Why this fund is perfect for these market conditions

In the first of a two-part series, Andrew Craig, author, investment manager and founder of Plain English Finance, explains why his VT PEF Global Multi-asset fund excels in volatile market conditions.

Here is part one of a transcript of a podcast recorded on Monday 10 December 2018 by interactive investor's Lee Wild and author, investment manager and founder of Plain English Finance Andrew Craig.

The podcast itself can be accessed either via the audio file embedded below or link at the bottom of this page.

Lee Wild, head of equity strategy at interactive investor:

Here with me today, I have Andy Craig, author, investment manager and founder of Plain English Finance. With his VT Plain English Finance Global Multi-Asset Fund up and running for a full year now, we thought it was a great time to find out how things have gone. 

Could you give us a brief potted history of Plain English Finance and how it came to be? Who is behind it?

Andrew Craig, author, investment manager and founder of Plain English Finance:

I've been in the city for about 20 years, and in 2010 I quit my then job as a stockbroker selling equities.

And I had this idea that I was going to start up a website that just gave lots of free information to people about finance, because I just perceived that something that's been born out of financial literacy is really bad. And we all, kind of, know that but it's worse even than we do know. So even people with pretty sophisticated jobs as accountants or lawyers or, you know, whatever else who you'd think might understand finance ... actually when it comes to the nuts and bolts of what  is a SIPP is, what an ISA is or how should I invest in the world? ... fall down and really don't, you know ... the general understanding of stockmarkets or financial markets in the general population is really poor.

So I had this idea to just produce a website, and I started this website called plainenglishfinance.com in 2010. After I'd written about something like 100,000 words on the website, being really naive about how people interact with websites, actually my cousin said to me, "You know, nobody wants to read 3,000 words on a website and then click to the next page to read another 3,000 words, so why don't you turn this into a book?"

So that became a book called, "How to own the world", and it was published in 2012, and randomly suddenly we had 50 five-star reviews on Amazon and it started selling lots of copies.

And so that then morphed ... it's been a kind of demand pull rather than a supply push story since then, because basically the book is now usually in the top one, two or three books on personal finance in the UK, and a third edition is coming out in March of next year with Hodder and Stoughton. 

Lots of people got in touch and happily a couple of those people were two professors at the Cass Business School, Professor Stephen Thomas and Andrew Clare. It's a bit of a longer story and it's a bit more complicated than that but by virtue of being able to work with them, and they're pre-eminent in trend following academically. They've written an awful lot of research on trend following and how it works and how it can be applied, and so what they don't know about trend following isn't worth knowing.

My whole thesis or shtick if you like is that basically there's a 200-year track record, but if you own all the major asset classes, so not just shares and not just bonds or not just gold or property or cash, but basically if you own all of them and you own them in all of the major regions of the world. So that basically means nowadays Asia, the US, Europe and I include the UK in that for now, despite what's happening tomorrow. If you own all assets in all areas of the world, you bang out consistent high single-digit, low double-digit returns. 

And so that's the whole thesis. That's why the book's called "How to own the world". If you can achieve that and add that to Einstein's eighth wonder of the world, compound interest, over a lifetime of investing in a really defensive way, high single-digit, low double-digit returns, but protecting the downside, you can achieve really big numbers. 

And so that's what my book's about, and happily by dint of meeting those two professors and a few other folk along the way, we were able just over year ago to launch our own investment fund that, kind of, incorporates all of those ideas. 

It's a small fund ... we've only got £11 million in at the moment, but these things, as you probably know, take time in attracting investment into funds. You need to establish yourself with a track record, so we've now got a one-year track record, and here we are. 

Lee Wild:

Could you tell me a bit more about the fund's objectives?

Andrew Craig:

Yes, so as outlined hopefully to a certain extent in the mouthful of a name ... by the way the name ... we wanted to call it the Own the World Fund but the Financial Conducts Authority said that that was misleading, so it's not really... it's a bit of a ridiculous name, but it does what it says on the tin. 

