For Wood-Smith, there are clear reasons to believe that the bull market is drawing to a close. Markets managed to shrug off unprecedented uncertainty – Brexit, Trump – with apparent ease, and valuations have climbed higher and higher.
Maybe it is a new era, he says, but “it’s different this time” has proved to be a dangerous assumption in financial markets.
Wood-Smith points to technology valuations as a sign that equity markets have become alarmingly high in some cases. He says: “The biggest risk is that investors start to conclude that Google owner Alphabet can’t really be worth 180x earnings. Once this technology bubble starts to crash, it would probably bring the whole wider equity market down with it.”
Naturally cautious
The magnitude of the crash, when it comes, will be determined by how far markets have moved in the interim.
Wood-Smith says: “If the FTSE 100 had stuck at 7,000, the downside might have been 6,000-6,500. If it goes to 7,500-8,000 on the way there, the downward move will be all the more painful when it comes.”
Wood-Smith says he is “naturally cautious” at the best of times but particularly so at the moment.
He considers his true benchmark to be the Retail Price Index, rather than benchmarking the portfolios to the WMA indices. His aim is to deliver a sustainable year-in, year-out RPI-adjusted return. This means reining back on assets that look expensive.
He says: “Until recently, the equity weighting on our standard balanced product had a 50% weight, compared with a 65% weighting for the WMA benchmark index. We have recently taken this back a little and it now sits at 45%. We are completely benchmark agnostic and our equity weighting reflects what we like – or dislike least, in the very bad times.”
Interestingly, in light of the recent turmoil, the reduction has come at the expense of the international rather than UK holdings. Wood-Smith believes the prognosis for the UK economy is relatively bleak, particularly in the wake of the messy general election. Further quantitative easing also remains a possibility.
However, on balance, he believes that the pound did most of its devaluation after Brexit, and has actually started to look quite cheap. He has withdrawn money from the US and Japan.
If the equity market looks bleak, the bond market is even more complex. Wood-Smith admits it is difficult to build a coherent picture on the bond market. “Does anyone really have a clear idea on whether UK inflation is higher or lower? This is important in the construction of a bond weighting,” he says.
“Certainly, portfolios need an element of safety and we have some sovereign bond exposure because of the chance of a significant slowdown. That said, the majority of our fixed income weighting we give to good strategic bond managers. There are some very capable investors out there.”
These managers, he believes, are in a better position to determine where value lies within bond markets.
Alternative options
Across the group’s portfolios, Wood-Smith is supplementing traditional bond exposure with a range of alternative asset classes. For example, he holds a number of convertibles funds, which he includes as part of the bond weighting. He also has a number of infrastructure debt funds and an asset-backed securities fund. Most of all, he is trying to find those managers who can make their own “independent alpha”.
Commercial property has had a difficult run, particularly in the wake of the Brexit vote. Nevertheless, Wood-Smith still sees value in some of the higher-yielding Reits. Within the portfolios, he includes the Target healthcare and custodian Reits. He admits that he is not alone in liking them and they have performed well. That said, he still believes there is some value there and yields remain relatively attractive.
In a climate where neither bonds or equities offer compelling value, Wood-Smith believes there is a place for absolute return funds and these make up an increasingly significant part of the group’s portfolios. He says: “In general, we feel absolute return funds get a bad press. While it is justified for some of the sector, there are some good funds. There are a number of very good long/short funds and we hold a number of these, including the Jupiter fund. We also hold a number of the strong asset allocation funds, such as Troy and Ruffer. We tend not to own the ‘no return’ bond funds.”
Income remains a significant challenge. Wood-Smith says that investors increasingly need to take greater risk to achieve the same level of income: “The risk profile of an income portfolio is now higher than that of a balanced portfolio,” he says. “To deal with this, we are trying to draw income from as diverse a range of asset classes as possible.”
He points out that for income investors, the mark-to-market value of the portfolio does not necessarily matter as much. They need to maintain the level of income, rather than look at the capital value and what the markets are doing. This gives some flexibility in the type of assets that they invest in.
