Richard Buxton: why the bond proxy trade is dead

richard-buxton-old-mutual-headshot

It hasn't been plain sailing for star investor Richard Buxton since he jumped ship from Schroders to join rival Old Mutual in the summer of 2013.

While Buxton, the head of the UK equities desk, landed himself a promotion to chief executive two years on from joining, fund performance has come off the boil. Buxton, who has retained his fund management responsibilities, insists, however, that 'investment remains my first passion and priority'.

Fund performance since Buxton swapped ships has been more middling than miraculous. The feted manager, popular with both do-it-yourself investors and financial advisers, attracted an army of admirers after steering the Schroder UK Alpha Plus fund to the top of the fund charts.

Between June 2002 and the end of May 2013 the fund returned 250 per cent, more than double the average fund return of 110 per cent in the Investment Association's UK all companies sector.

INEVITABLE ROUGH PATCHES

However, the Old Mutual UK Alpha fund, which Burton was running on a third-party basis from December 2009 while at Schroders, has slipped behind rivals over the past three years, returning 10.2 per cent against 16.1 per cent for the sector, according to FE Trustnet.

Additionally, the FTSE 100 index, which is Buxton's main hunting territory, has beaten the fund by 8 per cent since January 2014. On a one-year view, too, the index has gained an edge, up 26.1 per cent versus Buxton's fund return of 21.1 per cent, as at 23 January.

old-mutual-uk-alpha-five-year-performance

This performance blip will be music to the ears of the growing number of investors turning their backs on active management; 13.2 per cent of UK retail investors' money is held in tracker funds, a considerable jump from the figure of 6.7 per cent a decade ago, before the financial crisis struck.

But in Buxton's case a rough patch is understandable, as his preference for cyclical stocks over defensives means performance will go through hot and cold periods, as these companies are more affected by ups and downs in the overall economy.

The manager is refreshingly honest in agreeing that his performance has disappointed over the past three years.

'We sold the bond proxy names, the likes of Unilever and Reed Elsevier, in 2015. With the benefit of hindsight, this was a year too soon. I have instead been in undervalued areas such as financials, which have faced various headwinds.'

Bond proxies: time to buy

Central bankers' 'silly monetary policies' have gone too far in terms of distorting markets by 'throwing valuations out of the window', he adds.

He also holds his hands up in admitting he made the wrong call on Brexit and that fund performance suffered as a result. Some of his stock-specific bets also failed to pay off.

SEA CHANGE

However, a 'sea change' started to play out in the second half of 2016, with bond yields rising from their record lows in anticipation of higher inflation. Buxton is rubbing his hands at the prospect of a new era of reflation borne out of fiscal policy.

'The fund underperformed by 10 per cent in the first six months of 2016, but then outperformed in the second half of the year by 8 per cent. I believe we are at a turning point: the bond bull market is now over and the fear of deflation is also now off the table.

'Over time I expect both bond yields and interest rates to rise, and in response markets will function in a much more conventional fashion, focusing on fundamentals such as valuations.'

However, Buxton adds the caveat that the positive run enjoyed by markets since the US presidential election last November relies heavily on Donald Trump's pledged tax cuts and spending sprees bearing fruit. 'A market correction may well play out in the second half of the year,' he warns.

'Markets are going up in the hope that Trump's policies will be signed off, but there is always a danger when markets are travelling higher that they melt-up in euphoria'.

'Trump rally' will fade, but this will create buying opportunities

Buxton expects the UK economy to 'plod along quite steadily' until the country formally leaves the EU in 2019. He says: 'From then onwards, who knows? But there's a risk the economy, like the cartoon character Road Runner, could run off a cliff.'

So where is Buxton finding value at the moment? Of the 36 names held in the portfolio, which the manager typically holds for three to five years (longer in some cases), financials and commodity-related stocks are well represented.

'I look to buy companies that have strong business models, healthy balance sheets and unrecognised potential, reflected by cheap valuations,' he says.

