Markets have recovered since the UK referendum, but the impact of the UK’s historic vote on the underlying economy will not be apparent until data begins to come through in the later part of this year, leaving a huge amount of uncertainty for investors.

In this article we examine investment trusts which are designed to be highly flexible, offering dynamic exposure to multiple asset classes, geographies and currencies, with a focus on capital preservation and risk management.

Introduction

The growth of the UK funds industry over the last 30 years can be broken down into four phases, according to the Investment Association (IA) – whose members manage assets of more than £5.5trn of UK investors’ money.

In the first phase, during the 1980s and 1990s, the consistent strength of equity markets saw huge inflows into equity funds until, in the early 2000s, the dot-com crash saw the second phase begin with a shift into a broader range of assets. Phase three, in the wake of the Great Financial Crisis, saw investors moving into fixed interest funds, driving a boom in the asset class. Toward the end of 2012, the fourth phase, a resurgent equity market, saw investors piling back into equities, and it was not until the middle of last year that this rally ended.

It is perhaps unsurprising, then, that even before the surprise result of the UK referendum, this regular rotation of performance into different asset classes saw mixed-asset funds – which can invest anywhere, in anything, and more often than not in a variety of currencies – becoming increasingly popular.

AUM GROWTH/SALES OF MIXED-ASSET FUNDS

Source: Investment Association

According to the IA the mixed-asset sectors have been consistently among the best sellers overall since the credit crunch, with sales of more than £8bn in 2010 alone, and if mixed asset funds categorised in the ‘IA Unclassified’ sector are included, that number was well over £10bn (see above).

The uncertainty which has rocked the market in recent years, and in technicolor since Brexit, could pave the way for the next phase in the growth of the asset management business – the age of the multi-asset fund.

The appeal of an active approach to asset, region and currency allocation in an environment where no single asset class dominates – and where political instability means change is likely to be rapid, drastic and frequent – is obvious. However the extent to which the funds within these sectors actually use the full range of assets at their disposal to grow returns and shield capital is an important question. There is little homogeneity among them in terms of portfolio, benchmark or objective, so it makes sense to look at how they have used their multi-asset capabilities to achieve a return, and to place that in the context of the risk they have incurred to get there.

In this report we examine the AIC’s newly created Flexible Investment sector, using the IA’s open ended equivalents as a backdrop for comparison, and highlight a number of investment trusts which offer diversified multi-asset exposure, with a clear focus on the compromise between capital preservation and returns, and a currency-aware approach.+

A brief overview of the flexible sectors

The Investment Association launched the IA Flexible sector in November 2011, creating it from what was then the IA Active Managed sector at the same time as an overhaul of all of its mixed-asset sectors. At the same time the IA Cautious Managed and IA Balanced Managed sectors were renamed Mixed Investment 20-60% Shares and Mixed Investment 40-85% Shares, and a new sector was created – Mixed Investment 0-35% Shares – winning new ground in the industry’s battle for pithy nomenclature.

Perhaps the best known mixed-asset sector – and certainly one of the best-selling in recent years – is the IA Targeted Absolute Return sector, home to the mighty Standard Life GARS, a fund which with £26bn under management would, were it to attract any more money, would probably affect the earth’s gravitational field.

The AIC Flexible Investment sector, launched in January this year, is tiny by comparison – with only ten funds and around £4.5bn under management in total.

As the table below shows, trusts in the sector pursue a variety of objectives but in general terms they come in two forms – those which seek to outperform an equity index, and those which are effectively pursuing absolute returns. Likewise two investment methods dominate; direct exposure to a range of assets managed by an in-house investment team and the fund-of-funds approach.

AIC FLEXIBLE INVESTMENT SECTOR

Source: Kepler Partners/Investment Trust Intelligence

The funds

The investment trust structure is ideal for a multi-asset strategy, giving the manager access to a wide range of assets which would not be available to his open-ended peers and allowing him to invest without the need to consider portfolio liquidity to meet redemptions – those who run open ended funds (OEICs) must always bear in mind the need to meet investor redemptions, as the UK’s commercial property funds have shown in gory detail in the last month.

RIT Capital is a good example of a trust which pursues this broadly diversified approach to assets. This trust holds direct equities, property, long-only equity funds, hedge funds, absolute return funds and private equity funds, and invests directly in private equity, as well as using currencies to generate returns.

The management team aims to keep up with rising markets whilst protecting capital on the downside, and has shown itself willing to shift between assets as it pursues that goal moving, for example, from an average equity exposure of 55% during 2015 to 43% at the year-end as its view on the outlook became increasingly bearish.

PERFORMANCE

Source: Morningstar

RIT Capital has a strong performance track record. It is one of the top performing investment trusts in its sector over three years and has outperformed many of its open ended/OEIC rivals in the much larger IA sector. It has also done well over five years.

Originally set up to serve the Rothschild family, whose patriarch Jacob still serves as chairman of the board, RIT Capital’s stated aim is to “protect and enhance shareholders’ wealth over the long term”.

The trust was one of the top performers in 2015, doing well in the summer despite weakness across global equity markets, and over time it has shown itself capable of participating in market upside whilst avoiding the worst of the downside. Since inception (1988), they claim to have participated in 76% of up moves in the equity market, and 39% of market down moves

Personal Assets Trust, managed by Troy founder Sebastian Lyon, has a similar bloodline. Troy Asset Management is named after Lord Weinstock’s derby winning racehorse, and the trust is managed with a ‘family office’ style focus on preserving investors existing capital without forfeiting the right to make more of it when the opportunity arises.

Having performed very strongly during 2008 and 2009 the trust fell behind many of its open and closed-end peers in the rally which occurred after the credit crunch, and its three and five year numbers look weak, largely because the managers took a view that the recovery was built on sand and stayed firmly on a bearish footing – with a heavy weighting in gold drawing particular fire.

Performance

Source: Morningstar

Since markets began to crumble last year, however, performance has picked up sharply. Personal Assets is now one of the best performing vehicles in either the open or closed-ended flexible sectors over one year. The trust has achieved that with a lower volatility than the vast majority of its 164 open and closed end peers – the average trust in the sector is down 2% and has a volatility of 13%.

Moving further toward absolute returns we come to Ruffer Investment Company. This trust, managed by Hamish Baillie and Steve Russell, has an even stronger focus on capital preservation – something which runs deep at Ruffer as a house, where founder Jonathan Ruffer won fame when he called the credit crunch before it happened, and positioned his portfolios in such a way that they came through 2008 with flying colours (see chart below).

PERFORMANCE

Source: Morningstar

Ruffer believes the Global Financial Crisis isn’t really over, and the trust is very lean on equity exposure. Instead the managers are heavily weighted toward inflation linked sovereign bonds which they think will take off when (not if) government efforts to reignite the global economy finally pay off, and the same governments find they are unable to hold back inflation because by raising interest rates they will extinguish the very flame they have tried for so long to kindle. Debt – both corporate and personal – means interest rates cannot be used for their traditional purpose, and as a result continued monetary and fiscal stimulus will, when it finally works, result in 1970s style inflation.

As one might expect in such a bearish portfolio, the trust has failed to keep pace with the rest of the market in recent years, but examination of its performance in positive and negative markets is revealing.

In 2008, when the FTSE lost 29.9%, the trust delivered positive returns of 24% – a margin of outperformance of more than 50%. Again in 2011 when the FTSE was down 3.5% the trust remained in positive territory and, in fact, in only two of the last ten calendar years has the trust lost money – and then in each case losing less than 2%.