The latest rebalance of the FE fundinfo Crown Ratings have seen 16 new funds wine the highest rating at their first time of asking while strategies using environmental, social and governance (ESG) investing have come out well.

The FE fundinfo Crown Ratings are designed to help investors to distinguish between funds that have strongly outperformed their benchmark over the past three years and those that have not. Rebalanced in January and July, they take into account three key measurements of a fund’s performance: alpha, volatility and consistently strong performance.

The top 10 per cent of funds are awarded five FE fundinfo Crowns, the next 15 per cent receive four Crowns and each of the remaining three quartiles are given three, two and one Crown(s) respectively.

FE fundinfo’s analysts have just rebalanced the rating to include the second half of 2020, when markets continued their rally from the coronavirus pandemic.

During this time, some 85 funds hit their three-year anniversary and became eligible for an FE fundinfo Crown Ratings. Of these, 16 were handed the top rating of five – which can be seen below.

Source: FE fundinfo

Charles Younes, research manager at FE Investments, highlighted LF Blue Whale Growth as a fund that is “definitely one to keep an eye on”. Since launch in September 2017, the fund has made a top-decile 78.79 per cent total return, compared with 42.65 per cent from its average IA Global peer.

Younes added: “The manager, Stephen Yiu, along with his deputy Daniel Allcock, have adopted a similar successful approach to Terry Smith and performed admirably, returning more than 17 per cent over the past year in very challenging conditions."

Terry Smith, one of the best-known investors in the business, also has a fund receiving five crowns in its first rating: Fundsmith Sustainable Equity. This joins his flagship Fundsmith Equity fund in holding the top rating.

The inclusion of this fund highlights another trend seen in this rebalance of the ratings – the strong performance of ESG strategies.

While the coronavirus crisis of 2020 put some sectors under intense pressure, especially the likes of energy, travel and hospitality, others prospered.

ESG investing hit the mainstream in 2020 and ethical/sustainable funds were some of the best performers in the Investment Association universe and this was reflected in the crown rebalance.

Almost one-fifth of all the ethical and sustainable funds that were eligible for a rating were awarded five crowns. They now account for 8.44 per cent of all five-crown rated funds, despite ethical and sustainable funds comprising just 5.04 per cent of the total 3,255 funds that were considered.

Oliver Clarke Williams, portfolio manager at FE Investments, said: “There is no doubt that ESG investing has really taken off in the past year. While global lockdowns have had a huge impact on markets and traditional stocks have suffered, ESG funds have seen record inflows and increasing investor attention.

“Their success is reflected in our latest crowns rebalance, where they now make up a significant proportion of the best performing funds. We expect this trend to continue in 2021 with new regulations coming into play, meaning funds will have to be more transparent with their ESG disclosures. Fund groups will increasingly direct their efforts and resources into making their investments more sustainable in the long term.”

Across the entire rebalance, 72.6 per cent of funds saw no change in their FE fundinfo Crown rating, while 23.6 per cent were promoted or demoted by just one crown.

There were few extreme moves – only two funds jumped from one crown to five (Aberdeen Standard SICAV I Global Innovation Equity and NB Corporate Hybrid Bond) and nine funds dropped from five crowns to one.

When it comes to the individual peer groups, the strong performance of US equities throughout 2020 means the IA North American Smaller Companies sector has the highest concentration of five-crown funds. Some 29.4 per cent of its members won a top rating, followed by IA UK Index Linked Gilts (28.6 per cent) and IA Europe Including UK (26.7 per cent).

Source: FE fundinfo

As the chart above shows, the heavy dividend cuts of 2020 meant income-focused funds suffered with just 2 per cent of IA Global Equity Income and 2.4 per cent of IA UK Equity Income funds holding five crowns.

But as can be seen, there are four sectors were not a single member was awarded the top rating.

FE Investments’ Younes said: “2020 was for many a year of home-working, which brought about rapid change within the markets and clearly defined the winners and losers in the new Covid-19 environment. Funds invested in technology stocks reaped the benefits, while those in traditional sectors such as energy and financial services not only suffered from the great sell-off in March last year, but also failed to capture the upside.

“Looking forward and with the prospect of huge stimulus packages being delivered at policy level, we can expect to see those funds with positions in infrastructure and technology to continue to perform well, while the recovery for traditional stocks will continue to lag.”

Numerous asset bubbles will start to deflate in 2021, as money is siphoned away from financial markets towards the “real” economy.

This is according to Gary Potter (pictured), co-head of the multi-manager team at BMO Global Asset Management.

Last year saw numerous assets rocket in value, despite little change in their fundamentals; for example, Bitcoin rose by 164 per cent and Tesla was up 750 per cent. Potter warned there seems to be a belief in markets that “trees grow to the sky forever”.

“Well, they don’t,” he said. “Sometimes they exceed what you think they will do, but I’ve been around for nearly 40 years and eventually things fall.

“This is the biggest issue that all of us face in the marketplace: the belief that trends that have been established in the last two or three years are going to carry on.

“Speculation is bubbling away quite meaningfully and we think that is on the change.”

Anthony Willis, an investment manager in BMO’s multi-manager team, noted that Tesla’s current market cap of $805bn implies a value of $1.6m for every one of the 500,000 cars it sold last year. If a similar valuation metric was applied to Volkswagen, which sold 11 million cars last year, that stock would be worth $17.7trn.

As a growth stock, the case for investing in Tesla rests on the potential for future sales and although it only sold 500,000 cars in 2020, chief executive Elon Musk expects this to rise to 20 million by 2030.

Although Potter does not want to take a view on whether Tesla can fulfil its potential, he said its P/E (price-to-earnings multiple) of 1,300 is an example of the excessive valuations that can be seen in markets.

“Quite frankly, I want to be around to get my money back when I buy a stock or a fund and we’re much more comfortable buying funds or stocks on P/E multiples of 10 or 12,” he continued.

“If you examine a P/E multiple of 10, what it is basically saying is the price that you paid, if you call it a pound and if the company is earning 10 pence in a particular year, you have to wait 10 years to effectively get your money back in terms of the share price that you’ve paid.

“Whenever I talk about P/Es of 10 to 12, that means that I might actually have a chance of seeing my money back in the price I paid for the company’s earnings. There is another 1,000 or 900 years before I am ever going to see my money back in the earnings profile of Tesla, so there’s an awful lot of expectation built into some stocks which we think could actually falter.”

Value managers such as Potter have been calling growth stocks expensive for many years, yet the outperformance of these assets has continued to accelerate over the rest of the market.

However, he believes the fallout from the coronavirus crisis helped push many growth assets into speculative territory – and a normalisation of conditions could be all it takes to burst the bubble.

“Quite simply put, the more the real economy grows, the more that liquidity gets syphoned away from alternative homes, so it gets syphoned away from financial assets, and vice versa,” he said.

“When Covid struck and the economy hit a brick wall, the money that was destined for the economy went into financial assets and particularly things like Tesla and Bitcoin.

“As investors turned to financial assets, they chased momentum, they bought low-cost index funds and that became a self-fulfilling prophecy. Tesla went into the index and more people bought Tesla because they were being given money by the government.”

Kelly Prior, another fund manager on BMO’s multi-manager team, noted that the average gain of the largest 50 stocks between the announcement of their inclusion on the S&P 500 and their actual entrance into the index is 3 per cent. Facebook, the previous record holder, went up by 14 per cent. But Tesla rose by 70 per cent.

“They punted on the stock market because the economy was on its knees,” Potter continued. “That is most likely to change as we go through 2021. And it is quite possible that as the economic traction gets firmer post-vaccine, post-Easter, we start to see financial asset performance become a bit more of a challenge because the money might start to be diverted towards the real economy recovery.”

And the manager said that you do not need to look too far into the past for an example of where a similar scenario unfolded.

“If you think back, the US economy strengthened meaningfully in 2018, spurred by supply-side tax cuts passed at the end of 2017,” he added.

“Then what happened was the average equity market performance in mainstream terms fell about 10 per cent, because money was diverted away from financial assets into the real economy. And then of course, the Fed then tightened.

“The whole process was reversed in 2019 as the Fed eased long-term interest rates. In 2019, after a very difficult 2018, the market did very well; in fact, far better than it should have done, because liquidity went from the real economy into financial assets.

“Then in 2020, Covid struck.”

However, this does not mean Potter is pessimistic on the outlook for markets this year. In a previous article on Trustnet, he said the “starting pistol” in a value rally may have already been fired.

Performance of manager vs peers over 10yrs

Source: FE Analytics

Data from FE Analytics shows Potter has made 65.01 per cent for investors over the past decade, compared with 72.55 per cent from his peer group composite.

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Policy uncertainty, in and of itself, is negative for economic growth, and in this sense the Brexit deal should be positive. However, even a free trade agreement imparts significant short-term economic costs (and most likely long-term too), and remains an item in a list of reasons why the UK may emerge from the Covid-recession as an economic laggard.

Non-tariff barriers to trade

It has been much repeated that the new trade deal with the EU avoids the imposition of tariffs. This is good news. Economic research teams at Citi, Oxford Economics or Capital Economics concluded that “no deal” would have seen 0.5-2.0 percentage points less GDP growth by the end of 2022 relative to what it might be under the trade deal.

Over the long-term, however, non-tariff barriers (NTBs) are likely to exert by far the greater cost and the trade deal doesn’t negate these. The Bank of England expected around 80 per cent of the total reduction in trade as a result of “no deal” to be attributed to NTBs. The Cabinet Office recently estimated the cost to UK companies of filling out customs declarations alone, for example, could come to £7bn.

There is some good news. An annex on medicinal products sets out an agreement on mutual recognition of inspections and manufacturing practices. Medicinal and pharmaceutical goods are the third-largest category of UK exports, with the second-largest trade surplus among categories of goods. The deal also sets out steps for UK manufacturers that prove good behaviour to become Authorised Economic Operators, which would reduce some frictions but by no means all of the costs.

The UK won’t impose the new customs regime on imports from the EU until at least 1 July 2021 to allow firms to acclimatise, while the EU will impose full checks from day one. Therefore, the UK’s exports to the EU are disrupted by more than its imports from the EU. We’ve already seen the detrimental effects on Scottish seafood or M&S’s beloved Percy Pigs.

It has been known for some time that NTBs are going up. As has the near-unanimous verdict of economists (a rarity!) that the effects will be negative for UK growth. As investors, we focus on what risks may not already be compensated for by today’s prices.

Risks to trade in services remain

The trade resolution makes us more hopeful about crucial negotiations on cross-border financial services, digital and data transfer rights between the UK and the EU, or the portability of accreditation to conduct accounting services due to take place this year. The deal contains an agreement to permit lawyers to provide cross-border services. British politicians have pointed to the framework that the deal provides for establishing mutual recognition of professional qualifications. However, the EU’s deal with Canada also contained such a framework and yet no recognition negotiations have been successful.

In short, risk and uncertainty remain. The UK runs a large trade deficit in goods that is paid for mostly by its large trade surplus in services, which is almost entirely in financial and other professional and technical services.

The UK has legislated for a temporary passporting regime that allows EU firms to continue to operate in the UK while the process of obtaining full authorisation is worked out. The EU has not reciprocated, and UK firms have transferred their EU clients to EU subsidiaries to minimise the disruption.

Investment and public policy

The costs of Brexit can be broken down into three: (i) short-term disruption; (ii) productivity and capital losses; (iii) long-run costs associated with being a more closed economy.

