Carrington Investment Approach
A Look Back at 2014

The purpose of this note is to reflect on the past year and to comment on what we see going forward from here. We would normally send this note out in mid-January but we felt it should be delayed until we knew the outcome of the recent European Central Bank (ECB) announcement on quantitative easing.

2014 OVERVIEW:

  • Over 150 investment meetings
  • Introduction of our new ‘Low Volatility’ portfolio
  • Return of market volatility led to a difficult year for returns
  • Identification of a number of specialist investment providers
  • Outperformance of cash by a high margin

2014 was a very difficult market to operate in, with periods of much higher volatility being experienced as can be seen from the chart below.

FTSE 100 daily chart

FTSE100 Chart_170215

Despite the turbulent backdrop, all our portfolios produced positive returns and outperformed cash by some margin. The markets became very rotational in 2014 with money flowing between sectors with speed and no one theme lasting for more than a few months; it was this which made it much harder to achieve the returns we made.

We have continued to stick to our investment process and philosophy, leading us to conduct over 150 meetings throughout 2014 with various investment providers. This has meant we have kept up to date with our current holdings whilst at the same trying to find new investment opportunities.

It is through this we have launched our new ‘Low Volatility’ investment portfolio which should allow us to navigate down markets more comfortably. Following on from conversations we held with a small number of clients who had begun to feel increasingly nervous under market conditions, we decided to create and introduce a new portfolio offering. The remit for our ‘Low Volatility’ portfolio was to preserve capital during falling markets, yet provide positive returns well above those from cash. We believe that this portfolio will be of interest to a wide selection of clients and therefore if you would like further information on this then we would be more than happy to speak to you and provide some further background information including its composition and recent performance.

Our investment process is underpinned by the regular research which we conduct on the fund universe. We hold meetings with the managers of funds we currently hold, alongside meetings with managers who we feel are very talented within their specialist markets. This has led to us finding a number of fund managers who are largely unknown to the retail market.

Typical of this would be the recent purchases we made into Church House Investment Management. An example of this would be the ‘Tenax Absolute Return Strategy’ which at only £35.3million would not get through a lot of wealth manager’s search criteria; since our purchase however, the fund has gone onto win the category of Absolute Return Portfolio Manager of the Year as voted for at the Portfolio Adviser Wealth Manager Awards.  The fund targets positive returns over rolling 12-month periods and has achieved this in 92% of periods over the last 5 years. Most of their funds have attracted a lot of institutional support but very little from private clients.

2014 also saw the introduction of a number of funds provided by TwentyFour Asset Management, a speciality Fixed Interest manager whose AUM is now over £4billion. Most of their funds have been launched in the last 2 years, attracting a lot of institutional support but very little from retail clients.

CASH & BANK DEPOSITS

These are clearly risk free assets (up to £85,000 with any one institution protected by the Financial Services Compensation Scheme) but the returns are going to remain at historically low levels for longer than seemed likely 12 months ago. We may see the first rate rises towards the end of 2015 but they will be at the most quarter of one percent and will not rise either rapidly from there or in our opinion as high as they have done historically. We may see these rises first in The USA then the U.K. We expect rates to go no higher than 3.5% at their peak and this may well be some years before we see that level.

UNITED KINGDOM

UK OVERVIEW:

  • The General Election to cause uncertainty in the market
  • UK to be one of the leading developed markets
  • Small / Mid-Cap sectors to benefit from improving economy
  • 2014 Budget a real surprise

The General Election in May will create some uncertainty in markets as it is currently very hard to see any of the main parties winning with a clear majority. Historically a coalition government has been viewed as a weak government, which leads to weakness in the Sterling. The economy is performing reasonably well and many companies in the UK are seeing a recovery from the previously low levels of activity. We think that the domestic economy will continue to strengthen in 2015 therefore we will continue to look for funds that have a greater exposure to mid-size and smaller UK companies. We feel that companies which are below the main FTSE 100 will be stronger because they will benefit from a stronger domestic consumer and will be benefitting from lower input costs due to falling commodity prices. Those with mortgages and other forms of debt will also continue to benefit from the very low cost of borrowing.

