3 Alternative Picks for a Diversified Portfolio

7IM's Matthew Yeates highlights three diversifying portfolio picks for investors looking to smooth returns

Emma Wall 10 November, 2017 | 12:40PM


Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and joining me today to give his three investment picks is Matthew Yeates, Manager of the 7IM Real Return Fund.

Hi, Matthew.

Matthew Yeates: Good morning.

Wall: What's the first investment pick today?

Yeates: So, the first investment pick would be something that I think can deliver return independent of equity markets, are stable, low volatility return. And that's the BMO Global Equity Market Neutral Fund. This is a long-short equity fund. And the process that it's based upon is not a manager per se; it's a quantitative investment process that's filtering stocks based on their characteristics.

And it's a process that we have good understanding of, because people within our own team have worked originally alongside the managers. It's a fund that we help seed two, three years ago. And it's basically investing on the premise that over the long term, if you build smart beta-like factors in the correct way and you hedge out the equity market risk, if you believe in that systematic process, you can over the market cycle, get a return that is attractive. The target is 7%.

Since inception, it's delivered 9% annualised performance with a low correlation, almost negative correlation to equities. That's a stable return that we can rely on the portfolio that's independent of equity markets, which for us as a real return fund manager is perfect.

Wall: And what's the second investment pick today?

Yeates: So, another part of the market that we like is the CLO market. Within the U.K., on opportunity to get access to the CLO market through an investment trust for investors, trading on a discount is the Carador Income Fund (CIFU). And the CLO market, I suppose, it's a horrible three letter acronym. So, it conjured all these horrible pictures in people's minds of 2008 global financial crisis, what's going to happen, how is it going to unwind.

Well, here is an asset class, CLOs, where AAA-rated and AA-rated CLOs didn't see any defaults through 2008 where there is a dependable source of income, a dependable source of income that's floating rates independent of the overhang of central banks kind of pushing down nominal rates for kind of normal credit asset classes and it's delivered in a structure of diversified loans. So, I think, getting access to that kind of yield, which we think is going to be around 10% a year in the coveted market environment, in a floating rate format is an attractive prospect and Carador trading on a discount is a great way to get access to that.

Wall: And that structure, that closed-end fund structure, also lends itself – adds liquidity for investors who like this pick?

Yeates: Exactly. I think the overhang of liquidity is a question mark around CLOs if people think back to 2008. But many of the people that caused those liquidity problems, i.e., bank balance sheets, bank prop books aren't allowed to trade there anymore. Hedge funds have certainly scaled back the amount of kind of leverage they are introducing into the market. So, we don't think those overall liquidity concerns are as justified as they previously were. And correct, an investment trust allows the right sort of liquidity profile for that market, but it's something that's got to be managed very carefully. And we think, kind of, our size is a good size to be able to play that. The unitized UCITS structure that we operate within is the right structure to be able to play that investment trust discount premium story, somebody that's going to be watched though, something is going to be watched.

Wall: And what about the third and final pick?

Yeates: So, the third and final pick, I think, for me is a story around inflation and the idea of inflation, specifically, in the U.S. A real return fund mandate is clearly inflation-linked. The way to traditionally protect your portfolio against inflation, I suppose, would be using inflation-linked bonds. Now, the problem with inflation-linked bonds is, yes, you get exposure to inflation, but you also get exposure to kind of nominal rate duration as well.

So, something we moved to do last year was use specifically inflation swaps which isolate that inflation component from the duration component. As a case in point of how that can work in practice, buying into long-dated, so kind of 30-year inflation expectations, 30-year inflation in the U.S. last year. Inflation expectations rose about 0.5%, 0.7% from the middle of the year to kind of post-Trump, a huge, huge move in those long-term expectations.

If you bought an inflation-linked bond over that same period, you would have lost money, because rates rose at the same time. Isolating that call, kind of, between the middle of the year and the end of the year post-Trump we made around 10%, 15% on that position. So, we think, thinking about inflation is important, but not just buying inflation for the sake of it without thinking about the other exposures you're getting exposure to, is clearly important.

Wall: Matthew, thank you very much.

Yeates: Thank you. 

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
7IM Real Return C Acc150.66 GBP-0.12
Carador Income Fund USD Ord0.67 USD0.00-
F&C Global Equity Market Neutral 3 Acc59.35 GBP-0.30-
About Author Emma Wall

Emma Wall  is Senior Editor for Morningstar.co.uk