The drag on productivity from Brexit could be eclipsed by a publicly backed wave of digitalisation, green energy infrastructure and initiatives to raise productivity outside of the south-east. Overall public investment has been lower than in other leading economies in recent years, and investment in digital infrastructure still lags investment in transport, energy and utilities, which in turn lags the best-performing advanced countries.

Public investment and support for private business investment has been noticeably absent in UK fiscal policy during the pandemic, in contrast with the EU’s Recovery Fund. But it featured prominently at the recent Conservative Party conference. Moreover, November’s Spending Review maintained ambitious plans for public net investment, increasing from £42bn in 2019 to an average of £73bn between 2023 and 2026, targeting digital and transport infrastructure and regional “levelling-up”.

The continued uncertainty around trade facilitation and the portability of data, financial services and professional accreditations will likely continue to hold back business investment. Between the referendum and the beginning of this year, UK business investment did not grow, compared to average growth of 10 per cent in the other G7 economies.

Academic research concludes that the vote to leave has also cost billions of pounds in lost foreign direct investment (FDI), which is particularly important for the long-run productivity gains on which business profits depend. Despite its underrepresentation in the UK stock market, software technology is an important sector for FDI, often accounting for the greatest number of FDI projects in a calendar year. Business services is often the second most important sector on this basis. Future inward investment is therefore also contingent on the result of those negotiations slated for 2021. It is imperative that a concerted public policy effort is made to ensure that the UK remains an attractive place to invest for the long term, and that a decade of stagnant productivity and low rates of firm formation are put behind it.

Fiscal and monetary policy

With the second-lowest debt burden among the G7 economies, structurally low interest rates and its own currency, UK public finances are sustainable.

Discretionary fiscal spending in the eurozone will remain significantly expansionary in 2021. The US is likely to follow suit. Despite higher debt burdens, government borrowing costs in these regions have stayed extremely low. The UK chancellor has shelved plans to prematurely withdraw support. This needs to occur at some stage, but getting the timing wrong could leave lasting scars.

The weight of a pound

Although the pound has rallied substantially against the dollar since late 2020, it has done little since the Brexit deal was announced. On a trade-weighted basis, the pound is still 10 per cent below where it was on the eve of 2016’s referendum.

We expect the pound to continue to appreciate, but both global and local cyclical factors may still hold it back over the next year. The pound is a highly cyclical currency versus the dollar or the euro – it falls when global investor sentiment falls more broadly. That’s mainly because the dollar accounts for circa 60 per cent of reserve assets, the euro circa 22.5 per cent and the pound just 5 per cent.

UK equity implications

The FTSE 100 has underperformed the MSCI World equity benchmark over the last five years. This year it ranks 22nd out of the 25 developed market indices we monitor. Since the vote to leave, the gap between valuation multiples, such as price-to-book value, in the UK and overseas has widened to a degree not seen since the 1970s, when the UK had to ask the International Monetary Fund for a bailout.

The gap is now starting to close, but there are non-Brexit reasons why we expect the valuation gap to remain wide for the time being. Historically, the UK has offered a high-quality dividend yield, but it is less the case today. The UK has also outsized exposure to financial companies and oil and gas, whose profits are held back by bigger structural forces. The exposure to resource extraction may have driven some underperformance as investors formally build environmental, social & governance (ESG) factors into their selection processes.

A global antidote to UK gloom

Companies listed in the UK earn between 70-80 per cent of their collective earnings overseas. There are many for which Brexit is ‘more bark than bite’ and offer good long-term investment opportunities. We are becoming more optimistic about global activity while acknowledging short-term cyclical risks still to navigate. The approval of Covid vaccines has changed the risk-reward profile of equities in 2021 too. Given everything, we believe a global mindset is needed to participate in this recovery.

Ed Smith is head of asset allocation research at Rathbones. The views expressed above are his own and should not be taken as investment advice.

While some US mega-cap stocks have captured investors’ attention thanks to strong performance in recent years, Baillie Gifford’s Gary Robinson believes there is a new class of companies which he thinks are the biggest companies of the future.

Robinson, manager of the £1bn Baillie Gifford US Growth Trust, the best-performing investment trust of 2020, said he prefers to focus on the few “exceptional growth companies” to generate strong long-term returns.

Citing a study carried out by Hendrik Bessembinder into the total wealth creation of the US market, Robinson explained that over the long term just a handful of companies make up the majority of returns. Indeed, just 0.45 per cent of companies are responsible for a quarter of wealth creation in the 31 three-year periods since July 1926.

He explained: “What investors should be doing, rather than trying to avoid losers is identifying companies who’ve got the potential to be in the 0.4 per cent, the real outliers.

“In other words, it’s these outliers that matter for market returns.”

Robinson admitted that an obvious criticism of this idea is to go passive and own the entire index, but he thinks that is unnecessary as there are three characteristics that can help identify these companies early on: addressing large market opportunities; an ability to build and sustain a strong competitive advantage; and, those with a “distinct culture” often run by founders “who have skin in the game, and […] an attachment to the company rather than the share price”.

Tech has been a significant theme for markets in 2020 – and a major one across Baillie Gifford portfolios – and Robinson believes that it’s still an area of opportunity for finding such “exceptional growth companies”.

“Now it’s tempting after we’ve had such a strong run for technology-led companies to question whether the best returns might be behind us,” the manager said. “But what’s interesting about this new class of companies that I’m going to talk about is that they’re only just getting started.

“And I think each of them has got the potential to go on and be one of the biggest companies in the world.”

As such, he highlighted three companies – Stripe, Shopify and Twilio – what he calls “scale as a service platforms”, software companies that deliver infrastructure services via the internet.

Stripe

The first company is Stripe, a privately-held, global payments platform and a top-10 holding for the Baillie Gifford US Growth Trust.

“It’s doing for online payments what Amazon Web Services [AWS] did for computing,” Robinson explained.

Stripe was founded by two Irish brothers to overcome the difficulty of accepting payments online.

“The payments world is messy,” Robinson said. “There’s complexity within and between regions.

“Each country has its own unique banks, credit cards, mobile wallets, cultural norms, regulators and regulations. It’s a really difficult landscape for any company to navigate, never mind a starter.

He continued: “Stripe helps customers deal with these complexities. Its software platform sits above the financial system and interacts with it on your behalf. It makes sending and receiving money as easy as transferring information.”

Shopify

The next company is Shopify, a Canadian e-commerce platform.

“Just like AWS and Stripe, Shopify is a platform that sits behind the scenes powering a big part of the digital economy. It processed $16bn worth of goods in 2019 and it looks like it’s going to do double that in 2020,” Robinson said.

Shopify was developed in 2000 by Tobias Lütke, who originally wanted to build an online snowboard shop but realised that the programme he had built from scratch was more valuable, Robinson said.

“I think the best way to think about Shopify as platform is like an operating system for retailers,” Robison said. “It provides retailers with all the tools they need to manage their businesses online.

“Merchants can use Shopify’s platform to build online shop, run digital marketing campaigns, accept payments, manage inventory and borrow money.

“What Shopify’s platform does in essence is help automate routine tasks, tasks which frees up time for entrepreneurs to focus on the product,” Robinson said.

“One great example of the power of Shopify is Kylie Jenner, who famously built her billion-dollar makeup line in Shopify with just seven full time employees,” he added.

Twilio

The final company is Twilio, a more recent addition to the Baillie Gifford US Growth Trust which Robinson added to the portfolio last year.

Twilio is a software platform that allows developers to integrate and manage its communications functionality, such as sending and receiving phone calls and texts through the company’s apps.

According to Robinson it allows companies to just pay for what they use, a “stark contrast [to] the old model”.

According to Robinson, all three stocks have market opportunities over $1trn in scale, a strong competitive advantage and are run by “visionary founders”, the trifecta of his key characteristics.

“The icing on the cake is that as well as being attractive investments, they’re also performing an important role for society, and making it easier for entrepreneurs to start and scale companies,” he concluded. "That’s going to level the playing field between the biggest companies and the smallest ones.”

According to Robinson, all three stocks have market opportunities over $1trn in scale, a strong competitive advantage and are run by “visionary founders”, the trifecta of his key characteristics.

“The icing on the cake is that as well as being attractive investments, they’re also performing an important role for society, and making it easier for entrepreneurs to start and scale companies,” he concluded. "That’s going to level the playing field between the biggest companies and the smallest ones.”

These three companies, along with AWS, account for almost one-fifth of the trust’s portfolio.

Since launch in 2018, the trust – which Robinson runs alongside Helen Xiong – has made a total return of 246.27 per cent, outperforming both the IT North American sector (57.95 per cent) and the IA Mixed Investment 40-85% Shares index (21.87 per cent).

Performance of fund vs sector & benchmark since launch

Source: FE fundinfo

The trust is trading at a 5.4 per cent premium to net asset value (NAV), is not geared and has ongoing charges of 0.75 per cent.

More sterling corporate bond and strategic bond strategies climbed up the three-year performance table during the past six months, according to data from FE Analytics, as gilt funds have fallen away.

The average holding period for an open-ended fund, according to the Investment Association, is three years and has become an increasingly important period for investors to measure performance.

Nevertheless, three-year rankings are not set in stone and leadership can change as market conditions shift and strategies just celebrating their third anniversary enter the rankings.

Having previously looked at equity funds, Trustnet has ranked all the bond funds in the IA universe by their three-year returns and compared the current standing with how the rankings looked six months ago.

Given the changing market conditions as the markets have continued rallying in the latter half of 2020, there has been some change in the top-25 bond funds over three years, as the table below shows.

Source: FE Analytics

The best performing bond strategy remained the five FE fundinfo Crown-rated Allianz Strategic Bond fund, managed by Mike Riddell and Kacper Brzezniak.

The £2.7bn strategic bond fund – which invests in different parts of the corporate and government bond market – made a total return of 49.77 per cent over the past three years to end-December, compared with 13.53 per cent for the average IA Sterling Strategic Bond peer and an 11.85 per cent gain for the Bloomberg Barclays Global Aggregate benchmark.

Performance of fund vs sector & benchmark over 3yrs

Source: FE Analytics

The second best-performing strategy was the Barings Emerging Markets Sovereign Debt fund, which moved six places higher with a total return of 41.96 per cent. It was the only other fixed income strategy to make more than 40 per cent over three years.

The $949.6m, five Crown-rated fund is managed by Cem Karacadag and Ricardo Adrogué and is an emerging markets hard currency strategy investing in investment-grade and high-yield sovereign debt.

In third place was the €182.5m PIMCO GIS Euro Long Average Duration fund, overseen by Lorenzo Pagani and Michael Surowiecki, with a total return of 34.03 per cent. The fund invests mainly in euro-denominated bonds with duration typically within two years of its 15-year plus benchmark.

Allianz Strategic Bond was joined by three other strategies from the IA Sterling Strategic Bond sector in the top-25 performers: Nomura Global Dynamic Bond, Aegon Strategic Bond and Legg Mason IF Brandywine Global Income Optimiser, with returns of 25.69 per cent, 25.15 per cent and 22 per cent respectively.

The £286m Aegon Strategic Bond fund – managed by Alexander Pelteshki and Colin Finlayson – was the biggest mover in the top-25 climbing more than 100 places.

As well as new strategic bond funds, there were several sterling corporate bond funds moving up the three-year rankings, led by the £383.8m, five Crown-rated Schroder Long Dated Corporate Bond fund managed by Alix Stewart which was up by 31.52 per cent.

Other top-performing sterling corporate bond strategies included BMO Long Dated Sterling Corporate Bond, Schroder Sterling Corporate Bond, and Baillie Gifford Investment Grade Long Dated Bond.

