Premier Miton Defensive Growth Fund – The journey so far

Daniel Hughes and Robin Willis

Premier Miton Defensive Growth Fund

Daniel Hughes and Robin Willis, fund managers of the Premier Miton Defensive Growth Fund, reflect on three years of managing the fund.

As we look back over the last three years I think we could be forgiven for thinking that the Premier Miton Defensive Growth Fund had been under our stewardship for a considerably longer period of time, such have been the enormity and frequency of prominent macroeconomic events: the unwinding of long-term trends (such as falling interest rates, globalisation, the era of easy monetary policy and low inflation), the rapid crash and recovery in markets, not to mention the heightened geopolitical tension, war and subsequent energy shock in Europe. We appear to be experiencing shorter mini cycles with financial market reaction functions playing out much more quickly than we have seen in the past. Whilst it would arguably be easier to list the things that markets haven’t experienced in the last three years than what they have, it has certainly been a good test of the approach we set out with at the start of our tenure and has provided a number of important learning experiences.

Transition and restructure phase

When we took over management of the fund we had three initial objectives; remove the top-down macro sensitivity which had become the predominant driver of fund performance, refocus the portfolio around the core strategies within our investment specialisms, and finally, streamline the portfolio both by reducing the number of holdings and in simplifying the implementation of ideas.

Whilst still having a bearish outlook on the bond market we didn’t believe making big macro bets was where we could best add value, so we decided to focus on building a bottom-up portfolio from the derivatives and investment company universes. We believe both of these investment areas offer a significant degree of flexibility and ample investment opportunities. The belief was that having a portfolio where performance was not tied to a particular market direction or outcome would give greater reliability to performance through the business cycle. At the same time, the bearish strategies were restructured as Protection Strategies that were designed to mitigate portfolio risk, rather than be the driver of returns.

The Covid-19 crash and what we learnt

By the start of 2020 we were through the transition phase and felt happy with the setup of the portfolio, but ultimately it wasn’t long before we were in the midst of the Covid-19 shock and subsequent market crash. The drawdown of the fund from the peak to trough in equity markets, between 19th February 2020 and 23rd March 2020 was -6.41%* versus -32.41% for the FTSE All World Index, this fall was well within the parameters set but we were still disappointed with this and took a number of learning points from the experience.

The fund had initially performed positively in the early part of the sell-off as the alternative investments had remained uncorrelated and the protection strategies had started to perform as they were designed to do. It wasn’t until the second week of March where there was a liquidity crisis event that saw gold decline nearly 10% along with other safe havens such as government bonds as investors rushed to sell anything they could. In this environment, our low beta defensive investments as well as our uncorrelated alternatives became much more sensitive to markets and fell in price.

Accessing alternatives through the equity of investment companies mean these positions can become more sensitive in liquidity crisis events; in response to the experience in March 2020, we rebalanced the Protection Strategies, giving a greater weighting to tail risk protection. These are investments that are designed to generate significant return in market shock events like March 2020 when we know the portfolio can become more sensitive. They are designed to have a low cost or bleed to the portfolio returns in normal or rising markets, but can generate significant return in prolonged drawdowns or market shock events, exactly when the protection would be needed. Alongside the longer term tail risk Protection Strategies, we manage a portfolio of reactive tactical portfolio hedges, these are more actively managed where profit will be crystallised on any market drawdowns covered by the tactical portfolio hedges. The balance of these two parts of the Protection Strategies has helped dampen the fund volatility and reduce drawdowns when there has been weakness in asset markets, such as the drawdown in 2022, whilst not costing the fund significant return in more positive market environments like 2021.

2021: Positive fund performance with no sensitivity to equity market correction

*Performance source: FE Analytics. Based on UK sterling, class C income shares, on a total return basis from 31.12.2020 – 31.12.2021. Performance is shown net of fees with income reinvested. Please see important information for full source information.

*Performance source: FE Analytics. Based on UK sterling, class C income shares, on a total return basis, as at 29.07.2022. Performance is shown net of fees with income reinvested.

