Jupiter Merlin Portfolios update

Posted by Guest in Fund and industry updates category on 20 May 14


Merlin outlook

Background

In 2013, investors in the Jupiter Merlin range made positive returns across the board, but relative performance, compared to the relevant sectors, was below average. Policymakers continued to manipulate markets through the use of unconventional methods such as printing money, also known as "quantitative easing" (QE), to buy bonds. This had knock-on effects around the world. Then, as the US Federal Reserve (the Fed) indicated that it would reduce the size of this bond purchasing programme, some asset prices, emerging markets in particular, suffered as speculators withdrew.

In a world of market manipulation, fundamental ways of valuing assets and historical market precedents become less relevant. Correlations break down. Average time horizons become compressed. Investors who prefer to invest in companies for the long term find it hard to adapt. We have adapted somewhat, but, as ever, we are wary of chasing bandwagons if that obliges us to buy into low quality areas and take unwarranted risks.

Impact on performance in 2013

Equities over bonds

In 2013, bonds generally lost out to equities. For example, the benchmark 10-year US treasury yield moved from roughly 1.7% last year to just over 3% in January 2014, meaning bond prices fell. The S&P 500 equity index, meanwhile, rose by more than a quarter during the year. We only held bonds where we were compelled to do so in 2013. The nature of the bonds that we held were high yield, (bonds which pay a high level of interest due to their perceived higher level of risk than most other bonds), strategic and emerging market. The first two worked well, the third did not as emerging markets suffered.

Developed markets over emerging markets

Although different emerging markets have different dynamics, in 2013 they almost all suffered from expectations of earlier-than-anticipated monetary tightening in the US. Tighter policy would mean a more expensive US dollar and less opportunity for the "carry" trade of borrowing cheap dollars to invest in emerging markets, where the potential for larger returns might be made.

We reduced exposure to emerging areas considerably over Q3 and Q4 of 2013 and achieved good relative performance where we had exposure. In Latin America, for example, the Brazilian market fell by nearly a third in sterling terms, whereas our preferred fund lost just 9%.

Low quality versus high

Low quality investments, which we tend to avoid, outperformed high quality ones in 2013. As memories of the financial crisis fade, risky investments become more in vogue. This is rational behaviour provided that the structural problems that caused the financial crisis are resolved permanently. If those structural problems remain unresolved, which we think they are, this is risky behaviour. 

Currency factors 

The US dollar has been strong against virtually every currency around the world except the two that matter the most to the Jupiter Merlin range – sterling and the euro. Several factors should continue to support a strong dollar and see it strengthen against sterling and the euro. Shale gas means America is less dependent on external energy sources, i.e. it exports fewer dollars; growth should attract overseas investors and the budget deficit is narrowing. Europe does not have such a strong outlook while the UK is running a very large current account deficit.

Earnings in relation to share prices

In the US, the market return was mostly driven by higher share prices, i.e. investors were simply willing to pay more for equities, without any accompanying earnings growth. This effect was even more marked in Europe where earnings grew more slowly, but people still expected better times ahead. So why were investors willing to pay more for shares regardless of underlying earnings growth? The answer is lower inflation.

Gold

Gold also had a difficult year in 2013, despite the US, Japan and China continuing to roll their printing presses at elevated levels. This was partly due to the banning of gold imports in India. It was also due to speculators abandoning the precious metal as the level of fear decreased and more people became willing to invest in income-producing assets such as equities.

Outlook and current positioning

In our view, markets and economies will continue to be challenging; there is a greater than normal probability for a surprise event to disrupt everything. We are not going to change wholesale what we do as our approach has served our investors well over the years. But we have and will remain flexible. We continue to view the unwinding of the US’s monetary experiment as a significant risk to markets and we will monitor events closely.

Equities over bonds

Bonds have enjoyed a bull market, i.e. one delivering positive returns, which has lasted for over 20 years. Yields are low and bonds are heavily owned. Now that QE is being reduced, an important buyer of fixed interest investments (the Fed) is likely to disappear. If the world economy continues to recover, money should naturally gravitate towards equities and away from bonds. In all outcomes, apart from outright deflation, it is hard to see bonds outperforming equities over any decent time horizon. However, equities will probably remain more volatile.

While some commentators are already warning of bubble conditions in certain assets, equity markets in general seem to us to be some way from outright euphoria and, in our view, offer better returns than cash and bonds for the risk taken. We therefore continue to have a significant weighting to equities across the portfolios.

Developed markets over emerging markets
In the US, growth is picking up, aided by an abundant supply of cheap energy from shale gas and rising domestic consumption. As a result, exposure to domestically-focused small and medium-sized US companies has been increased where appropriate. Further recovery in the US is likely to have a positive effect on other developed markets. However, we continue to monitor the strength of sterling and could look more closely at overseas assets if it continues to rise.

Policymakers in Japan are attempting to stimulate growth in the economy. So far, inflation has been driven primarily by increases in energy costs due to a weaker yen. We now need to see greater wage growth and consumer spending in order to sustain positive price rises longer term and permanently rescue the country from its 15-year deflation trap.

Having reduced our position significantly last year, we continue to be wary of emerging markets as we feel that there is scope for further deterioration and volatility. This is especially likely in those emerging nations which need dollar financing. If the US continues to reduce its liquidity programme, then US yields could rise further, increasing the cost of borrowing dollars. Another unknown is how China will develop as it tries to rebalance its economy towards domestic consumption, liberalise its markets and deal with any debt problems.

Low quality versus high
We continue to avoid the more speculative areas of the market, in particular where prices are factoring in huge growth for companies that lack visible earnings streams. Instead, we prefer to focus on quality assets which, in the event of market volatility and/or a return to valuations based on fundamentals, could come to the fore.

Merlin outlook

Important information:

Past performance is no guide to the future. The value of investments and the income from them can fall as well as rise and may be affected by exchange rate variations; you may get back less than originally invested.

The above commentary represents the views of the Fund Manager at the time of preparation and may be subject to change and this is particularly likely during periods of rapidly changing market circumstances. Their views are not necessarily those of Jupiter or Willis Owen and should not be interpreted as investment advice. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.

The views and opinions contained herein are third party and may not necessarily represent views expressed or reflected by Willis Owen

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