Unlike six months previously, during the latest three-year period there were fewer gilt strategies as government bond yields have continued to fall and demand for safe-haven assets has dropped off amid an improving outlook.

  
 Source: FE Analytics

At the foot of the three-year performance table was the £81.9m Templeton Global Total Return Bond fund, overseen by Michael Hasenstab and Calvin Ho, which has made a loss of 14.23 per cent over the three years to end-2020, compared with a rise of 14.01 per cent for the Bloomberg Barclays Multiverse index and an 11.79 per cent return for the average IA Global Bonds peer.

Performance of fund vs sector & benchmark over 3yrs

  Source: FE Analytics

It was joined at the bottom by another Templeton strategy, the $5.5bn Templeton Emerging Markets Bond fund – also managed by Michael Hasenstab and co-manager Calvin Ho – which made a loss of 13.43 per cent.

The Holy Grail for most growth managers is to find a stock they can depend on to produce above-average returns for a period of at least five years. So when a consensus is reached with a long-term portfolio holding that “it will be easy for the next 10 to 15 years”, you could be forgiven for thinking that maximising exposure to this company would be the best way for an existing investor to take advantage of this opportunity.

Yet when this was the conclusion reached by ASML’s chief scientist after a breakthrough with extreme ultraviolet (EUV) lithography, James Anderson (pictured) of the Scottish Mortgage Investment Trust was more interested in the implications for the other companies in his portfolio – and for some that haven’t even been founded yet.

Lithography systems use ultraviolet light to create billions of structures on thin slices of silicon. Together, these structures make up a chip. EUV lithography involves harnessing light of a much shorter wavelength (13.5 nanometers, rather than 193 nanometers from traditional lithography). While this may sound like scientific jargon, Anderson said it is of “unparalleled importance” for the global economy.

“Moore’s Law [that the number of transistors per silicon chip doubles every year] has carried the world in productivity and growth terms in the last 30 years,” he explained.

“But it’s becoming more powerful. One of the most significant meetings that we’ve had was one of our sessions with ASML, which is critical to the survival of Moore’s Law.

“I was amazed when its chief scientist, a veritable genius, said, ‘well now we’ve solved EUV, it is easy for the next 10 or 15 years’. This really matters. If we say we’ve got another 12 years of that, that translates into approximately a 60-fold increase in computing capacity.”

Anderson said that while it is difficult to get your mind around the implications of this development and it is impossible to gauge the exact impact, it can be taken as a given that it will turn entire industries upside down.

“It is beginning to eat indices well outside of what we define as information technology,” he continued.

“In particular, ‘Big Data’ is finally, in combination with sequencing its own exponential growth, beginning to be transformed.

“I think the implications of Moore’s Law will if anything be even more profound in what they transform from here than they have been over the last 30 years.”

Anderson's co-manager Tom Slater said that one of the best examples of the impact this can have on scientific progress can be found in solar panels, where the cost of generating energy has “pretty predictably” fallen at 20 per cent per annum over the past decade. Meanwhile, the cost of storing electricity in a battery has fallen by about 16 per cent for every doubling in capacity.

But while these figures are impressive on their own, Anderson pointed out the reality is even more dramatic when compared with even the most optimistic expectations in the recent past.

“In a way, it is very predictable,” he said. “But to put it in context, the cost of solar energy is currently running somewhere between 50 and 100 years ahead of the International Energy Agency’s predictions from 2010.”

A reliance on these principles was one of the reasons why the managers bought Tesla in 2013. They had long been criticised for their position in the stock – it has fallen by more than 30 per cent on 10 separate occasions since they invested, while in a Trustnet article from January 2019, Anderson said he regularly received “20 calls a day” from journalists denouncing it.

However, it is up 638.37 per cent over the past year, which in turn has led to questions about whether it is in a bubble. Anderson just laughed these off.

“The application of capital really mattered in the technological progress [of renewable energy],” he said.

“But I would also throw in that I think that underplays what’s going on in China, which I think is both terribly important for Tesla itself and the scale of opportunities.

“I could throw that back and say we are now lucky enough to get lots of requests about the value and rating of Tesla. But of course, Tesla way underperformed Nio [a Chinese electric vehicle manufacturer] last year, so perhaps we should be asking Mr Musk why it is doing so badly.”

Performance of stocks over 1yr

Source: Google Finance

Looking forward, the managers said that the most exciting application of Moore’s Law may be in healthcare. For example, Slater said that a PhD student carrying out genetic research 10 years ago would either amplify a gene or knock it out in an animal model. Then, after studying the consequences of this action, they would enter into a “laborious scientific programme” to see how this discovery could be taken forward.

Yet the cost of gene sequencing is falling faster than the cost of computer chips, which Slater said was responsible for the “absolutely remarkable” speed with which a coronavirus vaccine was developed by two of the trust’s holdings: Illumina and Moderna.

“In effect, it took four days to find the solution to the Covid crisis,” he explained. “Two of those days were Illumina sequencing the virus and two of those days were taken up by Moderna taking that sequencing data and translating it into an RNA molecule that would trigger an immune response.

“Now obviously it has taken longer than that, from the launch of lockdown to the finished vaccinations and the appropriate process in terms of regulatory approval and testing. But to actually find the solution took four days.”

And Anderson said that far from the end point, this could be just a mere hint of what the sector is capable of achieving in the long term. The manager pointed to a recent conversation with Alex Aravanis, the co-founder of healthcare company GRAIL, who has now returned to Illumina to supervise the combination of the two companies after the latter acquired the former.

“He said, ‘what you’ve got to understand is that if you combine sequencing with machine learning, moving towards AI [artificial intelligence], then we’re getting insights, we’re finding indications for healthcare that are running well ahead of our understanding of human biology, which completely reverses the whole process.

“And that would morph into the second example, which is one of our unquoted companies called Tempus, which is beginning to see that enormous quantities of data are translating into actionable healthcare recommendations.

“Over the last few days, Tempus has just revealed a small, dice-like device which will go in hospital oncologists’ pockets to provide them with AI answers to all the queries they have.

“To go back to a conversation with [recently retired Scottish Mortgage board member] John Kay, he said, ‘heaven help the standard general practitioners of the future’.”

Data from FE Analytics shows Scottish Mortgage Investment Trust has made 911.04 per cent over the past 10 years, compared with 184.93 per cent from the IT Global sector and 184.62 per cent from the FTSE All World index.

Performance of trust vs sector and index over 10yrs

Source: FE Analytics

It is trading at a discount to net asset value (NAV) of 0.43 per cent and was 4 per cent geared as at the end of December.

The managers of the £2.2bn Mercantile Investment Trust are betting on a strong UK market recovery and explain why they are overweight UK tech stocks in the mid and small cap space.

JP Morgan’s Anthony Lynch and Guy Anderson, who both manage the trust, target UK companies outside the FTSE 100 that they believe have significantly more room for growth, which is often not recognised by other investors.

“The most important thing for me is the greater potential for smaller companies to grow at a higher rate than larger companies,” Anderson said. “Ultimately, larger companies become limited by the underlying growth of their markets where it is the smaller companies who have greater scope for growth.”

Anderson also highlighted the different sectoral and geographic exposure of small- and mid-cap market compared to the FTSE 100, which is concentrated at both the stock and sector levels.

The FTSE 100 has high weightings to individual stocks, where a company such as AstraZeneca comprises over 7 per cent of the index, and it is heavily biased towards sectors such as financials, which make up almost 20 per cent.

“The mid-cap market, in contrast, is very well diversified,” Anderson said. “There's no single stock in terms of the universe that makes up much more than 1.5 per cent of that part of the market. It is also very well diversified by sector and doesn't have that same sort of concentration.”

He also noted the geographical exposure of the FTSE 100: “The FTSE 100 is not actually a reference point for the UK economy. It's extremely international in terms of the end markets.

“The revenue of the companies that make up the FTSE 100 is roughly three-quarters international and about a quarter domestic. In contrast, for both the mid- and the small-cap indices it's more like 50 per cent domestic and 50 per cent international.

“So, the mid- and small-cap is far more exposed to the domestic economy than the large-cap market.”

The manager has an optimistic outlook for the UK equity market but especially within the mid- and small-cap spaces due to the above characteristics.

“We've clearly had had a tough time through Covid-19,” he said.

“The UK economy has been hard hit from that and we've had that uncertainty of Brexit to contend with. But when we look forwards, I think both of those clouds will disperse and there will be potential for a really quite nice earnings recovery.”

Performance of the FTSE 100 versus the FTSE 250 over the last decade

Source: FE Analytics

One such FTSE 250 stock in Mercantile Investment Trust’s portfolio is Dunelm Group, the UK-based homewares retailer.

Anderson said: “One of the things that they have benefited from is there has been a change in consumer behaviour. There was a bit of a boom in terms of consumers spending their disposable income on items that would be used at home and home furnishings absolutely sort of falls into that category.

“They have benefited from that little boom but, looking at it on a on a longer-term basis, they've got a very strong position in the homewares market. It's an incredibly fragmented landscape in the UK, but they are one of the leaders.”

He believes what separates Dunelm from the competition is its very strong multi-channel capabilities, citing the recent roll-out of click and collect and move to its own hosted web platform with better functionality for search and checkout.

“That has really allowed for a huge growth in their online sales as a percentage of their total sales, which obviously has been crucial through the last year but also is crucial for any retailer going forward,” he explained.

Performance of Dunelm over 1yr

Source: FE Analytics

The manager continued: “Retailers which are purely bricks and mortar are clearly in a structurally challenged place, whereas this is a business that's really come through over the last year or two and become a true omni channel retailer.

“Their underlying organic revenue growth has really accelerated over the last couple of years. There have been ups and downs, but it has generally been on an improvement trajectory. I believe that as we as we look ahead to the next year or two as we come out of this Covid period, they will continue to benefit from those investments.”

Technology and software services firms, however, make up the largest overweight positioning in Mercantile Investment Trust’s portfolio, accounting for around 11 per cent, compared with 7 per cent from the average investment trust in the sector.

Anderson said the sector uses a very narrow definition of software and that there are a lot of firms that he considers technology businesses but aren’t officially classified as them, such as online car marketplace Autotrader and online media business Future.

“When I think the true technology exposure in the portfolio is significantly higher than that number,” he said.

Two of its largest technology holdings are IT firm Softcat, which makes up 2.8 per cent of the portfolio, and Computacenter, which makes up 2.9 per cent.

Anderson described Softcat as “a value-added technology reseller that targets small and mid-sized businesses as well as the public sector, a part of the market that has typically been under served”.

“It's a growing market and one where they're very well positioned to continue capturing market share, and when we look at the business performance, they have a really phenomenal growth track record,” he said.

“They have delivered positive organic growth every single quarter, for the last 15 years, and that is obviously a tremendous performance.

“It's pretty rare to find a business that has delivered such a stellar growth trajectory over such an extended period of time, and they clearly, in my mind anyway, well set to continue with that that strong track record,” he finished.

The Mercantile Investment Trust has returned 73.51 per cent over the last five years, compared to 53.37 per cent from the average peer in the IT UK All Companies sector and 43.87 per cent from the FTSE All-Share ex Inv Co benchmark.

Performance of trust vs sector & benchmark over 5yrs

Source: FE Analytics

The trust currently pays 2.7 per cent yield and is trading at a 2.9 per cent discount to net asset value (NAV). It is 14 per cent geared and has ongoing charges of 0.46 per cent, according to the Association of Investment Companies (AIC). It has an FE fundinfo Crown Rating of four.

While the ‘giant’ funds of the investment world garner a lot more of the attention than the smaller ones, it doesn’t mean necessarily mean smaller funds aren’t worthy, or that smaller size equals worse returns.

