Semiconductor stocks have “underestimated potential for alpha” and their valuations are likely to climb higher than ever before, according to Blue Whale’s Stephen Yiu.
Semiconductor stocks are becoming less cyclical because their end-clients have changed and are now mega-cap tech companies rather than individuals. This transformation is not yet fully baked into valuations, according to Stephen Yiu, manager of the LF Blue Whale Growth fund, who thinks share prices will continue to climb.
Semiconductor stocks possess “underestimated potential for alpha”, the FE fundinfo Alpha Manager said, with valuations that “should be trading higher than before over the medium term”.
Share prices will be determined by new dynamics going forward, primarily ‘silicon sovereignty’, which he described as the biggest theme out there.
Currently, over 90% of high-end semiconductors are produced in Taiwan by the Taiwan Semiconductor Manufacturing Company (TSMC), which is controlling the supply of the chips needed for producing the latest technologies. To reclaim their silicon sovereignty, Western governments have decided to re-shore their semiconductor capabilities – a “reversal of a historical decision due to the geopolitical uncertainties in Asia Pacific” which started with the US Chips Act in 2022.
Fast-forward to today, over $400bn has been committed to building new foundries in Germany, France, Ireland, Malaysia, many US states, South Korea and Japan – all of which will need tons of mission-critical equipment at a pace that “has never happened before in history”.
According to Yiu, this new growth, which will be more supply-driven than demand-driven, is going to provide enough tailwind to offset the headwind that the end market is facing and is the first reason why semiconductor stocks should re-rate higher.
His second point, which is linked to artificial intelligence (AI), is that the quality of the industry’s client base has improved. In 2019, about 50% to 60% of TSMC’s business was in the end market (smartphones) and just 30% in larger applications such as data centres and servers; today, that number has flipped.
The customer base has changed from consumers, who were spending on discretionary technology, to enterprises investing in AI – a stickier client than retail consumers, who are a dependant on the economic cycle.
Before 2022, Nvidia’s revenue was mostly determined by crypto miners and gamers who wanted to accelerate their computers. Today, thanks to AI, Nvidia’s customers are Apple, Microsoft, Amazon, Google and Meta – the biggest companies in the world with a lot of cash on their balance sheets.
“The quality and sustainability of the revenue stream is evolving as we speak. This should make demand for semiconductors less cyclical in the future", Yiu said.
“We see all these changing dynamics as an opportunity. But if you look at valuations, the semiconductor companies are trading at similar levels as before, so the market has still not recognized the direction of travel.”
Despite these developments, the manager said the semiconductor industry will always retain a certain degree of cyclicality.
However, that's not necessarily a hurdle, with some managers trying to take advantage of that, including Julian Bishop, co-manager of Allianz’ Brunner investment trust, who bought ASML 18 months ago, when there was a big downturn in demand for its products.
Demand for semiconductors is currently in the foothills of the next upcycle, which could last through the middle of 2026, as the chart below shows.
Historical and estimated semiconductor demand
Source: BofA Global Research, Allianz. Data as at 12/2023.
“There's a shortage, prices go up and everyone over-bills. Demand overshoots and you get this big hangover, as customers stop ordering and microchips sales suddenly fall a great deal. That’s why historically, we have always had big downturns in the short term,” Bishop explained.
“Today, there's still a downturn,” he admitted. “But we are expecting demand to come back and there's great structural growth as well. These down cycles are an opportunity to pick up things at a good price.”
Mid-cap stocks and emerging market equities could outperform once the dust from the US presidential race settles.
The US presidential election campaign, which culminates today, has been extraordinary – marked by Joe Biden’s withdrawal as a candidate, the assassination attempts on Donald Trump and the abandonment of various electoral norms. For all the drama, the election remains finely balanced – especially in the crucial swing states. An election that’s too close to call, but what impact will it have on the world’s financial markets?
Surprises from history
Received wisdom might suggest that wins by the Republicans – the ‘party of business’ – lead to the best outcomes for the US stock market. But history paints a somewhat different picture.
Although Donald Trump made great play of the S&P 500’s performance during his administration, the US market underperformed its Chinese counterpart on his watch.