One real surprise in 2014 was the announcement in the budget allowing retiring pension fund owners to access all their funds in one go subject to a tax charge. This happens in April 2015. It may very well increase the amount of spending that takes place and help the economy to continue to expand against the rather more cautious predictions.

USA

US OVERVIEW:

  • Improving economy to be offset by a strengthening dollar
  • Oil price to become a tailwind
  • Continued performance in 2015

The recovery in the US is further ahead and more mature than most other economies; it is this which has led to the US dollar strengthening against almost all currencies, however the strength of the dollar is now providing some headwind as it means exports become more expensive in other markets.

US Chart

Some recent reports showed a considerable slowdown in consumer spending however the falling oil price will feed through to consumers, quickly putting spendable income into their pockets. With oil prices looking set to stay lower for some months yet, we expect to see consumer spending start to increase once more. The manufacturing companies will also be gaining from the lower oil price. The pressures will be in the energy sectors for the reasons we have outlined. The US market performed strongly in 2014 with the increased dollar strength contributing even further to our gains. We do not anticipate changing our asset allocation here significantly and expect to keep our exposure to the S&P index via an index tracking fund the same.

EUROPE

EUROPE OVERVIEW:

  • Deflationary pressures creating negative sentiment
  • Ukraine and Greece providing a headwind to European markets
  • Announcement of QE to provide fuel for growth
  • 2015 outlook very positive

Sentiment towards European markets in 2014 was very weak with the constant threat of deflation and the conflict in Ukraine weighing heavily on investors’ confidence in the region. Going into 2015 sentiment still remains weak with the prospect of further tensions in the Ukraine and the uncertainty around Greece and their continued membership of the European Union.

Our European exposure throughout 2014 didn’t really add to our performance, however we feel that despite the ongoing risks mentioned above, the decline in oil prices will provide some much needed assistance to economic growth alongside a weak Euro which will provide a stimulus to exporters. Within the last few weeks, the ECB has launched a massive financial stimulus programme which should help sentiment in the region considerably and provide a boost to both equities and fixed income investments.

The ECB have said that they are committed to increasing their balance sheet to the same levels seen at the end of 2011 in order to stave off deflation. The effect of this should bring interest rates down across the Eurozone and therefore increase bank lending whilst also improving the regions competitiveness through currency depreciation.

ECB Balance Sheets

Despite the negativity surrounding the Euro due to the recent bond buying programme announced, we feel that a lot of this has already been priced into the Sterling-Euro exchange rate. With the looming general election we could see the Euro actually start to strengthen, a move which would further increase our returns on any European holdings.

One of the two funds we own is the Invesco Perpetual European Income fund which is very much a bottom up stock picking fund and we continue to follow this with strong interest. We feel this market will surprise on the upside later in 2015 therefore we may look to add here later in the year.

Although this fund returned virtually 0% over the past 12 months, the 12 months prior to that it achieved an outstanding 40%. We are hopeful that with the combination of factors including weak investor sentiment, a depreciated currency, lower oil prices and an enormous stimulus package, this market could lead to superior returns in 2015.

JAPAN

JAPAN OVERVIEW:

  • Huge stimulus package to revive a deflationary economy
  • Decline in commodity prices hindering inflation
  • Yen level attractive to international consumers

Another surprise which we saw in 2014 was the announcement of a huge stimulus package which was intended to get Japan closer to achieving their 2% inflation target. The package arrived in the third quarter which as you will see from the attached chart saw markets respond strongly. In practical terms it may be difficult to hit their inflation target as the fall in commodity and energy prices is providing a drag on inflation levels. The continued weakness in the Yen should help the export side of the economy, with goods looking cheaper to international consumers. To offset any fall in the currency, we currently hold the Polar Capital Japan fund which hedges out any negative movements. Those doubts have caused the market to retrace some of the recent gains but we remain committed in our growth orientated portfolios to having holdings in this market.

