A tin of beans

22^nd March 2013

This blog was published in Portfolio Adviser on 25^th March 2013 http://www.portfolio-adviser.com/comment---analysis/bens-ketchup-and-fizzy-drinks-husselbee

Old Mother Hubbard's kitchen cupboard was bare, but most people can dig out a can of soup, a tin of beans and a bottle of Tommy K. These essentials were surely part of the attraction to Warren Buffett in swallowing up last month the biggest deal of his career - a US$28 billion takeover of HJ Heinz. His investment company, Berkshire Hathaway, partnered with 3G, the Brazilian private equity firm, to notch up the largest takeover in the food industry to date.

With a strong record of growth and cash generation, HJ Heinz looks a typical Buffett purchase. He likes brands and has long admired consumer goods companies, being famed for his large stake in Coca-Cola. However, as a well-known value investor paying a premium for soup, beans and ketchup  falls short of his customary investment approach. When we review fund managers for inclusion in our client portfolios we look for a robust investment process which makes sense and is consistently applied by an experienced team or individual. If Berkshire Hathaway was a holding in our portfolios, this acquisition would trigger a review - no matter that Warren Buffett is the world's most lauded investor with a long, successful public track record.

In his recent annual letter to Berkshire Hathaway shareholders, (a must read for all investors), Mr Buffett criticised his subpar performance relative to the firm’s S&P 500 Index benchmark in 2012. He firmly believes his company’s intrinsic value approach will outperform the benchmark for shareholders in future.  After all, they could always turn to a low cost tracker.  Yet, I find it hard to believe that his shareholders will be selling. This is only the ninth time in 48 years that Berkshire Hathaway (+14.4%) has failed to outperform the S&P 500 (+16%) in the calendar year. However, he did express concern for the potential loss of its five year rolling track record of market outperformance.

The letter explained that Berkshire Hathaway's relative performance did better when "the wind is in our face." He also told shareholders of his disappointment in failing to make a major acquisition in the year -  "I pursued a couple of elephants, but came up empty handed." That's not to say there was no reinvestment in Berkshire Hathaway investments, they spent a record U$9.8bn on plant and equipment. Buffett berates CEO's for blaming 'uncertainty' for their lack of capital expenditure.

The recent acquisition of HJ Heinz is his latest ‘elephant’, but despite his 82 years he has promised that he still has the appetite to bag some more. We meet many fund managers who adopt the Warren Buffett approach - scarcely surprising bearing in mind his 48 year track record which has compounded annually at 19.7%. His outlook is suited to investors with similar patience.  Short term speculators need to look elsewhere.  I have no doubt that many more fund managers would like to assume Buffet’s investment approach, but the short term quest for performance rules this out. To be the best performing fund in a falling market is a bittersweet marketing accolade.

All good things come to an end....... slowly

28th February 2013

 

Low interest rates in the UK, driven by successive rounds of quantitative easing, may have helped the Government to finance its borrowings, but they have been no good for savers.  In their search for greater yield, they have turned to the fixed interest markets. With government stocks offering little more than cash deposits, corporate and high yield bond funds have successfully attracted significant amounts of new money. Yet, whilst these do offer a much higher yield than cash deposits, they also represent a much riskier investment proposition.

Much has been written about the so called "Great Rotation".   With bond yields at such historic lows the case for switching into cheaper assets has grown compelling. The merit of buying low and selling high is indisputable. However, as we have witnessed in the Eurozone, whilst bond yields can move at lightning speed, it is not in the interests of the Government for yields to rise sharply anytime soon. Indeed, in the MPC minutes released last week, three members, including the Governor, called for more quantitative easing and one for an open ended facility such has been adopted by the Federal Reserve. Further gilt purchases would obviously keep a lid on yields.

The market is now expecting the resumption of more extraordinary measures, not on the grounds of fighting deflation but to support growth and employment. The cost to date has been increasing inflation, with a weak pound pushing up prices and leading to a reduction in living standards. Economic growth has proved elusive with the private sector preferring to pay down debt rather than spend. Indeed, high and rising equity dividends are partly a response to diminishing confidence in their future prospects. We must see the headlines in the business sections shift their focus from dividends to news of mergers and acquisitions before we have proof of a genuine return of confidence in future economic growth.