The stock market outcomes from previous Republican administrations tell a similar story. During the presidency of George W Bush (Junior), both emerging markets and China outperformed the US equity market. And although the Chinese market wasn’t yet established as a destination for global capital, emerging markets also outperformed under George HW Bush (Senior).
By contrast, the US stock market outperformed its global peers under Joe Biden, Barack Obama and Bill Clinton.
It would be naïve to argue that these outcomes depended solely on the party affiliation of the president. As we shall see, the US Federal Reserve’s independent monetary policy tends to be much more significant for the wider world than whoever occupies the White House.
Nevertheless, US fiscal policy and other government initiatives have played a part in determining the relative performance of US and international equities – as have a range of external events.
The US as global rate-setter
Tighter monetary policy is a hurdle for the US stock market. But high US interest rates and a strong US dollar tend to weigh more heavily on the performance of international markets – and especially emerging market equities.
After a slight contraction in the first quarter of 2022, the US economy continued to grow robustly even as interest rates rose to reach their highest level in over 20 years. During that period, the US growth machine sucked in capital from around the world, attracted by higher yields, and the US equity market has priced itself on that basis.
Meanwhile, an increasingly digitalised economy is intrinsically less vulnerable to higher borrowing costs, which have less impact on businesses reliant on software rather than physical assets. With the Fed having now started to cut interest rates, the stage is set for further domestic dynamism after a period of remarkable resilience.
But the Fed is also the world’s interest rate setter. The 10-year US treasury bond is often seen as a benchmark for global interest rates. Higher US yields lure investors away from riskier assets (i.e., those outside the US), even as higher borrowing costs dampen economic growth in countries that lack America’s remarkable dynamism.
Conversely, when US rates and yields fall, they have a significant positive impact on international markets – emerging equity markets especially.
Contrasts and common ground
A win for Kamala Harris would create some uncertainties. We have scant indication of her views on trade and the economy, for instance. But clearly, a Harris presidency would mean a greater degree of continuity than a Trump one.
In a split with recent precedents, however, a Harris presidency could be more likely to be positive for international markets and emerging markets in particular. That’s because a continuation of Biden-era policies is likely to give the Fed room to bring down interest rates further.
Some of Harris’ policies could weigh on certain sectors of the US stock market. Her anti-monopoly proposals could affect some of the technology giants that have led the market in recent years. Healthcare companies and producers of fossil fuels would also feel pressure from government policies on pricing and the environment, respectively. Against this, the consumer sectors would be likely to benefit from Harris’ proposed tax relief for lower earners.
Under a second Trump presidency, a key concern for global investors would be his proposals for higher tariffs, especially on Chinese goods. These would be likely to have an inflationary effect and could potentially arrest the Fed’s nascent rate-cutting cycle. This would result in renewed strength in the dollar, with the negatives for emerging markets that that entails.
The policies that Trump has outlined would have roughly the opposite effect to Harris’, with support for fossil fuels and big tech at the expense of the consumer, who would be hurt by the higher inflation caused by tariffs.
There are commonalties too. Both candidates look set to increase the US deficit; the Fed appears unalarmed by this. And both are proposing extensive tax cuts, albeit with different targets.
What comes next?
Despite all the excitement and uncertainty surrounding the election, our focus in the coming months will be on the Fed rather than the White House. The winner of the Electoral College is unlikely to be a major factor when the Fed’s Open Markets Committee mulls over what action to take at its November and December meetings.
Political rhetoric does not always become reality and the new president’s policies will take time to feed through into the hard data that informs the Fed’s decisions.
For investors, the worst outcome could be either party winning complete control of the legislature and executive – removing the checks and balances that come with a split. But in recent US history, ‘unified’ government tends to be fleeting; it has occurred in just six of the past sixteen years.
This has important implications. A lack of Congressional support could impede Trump’s programme of tariffs. More broadly, a split Congress would be likely to lead to more ‘horsetrading’ and consensus-building, with, eventually, more moderate outcomes.
Either a Harris presidency or a Congress-constrained Trump should leave the Fed room to loosen monetary policy further in the coming months. And from their current elevated levels, US interest rates have a long way to fall.
