My attention this morning was drawn to an article in FT Adviser, Multi-asset pledge ‘should set off alarm bells. “Investors should be wary of multi-asset funds promising 5 per cent income that could be taking a “gamble” with capital, experts warn” says the piece.
I can’t speak for all funds seeking to deliver a 5% yield but I can speak for ours. We have done extensive modelling on our VT Seneca Diversified Income Fund and we believe we can deliver this yield without putting real capital at risk over the longer term (I would agree that one cannot seek to protect capital over the short term, markets don’t work that way).
In order to achieve our investment performance objective, we need to deliver a gross total real return of just shy of 7% per annum over the longer term. After costs, this would come down to closer to 5%, which would be split between income of 5% and real capital of 0%.
So, the question then becomes, how do we deliver a gross total real return of 7%? The answer is that it comes from a combination of strategic asset allocation plus value added from tactical asset allocation and security/fund selection.
We think we will get around 4.5% from strategic asset allocation without taking undue risk. Our strategic asset allocation to equities is fairly low at 42.5% (our fund sits in the IA 20-60% Shares sector) and we think equities will deliver us around 6% real, in line with long-term historic averages.
Adding in bonds and specialists, which we think will provide 2% and 5% real over the long term, and you get to a total of around 4.5% (our strategic asset allocations to bonds and specialists are 32.5% and 25% respectively).
As for value added, we are looking to add 2.5 percentage points per annum from tactical asset allocation and security/fund selection. Whether we can do this depends on two things.
First, is the ex ante tracking error of our fund in relation to its strategic asset allocation giving it the potential to produce 2.5 percentage points of value added? Our risk models tell us that the answer to this question is ‘yes’.
Second, do we have an investment process that is able to deliver this potential? Again, the work we have done tells us that the answer to this question too is ‘yes’. Our tactical asset allocation process draws on well-regarded academic work that finds strong links between yields of equities and bonds and future returns.
Within UK equities, where we invest directly, we focus on mid-caps where there are higher systematic returns as well as greater stock picking opportunities that exist because of thinner broker research coverage. We also think that we’re able to spot third party managers of overseas equities funds who have strong, value oriented approaches that produce good returns over time.
So, while we would agree there may be funds out there promising 5% that don’t know what they’re doing, ours does.
Past performance is not a guide to future returns. The views expressed are those of Peter Elston at the time of writing and are subject to change without notice. They are not necessarily the views of Seneca Investment Managers and do not constitute investment advice. Whilst Seneca Investment Managers has used all reasonable efforts to ensure the accuracy of the information contained in this communication, we cannot guarantee the reliability, completeness or accuracy of the content.
Estimates of yields and long-term real returns are Seneca Investment Managers’ estimates. These estimates are derived from various third party sources, as well as the knowledge and experience of Seneca’s investment team. They are intended to be conservative, representing what Seneca hopes to achieve from each asset class in the way of income and capital return. Importantly, there is no guarantee that actual yields and real returns realised will be similar to or exceed these estimates.
Before investing in the VT Seneca Diversified Income Fund you should read the key investor information document (KIID) as it contains important information regarding the fund, including charges, tax and fund specific risk warnings and will form the basis of any investment.
The prospectus, KIID and application forms are available from Link Fund Solutions, the Authorised Corporate Director of the Fund (0345 608 1497). Seneca Investment Managers Limited, the Investment Manager of the Fund (0151 906 2450) is authorised and regulated by the Financial Conduct Authority and is registered in England No. 4325961 with its registered office at 10th Floor, Horton House, Exchange Flags, Liverpool, L2 3YL. . FP15/102.