Cautious Model Portfolio
September 2009
Prepared by Old Broad Street Research Ltd
Table of Contents
Page
Introduction to OBSR and the Model Portfolios 3
Cautious Model Portfolio Overview 6
Current Cautious Model Portfolio 10
Cautious Model Portfolio - Fund Descriptions 11
Introduction to OBSR and the Model Portfolios
Introduction
OBSR (Old Broad Street Research Ltd) has been engaged by Paradigm to advise upon the fund selection for a range of Model Portfolios. The Portfolios are available for use by Paradigm members and are designed to suit differing risk appetites. They are:
· Income Portfolio
· Cautious Portfolio
· Balanced Portfolio
· Active Portfolio
· Aggressive Portfolio.
The asset allocation for these Model Portfolios is sourced from Ibbotson and provided to OBSR by Paradigm. OBSR is responsible for the fund selection for the Model Portfolios.
About Old Broad Street Research Ltd (OBSR)
OBSR is an independently owned research and consultancy company that specialises in providing qualitative investment research and product analysis to financial intermediaries, life offices and investment houses. Its clients include many of the largest Independent Financial Advisers, Chartered Accountants, Insurance Companies and Investment Managers.
OBSR’s Research Approach
OBSR uses an investment research approach that has been in place since 1994 and is founded upon forward-looking, rather than backward-looking research. This leads to a strong emphasis on the qualitative aspects of research. Whilst their conclusions are informed by detailed statistical analysis, they are aware of past results rather than being driven by them. The key factors that underpin their research are:
§ Strength of investment process and length of time it has been in place
§ Continuity of investment personnel
§ Investment style that has proven durable over time
§ Clearly defined investment objectives
§ Strong and consistent past performance record
§ Favourable risk adjusted returns.
They believe that it is critical to gain a full understanding of a fund and its objectives and see their pursuit of this as one of their key strengths. Their rigorous analysis through direct and regular contact with fund management groups and fund managers enables them to understand differing investment approaches and objectives, ensuring that they are in a position to make fair comparisons between funds they consider to be similar. Critically, they also believe that risk and reward need to be assessed together and gauge superior returns in the context of the amount of risk taken.
OBSR’s qualitative, research-intensive approach is important to the way in which they consider funds in the context of enabling portfolios to be built. They prefer to combine funds on the basis of their current knowledge of the manager(s), investment house, investment objectives, philosophy and process, rather than basing conclusions on backward looking statistical analysis.
Definitions
In the following pages reference may be made to funds either labelled as core, core plus or specialist:
- Core – Core funds are likely to be diversified and the investment approach can be considered to be mainstream and non-specialist in nature. They are likely to be broadly representative of the asset class or managed fund sector when compared to other funds in the sector. Typically, core funds will be managed with tight risk controls relative to accepted main market or peer group benchmarks. Hence performance is not expected to stray too far from these, albeit with the intention of generating out-performance over the medium to long term.
- Core Plus – Core Plus funds are typically managed and structured with a view to out-performing the accepted main market or peer group benchmarks significantly over the medium to long term. Whilst they are likely to be managed with reference to accepted main market or peer group benchmarks they are not necessarily benchmark driven. Positions may deviate significantly from the benchmarks at the asset allocation, geographical, sector and stock selection levels. Such funds are likely to take greater levels of risk relative to the market indices and peer group benchmarks compared to Core funds.
- Specialist – by definition, Specialist funds are likely to be specialist and not core in nature. Thus is a heterogeneous grouping as it encompasses funds that adopt a wide range of different approaches. They are often managed with little or no reference to the accepted main market indices and peer group and therefore performance can differ significantly from these.
Reference can also be made to funds having a value bias, growth bias or blended investment style:
- Value bias – A portfolio which emphasises the value of stocks relative to their peers and their own price history. These stocks typically appear undervalued for reasons besides earnings growth potential. Such stocks are usually identified by their high dividend yield, low Price/Earnings ratio or low Price/Book Value ratio. Value managers may be “contrarian” in terms of approach – i.e. they may look to invest in lowly-valued stocks at times when such stocks are out of favour.
- Growth bias – A portfolio which emphasises the earnings growth potential of stocks. A growth company will typically demonstrate higher than average growth in sales and earnings and the ability to generate rates of return in excess of its cost of capital. It is therefore able to retain a high proportion of earnings, which grow faster than average when compared to their peers.
- Blend – A fund that is not limited by growth or value disciplines. Managers of blended funds may try to adapt their portfolios over the market cycle. Their portfolios may display growth or value characteristics, or a blend of both, at any particular point in time according to the manager’s assessment of the underlying stocks and the prevailing market environment.
The following pages provide some information about the funds that have been selected for the Cautious Model Portfolio and reasons why they have been chosen and how they have been blended.
Risk Warnings
This document is for use by professional advisers only and should not be relied upon by private investors. The Model Portfolios are intended as a guide only and they are not a recommendation to buy or sell any fund or product. OBSR accepts no responsibility for the appropriateness or otherwise of Model Portfolios for individual clients and responsibility for investment advice rests with the professional adviser. OBSR has sourced data from third parties, including asset managers, which it believes to be reliable, but takes no responsibility for its accuracy. Past performance is no guide to the future.
Cautious Model Portfolio Overview
Below we provide a summary of the Cautious Model Portfolio by asset class. Asset allocation is provided by Ibbotson and OBSR is responsible for the fund selection to populate this, subject to the availability of appropriate funds. We explain below why we have selected and blended the funds that feature in the Portfolio.
Investment Objective and OverviewThe investment objective, as provided by Ibbotson, is as follows: The Cautious Portfolio is designed for the investor who seeks both modest capital appreciation and income from their portfolio. While this range is still designed to preserve the investor's capital, fluctuations in the values of portfolios may occur from year to year.
