Top-Down vs Bottom Up
Well it's a great pleasure to meet you again Shaun. The first time I met you was in CNBC, it was in the green room, we were about to go on and I just got talking to you and I think we had quite similar views about the way the markets were working at the time. Yes I remember it well. And I thought "Yeah this guy's really good" obviously because you agreed with me. So maybe you could tell us a little bit about the way the top-down works in other words how your asset allocation committee works versus the kind of bottom-up information that you feed into your process.
Yes so we think very much from the top-down view macroeconomics, what is driving market cycles. Is it inflation? Is it policy stimulus, central banks lowering interest rates, is it earnings improving, margins improving, what is really fundamentally driving markets? So we think very much the top-down drivers and then from a portfolio perspective we're thinking very much about how much risk is really in portfolios. Often you've got lots of you views, lots of things about the dollar, about markets and actually when you look down, sometimes quantitatively, you find you've probably only got two or three factors really driving your portfolios. So we like to think about what is really driving your portfolios down to the simplest elements to really understand your risk in a lot of detail.
What do the robots do in Nutmeg?
Now everyone describes Nutmeg as a robo fund, now obviously if you've got just a computer which is running a portfolio it wouldn't understand certain things, so for example political risk, or Marine Le Pen, or Brexit so obviously this is a place where you can really add value. I mean how often do you feel you have to kind of delve into the machine, as it were, and alter the weights?
Yes, so the automation is very much about helping clients come on to the service, to use the service, to understand peoples' risk we use a lot of data to understand peoples' risk and to make the business very scalable, very efficient, but actually there's an investment team, I lead an investment team here at Nutmeg that are making decisions on a daily basis. So during the Brexit event we were very much focussed about political risk, we thought the risks about Brexit, a "yes" vote, were really very much understated. So we were doing things like buying gold, we were owning more dollars and yen and owning lots of long dated government bonds, which in the event really helped you in the subsequent days. When the UK stock market was down 7% generally our portfolios were positive, so some of these decisions around political risk were really important through that period. So it's not robot running these portfolios. Yes we use a lot of quantitative tools and automation to help us, but actually it's people making these ultimate investment decisions.
Brexit
And you did a great job on Brexit actually, and I think you've actually put that on the website haven't you as an example of...
Yes I think it's a really live example, I think actually a lot of our clients were shocked, they thought that the world had ended and actually it hadn't, for a multi-asset portfolio when you're global not just in the UK, other assets, you can actually produce a really good result. That was a really good experience for our clients learning more about investing, particularly for the first-timers who hadn't experienced this sort of world, global view when you come to investing. But yes political risk is very important when you think about portfolio construction.
Asset Allocation Team and Advisory Group
I was fascinated to look at your asset allocation committee because it's something I've sat a lot, I mean I've been on many asset allocation committees in the past because previously I was a strategist in asset allocation, so the actual people that sit on that committee were fascinating, a very broad range of backgrounds. Is that a deliberate thing on your part?
Yes it is, so we have the team that runs the daily portfolios thinking about on a monthly basis well, how should we change our portfolios, or even on a daily basis, and then we have an advisory group that inputs into that, and say actually does the investment team have the right processes, are they thinking about the right things, can we give them a different view they should be reflecting on? And that's really important to come from a different view of the world, not pure financial market. Sometimes for the politics we talked about already, from economics and the worlds of tech as well, so we get a lot of input from the tech world who's very fascinating about how the world is changing. So it's really good to get different views and actually if you look across the Nutmeg office you see a lot of people haven't worked in financial services before, so they come with a different perspective, they come very much with a customer perspective rather than the traditional finance view which can be very, very different.
Group-think
It's odd isn't it? We all seem to live in this bubble. We all read the FT, we all look at Bloomberg. So it's very easy to get into that kind of group-think mentality isn't it?
Yes, definitely it is I think. But they come very much from a customer perspective, and they say, "Well why is it like this?" and essentially "well, it is, often". And actually it's very challenging for us, as investors and for financial people to think about "well, maybe this should be different".
