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Three themes to spice up your portfolio

Japan, miners and European absolute return portfolios are the three out-of-the-way areas JPM’s Tony Lanning is looking to in order to boost returns on his Fusion fund of funds range.

Lanning, whose funds were launched in March of last year, is picking some lesser-known portfolios to benefit from these themes.

Here we look at his rationale and some more mainstream alternatives.

Japan

Lanning is topping up his exposure to the Japanese market following its recent weakness.

The TSE Topix index is down 4.13 per cent since the start of the year, according to data from FE Analytics .

Performance of index in 2014

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“A poor start to the year has cleared much of the froth out of the Japanese equity market and has allowed us to increase exposure at lower prices,” Lanning said.

“Earnings growth is set to outpace other global markets, led not only by a weaker yen but also continued corporate restructuring and improvement on shareholder returns.”

“Even after the blockbuster return in 2013, valuations are still attractive and offer one of the cheapest ways of benefiting from a synchronised acceleration in global growth.”

“Worries about a lack of progress on Abe’s third arrow of structural reform are largely irrelevant, as are fears over the impact of an imminent rise in the sales tax.”

“Japan needs inflation and higher equity prices if it has any chance of addressing its debt mountain.”

“Having historically been hamstrung by a chaotic political system, this is now something the current government has the time, legal power and desire to do.”

“The easiest route to this outcome remains a weaker yen – expect further monetary stimulus on top of the already aggressive easing the Bank of Japan is pursuing.”

Lanning favours the 412m Polar Capital Japan fund for his exposure.

The fund is domiciled in Ireland, but is available through some UK platforms.

It is an all cap fund with 31.6 per cent in the largest companies on the market, 39.8 per cent in the mid cap area and 28.6 per cent in the small cap area. This compares with weightings of 62.7 per cent, 28.8 per cent and 8.5 per cent from its benchmark, respectively.

It is overweight industrial sectors such as machinery, chemicals and metal products and underweight pharma, food and IT.

Two portfolios with wider availability and that fish throughout the different areas of the market are the 45m Axa Framlington Japan fund and the CF Morant Wright Japan fund.

The latter has roughly 60 per cent in mid caps and 38 per cent in large caps with very little in small caps.

The former has 24.24 per cent in large caps, 19.44 per cent in mid caps and the remainder in smaller companies.

Performance of funds vs index over 3yrs

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FE data shows the AXA Framlington fund has the superior track record over the past three years, returning 17.85 per cent.

Mining ETFs

Lanning thinks the mining area is also undervalued and is choosing to access the theme through an ETF: the DBX Stoxx 600 Basic Resources fund.

“The mining sector remains as unloved as Japan was 18 months ago,” he said.

“Chronic overinvestment and fears over a China slowdown led to the sector lagging behind the FTSE All Share by over 30 per cent in 2013 – a significant source of alpha for virtually every UK equity manager who were universally underweight.”

“However, brighter times lie ahead. New management is making good progress increasing free cash-flow through reduced capex and costs.”

“Dividends from the sector, which already exceed that of the broader market, will continue to grow.”

“Further support will come from a depreciation in the Australian dollar and other producer nations’ currencies. All this will make it increasingly hard for investor positioning to remain so depressed.”

For anyone who doesn’t want to use a passive, a more mainstream way to play the theme would be through Evy Hambro and Catherine Raw’s 4.6bn BlackRock World Mining fund.

However, the tracker would have produced better returns over the past three years, according to FE data.

Performance of funds vs index over 3yrs

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The BlackRock fund has also underperformed its HSBC Global Mining benchmark over the past three years.

European absolute return

Lanning says that in the fixed interest portion of his portfolios he is looking to reduce duration, in part by increasing his weighting to absolute return.

“We have been reducing duration to protect portfolios against the rising interest rate environment, however we still believe that portfolios should be fully diversified,” he said.

“Where we have reduced duration, we have favoured more benchmark-agnostic fixed income managers that can be short duration if they deem it appropriate.”

One fund the manager likes is Melchior European Absolute Return.

This 168m long/short fund is listed in Luxembourg and is available only to institutional investors.

It has a volatility score of 2.77 per cent over the past three years, compared with 18.23 per cent for the MSCI Europe ex UK index.

Over that time it has quite a strong negative correlation to the equity market of -0.46, suggesting it can do a good job of hedging a portfolio.

There are a number of onshore alternatives for retail investors.

The 15m FP Argonaut Absolute Return fund benchmarks itself against the MSCI Europe, and has a correlation of just 0.29. Its volatility is 7.62 per cent, however, one of the highest in the sector.

On the other hand, it makes this extra volatility count, with the best Sharpe ratio in the IMA Targeted Absolute Return sector.

The 64m BlackRock European Absolute Alpha fund has a much lower volatility of 2.85 per cent and is also top quartile for Sharpe.

Its correlation to the index is -0.46.

Henderson European Absolute Return has a correlation of 0.51 and Liontrust European Absolute Return -0.31. Both have volatility around the sector average.

Performance of funds vs index over 3yrs

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FE data shows that the Argonaut fund has far and away the better returns, making the most of the extra volatility, while the Liontrust fund has gone off the boil over the past 12 months.