This was shown by the £169.9m L&G European Trust, which was the best performing European equity fund under £300m across the three IA European equity sectors in 2020.

The L&G European Trust was the best performer from across the IA European Excluding UK, IA European Including UK and IA European Smaller Companies sectors making a 46.69 per cent total return, outperforming some of the Beating significantly larger strategies in the process.

Source: FE Analytics

Fund manager Gavin Launder, who has run L&G European Trust for almost a decade, said its growth-focused approach and ‘multi-theme’ investing are what helped it outperform in 2020.

One of the major themes for the fund in 2020 was tech, also a significant sector for global markets last year as well.

Launder said: “Europe is often accused of not having growth companies and that you have to look at the US [for them]. That is sort of true in that we don’t have a Facebook or much of anything like an Amazon, although Zolando and ASOS are trying.

“But we do have a lot of very strong tech companies that are sort of behind the scenes type things like ASMl Holding, SAP, Infineon and so on.”

Launder (pictured) added that while tech had been a big focus for the fund it had also invested in strong “non-tech growth stories”. One of which was ESG (environmental, social and governance), or what Launder called “the green theme”.

ESG has been a major investment theme across the investment space in 2020, as the pandemic highlighted the need and opportunity to invest in climate and social solutions.

Europe has appeared ahead of other markets when it comes to the number of ESG or sustainable companies on offer and government policies supporting sustainability. This has been seen with the EU’s Covid Recovery Fund which works directly with its Green Deal and includes explicit financial support for climate change solutions.

Launder said that “ESG has been increasingly integrated into the whole process over the last few years”, noting that part of this integration involved splitting it into three sections.

One, is the ESG ‘sinners’ such as oil, gas or tobacco companies, which Launder said, “they’re never going to get in there [the fund]”. The second section is ESG ‘winners’: companies which are fully immersed in ESG and sustainability, providing active solutions. Stocks falling into the middle make up the third category where Launder said the bulk of the portfolio is invested and where the L&G apply more of their engagement focus, encouraging companies to become more environmentally or socially friendly.

“[There] you’ve got everyone else and varying degrees of ESG sinning or winning and we’re very happy to engage with companies,” he said.

“And what we’re trying to establish is what their path is to improvement and whether it’s possible or feasible. And so that would be the bulk of the portfolio in a way, because there are only so many high ESG ratings you have.

“And it’s not like the market has missed them at the moment,” he said.

Some of the fund’s ESG names were the strongest performers last year, according to Launder. Such as Dutch company Alfen which manufactures and connects renewable energy to power grids.

“They’ll do battery storage for big events,” said Launder. “So back in the day a rock concert would have a big 20-foot container behind the stage with a diesel generator.

“Nowadays, it would be that 20-foot container with a big electric battery in it that they would have charged and delivered. And then they [also] do charging ports [for vehicles].

“So [they’re] throughout Europe, including in the UK. And that I think was our best performer last year, so it was a very strong name.”

Looking ahead to 2021, Matthew Courtnell, equities product specialist on the fund, said that the ‘green theme’ as an investment opportunity in Europe cannot be understated.

He said: “I really think on the outlook I do not think you can underestimate the impact of sustainability as a tailwind to Europe in particular.

“You’ve got a lot of markets with rich industrial heritage which are effectively shifting quite rapidly with the emergence and growing focus on companies with sustainable solutions or solution enablement, [which] is only going to get more significant in Europe [compared] to other markets in the world.”

He added that t government policy to support decarbonisation is going to benefit secular growth trends – and the fund – in the long-term.

“But now I think just emphasising that stainability angle, and that transition across Europe is really going to benefit the fund and how it’s positioned,” he said.

Discussing the market’s recovery from the Covid-19 coronavirus, Launder agreed that the delay in getting a unified vaccine programme rolled out across Europe would impact the market’s recover.

Europe is currently behind the UK in terms of vaccine rollout, but it’s expected that by the summer the people most vulnerable to coronavirus will have received their vaccine, Launder said.

But during that recovery Launder said that the market might rotate into more value areas as things like travel and airlines start to pick up.

However, this won’t change what he is doing in the fund.

“I think we’re going to see some rotation into those sorts of names at some point,” the L&G European Trust manager said. “But principally we wouldn’t be changing much.

“What we’re investing in we hope and believe our multi-year trends, the lower carbon economy, the circular economy, technology-driven disruption. These are things that are here to stay for quite some time.”

While some of these themes “may have gotten a bit expensive in the last year”, according to Launder he still thinks that investors will ultimately come back to quality stocks.

“You get these periods of rotation,” he explained. “Every year in the last five years there’s been a period stretching from two weeks to two or three months where you’ve had that rotation.

“But typically the world has focused back on quality again because, I believe firmly, that’s what equity investors want, as a core their long-term holdings.”

Performance of fund vs sector & benchmark over 5yrs

Source: FE Analytics

Over the past five years the L&G European Trust has made a total return of 111.37 per cent, outperforming the FTSE World Europe ex UK index (83.72 per cent) and the IA Europe Excluding UK sector (71.71 per cent). It has an ongoing charges figure (OCF) of 0.81 per cent.

Investors are increasingly looking to align financial returns with social and environmental impact.

Green bonds have traditionally been seen as an attractive way to do this. But with growing awareness of other issues, including social issues that have been exacerbated by the pandemic, “impact” bonds are becoming increasingly popular. 

What is the difference between a green bond and an impact bond?

A green bond is an instrument in which the proceeds are used by the issuing company or government specifically to fund projects with environmental benefits.

Though issuers have, historically, been mostly governments or supranational entities, the private sector is increasingly becoming involved. For example, the private sector has accounted for approximately two thirds of issuance year-to-date (Source: Bloomberg as at 27 November 2020).

But, environmental degradation isn’t the only challenge facing our planet. We’re also contending with issues ranging from poverty and economic inequality, to limited access to healthcare and financial services, amongst many others.

It makes sense that those who feel strongly about these issues may look to allocate capital toward such causes.

Investing with purpose

To cater to this demand, public and private markets all over the world have introduced “impact” or “purpose” bonds, in which the proceeds are used to fund projects with specific social and/or environmental objectives.

Some examples of these include blue bonds, gender bonds, transition bonds and even rhino bonds.

“Pandemic bonds” have been issued this year by countries such as Guatemala and Paraguay, but also by development institutions and corporate issuers as a way of alleviating the adverse economic impact of the Covid-19 pandemic.

The International Finance Corporation (IFC) issued a social bond to provide loans to small and medium-sized enterprises (SMEs) negatively impacted by the pandemic and also to finance research or the development of tests, vaccines and other medications.

We have also seen bonds issued in support of the United Nation’s Sustainable Development Goals (SDGs). The SDGs are a “blueprint to achieve a better and more sustainable future for all”. The UN describes them as a “call for action” to “promote prosperity while protecting the planet”.

For example, Mexico issued a $890 million bond, the proceeds of which will be earmarked to support small farmers, provide free school meals and help sustain the healthcare system.

On the private side, Bank of America issued a $2 billion bond in September 2020, the objective of which is to help low-income and minority communities in the US. 

What should investors look for in an impact bond?

We’d argue that its crucial the issuer has a transparent impact framework in place which ensures the proper allocation of the proceeds and measures its results.

Though regular self-reporting is critical, it’s not enough as it tends to lack objectivity.

One solution can be for an issuer to link funding costs to its environmental or social targets. For example, Suzano, a Brazilian paper company has tied the coupon of its sustainability-linked bond to its emission targets.

If the company fails to reach its targets, then the coupon on the bond increases for investors and the cost increases for the company. This structure creates a clear and easily communicated incentive for the company to reach its objectives.

Industry changes needed

The other problem with current reporting mechanisms is that they are not standardised.

By providing common screening criteria and performance thresholds that can be used across different issuers and bond purposes, you can begin to compare issuances and create a set of baseline expectations for investors.

The European Union created a taxonomy in March 2018 aimed at creating a universal classification for sustainable investments. Technical screening criteria in respect of environmental metrics are expected at the end of 2020, and investors have until the end of 2021 to submit comment and provide input on the future of the framework.

The asset management industry has to take an active role in helping clients align their social and environmental values with their financial goals. We believe we have a unique opportunity to influence the development of such products in a way that ensures their efficacy and attractiveness to investors as well as genuinely benefit society and/or the environment.

References to companies are for illustrative purposes only and not a recommendation to buy and/or sell.

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This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.

The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.

Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.  Exchange rate changes may cause the value of any overseas investments to rise or fall.

Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.

The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.

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Despite downbeat forecasts for the UK’s dividends over the coming year, investors think should be seen as 2020 to be a “reset year” and believe payouts will be better than feared over the immediate future.

This week’s UK Dividend Monitor, published by global financial administrators Link Group, found that headline payouts from UK companies dropped 44 per cent in 2020 to £61.9bn – the lowest annual total since 2011.

The group also painted a gloomy outlook for 2021, saying UK dividends would rise by 10 per cent to £66bn in its best-case forecast. Under the worse-case scenario, payouts would fall again in 2021 to a total £61.5bn.

Susan Ring, CEO corporate markets of Link Group, summed up 2020 as a “dreadful result” for UK income investors, despite signs of improvement towards the end of the year.

“UK payouts have been more severely impacted than in most comparable countries because of their heavy concentration in the hands of just a few very large companies, mainly in the oil, mining and banking industries – all sectors that have had to cut dividends steeply,” she said.

“There are reasons for optimism, but the resurgent pandemic has pushed back the reopening of the economy even further, especially in the UK. We still believe the worst is past, but a new lockdown means our expectations for 2021 are significantly more subdued.”

Source: UK Dividend Monitor

Ring added to the most significant upside could come from UK banks, which were forced by the regulator to cut dividends in the coronavirus crisis but are likely to, albeit partially, restore them in 2021. On the other hand, she expects the cuts from the oil sector to take several years for the wider market to make up.

“The social and economic scars of Covid-19 will be deep,” she said. “We think it is highly unlikely dividends can regain their previous highs until 2025 at the earliest, and potentially even a year or two after that.”

While Link Group’s conclusion that UK dividends will take five years or more to make up their lost ground looks bleak, Willis Owen head of personal investing Adrian Lowcock is one who thinks investors should find some positives.

“We have long believed that 2020 was a reset for dividends,” he explained.

“Dividends had become unwieldy before last year, but now investors should be reassured that going forward, dividends from companies will be more sustainable, whilst dividend growth could easily surprise if the economic recovery is more robust than expected.”

Lowcock also argued that “the worst seems to be behind us”, noting that firms were fast to make cuts to protect their business in the long run and have used the time since to restructure, recapitalise and adapt. While he still expects some companies will announce further cuts in 2021, dividends on the whole will grow as the pandemic passes and business activity returns to normal.

Where the Covid-19 dividend cuts fell hardest in 2020

Source: UK Dividend Monitor

Simon Young, manager of the AXA Framlington UK Equity Income fund, is another who remains optimistic in the outlook for UK dividends despite 2020’s “annus horribilis” and agrees that 2020 should be viewed as something of a “reset”.

“After such a big decline in income levels from UK plc, we have effectively had a big reset for many companies. We expect a vaccine roll out to improve the outlook for economic growth globally and hasten a recovery in earnings and thus dividends in 2021,” Young said.

"Headwinds remain, not least the impact of FCA rules on bank dividends, and this will weigh on the rate of dividend growth from UK equities this year. Nonetheless, despite the cuts, the starting dividend yield for the FTSE All Share is above 3 per cent and we expect dividend growth of 5-10 per cent this year.