ASIA-EX JAPAN

ASIA-EX JAPAN OVERVIEW:

  • Markets subdued due to Chinese slowdown fears
  • Opportunities to be found in the right countries / sectors
  • Cyclical companies cheap on a relative basis
  • Commitment from China for continued stimulus
  • Pro-growth governments to provide interesting investment opportunities

These markets were very subdued in 2014 due to concerns about the extent of the slowdown that could be taking place especially with rather weak growth numbers from China. This is a very diverse region but we feel it is right to have exposure in all our portfolios. Our lower risk strategies own the Newton Asian Income whilst the higher risk offerings have the Hermes Asian fund. We still think there are good opportunities in the region and expect to maintain a reasonable exposure in 2015.

Asian markets were weak for the majority of 2014, with cyclical companies in particular showing signs of weakness. Valuations relative to more defensive companies are now at similar extreme levels that they reached in 2009 after the financial crisis. The Hermes Asia fund we own, has a high allocation towards the more cyclical companies therefore even a modest switch out of defensive stocks could see a strong performance for the fund in 2015. In the last quarter of 2014 we saw sentiment change quite markedly towards China and this fed through to better market performance across Asia. A key driver of market performance in Asia last year was also the government elections in both India and Indonesia, which led to a quick move to the upside in their local markets and this was taken by investors as a sign to increase portfolio allocations to these countries. The governments elected are seen to be pro-growth and this could be a very interesting area over the coming year.

Despite weakening growth numbers coming from China, the government showed that they were committed to continued pro-growth stimulus which has been continued in 2015 with the reduction in the banks’ reserve requirement. The Chinese market returned close to 50% last year, and we feel that this is an area of high interest still.

ALTERNATIVES

ALTERNATIVES OVERVIEW:

  • Volatile price movements here to stay
  • Introduction of low correlated assets

As previously mentioned, in 2014 we started to see much bigger and more frequent price swings, and we see this volatility being a prominent feature of the coming year. This has led us to expand our investment remit and we have since identified a number of funds which have much lower volatility and correlation to markets, yet still providing positive returns in most market conditions.

Two of the funds which we have identified include Church House Tenax Absolute Return fund and the Premier Defensive Growth fund. We have since added these to our panel of recommended funds following a number of meeting we had with their respective managers. We were particularly impressed back in October when markets dropped by over 7% in a not much over a week, yet the funds mentioned above remained virtually unchanged and managed to finish the year with positive returns that exceeded cash deposits by some margin.

OUTLOOK

Our performance YTD has been strong with the majority of our portfolios beating both benchmark and competitors. We feel that our exposure to Europe and UK Small / Mid-Caps whilst being a drag on performance in 2014 will actually show signs of considerable growth in 2015 and provide us with strong returns. Despite our positivity for the year ahead, we remain committed to ensuring that we do not become complacent and that we retain our ability to change our asset allocations swiftly in order to maximize performance.

Some of the concerns from 2014 will no doubt be present in the new year with worries regarding Ukraine, the Eurozone, in particular Greece, and the declining oil price persisting. Despite the negativity and worries surrounding oil prices, we think that this in fact will prove to have a positive impact as it places more money in the hands of consumers, reduces manufacturing costs and also the costs of distribution which will also help in controlling short term inflationary pressures. The negative is that banks may well be exposed to non-performing loans to oil companies which I have no doubt will get more media coverage over the year.

We think that 2015 will continue in the same vein as the last few months and show an increased amount of price swings, we do however feel that there will still be good opportunities to be found within select asset classes and markets which should provide us with strong returns.

If you have any queries, please do not hesitate to contact us.

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