Investors who buy fixed interest securities now should be looking for income and diversification rather than capital growth. The 'Great Rotation' should not be dismissed, but of greater concern is how to mitigate risk when the buying declines rather than the panic-selling begins. Some investors will look at alternative defensive assets but others, like pension funds, need to invest in bonds. For retail investors the additional risk techniques offered by strategic bond funds may offer a solution. These managers can construct well-diversified bond portfolios as well as wield the ability to hedge out interest rate risk. Bond or credit selection as well as hedging will be critical for these funds. To include currencies in the equation, there is a wide and deep universe to achieve positive returns.

After such a good run in this asset class, there may be some retail investors attracted into bond funds for further capital gains, but this is never a reason to hold a bond fund in a diversified portfolio.  There is a very real danger that this lesson is about to be learnt the hard way.

The Giant X Factor

22nd February 2013

 

This blog was first published in Portfolio Adviser on 22nd February 2013, the link  http://www.portfolio-adviser.com/comment---analysis/rise-of-real-assets-as-fund-giants

 

It may come as a surprise to some fund buyers to learn that Standard Life’s Global Absolute Return Strategies Fund, at £14.4bn, currently stands as the UK’s largest retail investment fund. What is astonishing is that five years ago this giant didn’t even exist.

In those days Invesco Perpetual High Income (£9.5bn) was the largest. Indeed, the manager, Neil Woodford was also responsible for the second largest fund, Invesco Perpetual Income (£6.7bn), heading up a ‘top ten’ dominated by UK equity income funds, including Jupiter Income (£4.0bn) and Newton Higher Income (£3.4bn). UK equity funds were well represented with Legal & General UK Index (£4.5bn) and M&G Recovery (£3.0bn) also ranking. Europe, Balanced, Global and Specialist funds completed the list - Fidelity’s European Fund (£4.8bn) coming in third and M&G matching Invesco Perpetual with two funds in the 2007 ‘top ten giants’.

Flash forward to today and only four funds from 2007 remain - Invesco’s two income funds, M&G Recovery and BlackRock’s balanced fund, Consensus 85.  New entrants include Scottish Widows’ UK tracker, which replaces Legal & General, as well as an Asian, two absolute return and two bond funds.

This shift in orientation reflects investors’ changing appetite for risk following the global financial crisis of late 2008. First State Asian Pacific Leaders (£6.6bn) has attracted investors looking to participate in the growth of the progressive economies of the Far East. Seeking absolute return through investing in quality has proven a winning formula for drawing in new inflow for the manager.

Newton Real Return Fund (£7.1bn) has also been a success as investors have prioritised capital preservation over growth. M&G’s two bond funds, Optimal Income (£11.2bn) and Corporate Bond (£6.4bn), both managed by Richard Woolnough make up the ‘ten’. The fund flows into the IMA’s fixed interest sectors are well documented.  In an environment of low interest rates unsurprisingly, investors have been chasing yield. Gilt yields fell to record lows last year, with fund buyers preferring corporate to government debt. M&G’s Optimal Income Fund, launched six years ago has been a major beneficiary. This is a strategic bond fund where the manager looks to maximise returns in a diversified bond portfolio.

Absolute Return funds have also been a magnet for much retail investment - not those pursuing the strategies associated more commonly with hedge funds, but diversified multi asset funds prepared to invest in both traditional and alternative asset classes.

Is there a way to predict the giants of 2017?  Let’s consider the trends. The growing economic independence of the East will lead to the accumulation of more Asian and Emerging Market assets.  However, domestic equity, therefore UK funds, long the cornerstone of portfolio construction, will remain in contention. RDR favours outsourcing, so arguably more managed funds may rise to the top, whilst absolute return funds could become less attractive as we enter a new secular equity bull market. As for bond funds, that depends on the future path of interest rates - and if inflation rises, real assets will become the asset class of choice.