"We are optimistic for the future of UK companies, which in the main, have shown a great deal of resilience, pragmatism and often ingenuity in dealing with a fast-moving virus that has warranted changing government policy with little or no notice.”

The widespread dividend cuts, combined with the weaker performance of UK equities in general, meant that IA UK Equity Income was the worst-performing sector of 2020 after its average member lost 10.66 per cent.

But Lowcock said his preferred three funds in this space considering the current market backdrop are Threadneedle UK Equity Income, Man GLG Income and JOHCM UK Equity Income.

Performance of funds vs sector and index over 10yrs

Source: FE Analytics

Threadneedle UK Equity Income is headed up by Richard Colwell, who Lowcock described as “one of the best-known specialists in the IA UK Equity Income sector”. The £3.7bn fund has a very strong long-term track record and currently top-quartile over one, three, five and 10 years.

Colwell tends to own a blend of high-quality companies with strong cash generation and out-of-favour stocks with recovery potential, some of which may not currently pay a dividend. Top holdings include AstraZeneca, Imperial Brands and Unilever; while the portfolio is invested in blue-chip stocks, Colwell will take significant sector bets against the index to match his thematic views.

Threadneedle UK Equity Income has an ongoing charges figure (OCF) of 0.82 per cent and is yielding 3.06 per cent.

On Man GLG Income, Lowcock said: “Manager Henry Dixon's proven value style underpins his philosophy that pricing inefficiencies can be profitably exploited.”

Dixon is another manager with a strong long-term track, with the £1.8bn fund being top-quartile since he took over in November 2013. The manager looks for undervalued stocks that must have a dividend yield that is at least equal to the UK stock market and his portfolio includes significant exposure to mid- and small-caps. Top holdings include defence contractor QinetiQ and specialist lender OSB Group, as well as larger names like British American Tobacco and Royal Dutch Shell.

Man GLG Income has a 0.90 per cent OCF with a yield of 5.47 per cent.

Clive Beagles and James Lowen have co-managed the £1.9bn JOHCM UK Equity Income fund since launch. “Their skills are complementary. Beagles tends to focus on economic factors and trends to generate ideas, while Lowen focuses more on company analysis,” Lowcock said.

“The two have proved highly adept and disciplined in applying their contrarian approach to equity-income investing that focuses on companies with an above-market dividend yield and reasonable growth prospects.”

JOHCM UK Equity Income has a longstanding bias to smaller companies, which has aided returns over the years but also adds to the fund's volatility. It currently has 17.2 per cent of its portfolio in smaller companies, although all of its top 10 holdings are FTSE 100 names.

It has an OCF of 0.80 per cent and is yielding 5.39 per cent.

Covid-19 has accelerated many of the trends that were already in place before the word ‘coronavirus’ entered the everyday lexicon. Although vaccines have begun to be rolled out and this year promises some semblance of normality, the consequences of the pandemic for markets and economies will be long lasting and deeply structural. While the short-term outlook is probably more in the hands of scientists than politicians and central bankers, there has probably never been a more difficult or important time for policymakers to ensure they navigate a very treacherous medium-term outlook. But what does this mean for investors?

Technological acceleration

There is no doubt that the way we consume, work, travel and communicate was changing long before the pandemic. However, many of the trends that have accelerated, such as home working, online shopping and increased internet usage, are here to stay. The UK equity market is not deemed to be technology-heavy at a sector level, but every company now has technology embedded in their business. What really matters is how they use it to augment their business model. It is therefore important to own companies that come out of the pandemic in a stronger position than when they went in; companies such as clothing retailer Next, with its superb online distribution model, Ascential, which optimises digital retail for the world’s largest manufacturers, and GB Group, with its strong position in online fraud and identity verification, fit this bill.

It’s the economy, stupid

We have just had the largest peacetime shock to the global economy on record and yet one would assume from the strength of markets that once populations are vaccinated it is business as usual. I believe nothing could be further from the truth and many of the weaknesses of the UK economy before the pandemic have only been exacerbated further. The Office for Budget Responsibility (OBR) is now forecasting an 11 per cent fall in UK GDP for 2020, the largest annual drop since the Great Frost of 1709.

Given that more than two-thirds of UK GDP is domestic consumption, much of this reflects the rise in the savings ratio from 5 per cent to as high as 28 per cent. Of course, much of that increase in savings has been forced as consumers could not spend and so the rebound in the economy will reflect the subsequent fall in the savings ratio as shops re-open.

However, the OBR assumes that we retrace back to the previous low levels of savings and consumers spend as they did prior to the pandemic. I just do not see that as credible as we will be in a period of higher unemployment and increased economic uncertainty. I believe precautionary savings will remain elevated and thus the ability of the UK economy to rebound quickly is very unlikely. Furthermore, although a thin trade deal has been announced with the EU, it remains to be seen how challenging the transition is for businesses, so there are tough times ahead for the UK economy.

The end of the road for the monetarists?

The final trend is one that may not fully play out for many years but is probably the most important for long-term investors. Can regulatory authorities navigate a path back to growth and out of the increasing constraint of government debt?

Quantitative easing (QE) does not make consumers spend, or businesses invest. In economic terms, it increases the money supply but does not necessarily increase the velocity of circulation of that money in the economy. The pandemic has thrust QE once more into the limelight as the UK government has seen a forecast £57bn fall in tax revenues in 2020 and a £281bn increase in spending. The Debt Management Office is therefore selling billions of pounds of gilts every week to fund the £394bn annual deficit. It is not an accident that the Bank of England has increased since March the amount of QE targeted by £250bn to £895bn; effectively the Bank of England is financing all of the government’s significant gilt issuance.

This makes the UK increasingly vulnerable to any future rises in interest rates off the back of inflation, credit risk or even growth. Therefore, investors need to keep aware of the risks of a steepening yield curve; in our Ninety One UK Alpha Fund, we own names such as Charles Schwab and Lloyds, who provide us with protection on that scenario.

A diversified approach is key

In conclusion, the pandemic has left the world and, in particular, the UK in a very uncertain place. In constructing a portfolio, we can still find many opportunities of companies that can still grow, have embraced technology and will exit the pandemic in a strong position. However, we find ourselves in a deep recession, with government balance sheets completely transformed and a step-change in how we use technology. This time it is different, and the world will not revert to the previous status quo. The key for investors is, therefore, to have a diversified approach and own those companies that can navigate a world of geopolitical stress, economic uncertainty and structural change.

Simon Brazier is the portfolio manager on the Ninety One UK Alpha fund. The views expressed above are his own and should not be taken as investment advice.

With the inauguration of Joe Biden as the 46^th US president on Wednesday 20 January, Donald Trump’s time in the White House came to an end. After four years of an unconventional administration, the presence of the National Guard was needed in Washington DC to ensure a peaceful transfer of power after the invasion of the Capitol building earlier this month.

As president, Trump frequently measured his success against the strength of the domestic economy, often referring to it as “the greatest economy in the history of the world”.

And in his farewell speech, he referred to its resilience in the face of a global pandemic, a crisis which has so far claimed the lives of over 400,000 Americans.

“The whole world suffered, but America outperformed other countries because of our incredible economy and the economy that we built,” said Trump. “Without the foundations and footings, it wouldn’t have worked out this way.”

However, while his administration made considerable strides in unemployment and real wages, it’s hard to determine whether those were directly correlated to his policies or were trickle-down effects from other administrations.

Indeed, the performance of the Dow Jones Industrial Average (DJIA) – a benchmark he frequently referred to – returned 51.77 per cent during his administration, in sterling terms.

Performance of DJIA under Trump

Source: FE Analytics

With his tenure now over, and using data from FE Analytics, Trustnet decided to look back over four years of Trump’s administration, from 20 January 2017 to 20 January 2021, to find out which funds performed the strongest.

Looking across the IA North America, IA North American Smaller Companies, IT North America, IT North American Smaller Companies sectors, the 20 top-performing funds were open-ended strategies.

Performance of all funds under Trump

Source: FE Analytics

The leadership of US stocks – and its technology giants in particular – saw large-cap strategies dominate the top-20 funds, with 17 from the IA North America sector compared with three from IA North American Smaller Companies.

The stand-out performer was the £7.1bn Baillie Gifford American fund, at the top by quite a margin with a total return of 304.11 per cent during Trump’s four years in power.

Managed by Gary Robinson, Tom Slater, Kirsty Gibson and Dave Bujnowski, the five FE fundinfo Crown-rated fund and – like all Baillie Gifford funds – has a strong growth focus.

Using a bottom-up, high conviction stock selection process, half the fund’s portfolio is invested in just 10 names, which means performance generally comes at the expense of higher volatility relative to its peers. However, those 10 names include some of the best-performing US stocks in recent years, such as Tesla, Amazon and Shopify.

Second-placed is the £7bn Morgan Stanley US Growth fund which seeks high-quality, established and emerging US companies with sustainable competitive advantages, strong free-cash-flow and favourable returns on invested capital trends.

Including many familiar high-growth names, it has made a total return of 250.63 per cent.

The Lord Abbett Innovation Growth fund is third-placed and has only really known a Trump administration – having launched in March 2016. Relatively smaller than the other top performers at £134.6m, it has made a total return of 180.01 per cent.

With a return of 160.14 per cent, the £519.2m JP Morgan US Small Cap Growth fund is one of the three smaller companies’ strategies to make the top-20.

Managed by Eytan Shapiro and Timothy Parton, it has seen its size increase by 112.93 per cent in 2020 as investors put capital in US growth names – and increasingly ones with smaller market capitalisation.

While investment trusts do not make the top-performing funds, it must be noted that there are far fewer strategies within these sectors, just nine in total spread between seven in IT North America and two in IT North American Smaller Companies.

Performance of investment trusts under Trump

Source: FE Analytics

However, the top performing trust was a Canadian equity strategy: the £748.9m Morgan Meighen & Associates Canadian General Investments fund, which made a total return of 98.08 per cent during Trump’s tenure.

Canada provides a useful window on the health of the US economy making up around three-quarters of its exports, according to the World Bank.

Canadian equity strategies also tend to have direct exposure to the US market, and this fund is no exception with 23.2 per cent invested in its southern neighbour, including tech giants Apple, Amazon and Nvidia.

The second best-performing trust is the £1.2bn JP Morgan American Investment Trust, managed by Timothy Parton and Jonathan Simon, which posted a total return of 72.77 per cent.

Parton is a growth manager while Simon is value-orientated, combining to create a blend of both styles.

“The concentrated strategy seems especially well suited to a closed-ended fund, where the structural advantages afford more latitude to run concentrated portfolios,” said analysts from Kepler Trust Intelligence.

Rounding out the top-three is the JP Morgan US Smaller Companies investment trust which made a total return of 61.14 per cent.

The £256.9m JP Morgan US Smaller Companies trust is run by Don San Jose, Daniel Percella and Jon Brachle and seeks to identify companies that have strong management teams and are trading at a discount to intrinsic value.

With the FTSE 100 below its 1999 closing level, the latest edition of Trustnet Magazine considers why it has gone backwards over the past 21 years and finds out what it can do to follow in the footsteps of more successful markets such as the US.

Staying on this subject, Pádraig Floyd looks at some of the companies partly responsible for the FTSE 100’s lack of progress, as he rounds up the stocks whose share prices are lower now than they were 10 years ago, while Daniel Lanyon asks if a coming bonanza in tech IPOs offers a potential solution.

This month’s sector focus falls on the IT Debt sector as Adam Lewis finds out if the high single-digit yields make up for the greater risk associated with its specialist trusts.

