation to equities, which Hughes describes as being well balanced, investing globally. However, he says there is one key different in strategic asset allocation in that it is not all done purely on a regional basis; and the managers spend time analysing the market sub-sectors.
“We ask whether adding a particular sector on a strategic basis can improve the efficiency of the portfolio over the long-term,” he says. “The sub-sector we’ve added is technology, which we think can offer diversification away from traditional equities.”
The MPS 3 strategy launched with a 5% weighting to technology through Polar Capital Global Technology. This sector weight sits alongside the fund’s traditional regional allocations: 21% in the UK, 10% US, 7% Japan, 6% emerging markets, 4% Pacific ex Japan and a 3% allocation to Europe.
“Longer term, our regional allocation may differ from our peers through a greater allocation to emerging markets and Asia,” according to Hughes. “Our allocation to the two sectors combined is greater than the US as we think this is where the faster growth will come from on a multi-year basis.”
Active Managed Portfolio Service 5 & 6
Source: AJ Bell
In terms of fund selection, Hughes and Molica invest in Invesco Perpetual Asian and Fidelity Emerging Markets to provide exposure to the two regions, while they hold 10 equity funds in total.
For exposure to the US sector, Hughes opts for both the passive and active route, with a 7% weighting in the Fidelity US Index Fund and a 3% position in the Dodge & Cox US Stock Fund.
Managed Portfolio Service 3 strategic asset allocation
Source: AJ Bell
“The long-term core of our US exposure is to a passive solution but we also added the Dodge & Cox fund for some active positioning,” says Hughes.
“While Dodge & Cox is an old and well established US manager, it is not very well known in the UK. We like the fact its approach is very long-term, as it is essentially a bottom-up research house that seeks well established businesses able to deliver earnings growth and cash flow. It also has a slight value tilt to its investing.”
The portfolio has 21% of its assets in the UK, split between three funds: Investec UK Alpha (7%) and Man GLG Undervalued Assets (7%).
“We have to be aware of the volatility of the currency market,” says Hughes. “Our investors are UK-based. They invest in sterling and want a return in sterling. We don’t want currencies to be a driver of the portfolio, so it encourages us to have more in sterling denominated assets to provide stability.”
When selecting funds Hughes opts for managers with three distinctive investment styles to provide a blend.
“Simon Brazier’s Investec fund is a core position, which marries well with Henry Dixon’s Man GLG, which is more pragmatic, value-orientated and short term in its approach and provides small-cap exposure,” says Hughes.
“Then you have Francis Brooke’s Troy fund, which is much more defensive, with a focus on capital preservation and low turn-over. The fund has struggled in recent years, which we would fully expect because of its style but if things do become challenged it should give us a nice underpinning to our equity allocation.”
“Troy is the defender in the portfolio. Investec is the go-anywhere midfielder and Man GLG is the flamboyant striker that can do unpredictable things.”
Hughes likes Stephen Harker’s £2.1bn Man GLG Japan Core Alpha Fund because he believes it is “unashamedly” making a call on value stocks in Japan becoming significantly discounted.
“Harker is a proper value manager. A lot of these stocks have been left behind in the Japanese rally and we think there will be an element of mean reversion and the gap will close,” he says.
The active MPS has just a 3% strategic allocation to Europe, for which Hughes and Molica prefer Richard Pease’s Crux European Special Situations Fund. This allows them to capture the opportunities at the mid-cap domestic end of the market.
The portfolio also has an 8% weighting to alternatives, though Hughes decided against investing in UK commercial property, instead opting for two absolute return funds in the form of Janus Henderson Absolute Return and the M&G Absolute Return Bond.
Says Hughes: “We are of the view that now is not the right entry point for the physical commercial property. As a result we have opted for the absolute return route to replace this exposure while still bringing diversification away from equities and fixed interest.”
Author: Adam Lewis Portfolio Adviser, April 2018