Shaun's Broad Market View
So in terms of the way you see markets at the moment, I can't resist a market chat since I've got you here. One of the things which intrigued me is that you're going more overweight Emerging Markets. Now, just to explain, I think the Emerging Markets are generally seen as being more risky but when there's global growth they've got a high leverage to that growth. So is that the way you see the world at the moment?
It is. If you think about the last four years everyone's been obsessed about falling prices, about "deflation" as the industry calls it and looking for what people talk about quality companies with lots of dividend with a lot of income rather than very much about growth. Now we think, because global trade is improving, actually Chinese growth is quite okay but the U.S. is firing on all cylinders now employment's very strong, so we think it's a time to actually own more exposure to global trade improving, global growth, and that's where you want to own Emerging Markets. It's also where you want to own Japan stocks as well but particularly we think that Emerging Markets are more attractive at the moment but they're not necessarily very cheap but they're probably less expensive than some other areas like the US for example. So I think it's good to get that global exposure, actually Emerging Markets have become less volatile than they have in the past. Not to say that that's going to continue but I think it's right to have more exposure to this global pick-up in trade.
Volatility Crash and Risk Management
But do you think that volatility dampening is just because of this Trump Trade? Because we've seen volatility crash everywhere. I mean if you look at the U.S. volatility's below twelve percent I think in the US market it's been there for quite a while.
Actually in the Chinese "A-shares" market, mainland China, volatility is only ten percent and we've seen it at forty three percent before so there are some extraordinary things going on, so we never really focused just on the here and now when it comes to risk. Actually, if we look at our portfolios during really bad events, say for example the Asian Crisis, or other crises through the last twenty years, how would portfolios perform? You know, what's that bad month you're thinking about, not just its a low volatility environment now, but actually how bad could it get and how much diversification in your portfolio. So we own gold, which is relatively unusual for us, and it adds a bit of diversification, we also have some japanese yen in our portfolios. Its, as you know, classic kind of hedges as we would call it, but some defensive parts in the portfolio.
Currency risk and Brexit
Presumably we're about to trigger Brexit perhaps we've already done it, are you worried about the effect on sterling?
Yes we do think about currency very much as an active decision so maybe when we buy the US market, own the US market, think we own dollars as well. Often many private investors forget about the currency. Often the fund or the ETF is traded in sterling it's priced in sterling so you don't think you have any dollars but, absolutely, you have currency exposures. So we think about that very actively. At the moment it's been sort of obsessing in our decisions around currency. Well how much dollars should we own in portfolios at the moment? We think that sterling has a bit more weakness to come but we're getting close to the bottom even though the Brexit machinations are going to go on to for some time maybe beyond the two year horizon we've got coming up. So we think very much about currency as an active decision, as part and parcel of any other investment decision we make, so I think we're leading to a circumstance where we're probably looking to maybe hedge all of our foreign currency exposure. I can see us getting to that point perhaps in the next year, because it's going to be a very big risk for UK investors when they're owning overseas assets. Sterling could look very very cheap maybe twenty percent, thirty percent cheap if we get a good result on Brexit. "Soft Brexit" with access to the single market. So it's a really important decision one should think about now, at the moment.
That's interesting thirty percent upside for sterling... okay.
On a good result on Brexit, so that's very much the optimistic case, but it's certainly not factored into markets. I think there's not really any big positions being taken against the pound at the moment and if we move toward a closer IndieRef in Scotland then I think the pound could to take another leg down, but longer-term if we move to a softer exit, you know, continued EU market access for some period after two years then I think, you know, sterling could look very cheap.
Is US Equity Too Expensive?
Now the Trump Rally, I think it's something like thirteen to fifteen percent so far now, assuming that they cut their corporate taxes for companies that's going to provide some upside, how much of that do you think is already priced in, given that, you know, if you look at the Case-Shiller PE, or this valuation measure, over the long term its looking very expensive now.
The thing is the U.S. has looked expensive for some time. I think everyone said you shouldn't own the U.S. and actually the U.S. has continued to outperform, and we're really glad that we've had lots of U.S. stocks and ignored that narrative about the U.S. being expensive. I think it's expensive for a reason. There's a lot of growth in the US at the moment there is a lot of potential for the US to expand even margins from these levels I think, given how strong the US is. So we've actually taken some exposure out of small companies in the US, they probably ran too far ahead of the economic news, I think, and we've taken profits on our smaller companies in the US. Still got a big holding in the US, I think it's an important part of a global portfolio to own the US. But I think the direction of travel is for less US exposure than there is for more. We've enjoyed our performance in having lots of US for a time and one other part of that is looking at Emerging Markets, where is the next growth going to come from I think it's Emerging.