In the magazine’s regular columns, John Blowers gives the major platforms the chance to reply to his recent criticism of their business practices, Rathbones’ Alexandra Jackson names three little-known companies that provide vital “back office” services for household names and Charles Stanley’s Ben Gilmore reveals why he is buying the Premier Miton US Opportunities fund.

As always, Trustnet Magazine is free – you do not even have to enter any details. Simply click here to start reading, then click the arrow pointing down on the right-hand side of the screen if you want to download the PDF.

The winners of an “ongoing industrial revolution” are mostly in Asia and California, according to Carmignac’s Xavier Hovasse, creating the opportunity for strong returns in emerging market equities.

Investing in these ‘winning’ companies when other investors feared a tech bubble is what propelled Hovasse’s £291m Carmignac Portfolio Emergents fund to the top of the IA Global Emerging Markets sector in 2020 with a 65.86 per cent total return.

“We understood very well that there was an ongoing industrial revolution,” Hovasse said. “In the last few years, there was this chat about whether there was a tech bubble or if Alibaba or Tencent were a bubble – and we understood that it was not the case.

“We're in a situation where we are experiencing an industrial revolution and in an industrial revolution, stock prices move very quickly.”

Performance of fund vs sector and index in 2020

Source: FE Analytics

The manager added that the moves in share prices are often very sharp because companies fall in either two camps: the ‘disrupters’ and the ‘disrupted’.

He said: “We have understood for the last few years that this was not a tech bubble – it was a proper change of the world.”

This is why Carmignac Portfolio Emergents was invested in the emerging market ‘winners’ of this industrial revolution. Many of these stocks have rallied dramatically, with investments in e-commerce companies paying off handsomely.

In Latin America, its holding in e-commerce retailer Mercadolibre was up 175 per cent in 2020, while in south-east Asia, it had a position in e-commerce and gaming firm SEA Limited, which was up 390 per cent.

Hovasse described these two firms as the ‘Alibaba’s’ of Latin America and south-east Asia.

Samsung and Taiwan Semiconductor Manufacturing Company (TSMC) were two other large holdings in the fund, which Hovasse described as “big winners” of the industrial revolution.

“This is because the digital revolution is going to imply more usage of semiconductors, because you will need more of them for servers, for the 5G rollout and for autonomous cars,” he said.

“They are beneficiaries and they are monopolies. TSMC is a quasi-monopoly in the foundry business and Samsung is a quasi-monopoly in the DRAM [dynamic random access memory] business, so they are the big winners of the of the tech revolution.”

Share price of TSMC over 1yr

Source: Google Finance

The standout performance in 2020 means Carmignac Portfolio Emergents is in the IA Global Emerging Markets sector’s top decile over three and five years, with much of this performance attributed to sticking to its investments in Asia. The portfolio is overweight Asia with more than 90 per cent invested in the region.

Aside from the fact that Asia holds many companies at the heart of the industrial revolution, parts of the region handled the Covid-19 pandemic much better than developed markets and without taking on the same amount of debt via monetary and fiscal support.

“Who are the winners of the industrial revolution? They are in California and Asia,” Hovasse said.

“Asia is where you have the factories that manufacture the technology products and that’s where you have the huge Chinese market as well.”

Aside from the fact that Asia is one of the main winners of the industrial revolution, there are several other reasons to be overweight emerging markets, according to Hovasse.

“First of all, they've underperformed for 10 years and by a lot,” he said. Indeed, emerging markets has lagged most other major equity markets over the last decade.

Performance of emerging markets versus other markets over 10yrs

Source: FE Analytics

“Secondly, in 2020 Asia did much better than the rest of the world and Asia is 80 per cent of emerging markets, as far as I'm concerned as an equity investor,” Hovasse said. “If you look at equities, market caps, the volumes are in Asia.

“Asia did much better than the rest of the world to manage Covid-19, so they had higher growth with lower stimulus.”

The third reason to reason to be positive on emerging markets is down to a weakening dollar environment.

“In the US, you had a huge fiscal deficit financed by the Fed printing money and that is bearish the dollar. It’s going to push the dollar probably into a three- to four-year bearish cycle and, if that is the case, it's very positive for emerging markets,” Hovasse said.

He is also bullish in the ex-Asia part of emerging markets, namely Latin America and eastern Europe, because currencies there have collapsed to the point where there are current account surpluses.

“Brazil has a current account surplus for the first time since 2006. Even South Africa is now in a current account surplus. India has a current account surplus for the first time since 2004,” Hovasse noted.

“So there's been a significant improvement in the fundamentals, even in the weak links of emerging markets. These are very spectacular changes that we are seeing.”

Therefore, the fund is now adding to Brazilian equities due to the cheap currency and its correlation to the prices of commodities.

“The Brazilian real is highly correlated to commodity prices,” the manger said. “Look at the price of iron ore last year, it had fantastic performance. Even the soft commodities, the agricultural commodities that are exported, performed quite well.”

He said there is as a result a “big discrepancy” between the fundamentals and the price action on the Brazilian currency, which makes it relatively attractive.

Performance of fund vs sector and index over 5yrs

  Source: FE Analytics

Over the last five years, Carmignac Portfolio Emergents has delivered a total return of 174.97 per cent, compared to 119.81 per cent from the average fund in the IA Global Emerging Markets sector and 133.42 per cent from the MSCI Emerging Markets benchmark.

It has an ongoing charges figure of 1.15 per cent and holds an FE fundinfo Crown Rating of five.

Investment trusts focused on US, Asian and European equities tended to generate higher returns than their open-ended peers last year, analysis by Trustnet has found.

Analysts at Winterflood Investment Trusts described 2020 as “a very good year for investment trusts” following their strongest relative return in 30 years. The FTSE Equity Investments Instruments index posted a 17.8 per cent total return last year, which was 27.6 percentage points ahead of the 9.8 per cent fall in the FTSE All Share.

Meanwhile, the investment trust index is up by 167 per cent over the past decade, compared with 72 per cent for the FTSE All Share, and has outperformed the wider market in seven of the past 10 years.

“The obvious question is, why has the sector done so well in recent years? There are several answers to this, in our opinion,” Winterflood said.

“The UK market has been hamstrung over the last decade by its large weighting to sectors such as banks and oil, while domestic plays have struggled, particularly since the EU referendum in 2016. In contrast, the investment companies sector has found itself increasingly exposed to global equities and growth areas such as technology and healthcare.

“In addition, the growing importance of specialist mandates such as infrastructure has meant that the sector’s beta to the market has fallen. We estimate that 38 per cent of the sector’s assets were not exposed to publicly traded equities. Finally, it is worth noting that while performance has been assisted by discounts narrowing over the last 10 years.”

While investment trusts performed strongly against the wider market in 2020, Trustnet has looked to see how returns in the Association of Investment Companies sectors compared with their counterpart peer groups in the Investment Association universe.

Source: FinXL

The area where trusts outpaced open-ended funds by the widest margin was Asia-Pacific equities. As the chart above shows, the average trust in the IT Asia Pacific sector made a total return of 42.64 per cent in 2020 – some 22.63 percentage points higher than the average for the IA Asia Pacific Excluding Japan sector.

Asian equities in general had a relatively strong year in 2020, largely down to the performance of China. Although the country was the first to lockdown because of coronavirus, it was also the first to open up its economy and witnessed a speedy recovery.

The best performing Asia-Pacific investment trust last year was Baillie Gifford Pacific Horizon, which made a 128.58 per cent total return. The trust has 37.3 per cent of its portfolio in Hong Kong and Chinese stocks.

Pacific Horizon was the second best-performing trust of 2020, beaten only by Baillie Gifford US Growth’s 133.45 per cent total return. Scottish Mortgage, another Baillie Gifford trust, was in third place with a 110.49 per cent gain.

This compares with a 60.36 per cent return from the best-performing open-ended fund in the IA Asia Pacific Excluding Japan sector: Baillie Gifford Pacific.

Performance of Pacific Horizon vs Baillie Gifford Pacific over 2020

Source: FE Analytics

The fact Baillie Gifford has the best two Asian equity strategies, which are both run with a similar approach, but such different levels of total return highlights some of the advantages that the closed-ended structure can have.

Winterflood’s analysts said: “There will be those cynics who will discount [Baillie Gifford’s] recent success as simply a reflection of the dominance of a growth investment style over value in the last 10 years.

“However, in our opinion, this is to overlook how Baillie Gifford has embraced the opportunity set provided by the listed closed-ended fund structure in taking longer-term investment decisions, deploying gearing and investing in unquoted companies. Notably, there are no unquoted companies in any of its open-ended mandates.”

As the table above shows, the average trust in the IT European Smaller Companies, IT Japan, IT Japanese Smaller Companies, IT Europe and IT North America sectors also outperformed the open-ended space by a decent margin.

UK equity income and all companies investment trusts also beat their counterparts in the Investment Association peer groups, but lagged behind when it came to UK smaller companies.

However, there were six areas from the 15 we compared in this research where the average investment trust didn’t outpace its open-ended rival.

Performance of sectors in 2020

Source: FE Analytics

As the chart above illustrates, the heaviest underperformance from trusts came from the IT North American Smaller Companies sector. The average member of this peer group made a 10.80 per cent total return in 2020, which was 12.80 percentage points behind the 23.61 per cent average for the IA North American Smaller Companies sector.

The highest return from this group of strategies came from the open-ended Premier Miton US Smaller Companies fund, which gained 66.97 per cent in 2020.

Of 21 funds and trusts focused on North American smaller companies, the top 11 are open-ended; JP Morgan US Smaller Companies was the highest-ranked trust, in 12th place with a 15.47 per cent total return.

Terry Smith has told investors that different sectors of the market could emerge at different trajectories as economies begin to emerge from the Covid-19 pandemic.

In his annual letter, Smith – manager of the £22.7bn, five FE fundinfo Crown-rated Fundsmith Equity fund – said that in contrast to the views of many other commentators, “it may not be strictly true that the events of 2020 are without precedent”.

There are even some parallels that can be drawn from past pandemics that may act as a guide to what might happen next, the FE fundinfo Alpha Manager said.

One of the lessons from previous pandemics is that they don’t cause new trends, but accelerate existing ones, said Smith (pictured).

“The most obvious comparator — and one which people have most frequently alighted upon — is the Spanish Flu pandemic of 1918–19,” he said.

While the assembly line was not invented as a result of the Spanish Flu pandemic — with the Model T Ford first put on an assembly line in 1913 — it did accelerate its adoption, he explained.

Smith continued: “The death toll of at least 50 million people caused a reduction in the workforce, which may have been a factor in the subsequent widespread adoption of assembly line techniques for mass production.”

The resulting increase in productivity helped to fuel an economic boom as the cost of producing items – such as cars and household electrical appliances – was reduced as the volume of production rose.

“This helped to fuel the economic and stock market boom of the ‘Roaring 20s,” said Smith. “Might something similar happen as a result of Covid?”

The manager said trends that have taken off during the pandemic – such as e-commerce, home cooking & food delivery, online schooling & online medicine, social media & communications and automation & artificial intelligence – have made people more productive.

“Salespeople can visit many more clients if video conferencing is acceptable and at virtually no incremental cost,” he said. “We receive reports of factories which we are told are operating with 50 per cent staffing due to social distancing rules but which have more or less maintained production.

“I wonder what conclusion that leads to?”

Nevertheless, Smith noted that not all companies will benefit from trends that have emerged from the pandemic.

Despite the “meaningless alphabet soup of predictions” about the shape of the economic recovery, Smith said he has found one that may be correct and help to explain what is about to happen.