2022: Positive fund returns during significant equity market drawdown

*Performance source: FE Analytics. Based on UK sterling, class C income shares, on a total return basis from 31.12.2021 – 29.07.2022. Performance is shown net of fees with income reinvested.

The experience of March 2020 also led to the expedition of the transition within the derivative portfolio, away from legacy packaged derivative investments (such as structured products), to accessing derivative exposure through index-based strategies (known as quantitative investment strategies) where the liquidity is written into the legal terms of the investment. This means that you know you will be able to unwind at predetermined exit costs regardless of the stress in markets, whereas with a packaged derivative investment you are reliant on an investment bank counterparty providing a price, something that wasn’t forthcoming during March 2020. A result of this transition means that instead of giving capital to an investment bank, we are able to use an Over the Counter (OTC) derivative to get the exposure and keep the capital within the fund within what we define as the Asset Pool. This Asset Pool consists of highly liquid securities, such as cash and short-dated government bonds, and means the overall liquidity profile of the fund is dramatically improved, particularly in stressed market environments.

Alternatives

Since we took over the management of the fund, we have increased the exposure to alternatives. We look for strategies that are less sensitive to broader economic and financial market conditions than the more conventional asset classes of equities and bonds. The objective is that these positions increase diversification and therefore reduce risk for investors. In fact some positions, through the use of derivatives, may benefit from market volatility and therefore perform strongly while conventional asset classes are under stress. This has the effect of dampening overall portfolio volatility, resulting in a potentially smoother return profile for the fund. However, that is not to say the individual positions themselves are always low risk. The difference is that the risk is more idiosyncratic than that of equity and bond positions which tend to be more sensitive, especially in the short term, to market movements. We believe a portfolio of appropriately sized alternative asset holdings, with their own individual risk characteristics, can play an important role in the fund from both a risk and return perspective.

As we briefly noted above, we gain exposure to Alternative investments via both investment companies and derivative strategies. We believe the permanent capital element of investment companies make them an attractive vehicle to access some underlying investments that may have less liquidity than bonds or equities. Within the derivative space, there has been continued innovation to provide access to alternative risk premiums through systematic quantitative investment strategies. These are passive, rules-based strategies that can offer low-cost access to themes and alternative asset classes often replicating higher cost hedge fund strategies.

The asset class has developed significantly over recent years. As the risk adjusted return profile and potential diversification benefits of the bond market have become seemingly less attractive, there has been increasing demand for alternatives. The increase in investors prioritising investments with high ESG credentials has also resulted in further opportunity for alternative asset providers. There has been an influx of new products made available in an attempt to satisfy that demand. The underlying asset classes are broad in range which means there is always something to look at whatever the broader market environment.

Recently we have been adding exposure to renewable energy generation. We initiated positions as energy prices rose sharply in 2021 and added to these following the Russian invasion of Ukraine. We now have a portfolio which is diversified across technology and geography, which has proven to be a useful diversifier over the year to date. We believe that although power market forecasters are predicting renewable generation will lead to lower electricity prices over the long term, over the medium term the revenues available to these companies with power market exposure has significantly increased.

We have also added exposure to property which, as a real asset, tends to benefit from inflationary environments. We have added to German residential property where we believe the structural supply/demand imbalances offer an attractive opportunity. We also have exposure to defensive sectors such as supermarkets and healthcare. We also opened an investment in an owner of student accommodation which had been trading at a significant discount to asset value.

Performance Drivers

It is notable that there have been very different drivers of the fund’s performance in the different market conditions experienced over the last couple of years. During the more benign environment of 2021, the Defined Investments performed strongly as they continued to recover from the COVID-19 sell off. The Alternatives were also a significant positive contributor. Meanwhile, the Protection Strategies were a detractor as markets moved higher. However the more reactive protection strategies did a good job in smoothing the returns of the fund during the pockets of higher volatility during the year.