Strictly, if you look at the fund prospectus document, it says, "Medium term capital appreciation with significant downside protection." So, in a nutshell, what we're trying to do is invest globally, have a trend following overload, and by virtue of that, really, really peg the downside. 

The 17-year back tested numbers that we've done are producing 7.52% annualised numbers which over time ... in four years they were 20% or more, but very, very importantly only three years that were negative, one of which was 2008. That was only -6.6%. 

Lee Wild:

The question that investors will ask is, "How do you do it?" There are a couple of key investment techniques - true diversification and formula based trend following - that you use those to achieve the fund's goals. Could you just explain a bit more about those two ideas?

Andrew Craig:

The richest and smartest people in the world for many, many years basically owned all assets in all geographies. In 2007 through 2009, the S&P 500 halved, the FTSE 100 halved. 

Lots of stockmarkets did worse than halve, emerging markets and so on and so forth. Very, very painful but gold went up 19.5 % in 2009 in dollar terms and in 2008, oil hit an all-time high. Sometimes Japan is a fantastic place to be, sometimes China is great, sometimes LatAm is great, sometimes hard assets like gold are great, and sometimes equity is the place to be.

So the insight really is that rather than try to work out which one is going to win, if you just own all of them, which we call owning the world, that's your true diversification. 

Now my parents or grandparents couldn't invest like that. If you were the Rothschild family in 1850, you could. If you were a Harvard University in 1950, you could. But if you were a normal person you couldn't until about 2000, when inexpensive ETFs and cheap B trade accounts. People today can invest this way, but there is still a slight missing piece of the jigsaw, because if you do that you will still have years like 2008 where it's carnage, because basically everything falls at the same time. 

So, happily, by meeting the professors, what they lay on top of that was work they've done that goes back to 1872. They've basically gone back as far as they can with each of the main asset classes, and the S&P is since 1872 so they've done that analysis for S&P. 

But if you put on basic trend following, so for people listening who perhaps don't know what that is, it's actually this idea that humans are a herd. We have a pack mentality. So why does trend following work? 

All trend following does is look at the direction the market has been going in over a certain amount of time, and if the price today is above the average price looking back, however many times ... if it was 200 days or you could even look back 10 years. Some high-speed FX traders look back 10 minutes and compare the price this minute or probably more like an hour, but if you compare today's price to an average over the last however many time periods, and it's above it, probabilistically the likelihood is the price will carry on going up. And equally if the average price is now below that moving average, the probability is the price goes down. 

Now our insight and the professors' work says that the best way to use that kind of technique that consistently works over decades, and they've got decades' worth of evidence, dare I say centuries, is to take basically a long time period and only trade once a month. 

So we're very much the tortoise of investment not the hare. We're not a super smart hedge fund doing hundreds and thousands of trades every day based on what happened in the last 10 minutes. We're basically looking back almost a whole year essentially and saying, and we're doing it ... so the multi-asset bit is we started with 97 assets that represent the whole world, and the professors did all this work ... whittled down to the 80:20 rule - you get 80% of your results from 20% of the effort. 

And obviously we don't want to run a fund with 97 assets because that's extremely time consuming, expensive and pretty difficult to do. So where was, if you like, the Goldilocks place where we had all of the upside and protection of diversification but without all that hassle? And we found it was 24 and those 24 - most people who know anything about investment could basically tell us what those 24 are, just shooting from the hip.

So the FTSE, the S&P, the Nikkei, gold, energy commodities, bonds, etc, a bit of real estate, a bit of infrastructure. So that's the diversification and then on each of those 24 silos we run a very, very simple trend following methodology so that when things start falling, we should very slowly and carefully like a tortoise come out of each of them discretely and into cash.

Lee Wild:
The fund was launched in September 17. How has it performed versus peers and the benchmark? Are you happy with the outcome? It's been a very odd 12 months, very volatile in the market, more so over the past couple of months and weeks. 