Frontier Markets
That's usually the stages stages in which it happens: we get the DM surge and then we get the the EM. Yes. And then if things last long enough without a crisis maybe Frontiers but that's a long way down the line.
I think it's a long way down the line. You need to speak about liquidity. Can you buy and sell for example Nigerian stocks very easily or Vietnam? That's a bit more problematic.
US High Yield Credit
So, talking about liquidity, high yield in the US looks like it's on fire it's just unbelievable, it's just rallied massively, something like 16% last year and it's looking pretty strong this year. Do you think that's got further to run?
Not mutch. I think it looks looks great, attractive, from a running yield perspective, it's got a good yield, more than 5% I think, if I remember right, but relative to investment-grade bonds looks very expensive so we'd almost rather own the edges, so own Treasury index-linked bonds so inflation linked bonds on one side and actually own equities on the other side, rather than own the hybrid that is high yield. Because it is still very much a risky asset it just looks very cheap, very stable at the moment. With oil prices falling high yield could have a bit of a bumpy few weeks.
Duration risk
That's true, and in terms of the duration argument? Because one of the things if you have very long duration bonds you're very exposed to interest rates flopping up and down, so the trouble with inflation-linked bonds is they tend to have a very long duration sometimes 20, 30 years. Is that a problem with having this inflation-linked exposure?
So it is a problem in the UK. So I think duration is 17 years in the UK market so you own a very long bond it's very volatile and can be very profitable but also you can get burned. But the real yield is so negative in the UK we think UK bonds are very strongly overvalued relative to other bonds so we're actually buying US inflation-linked bonds which have seen quite a big fall in price quite a big rise in real yields so we're happy owning the US bonds compared to the Gilts, so we've been selling some of our UK exposure towards index-linked securities in the US.
US Real Yield Upside
You think US real yields haven't got much further to run?
Nowhere near as much as the UK. I think the UK ones look very very expensive so we're happy to move some exposure. I think globally real yields are rising everywhere but it's nice to have some degree of inflation hedge. The UK bonds just look too expensive. Whether you're buying index-linked bonds or whether you're buying normal government bonds.
How does the Nutmeg Portfolio Simulator work?
One of the things I wanted to ask you about, because yesterday I actually put my money into one of your ISAs, and I had a fantastic experience, I mean the support was fantastic, I left a good review. One of the things I liked most about your on-boarding was the simulator. So at some point, you know, you go through your risk references but then it actually comes up with your Nutmeg pot it projects the value of that portfolio into the future but it doesn't just give you a single number, it doesn't say you'll get 20%, 30%, it gives you error-bars, which I've always been a big fan of, but it says, you know, there's a one in twenty chance that it'll actually go down by this amount, as well as a one in twenty chance it'll go up. So how does that work?
So we use quite conservative estimates of what we think future returns are. Not the 8% you could have got from equity markets in the last twenty years it's much much lower, it's closer to 6% even for the highest risk portfolios. We include fees as well because that needs to be realistic. So we've got quite simple, low assumptions of future capital returns from where we are now. So it's not just thinking that return will mirror the past we actually need to think about the future. And the future's going to be very low cash rates and lower asset class returns. So that's baked into our projections. We also think about how has this gone wrong in the past, so talk about those bands how bad could it be on a rolling basis for some of your portfolio returns. So we do show clients what could be your worst twelve months in this kind of strategy? What is a bad year with a strategy? So you kind of see it coming before it actually happens? It's really important to show customers what it could be like before they go to sign up and before they put money in because we need warn people that this can be a bumpy ride but also, through their investing experience with Nutmeg we need to coach them so, for example, when markets are very volatile we need to talk to customers more we need to get customers to come in and talk to our customer support we need to improve the education about what markets do. For instance, you know, a 20% fall in stock markets is actually a relatively normal, almost annual, event. And it can feel like the end of the world for a new investor even if they've got a lot of risk tolerance and they've got a long time frame for others. So, rather than people go "Oh, I've lost 10% this is time to finish, I didn't enjoy it" we need to bring people through that experience to see the other side.