2022 has so far been very different. The Defined Investments, while still displaying their defensive qualities, have been less of a contributor in the more volatile market conditions. Meanwhile the Alternatives and Tactical Trades performed strongly. The volatility in markets has meant that this year to date has been a very active trading period. Higher levels of volatility tend to mean there is greater turnover of ideas as there are more opportunities in markets and those trades can come to fruition more quickly. The Protection Strategies have been actively managed during the period, with profit crystallised on a number of positions that had performed well as a result of the volatility and weakness in bond and equity markets.

It has been pleasing to see such a broad range of the portfolio’s strategies providing positive contributions during such a difficult time for most investors. We believe that in such conditions it is important to focus on investment strategies that can generate an uncorrelated source of returns versus equity and bond markets. We believe the flexible nature of the mandate, which was enhanced following the restructure at the start of our fund tenure, means this environment suits the fund as we are able to quickly react to fast paced markets and capitalise on opportunities.

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Risks

The value of investments may fluctuate which will cause the value of a portfolio to fall as well as rise and investors may not get back the original amount invested.

Alternative investments – these typically behave differently to traditional investments such as bonds and equities. They can include a range of assets such as specialist lending, private equity, hedge funds and gold. Adding alternative investments to a portfolio can help to make it more diverse but can also make it more volatile.

Derivatives are contracts whose value is based on the change in price of a specific asset or index. When derivatives are used within a fund, it doesn’t necessarily increase risk. However, price changes in the underlying asset can translate into big swings in the value of derivatives (up and down), which has a direct effect on the value of the fund.

Over The Counter derivatives are types of derivatives that are not traded on a public exchange. Agreed privately between two parties, OTC derivatives can be tailored to meet the exact needs of each party. They can make a fund more volatile from time to time.

Property values can rise and fall sharply depending on the strength of a country’s economy.

A hedge is designed to offset the risk of another investment falling in price. It can also act as a limit on potential gains if the investment that has been hedged increases in value.

Future forecasts are not reliable indicators of future returns.

IMPORTANT INFORMATION:

For Investment Professionals only. No other persons should rely on any information contained in this fund manager insight.

Whilst every effort has been made to ensure the accuracy of the information contained within this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice. Reference to any particular stock or investment does not constitute a recommendation to buy or sell the stock / investment.

All data is sourced to Premier Miton unless otherwise stated. Persons who do not have professional experience in matters relating to investments should not rely on the content of this document.

*Performance source: FE Analytics. Based on UK sterling, class C income shares, on a total return basis. Performance is shown net of fees with income reinvested. On 20 January 2020, this fund moved from a single pricing basis (mid) to a swing pricing basis, which is where the price can swing to either a bid or an offer basis depending on the investment and redemption activity in the fund. This means the investor selling or buying fund shares bears the associated [dis]investment costs and protects the continuing holders in the fund. Performance could be shown on a combination of bid, mid or offer prices, depending on the period of reporting.

Source: FTSE International Limited (“FTSE”) © FTSE 2022. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE under licence. All rights in the FTSE indices and / or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and / or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

To help investors assess the performance of the Fund, SONIA (Sterling Overnight Index Average) is used for comparison purposes. As the fund invests in different asset classes in the UK and globally, we believe the FTSE All World Index is also a useful performance comparator.

SONIA is a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans. As the fund aims to deliver a positive return over rolling three year periods through a portfolio that includes investments with predictable return profiles, we believe it is a meaningful comparator to help investors assess the performance.

For your protection, calls may be monitored and recorded for training and quality assurance purposes.

A free, English language copy of the fund’s full prospectus, the Key Investor Information Document and Supplementary Information Document are available on the Premier Miton website, or you can request copies by calling us on 01483 306090.

Financial Promotion issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227. Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

007392/230822

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This section of the website and the content it contains is for retail clients only and by persons who are resident in the United Kingdom [who are not US persons]. Professional advisers should refer to the Professional Advisers site.

The content of the pages of this website is for your general information only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

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