Andrew Craig:

We're very happy if the fund protects downside in times like this, which is the tortoise. It's boring, it's unimpressive but it doesn't fall 40% like an S&P 500 tracker would do in a year like 2008. And then what we hope is that in years where there's a real, discernable trend like it's 2009/10 coming out of the big crash, our indicators will get us into the necessary things and we'll have big up years. 

So since launch, markets have very much been ranging not trending. So what we've had to endure is those 24 assets, there's nothing that's really powered ahead apart from the S&P which happily we're still long, but that's only one of 24 of our silos, so we're down I think in absolute terms, we're basically down 4.5% since launch. 

Interestingly relative to ... let's take the FTSE All-Share ... we're basically in line so if you look at our fund three months after launch versus the All-Share ... I've got them somewhere here but we were ... at three months, six months, nine months and 12 months, we were either slightly ahead or slightly behind them, and we're now basically level. But the key point here is that in that time, we've been significantly less volatile than the FTSE All-Share. 

So the way our fund is designed is, if there is a big crash, whenever that comes ... 30, 40, 50% over a 12, 18 months period as is the record of 2000, 2001, 2007, 2009 ... we hope we're still -4% not -40%, and then when the bounce comes we'll be back here.

The record of the back testing is that in 2008/09 ... through 2008 when the crash was happening and the fund strategy went more than 90% cash, and then as the recovery came, it was 45% equities within only two or three months. So all the signals worked to go back in, and so the full year performance in year nine was 21.4% or thereabouts, and so I'm very hopeful that's what we're doing.

It's been very boring so far, and obviously am I delighted? No, I wish we were in a really discerningly trending year and we up 12, 14, 16 on absolute terms, but as long as it does what was said on the tin. So it pegs the downside as best we can, and catches upside when the time comes, then basically yes, I'll be happy. And I hope that happens in the next couple of years.

Lee Wild:
You talk about sales signals, and the portfolio is generating more sales signals currently across most equity regions, but interestingly not the US. What's your view on the US market?

Andrew Craig:

It's not informed by humans ... it's entirely systematic, entirely rules based. 

So yes, we're still long on S&P and we're not long Europe, Japan, Asia Pacific ex Japan, or UK. We're out of all of those developed markets. We're out of all emerging markets equities, but we are still on the S&P. Why are we still on the S&P? Because the S&P is still trending beautifully up.

And we can all argue about valuation ratios and is that sustainable and all that good stuff, but we really park that thought process at the door and we just slavishly follow, you know ... and our hope is and the evidence of decades of back testing not just three years of track record, but decades of back testing is that by doing that, as I say:

"You peg the downside and capture the upsides."

So the signals tell us not to be in a lot of developed market equities and we pay attention to them and we listen to them, so actually at the moment, I said we were 90% cash when things went horrible in 08. Now, 13 of 24 silos are in cash, which will give you an idea. So the red light, green light traffic light is very indicative of the fact that times are tricky for financial markets.

Lee Wild:
You use ETFs to keep costs down, but how does the portfolio work in a falling market when passives might underperform active managers?

Andrew Craig:

"We're really agnostic as to active versus passive."

I think we might describe ourselves without wanting to sound big-headed as clever passive. So we're using inexpensive passive investments, but there's moving averages and the trend following overlay is a kind of active on top of that.

But what is most important to us is protecting the downside, because of the breakeven fallacy. If you lose 50%, you need to make 100% to get back to scratch. It's actually for most people psychologically better to make 8.5, 10, 7.5% per annum consistently and never fall more than six, seven, eight, nine, 10% than it is to go back to that small cap example, even if you get the same result over 20 years of being up 60 and down 40 and up 30, psychologically you're far more likely to stick to your guns and own something.

To find out more about breakeven fallacy, sequencing and compounding, click here to read the article or here to listen to the podcast.