Managers must be more dynamic

There is a temptation at the moment within the investment industry for fund managers to sit on their hands due to being 'shell shocked', writes Caroline Madden

‘WHEN THE facts change, I change my mind.” Deutsche Bank’s UK head of portfolio management Martyn Surguy quotes Keynes when explaining that fund managers must adjust strategies to suit the new, and fundamentally different, investment landscape. If Surguy is to be believed, the “financial sector earthquake” has been so severe that much of the conventional wisdom in the investment world has been challenged.

One such tenet is the “buy and hold” mentality, the belief “that it’s going to be all right in the end because equities usually go up over the long term”, as he puts it. “I suspect that going forward, that’s not going to be the right strategy,” he predicts.

The effectiveness, or otherwise, of the “buy and hold” strategy depends on the time horizon of the investor – there have been regular extended periods when equity markets delivered no returns. “If you’re prepared to hold equities for upwards of 18 years, yes, there are very few rolling periods of 18 years where you’d ever make a loss,” he says. “I wonder the extent to which our clients have really got an 18-year time-horizon.

“I think it’s important to be flexible and not to believe that you buy an equity and you tuck it away and you look at it again in 10 years’ time,” he continues. “I think it’s incumbent on managers to act very much more dynamically than perhaps they historically ever have.”

There is also a temptation at the moment within the investment industry for investment managers to sit on their hands because they are “shell shocked”, he says, and because the consensus is that everybody needs to be as conservative as possible. “But I think to use that as an excuse not to do anything is also wrong,” he adds.

Surguy was in Dublin yesterday to brief clients of Key Capital Private (Deutsche Bank’s Irish partner) on how his “unconstrained portfolio” product performed over the last year, and the strategy being adopted in 2009.

Essentially, an unconstrained portfolio approach means the investment manager diversifies across a wide range of asset classes, and doesn’t compare itself to an industry benchmark. Instead, it aims to deliver an absolute return. Last year, Surguy’s key product fell by 12 per cent, which is better than some of its competitors, but that doesn’t take away from the fact that it failed to deliver a positive return. A difficulty in 2008 was that correlation between asset classes was very high because the value of so many asset classes headed downwards. “So even diversification didn’t protect you as much as it would have done in normal conditions,” he says.

How exactly has Surguy adapted his strategy to suit the changed investment environment?

Not surprisingly, investments in equities, hedge funds and alternative assets have been pared back in favour of fixed income and cash.

He explains that the strategy for 2009 is to have a core investment of “very transparent, highly liquid or defensive assets”. This could include a modest equity exposure and investment grade credit. This core will be supplemented by “satellite” investments such as equity infrastructure stocks, and what he calls “cheap insurance” that will protect the portfolio should the core investments perform badly.

So what investments can be used as “cheap insurance”? Gold, Surguy says. “It has the advantage of not being tainted by any of the excess of securitised credit or many of the issues that still are so prevalent,” he explains. He sees gold as a store of value and as cheap insurance against the economic situation deteriorating significantly.

So in Surguy’s book, gold remains very much a safe haven asset, but not so sovereign bonds. Traditionally, government bonds have been viewed as the ultimate safe haven, he says, but he points out that current treasury yields represent historic lows. “Normally we buy them to be safe havens, to be secure capital, and it strikes us that with yields down there, your capital might not be quite as secure as you think,” he says.

“If the authorities are successful in reflating the economy . . . yields could [come] back up quite sharply from here, which would leave you with significant losses on your government bond portfolio,” he continues.

He is not alone in describing government bonds as representing “return-free risk” at the moment.

He has advice for investors who are nursing losses, whether they were sustained in equity, property or other asset classes. “You don’t have to make it back the way you lost it. There is always the natural psychological view that if your asset has lost you a certain amount of money, you want to get back at least what you paid for it before you consider selling, but of course you don’t have to make it back the way you lost it.”

He also notes that money tends to gravitate to “the last best-performing asset” (the Irish property market illustrates this point well) which is exactly where the highest risk is, as its popularity means that there could be a speculative bubble forming.

He feels this is a much better time to consider investing in renewable energy than when it was a fashionable story attracting a lot of money, which pushed up prices. “One of the first things that managers did when they were recalibrating their portfolios in light of 2008 was sell down all of the perceived higher-risk or long-term stories that they had in their portfolios, of which those sort of stories were one of them, regardless of the fundamentals of the industry or the concept of the planet,” he says. Though he says he’s not an expert, he feels some renewable firms and assets are looking “extraordinarily cheap” now that they’re out of favour.

Does he feel that markets are close to bottoming out?

“I think there’s always a prospect for asset classes to get sharp rallies within this period, but believing that we’re close to the bottom I think is premature economically,” he says.