AI for timing customer contact
It's interesting it's on your form when you actually sign up for this it says "Would you mind making a loss on your investments" and as I said no, I wouldn't mind, it made me think that actually, when it actually happens, you may not feel so peachy about the whole event.
Absolutely, so we use a lot of a data to predict behavior and say actually, based on your behavior, based on your risk profile, based on how markets perform this may be a good time that we should be contacting a customer saying "This is how the market's doing, if you want to talk to someone this is a good time to do it"
So you pro-actively contact customers?
We pro-actively use data so this is really the frontier where you go is actually how can you use data to inform people's experience of investing and how can you bring people through this journey to focus very much on goals so you'll see that the onboarding process is thinking is designed around what are your goals in investing? Some people just invest, some people it may be a house deposit which could be a short time frame or retirement. If you focus people on goals they're much more anchored to the goals and less sensitive to market volatility. So when markets are turbulent, think about why you're saving and one of the best ways to save is actually to increase the money you're putting into markets and to increase, to get to your goal earlier rather than relying all on market returns, so the more you anchor to goals the less people are sensitive to market volatility.
Reason for fixed allocation portfolios
Well that's an interesting way of putting it, and I love the fact that you could actually tailor your message according to, according to what you know about customers. Now I think you were one of the driving forces behind moving from a fully managed offering which is I think it's about 0.75% per year if you've got less than £100,000 to the fixed allocation portfolios which are about 0.45% per year, so what was the thinking behind that?
The primary reason is we're talking to customers about portfolio management. I have a lot of interaction with customers both through our customer support and also interaction with customer groups and meeting customers. What what do they want us to do, and what's really interesting to them? There is a definitive, a definite part of our customer base that likes the idea that no one's touching anything. That no tinkering would be the way to expense it. So all you do is just re-balance the portfolio? Yes, so we build portfolios that I'd be very happy to put in a box for five years or maybe ten years and open the box and actually this is still good portfolio. So it's a lot of core asset classes in it, it's got holdings that we're prepared to carry forward over five years, it's things that we think are good through economic cycles, so for example gold's not in the portfolios because I don't think it's a really good buy and hold asset. Really well constructed around risk, very solidly built, and they're just set to travel with markets. If they get too far out of line with risk it's automatically rebalanced back into those fixed allocations. So for some investors, particularly experienced investors that's exactly what they want. Whereas other investors really do like the idea that me and the rest of my team are actually thinking about portfolios, thinking about Brexit, thinking about the French, the Dutch elections
We want to make sure you don't sleep!
Exactly! Work harder. So people do like the idea that we are on and reacting to market events, reacting to political events thinking about how the future could change compared to the past, so it's very much a different stylistic way of investing I think both approaches have their merits obviously as the person managing a portfolio I would say that managed is better but they're both designed to be amazingly amazingly good portfolios and very low-cost, the fund's we're using are super low cost and we like to get those costs down. But given that there's less interventions with the fixed portfolios they are charged at a lower rate because there's no human involved in that day to day.
Demographics and long-term asset returns
Okay, so final question for you about demographics now a lot of people have been talking about people aging well in China as well nowadays, but basically in developed markets such as the UK. Do you think that's going to have an effect on long-term returns of asset classes and is it something you think about?
It's something we think about, we worry about really I think, people's expectations of what can be achieved very much placed on the past and 8% return is very unlikely in the future. So that's something we do think about. Bear in mind there could be other sources of return coming up in different demographics of different markets and different asset classes so returns could improve, it's not necessarily a one-way street but we know the surest way to improve your return is to get your costs down so we do focus very much about getting our fund costs down, having a really good competitive management fee for us, thinking about technology that could potentially lower the cost of investing coming down. Talking to product providers to get the best possible product we can for investors to get fund costs really low. There's two sides of the coin: improving returns and also reducing costs as well. So I think we have a strong emphasis on trying to get that cost down as well.