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Boutique CIO attacks ETFs, defensive stocks and liquidity levels

Boutique CIO attacks ETFs, defensive stocks and liquidity levels

The scale of the flows into ETFs should have investors seriously worried, and hiding in so-called defensive stocks is a lazy and complacent way to combat a genuine market threat.

That is the view of James de Uphaugh, chief investment officer of independent group Majedie Asset Management.

In a strongly-worded statement on the company’s website, de Uphaugh said his firm is ‘swimming against the tide’ given the rising volume of passive players in the market. He voiced the concern that a sudden shift could wreak havoc in markets.

‘ETF liquidity is something you need to think about. There have been several articles lately about the fact that some big market makers in the ETF space, big global banks, have been stepping back. Why are they doing that? Perhaps the risk of regulatory blow-back in the event of a dislocated market is too high.

‘What happens when this flow reverses, which we think it will start to do in 2018? The ETF space in its current form is untested. We see fragility. And accordingly, we continue to avoid stocks which are potentially vulnerable.’

Bigger fish to fry

De Uphaugh, who said market prices are inflated at present, said it is not just the ETF impact which is forcing him and his fund managers onto a cautious footing. He cited an aging economic cycle and fears of central bank policies abruptly changing course.

‘What are the implications for financial assets if interest rates have to rise quickly? In six years in the 1960s UK inflation went from 1.5% to 27%. No one in the market expects that to ever happen again. But what if inflation surprises on the upside? What does that mean for portfolios?

‘We have been frustrated by the performance over the past six months but believe that there is an air of complacency to the current market zeitgeist. We are trying to ensure our clients’ capital is invested in areas where we see a buffer, whether that be in a low valuation or low expectations.’

De Uphaugh said the idea of using defensive stocks to fend off uncertainty is short-sighted. ‘The term defensive is lazily thrown around. What is defensive? The classic defensive areas of the market – think tobacco, consumer staples and healthcare – are no longer cheap. And many of them also have deep structural issues.

‘In the context of tobacco, an invigorated food and drug administration; in the context of staples, a broken media link with customers and the rise of fashionable, cheaper competition. Pharmaceutical companies also face pricing pressure, in addition to pushing some accounting practices.

‘There is nothing that carries greater risk than being invested in something that is thought to be safe, or boring, or defensive – but isn’t.’

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