“A K-shaped recovery occurs when different sectors of the economy emerge from a downturn with sharply differing trajectories — like the arms of the Roman letter K,” he said.

However, Smith also warned against trusting forecasts and timing the market.

He continued: “Imagine if you had been told this time last year that there would be a pandemic and that the measures taken to contain it would so affect the world economy that US GDP would fall by 9 per cent in the second quarter of the year and the hospitality and travel sectors would be devastated by the measures, as would large segments of traditional retail activity.

“Considering this, would you have predicted that the MSCI World index would deliver a return of 12.3 per cent, slightly above its 10-year average?

“Hopefully this illustrates the dangers of forecasting and market timing even when you know what major events will occur.”

Last year, Fundsmith Equity made a total return of 18.29 per cent, outperforming the average IA Global fund's 15.27 per cent gain.

Performance of fund vs sector in 2020

Source: FE Analytics

“Returns on capital and profit margins were lower in the portfolio companies in 2020,” said Smith. “This is hardly surprising in light of events in the economy, but the scale of the falls were hardly disastrous.

“When people have said to us, ‘You invest in non-cyclical businesses’, I always reply that I have never found one. It is the degree of cyclicality in our portfolio which we seek to control through our stock selection.”

He continued: “As a group, our stocks still have excellent returns, profit margins and cash generation even in poor economic conditions… the same cannot be said for the major indices even though they have the benefit of including our good companies.”

The market cap of negative-yielding assets has grown in 2020, a continuation of the trend that started for real in 2016, as bond yields rallied around the world.

Today, this number tops nearly $18trn, combing both government bonds and high-quality credit.

Whilst it may appear unusual, and certainly counter-intuitive to own a bond that guarantees a negative return over the life cycle of the asset, it’s a natural consequence of near-zero interest rates, and at times negative base rates.

Combined with massive quantitative easing (QE) programmes rolled out by central banks, it has become a simple equation of greater demand than supply, causing bonds to increase in value.

Negative debt pile to rise

Major markets have historically low yields. Take Germany where 10-year bund yields, one of the more extreme examples of negative yields in markets, are trading at minus 0.52 per cent. In Switzerland 10-year bonds are at minus 0.54 per cent. UK debt is negative-yielding up to five years currently, with only the US positive along the whole of the curve (commanding, as it does, a yield of 0.08 per cent on three-month paper). It’s entirely possible that the pile of negative-yielding debt grows further in 2021.

Given the magnitude of the hit to global growth, and the level of central bank support required to install confidence in the financial system, we do not expect interest rate rises, nor an easing in the levels of QE, for at least the next 12 months.

Other big buyers apart from central banks also exist. Pension funds, insurance companies, and mark to market investors (including UK ones) continue to own high-quality government bonds either as a regulatory must, or as an offset to other riskier assets that may be in their portfolios, or as an alternative to zero interest rate cash on deposits.

Within that context, the large-scale central bank bond buying, combined with the structural demand for any positive yielding assets, which is hard to come by in a world of zero interest rates, means that the stock of negative-yielding assets should grow once again this year.

What will burst the negative-yielding debt balloon?

Globally, from a macro view, the problems of 2020 are now the problems of 2021 and we don’t think a lot of them will get solved this year. To see a material reversal of the growth in negative-yielding assets, arguably you need some or all of the following to happen, which we believe are still some way off.

Firstly, sustained higher inflation expectations in the US and Europe. Second, a seamless economic recovery and an eradication of the ongoing risks to the economy and livelihoods posed by the pandemic.

Finally, rising official interest rates and a significant sell-off in government bonds to lead to what many investors would deem “normalised” levels, perhaps back to those seen prior to the negative yield environment with US 10-year Treasuries at 3 per cent.

One possible consequence of such a move might be another “taper tantrum” type environment where spreads widen and equities fall, in tandem with the shock of a bond market selling off and trying to find a clearing level.

In that environment, you might be better off in the relative safe haven of government bonds with their risk characteristics of having little or no credit risk.

Negative bond yields are counter-intuitive, but just maybe are a necessary evil of the complicated world of weak growth, low interest rates and low inflation expectations. Given the events of bond markets in 2008 to 2020, why shouldn’t we expect more of the unexpected in 2021?

Nick Hayes is a manager on the AXA Global Strategic Bond fund. The views expressed above are his own and should not be taken as investment advice.

After the UK’s CPI figures rose slightly in December, fund managers are growing increasingly worried about rising inflation despite it remaining well below the Bank of England’s 2 per cent target.

The Office for National Statistics (ONS) today revealed that consumer prices index (CPI) inflation jumped to 0.6 per cent in December, from 0.3 per cent in November, pushed higher by rising transport and clothes prices.

The US also reported rising inflation figures last week after CPI increased to 0.4 per cent in December from 0.2 per cent in November, largely due to a jump in gas prices.

Close Brothers Asset Management chief investment officer Robert Alster believes the UK is “extremely vulnerable” to a rise in inflation next year, due to soaring government debt and individual purse strings tightening.

However, he added: “Should inflation weaken further, action may need to be taken to stimulate spending and boost the economy; it’s worth remembering that negative interest rates have not been taken off the table as a possible policy tool.”

Laith Khalaf, financial analyst at AJ Bell, said investors shouldn’t draw too many conclusions from the current CPI measures due to how distorted economic activity is.

“While inflation looks well contained, there is increasing concern it could start to be a problem once social restrictions are lifted, as a wave of pent up consumer demand is unleashed,” he explained.

“Central bank stimulus, helicopter money from the government and high levels of cash savings built up during lockdown all support the thesis that the inflation genie may pop out of the bottle in the coming year.”

However, he acknowledged that there are also deflationary pressures in the economy, namely rising unemployment, technological advances and an ageing population.

“While monetarist economic theory tells us that the huge increase in money supply will deliver inflation, this is a dog that didn’t bark after central banks embarked on the QE experiment in the wake of the financial crisis,” Khalaf said.

Indeed, over the last three decades, inflation in the UK has been trending downwards and continued this trend even after the financial crisis of 2008-09.

Inflation over the last 30 years

 
Source: ONS

“Today however, loose monetary policy is combined with fiscal stimulus and could be turbo charged by the prospect of consumers making up for lost time when social restrictions are eased,” Khalaf argued. “So there is some reason to believe this time really is different.”

The analyst said a “nightmare scenario” for the central bank would be stagflation – where inflation becomes rampant but the economy stalls.

“This would force the bank to choose between letting inflation spiral out of control and keeping the wheels of the economy turning,” he explained.

Anthony Rayner, fund manager at Premier Miton Investors, said that while inflation expectations have increased, they are not yet at excessive levels.

He noted that the recent Democratic sweep of the Congress suggests a larger stimulus package for the US, combined with vaccine rollouts and the OPEC+ output cut, could mean that “the stars are aligned for reflation”.

“Indeed, there is no talk of the spectre of extended lockdowns and maybe markets are looking through that but how far are they looking forward?” he asked.

“Certainly, markets are not looking through the reflationary concept, to inflation. For example, there seems minimal interest in how higher resource prices feed into cost-push inflation.

“We include ourselves in that group that think bonds might struggle this year, particularly developed government bonds, while other safe havens such as gold might do less well if real yields rise.”

Graham Campbell, co-manager of the £90m TB Saracen Global Income and Growth fund, is sceptical as to whether the government can restart the economy while controlling inflation.

He observed that investors have not been considering inflation as a risk and, whilst this position is slowly changing, it is “still not taken as a serious concern”.

According to Campbell , investors have been too used to the “Goldilocks” scenario where growth has been stable and inflation kept in check.  

“But what happens after a sharp recession, when governments massively expand money supply, increase debt and hold down interest rates to stimulate growth?” he asked. “Will they be able to restart the economy and will they be able to fine tune the levers to control inflation?

“Those with memories of the 1970s and 1980s will remember how difficult it was for governments to subdue inflation once it got out of the bottle.

“With Democrats now having a clean sweep over the White House, Senate and House of Representatives, it is likely the US will continue to increase public spending, adding to inflationary concerns.”

Florian Ielpo, multi-asset portfolio manager at Unigestion, believes recent developments in inflation drivers on both demand and supply, suggests that inflation is about to make a temporary comeback.

“We believe that this is a material risk and investors must respond,” he said. “This is all the more the case as inflation assets are less favoured than growth assets for the moment. This inflation comeback requires preparation.

“The risk for 2021 is not really on the recessionary side in our view, but rather on the side of the natural consequence of rapidly accelerating economic activity: inflation. The recognition of a growing inflation risk is the most important change in our investment policy in recent months.”

As a result, Unigestion is allocating towards both growth assets and inflation assets, with a preference for inflation breakevens as well as energy and industrial metals.

BlackRock’s Investment Institute have also said that the Democratic majority in Congress could accelerate its ‘new nominal’ theme in 2021.

It expects significant fiscal support coming from the Democrats to push inflation higher over time, but that the Federal Reserve will keep the rise in US Treasury yields in check.

When Treasury yields breached 1 per cent for the first time since last March, driven by increases in both inflation expectations and real yields, the institute believes this suggests “markets are likely to test the Fed’s resolve to lean against any excessive climb in nominal yields”.

BlackRock also expects greater fiscal spending to be funded through increased deficits rather than higher taxes and a strong vaccine-led restart later in the year.

“All this reinforces our view on growth, rates and inflation, and underpins our preference for inflation-protected securities over nominal US Treasuries,” it finished.

Dividends from UK companies fell by 44 per cent last year to £61.9bn – the lowest level since 2011 – as the Covid-19 pandemic saw companies cancel or cut payouts, according to the latest UK Dividend Monitor from Link Group.

According to the administrator, cuts related to the coronavirus crisis (excluding special dividends) totalled £39.5bn last year.

Headline dividends including specials fell from £110.6bn in 2019, a record year, as two-thirds of companies cut or cancelled dividends between Q2 and Q4 last year. On an underlying basis – excluding specials – payouts fell by 38.1 per cent to £61.1bn.

A better-than-expected Q4 – boosted by reinstated payouts – helped 2020 beat Link Group’s ‘best case’ estimates “by a whisker” as headline dividends reached £10.3bn.

The biggest impact last year came from the financial sector, which accounted for two-fifths of the Covid-19 cuts between April and December, as £16.6bn in dividends were cut or cancelled, with the majority attributed to the financial sector.

Aside from banks, companies dependent on discretionary consumer spending made the biggest percentage cuts, which fell by £5.5bn as lockdown conditions hit retailers and the airline, leisure and travel sectors.

 

Source: Link Group

Looking ahead to 2021, Link Group claimed higher share prices and a lower forecast for dividends mean a compression of the prospective yield on equities.

As such, based on its best-case scenario for 2021, UK equities will yield 3.1 per cent or 2.8 per cent if its worst-case materialises.

Susan Ring, chief executive for corporate markets at Link Group, said while there was a “slightly better end to 2020 may be a cause for relief”, it was a dreadful result for UK investors.

She said: “UK payouts have been more severely impacted than in most comparable countries because of their heavy concentration in the hands of just a few very large companies, mainly in the oil, mining and banking industries – all sectors that have had to cut dividends steeply.”

Ring continued: “There are reasons for optimism, but the resurgent pandemic has pushed back the reopening of the economy even further, especially in the UK.

“We still believe the worst is past, but a new lockdown means our expectations for 2021 are significantly more subdued.

“The social and economic scars of Covid-19 will be deep. We think it is highly unlikely dividends can regain their previous highs until 2025 at the earliest, and potentially even a year or two after that.”

