Portfolio Positioning Update

Jase

Whilst I write this, we are reflecting on the fact that we have again today sold out of the FTSE 100 tracker and bought a position that shorts the FTSE 100 (make money when the indices falls) to hedge against what is expected to be a fall in the main indices over the coming months. We have made this decision because from a tactical perspective (see chart below) the FTSE 100 has risen to a level that signals it is over bought and normally at these levels it falls, as technical analysts and tactical traders lock in profits. Therefore within each portfolio we have had between 15% & 20% exposure to the FTSE 100 as a tactical overlay, and this has now been reversed as regards to the polarity, so that if the FTSE rises it will be a drag on performance and if it falls it will be a performance enhancer.

The chart below illustrates how the FTSE 100 has risen exponentially over the last six weeks compared to other global indices.

Total Return Bid-Bid line chart (from 01 Apr 2014 to 13 May 2014) from UK IMA universe. Rebased in Pounds Sterling

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Conviction

From a conviction led basis and in relation to the portfolios, the last six weeks have been interesting as an Investment Manager because we have underperformed the FTSE 100, which has gone up sharply, because our portfolios are positioned in the Mid Cap, sector specific focussed areas, not Large Cap, international power houses. We also have exposure to technology stocks within the global and sector specific sectors, which have over the last six weeks, seen profit taking at quite a high level.

What made the movement in assets and momentum change “interesting to watch” is that you would normally only see such a momentum change from mid /  small cap companies to large cap, at the end of the expansion phase, of an economic cycle. If therefore the recent rally in the FTSE 100, had been a signal that we were at the end of the expansion phase economically, well, it is about three years too early.

If therefore we are not at an inflection point and the global economy is not about to fall into recession, what caused this momentum change and is it anything to worry about?

The answer to that is two fold. The first and most important is that “no” it is not anything to worry about and the second is that the movement into large cap in the UK was because of Russia and a fear of contagion stalling the global economy (which is unfounded and would require a 5000 word thesis to explain)  coupled with short term profit taking. Neither of these factors concerns us and we are confident therefore that the rise in the FSE 100, which was a lone riser over the period is one that will result in the mid cap and small companies again becoming favourable as the sector is no longer perceived as being expensive.

Therefore in a perverse way we are happy that in the short term the FTSE has risen so much whilst we had an allocation to it of between 15% and 20% and that at the same time other assets have delivered nothing. This is because we can short the index as it falls and then get a second bounce on that asset, as the assets that have been out of favour in the last six weeks become flavour of the month again, as investors again focus on fundamentals, which have continued to get stronger.

Overall therefore we have been watching, not worried, and we are definitely not at the end of the expansion phase of the economic cycle. We have taken profit in the FTSE 100 and overall believe that the asset allocation we have today with the tactical overlay, which we positioned as at the 9th April, of the core portfolio being UK and globally biased with sector specific asset allocations in mid cap and small cap in UK and Europe with a tracking position tactically on the FTSE 100, and with exposure again to emerging markets and gold, is correct, and is based on where we believe you need to be invested in the coming three to six months to make gains.

There is no doubt that risk has not been rewarded in the last six weeks and was before, but nothing has changed so we remain risk on, because we do not expect market volatility to breach our indicative constraints and also because this is exactly where you should be positioned at this stage of the economic cycle to make the most out of what is viewed to be a very optimistic coming 18 to 24 months.

Total Return Bid-Bid line chart  year to date  (from 31 Dec 2013 to 14 May 2014) from UK IMA universe. Rebased in Pounds Sterling

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As always if you want to talk to talk to any of us please contact us immediately and we look forward to the rotation back to mid cap equities and technology and away from the FTSE 100 over the coming six weeks, to correct the imbalance seen in the last six weeks.

All the very best

Jason Stather-Lodge

Founder & CIO