Stewart manages Newton’s £10 billion Real Return fund. Absolute return funds such as his have been the hottest launches in active management in the past five years but his fund is a sector granddaddy, having been launched back in 2004.
Its performance has certainly remained vigorous. Over five years and longer Real Return holds its own. In the past five years, it has made an annualised 3.5%, just ahead of the average absolute return fund on 3.4%, and over 10 years, it’s made 5.6% a year to the sector’s 3.3%. In September, retail adviser Morningstar handed Stewart its “outstanding investor” award, for “consistency of approach” and having “met the fund’s real return objective, to the benefit of long-term investors”.
Stewart has achieved this with a risk-averse strategy which, famously, includes investing in gold, a trade less common among his peers.
Right now, the chief risk he is running is a risk-averse stance; illustrated by a stock rally following the unexpected victory of Donald Trump in the US election. Real Return operates with a “core” of assets that aim to generate returns, things like equities and high-yield bonds, and a protective outer layer, or “car tyre” as Stewart puts it, of insulating risk-reducing assets, like government bonds and gold.
Sometimes the “tyre” has been a thin layer of rubber, just 5%. Stewart said: “Right now it’s a big fat car tyre, suitable for going off-road.”
This positioning meant the fund took a hit during the post-Trump rally, losing 4.5% between October 31 and November 25, while the average absolute return fund fell 0.7% and the MSCI World Total Return index was flat.
But Stewart is sticking to his guns, on a thesis that equity markets are long overdue a correction.
A former biologist, with a PhD in marine biology, Stewart worries that macroeconomic policymakers are too much in love with simplistic models such as the Dynamic Stochastic General Equilibrium model favoured by central banks – rather than understanding the economy as a complex ecosystem. This has led them down the road of quantitative easing; a simple one-lever monetary solution to a complex economic problem.
He found the same tendency when studying fisheries policy in the 1980s; governments wanted a simple one-line assessment of fish stocks. Stewart switched careers to finance after university, amid a tough environment for science funding. His background gives him a different perspective to the mainstream of fund management, he feels “maybe that’s been useful”.
This year, he has been a big investor in government bonds, a position that boosted returns – until Trump came along. He said: “Markets have decided to price in what they see as the ‘good’ Trump potential policies immediately.”
But he is sticking firmly to a belief that shares and other risk assets are overpriced. He said: “Most investors feel the bond markets are distorted but equities are OK. We think the central banks have distorted everything. Valuations are very high for risk assets like equities – the S&P 500 is on 26.6 times its cyclically adjusted price-to-earnings ratio. If you pay a high price for something you will probably get a low return.
“If something comes along to change the situation – probably an economic downturn – we think that government bonds are a reasonable place to be while risk assets re-set.”
Despite the Trumpian setback, during the 12 months to November 25, Stewart’s fund is up 3.2%, which handily beats the losses suffered by some leading multi-asset absolute return rivals like Standard Life Investments’ Gars fund or Aviva Investors’ newer competitor Aims, which has come off the boil recently.
It also beats Invesco’s £7.3 billion Targeted Returns strategy, on 2.3%, according to figures from FE Analytics.
All these absolute return funds aim to produce equity-like returns without the occasional falls that equity investors need to tolerate. However, Stewart’s fund, like rivals, has fallen short of this bigger goal – by a long way.
His 12-month return of 3.2% looks decidedly pedestrian compared to the 26% a UK investor could have made by putting their money in a simple MSCI World index tracker. (It has to be said, because the MSCI World is in US dollars, sterling’s recent slump flatters that number considerably.)
However, over all periods and in common with many peers, Real Return has failed to keep up with stock markets. An MSCI World tracker would have beaten the fund over one, three, five and 10 years.
This is a growing problem for the multi-asset absolute return sector, but it’s one that could swiftly change – and will if Stewart is proved right that equity markets pumped up with easy money from central banks are overdue a meaningful correction.
In fact, he has rarely been so pessimistic in his positioning – so if he’s wrong, and equities continue to soar under President-elect Trump, even the fund’s long-term record could start to tarnish. The stakes are high.
His colleague, Suzanne Hutchins, points out the fund’s exposure to assets in its “core” has rarely been so low in its 12-year history. About half its £10 billion value is held in these, but the exposure is currently reduced to 21.4% by shorts on the S&P 500, FTSE 100 and Eurostoxx 50.
Hutchins said: “This is one of the lowest in the history of the strategy. We have been up as high as 95% in the past.”
She added: “It’s not just the size of the core, it’s what you own in it as well. In the past few years we have wanted some exposure to cyclical stocks, but we have bought the debt rather than the equity. We think this is a very good way to reduce volatility but churn out a decent return.”
She cites a position the fund has in bonds issued by Sprint, a US telecoms operator whose restructuring has led to volatility in its share price. The debt has been a much safer bet.
Stewart added: “What we would really like to do is buy assets on a better valuation level, but we don’t see that happening because the [economic] fundamentals [will] improve. It’s more likely the price level will change.”
Within their limited equity holdings – about 60 stocks – Stewart and his team are fans of sectors such as pharmaceuticals, which is a familiar play on ageing populations, and perhaps more surprisingly, media.
Stewart explained: “We have been playing the tech theme by investing in companies that are priced as if they are being disrupted by tech firms, but have actually responded well. Reed Elsevier is a good example in our portfolio; also Wolters Kluwer and Vivendi. These are capital-light business models operating in specialist and scientific media, who have pricing power on the internet platforms.”
In recent months it has been building new positions in listed infrastructure funds, like John Laing and HICL, and utility groups like Centrica and United Utilities. Stewart thinks they will be given a long leash by governments to implement a drive to renewable energy.
But he is not a fan of banks, which again have rallied following Trump’s victory, comparing some of them to “unexploded bombs” because of their high level of derivatives exposure.
He said: “If things go wrong we want to be very resilient, which is why banks are a problem for us. We don’t want to own any assets that could be worth nothing tomorrow.”
Stewart is particularly famed for keeping a substantial holding in gold. He subscribes to the view that it is a “separate entity” to other commodities because it is a monetary asset; he also points out the supply “if anything will disappoint” because all the “easy to extract gold has already been extracted”, further helping it to hold value.
“The problem is it’s hard to value, but we would suggest a government bond with a negative yield is also pretty hard to value. Gold makes sense as a hedge.”
The fund’s 10.2% position in the commodity is currently held mostly in physically backed ETFs from ETF Securities and Source, though the fund also allocates to gold mining stocks, dependent on whether they offer good value relative to the commodity itself.
Stewart said: “At times we have had more with the miners than at other times. At the start of this year we had a balanced split. Then six months in, the gold miners did extremely well, having come from a very low base. They are much more of a geared play on the gold price. We substantially took some profits and put it into the [ETFs], to maintain the level of gold exposure.”