'Today, several years on from the financial crisis, banks have become much more stable businesses in holding higher levels of capital, yet they are still ludicrously undervalued.

'Over time the sector will deliver stable dividend streams and will also benefit whenever interest rates finally go higher, although Bank of England governor Mark Carney seems to not want this to happen under his watch.'

INFLATION SHOCK A POSSIBILITY

Nonetheless, Buxton thinks Carney may have to step in if the weak pound falls too far and inflation shocks on the high side. Broadly speaking, over the next couple of years he expects rates in the UK to follow the direction of those in the US.

As a result, he has moved to sell housebuilder Taylor Wimpey, held for five years. 'I am selling a bit too early, but I did buy the shares early too and made good money.'

old-mutual-uk-alpha-top-ten-holdingsElsewhere, he is maintaining his positions in the two oil majors, BP and Royal Dutch Shell, as he expects oil prices gradually to move higher. He is also keeping faith with two troubled domestically focused shares, Next and Tesco.

Dealing first with the former, he says: 'The company is no longer ahead of the pack in terms of online sales and needs to revamp its website, and it also needs to get up to speed with mobile. But I like the management team and also the fact that Next is a huge cash-generative machine.'

In stark contrast, Tesco has plenty of debt on its balance sheet, so investors shouldn't expect the firm to reinstate its dividend anytime soon. Buxton is confident, however, that the management team's turnaround is starting to pay off.

'Tesco is going back to basics, focusing on what it does best. It will take a couple more years for it to get to where it would like to be, but I think the business will become much more profitable than it is today.'

Recent portfolio activity includes two new purchases, Smith & Nephew, the UK's biggest orthopaedics company, and a Trump-inspired infrastructure play, CRH, an international supplier of building materials. Areas he is avoiding include the bond proxy tobacco and consumer staples sectors.

He says: 'These [latter] shares are vastly overpriced and will suffer as bond yields shift higher.

'Investors in this part of the market, such as Fundsmith's Terry Smith, will say these businesses are the survivors, and I have no issue with that: they are great businesses, and at some point there will be an opportunity to go back in.

'But I think there's going to be a reversal of the cash going into these quality names as we enter a more normal environment with a steeper yield curve.'

Does inflation on the rise make Fundsmith Equity a 'buy'?

Looking ahead, Buxton is energised by the end of unconventional monetary policy, and is determined to keep his star fund manager status shining bright.

He says the recent growth of passives should be viewed as an opportunity for active fund managers to prove their worth and 'add value'. If his long-term track record is anything to go by, it is a challenge Buxton should pass with flying colours.

Richard Buxton: the FCA is 'definitely pro-passive'

BUXTON IN SIX

My best investment was...

Reuters. I bought in 2000 and then sold in 2008, when the company was acquired by Thomson Corporation. I made 10 times investors' money.

I had been attracted to the stock because it was so out of favour at the time, falling behind its nearest competitor, Bloomberg. I bought thinking it was the classic case of a cyclical stock at the low point in its cycle.

The one share I regret buying is...

There have been some near-99 per cent wipeouts, but investing in cash shells is where I have been burnt a couple of times.

One was a mining vehicle co-founded by London financier Nat Rothschild that ended being renamed Bumi.

Alternative career would have been...

Something academic, related to English. I have a degree in English language and literature from Oxford University.

In my spare time I like to...

Cook. I find it relaxing and like the fact that the results are more or less instantaneous. Signature dish? That would probably have to be my salmon en croute.

The one thing I would like to see change in financial services is...

Given our ageing demographic and the fact that millions of people in the UK have no pension savings at all, I would welcome the introduction of compulsory pension savings at source, similar to the system in place in Australia, where pension scheme opt-outs are not allowed.

Do you invest personally in the fund you manage?

Aside from my Old Mutual shares, all my personal investments are in the Old Mutual UK Alpha fund. I do not own individual stocks separately, as I want to ensure I am completely aligned with investors.


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