Contrarian investors challenge conventional wisdom; getting them to agree with the consensus is like trying to herd cats. They do not always get it right but mavericks are always worth listening to, if for no other reason than to question your understanding on a chosen investment strategy. Perhaps the most famous contrarian investor in the UK is Neil Woodford, subject of my last blog post, but in this article I want to share the thoughts of another, Alastair Mundy who manages the Investec Cautious Managed (ICM) fund amongst others. He is down to earth and his communications are interesting, clear and are not unnecessarily complicated by technical charts and analysis. I have recommended the ICM to many of my clients and whilst the long term returns have been excellent the fund has underperformed its peers in recent years.
One of the reasons the ICM has underperformed its competitors in the Investment Association Mixed Investment 20-60% shares sector is Mundy is bearish on the global economy and has taken a defensive position in his portfolio. So whilst the fund can invest a maximum of 60% in equities in recent years the ICM has had a significantly lower allocation compared to its peers and has consequently underperformed. Mundy also has a short position in US equities on the basis they are expensive. It means if the market tanks the fund will gain. To date however the short on the S&P 500 has detracted from performance.
Another reason why the ICM has underperformed is its allocation to complementary assets. These include Norwegian government bonds denominated in Kronor, gold and silver and index linked bonds. You generally will not find these in other portfolios. The former are safe haven assets, whilst precious metals and index linked bonds are traditional hedges against inflation. With “risk on” sentiment favouring equities, event risk subsiding, the dollar strengthening and inflation muted these complementary assets have underperformed. However Mundy’s argument for his asset allocation is compelling. Firstly he questions whether funds labelled as cautious really are cautious with their high weightings to equities which look expensive by conventional measures.
Further in a recent webcast Mundy presented some interesting data to support his cautious outlook. From the fourth quarter of 2007 to the second quarter of 2014 global debt has risen from $144 trillion to $199 trillion. This includes government debt up from $33 trillion to $58 trillion (Source: McKinsey & Company, February 2015). Debt is still clearly a big problem for the global economy. Mundy also argued that there are plenty of other things to worry about, a Greek exit from the Euro, interest rate rises in the US and UK and a slowdown in China, yet he considers equity valuations seem to be saying there is nothing to worry about at all! The one equity market where he sees value is in Japan and this is reflected in a 12.6% weighting in the portfolio at 30/6/15, quite a big bet for a cautious multi-asset fund.
Finally Mundy suggested that the markets are underestimating the potential for inflation. Data from 1915 & 1917; 1945 & 1947 and 1972 & 1974 showed how price inflation rocketed from nowhere over two years. For example from 1972 to 1974 it went from 2.9% to 12.3%. (Source: Incrementum AG). He questioned if investors actually saw the catalysts for these inflationary surges? Finally Mundy suggested central bank policy could be used to keep interest rates below inflation in order to shrink debt, a process called “Financial Repression.” If inflation surprises on the upside index linked bonds at least should rally.
The inclusion and retention of a fund like the Investec Cautious Managed in client portfolios despite a period of underperformance serves several purposes. Firstly it has an easily understood target return of CPI + 4% p.a. meaning its goal is to beat inflation. For me the use of the Consumer Prices Index is preferable to the less understandable LIBOR (London Inter Bank Offers Rate) which other targeted return funds use.
The ICM is a genuine cautious managed fund and as such it is not recommended for “shoot the lights out” performance. It complements pure equity and indeed other multi-asset portfolios with its unique asset allocation. Low or negative correlations mean risk reduction. Given these points comparisons with the ICM’s so called peers in its IA sector should not be given too much significance.
Finally I like fund managers who are willing to back their convictions. As noted Mundy has a big position in Japanese equities. It is at first sight a puzzling contrarian allocation for a cautious risk fund. However when valuations and other factors are taken into consideration it makes perfect sense. The latter include money printing, a weaker Yen, more investment into equities from the government and other public pension schemes and increased dividends and share buy-backs.
This blog is intended as general investment commentary and reflects my own views. It is not an invitation to invest in the assets and fund highlighted as these may not be suitable for you. You should seek individual advice before making investment decisions.