The Portfolio is allocated to cash, property, fixed income, UK equities, European equities, North American equities, Asian equities, Japanese equities and commodities. Around half of the Portfolio is allocated to cash and fixed income and within the equity portion, which amounts to 44%, the majority is allocated to UK equities.
Source: Ibbotson
CashThe cash portion is invested in a relatively low risk cash fund, where this is available. Otherwise cash is invested at the discretion of the adviser. For the purposes of the Model Portfolios, we have used the Fidelity Cash fund. This is a low risk cash fund that seeks to offer a very high level of security and liquidity.
PropertyFor the Cautious Model Portfolio, we have selected the Threadneedle UK Property Trust, which is directly invested into UK commercial property. The Trust was launched in February 2007 and is managed by experienced practitioners in this specialist field. Its more recent launch has been of benefit as the fund does not suffer from some of the legacy issues of other longer-established funds.
Fixed IncomeThe fixed income portion of the Cautious Model Portfolio is diversified across different parts of the market.
We have selected two gilt funds for the Portfolio, the Royal London UK Government Bond fund and the Schroder Gilt & Fixed Interest fund. These are both actively managed funds that seek to generate attractive performance through duration, yield curve positioning and stock selection
For the allocation to inflation-indexed bonds, we have selected a tracker fund, namely Legal & General All Stocks Index-Linked Gilt Index. This is a tracker fund and provides investors with the required exposure to this part of the market.
For the UK corporate bond exposure, we have selected the M&G Strategic Corporate Bond fund. We have high regard for the manager of the fund and the broader team at M&G, and the fund has performed very well over time and notably, during the difficult fixed income environment of 2008. The fund is located in the Sterling Corporate Bond sector but it has a more flexible mandate than that of its sister fund, the M&G Corporate Bond fund. Specifically, the manager is able to take greater duration and credit risk calls and can invest up to 20% in high yield bonds. He has done this to good effect over the life of this fund.
For the allocation to global fixed income, the Invesco Perpetual Global Bond fund features in this Portfolio. The fund is managed by two of the most highly regarded fixed income managers in the UK market. It is invested in sovereign bonds but the managers will also invest in credit opportunities when they believe compelling value to be present. The fund provides investors with actively managed exposure to different currencies and this provides further diversification of returns to the Portfolio. Over a number of years, the managers have added value for their investors through their experience and their active approach to fixed income portfolio management.
UK EquityThe UK equity portion of the Cautious Model Portfolio is invested in one equity income fund, the Invesco Perpetual Income fund, and three funds from the UK All Companies sector, namely Newton Income, BlackRock UK Dynamic and Standard life Investments UK Equity Growth.
Invesco Perpetual Income is managed by Neil Woodford, a highly regarded and very experienced income investor who has an investment style biased towards value. The Newton Income fund is a mainstream large cap core fund within the UK All Companies peer group, although it also has a yield objective. This fund also gives the Portfolio exposure to Newton’s proven thematic investment process while retaining some yield discipline. The BlackRock UK Dynamic fund has been favoured alongside Newton and Invesco Perpetual as the fund manager, Mark Lyttleton, has demonstrated over time that he can successfully invest across the market cap spectrum and adapt his investment style to the prevailing market conditions. Finally, the Standard Life Investments UK Equity Growth fund is managed by experienced manager Karen Robertson. She manages the fund according to the team’s ‘Focus on Change’ approach and she seeks to both identify and understand the key factors that drive the market price of an investment and the dynamics behind these drivers. The manager has used this process to good effect over time.
Europe EquityTo represent the European portion of the Cautious Model Portfolio, we have selected the Cazenove European fund. It is managed as a core fund which is positioned according to the manager’s business cycle assessments. The manager is very experienced and his approach has worked well over a number of years.
North America EquityFor the North American equity exposure we have selected the Threadneedle American and M&G American funds for the Cautious Model Portfolio.
Threadneedle American is managed as a core fund and the manager seeks to perform well across the cycle. The process is strongly team driven and based upon disciplined fundamental research. The M&G American fund is also managed in a highly disciplined manner but the manager has the flexibility to invest across the market cap spectrum. He and his team have a strong focus on cash flow analysis and look for companies that are positioned to benefit from changes in capital allocation. The manager also works closely with the internal strategy and risk team to ensure that the risks of the portfolio are understood and appropriately managed.
Asia Dev ex Japan EquityThe First State Asia Pacific Leaders fund has been selected for the Cautious Model Portfolio. The fund is managed by Angus Tulloch – one of the pioneers of investing in the Asian region. He has built up an outstanding track record, managing the fund since its inception in 2003 as well as other Asian funds since the mid 1980s. He has also instilled a deep commitment in the analyst team to First State’s rigorous approach which focuses on quality companies trading at attractive valuations. We have met with several team members for whom we have high regard and we also rate other First State funds managed by the team.
Japan EquitySchroder Tokyo has been selected for the Cautious Model Portfolio’s Japanese equity exposure. The Schroder team has a long heritage of investing in the Japanese stock market and the team is very well resourced. The manager, Andrew Rose, has been involved in Japanese equities since the early 1980s, and he has a pragmatic approach which has produced consistent returns over the long term.
CommoditiesThe BlackRock Gold & General fund has been selected for the commodity exposure in the Cautious Model Portfolio. This fund seeks to achieve long-term capital growth in gold, mining and precious metal related shares. The fund manager is very experienced in the area of commodities and the BlackRock team is highly regarded. This is a specialist fund that provides diversification within a broad portfolio.
Cautious Model Portfolio – September 2009
The annual Ibbotson asset allocation update was communicated in May 2009 and the Cautious Model Portfolio was therefore updated at this time. There were no changes to fund selection following the regular review at the end of the third quarter 2009.