David Smith, fund manager of £263.2m Henderson High Income Trust, said 2020 had been an “incredibly tough year” for UK income investors, albeit with a glimpse of optimism in Q4 as some previously suspended dividends were reinstated.

He said: “It’s likely that more companies will continue to return to the dividend register in 2021 but at low levels as companies remain cautious until there is a clearer path for cash flows to recover and balance sheets to be repaired.

“While I would expect some growth in dividends this year, it is likely to be at least 2022 before we start seeing more significant dividend growth.

“Having said that, there will be pockets of strong dividend growth within the market this year for the selective investor.”

Nevertheless, Smith said a dividend yield of 3.1 per cent for the UK market is still attractive and is likely to be more sustainable going forward with the opportunity to grow.

There are two broad areas of value in the UK market, financials and commodities, that in aggregate make up around a third of the FTSE All Share index. Within this, however, there are vast differences in both quality and performance. (Please see the end of this article for a glossary of terms).

2020 was a year where it was important for a UK investor to distinguish between "value traps" and "quality at a reasonable price".

We illustrate this with two sector examples: insurers compared to banks, and miners compared to oil stocks.

Insurance vs banks

In March 2020, at the start of the Covid-19 crisis, the UK’s financial regulator (the Prudential Regulatory Authority) allowed insurance companies to continue to pay dividends but decided that banking dividends should be scrapped and remain capped at low levels for 2021. Why was this?

The answer lies in the various regulatory regimes on capital requirements. The Solvency II regulatory regime for insurers is now more mature and stable compared to the alphabet soup of ever-changing banking capital regulations.

The other nuance has to do with risk. Insurance companies’ assets tend to be dominated by high quality bonds held to maturity with default risk very low, even in times of global crisis. Bank balance sheets are more open to default via unsecured loans and higher risk loans to small and medium-sized enterprises (SMEs).

Coming into the Covid crisis, both sectors traded with dividend yields in the 6-8% range, but one industry has paid out these handsome dividends and the other has not. You can therefore see why the insurance sector has outperformed the banks both in recent years and again in 2020.

Miners vs oil companies

These are two very capital intensive sectors and both have chequered pasts on capital allocation, particularly during the “supercycle” years of the 2000s. However, there are a few key differences which in 2020 led to a huge divergence in performance.

Firstly, the large mining companies de-geared their balance sheets (i.e. reduced long-term debt) in a big way following the trouble after the last cycle ended in 2013/14. Despite six years of low metal prices, miners’ balance sheets have been buttressed by capital discipline, disposals, and consolidation.

Now, the iron ore and copper markets are dominated by three or four global players that have a high level of supply discipline. As we head in to the 2020s, and as the world electrifies its energy and transport networks, metals such as copper, cobalt, and nickel are to be increasingly in demand. Indeed, copper prices hit a seven-year high in December 2020.

The oil majors, on the other hand, have failed to de-gear their balance sheets. This is partly because oil prices remain low, but also because they have been forced to invest in growth to replace declining barrels. They have also faced pressure from shareholders to reinvent themselves as renewable players in the long term, which could end up being a very costly transition.

Secondly, geology plays a role. Miners have decades-long mine lives, sometimes even as much as 70 or 80 years (for some Rio Tinto and BHP Billiton mines) compared to the oil reservoirs that decline quickly over a decade or so. In this sense, oil is a more capital-intensive industry and investment decisions have to be made with more urgency than for miners who can wait many years to invest when the time is right.

Lastly, there is a wedge appearing between the two with regard to fossil fuel generation. The large FTSE-listed miners are increasingly moving away from coal and other fossil fuels and investing in ore assets that will enable the electrification of the world.

Focus on finding quality

Our investment process involves seeking out quality at a reasonable price. The key arbiter of quality for financials tends to be return on equity through a cycle, and for capital intensive sectors like miners and oil stocks it is return on invested capital.

For the insurance stocks, returns have been in the teens/twenties compared to the banks in the mid-single digits. This means the difference between the amount of capital generated to fund ongoing dividends is like the difference between night and day. It is the same story in the commodity space where the large diversified miners are seeing return on capital in the teens compared to single digits for oil majors.

As investors, our main focus is in buying stocks with high returning cashflow streams, regardless of whether they be in growth or value industries. Keeping that focus on quality was an important lesson for 2020, and will be for the coming year as well.

Glossary:

Value - A value stock is one that appears to trade at a lower price relative to its fundamentals, such as dividends or earnings.

Quality – Higher quality stocks refers to companies that are well-managed with attributes such as strong cash flows and more reliable profits.

Return on equity (RoE) – Return on equity is a profitability measure. It reveals how much profit a company earned in comparison to the shareholders’ capital retained in the business.

Return on Invested Capital (RoIC) - Return on invested capital is a calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments.

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Artemis US Extended Alpha, Schroder US Mid Cap and T. Rowe Price US Smaller Companies Equity are among the funds that could benefit from a Democrat-controlled White House and Congress, according to several experts Trustnet spoke with.

With Joe Biden being inaugurated as the 46^th US president, the new resident of the White House is likely to take office with the support of his Democrat Party colleagues, who now hold both houses of Congress.

As such, Trustnet asked several fund pickers which strategies they think could benefit from the so-called ‘blue wave’ that has swept the Democrats to power.

Artemis US Select

First up is the £439.1m Artemis US Select fund run by Cormac Weldon and recommended by Willis Owen head of personal investing Adrian Lowcock.

The fund invests in companies that are economically-sensitive and perform best during the ‘growth’ economic phase, said Lowcock.

The process involves “meticulous company screening”, running models to show what impact wider economic trends will have on the stocks, combined with wider social, economic and thematic research.

Performance of fund vs sector & benchmark over 3yrs

Source: FE Analytics

Over the past three years the fund made a total return of 53.25 per cent, beating the S&P 500 benchmark (43.37 per cent) and its IA North America sector (42.89 per cent). It has an ongoing charges figure (OCF) of 0.89 per cent.

Schroder US Mid-Cap

Another fund pick by Willis Owen’s Lowcock was the £1bn Schroder US Mid-Cap, overseen by Robert Kaynor since January 2018.

“Kaynor is a cautious investor and views avoiding losses as the most effective way to grow capital over the long-term,” he said. “This approach will cause the fund to lag during strong bull-markets but should deliver over time.

This can be seen in its three-year performance, where Schroder US Mid-Cap underperformed the Russell 2500 benchmark (42.94 per cent) and IA North America sector (42.89 per cent) making 21.10 per cent.

Lowcock added: “The fund invests in three;types of stocks: mispriced growth, where the current share price doesn't reflect the potential growth; ‘Steady Eddies’, companies with stable growth and earnings; and turnarounds, recovery stocks with low or negative growth but where change is occurring.”

It has an OCF of 0.91 per cent.

JP Morgan US Equity Income

AJ Bell’s head of active portfolios Ryan Hughes picked the £3bn JP Morgan US Equity Income overseen by Clare Hart because its overweight towards financials and oil makes it well-positioned to benefit from further US stimulus.

According to Hughes, “the Democrat ‘blue wave’ is likely to unleash further waves of stimulus, possibly even bigger than was talked about before the election”.

This could awaken the economy, leading to a steepening yield curve, which Hughes said would benefit financials and increased economic activity aiding the oil price.

“With a value tilt, the fund could be well placed to benefit from this stimulus, especially if the recent rotation towards value stocks continues,” Hughes said.

Performance of fund vs sector & benchmark over 3yrs

Source: FE Analytics

Over three years, JP Morgan US Equity Income has underperformed the IA North America sector and S&P 500 index, returning 25.51 per cent. It has an OCF of 0.79 per cent.

Brown Advisory US Sustainable Growth

The $2.6bn Brown Advisory US Sustainable Growth fund is tipped by interactive investor analyst Teodor Dilov who thinks it will benefit from the renewed presidential support on climate and environmental projects.

“Tackling climate change was not high up the list of priorities in the Oval office under Trump’s tenure, but that’s expected to change once Biden takes power,” Dilov said.

“Biden has already vowed to make the issue a top priority and reverse many Trump administration policies, such as re-joining the Paris Agreement on climate change immediately upon taking office.

“As such ‘green’ investments could prosper under Biden’s premiership.”

Performance of fund vs sector & benchmark over 3yrs

Source: FE Analytics

Over three years, Brown Advisory US Sustainable Growth outperformed the Russell 1000 Growth index and IA North American sector, shown in the graph below. The fund has an OCF of 0.63 per cent.

Merian North American Equity

Dilov’s second pick is geared towards the healthcare and technology themes which he also expects will see to do well under Biden.

With Biden looking to build on the Affordable Care Act – more commonly known as Obamacare – and the rollout of 5G providing continued growth for tech stocks, Dilov said the Merian North American Equity fund could do well with its significant exposure to these sectors.

He said: “The fund’s duo of experienced managers, Ian Heslop and Amadeo Alentorn follow the money under a quantitative model to establish what type of stocks other investors are buying and then buying the best ones in those categories.”

While Merian North American Equity has struggled in recent years, Dilov said that its tech and healthcare allocations could see it have a “performance revival in the Biden era”.

Over three years, the fund made 35.75 per cent, underperforming both the MSCI North American index (45.33 per cent) and the IA North America sector. It has an OCF of 0.95 per cent.

T. Rowe Price US Smaller Companies Equity

The next fund pick comes from FundCalibre’s Juliet Schooling Latter, who doesn’t think that the Democrat majority is going to cause major change.

“I’d say it’s more of a ‘blue ripple’ than a ‘blue wave’,” she said. “The Senate is split 50:50 and, although the vice president carries the tiebreaking vote, reform is still possible but highly disruptive changes are unlikely.”

And while there may be more stimulus and policy changes, the US will “remain divided”, according to Schooling Latter, with Biden focused on unity and stability rather than unsettling change.

Therefore, she thinks that the T. Rowe Price US Smaller Companies Equity fund would be a good choice, invested in both growth and value, small- and mid-cap stocks.

Performance of fund vs sector & benchmark over 3yrs

Source: FE Analytics

Run by Curt Organtm the £109.4m fund has beaten its sector and benchmark over three years, with a total return of 74.49 per cent.

It has an OCF of 0.17 per cent.

FP WHEB Sustainability

Penultimately is Charles Stanley Direct’s pension and investment analyst Rob Morgan chose the £790.2m FP WHEB Sustainability fund.

With the Biden camp declaring its support for more environmentally friendly policies, Morgan thinks that funds focused on the transition to a more sustainable world could benefit.

The £790.2m fund, run by Ted Franks and deputy manager Ty Lee, invests in companies which are “providing solutions to sustainability challenges”, Morgan said.

“The managers are highly experienced in sustainable and impact investing and have a clear philosophy and approach,” he added.

Over the past three years, FP WHEB Sustainability has made a total return of 38.39 per cent, beating the MSCI World index (33.45 per cent) and the IA Global sector (33.24 per cent). It has an OCF of 1.05 per cent.

Artemis US Extended Alpha

The final pick is the Artemis US Extended Alpha fund, highlighted by GDIM investment manager Tom Sparke.

Sparke said while increased fiscal support is likely under a Biden presidency, some sectors will continue to struggle.

“As such, I would prefer to hold an active fund that has the power to back the best performers and short the inevitable strugglers,” he said, noting the Artemis US Extended Alpha’s ability to hold both long and short positions.

Run by FE fundinfo Alpha Manager William Warren, fund has made a total return of 49.24 per cent over three years, beating the S&P 500 and IA North American sector. It has an OCF of 0.89 per cent.