Lower US rates and, consequently, a weaker US dollar should feed through to lower rates worldwide and growing interest in the potentially higher returns on offer in emerging markets.
Lending from foreign banks to emerging market companies usually rises when lower US rates make such loans more attractive, allowing economic activity to accelerate.
A weaker dollar also tends to raise demand for commodities such as oil and metals, boosting both their prices and the equity markets of the countries that produce them – many of which are emerging markets.
For these reasons, falling US rates have historically translated into stronger returns from emerging market equities, which typically outperform their developed counterparts during rate-cutting cycles.
One exception might be China. The fortunes of the world’s largest emerging market are increasingly dependent on domestic drivers rather than external forces. We are still waiting to see how Beijing’s recent stimulus measures will play out beyond the initial excitement; in the meantime, investors might be best advised to consider China separately from other emerging markets.
Finally, a sustained rate-cutting cycle in the US is also likely to benefit mid-cap stocks in many markets. Mid-cap stocks tend to respond more vigorously to rate cuts than their large-cap peers – not only because they tend to have a greater proportion of floating-rate and shorter-term loans, but because they benefit from the unleashing of animal spirits as investors take heart and allocate away from bigger, safer choices.
We have already seen signs of this in the US, where the stock market rally has begun to broaden out beyond the mega-cap tech stocks to areas where valuations are less eyewatering. Once the dust from the US presidential race settles, there could be much more of this to come around the world.
Michael Browne is chief investment officer of Martin Currie. The vies expressed above should not be taken as investment advice.
Last week’s Budget sparked some volatility in the gilt market but Hargreaves Lansdown thinks yields are attractive enough to lock in.
Investors are split on the outlook for gilts in the wake of the volatility that followed last week’s Budget, but analysts at Hargreaves Lansdown think investors should consider locking in the higher bond yields currently on offer.
Gilts yields have been rising – and therefore prices falling – since mid-September for a few reasons, with one being uncertainty around the first Budget of the new Labour government.
Bond investors were nervous about expectations of higher future borrowing. This, along with factors such as interest rate expectations and the US election, meant the yield on 10-year gilts had risen to around 4.3% the day before the Budget.
Yields climbed further after chancellor Rachel Reeves finished her Budget speech last Wednesday, in which she announced £40bn in tax hikes and new fiscal rules that allow more government borrowing.
At the time of writing, six days after the Budget, the 10-year gilt yield was around 4.47%.
Performance of gilt prices over 2024
Source: FE Analytics
The volatility of the gilt market has left investors spilt in their outlooks.
Althea Spinozzi, head of fixed income strategy at Saxo, said investors should stay bearish on UK government bonds following the announcements in the Budget.
“Looking ahead, there are compelling reasons to anticipate that gilt yields may continue to rise,” she said.
“Inflationary pressures stemming from the budget – such as higher minimum wages and increased employer National Insurance contributions – could prompt markets to expect a more cautious approach from the Bank of England concerning rate cuts.
“This mix of increased inflation risks and higher supply expectations is likely to exert sustained upward pressure on yields over the longer term.”
However, BlackRock Investment Institute UK chief investment strategist Vivek Paul welcomed the measures in the Budget, arguing that they are “an attempt to turn around the UK's economic fortunes”.
He said that by creating headroom for more government borrowing but not using it all at once, Reeves is trying to signal to markets that there is a runway to support growth further but spending will be used “judiciously”.
BlackRock remains overweight UK equities and gilts, citing the UK’s relative political stability thanks to the summer's decisive election result and its view that the Bank of England is likely to cut rates more than markets currently think.
Hal Cook, senior investment analyst at Hargreaves Lansdown, sees some merit to investing in bond funds at the moment despite the tick-up in volatility and the forecast this will continue into 2025 on shifting interest rate expectations and political instability.
“With the 10-year gilt and US treasury yields both still above 4%, bonds are broadly as attractive today as they’ve been all year,” he explained.
“Taking a long-term view, it’s likely that yields will be lower than 4% in future, meaning investing in bonds today gives the potential for capital gains as well as receiving the income that they provide.”
For investors thinking of buying a bond fund, Cook gave three strategies to consider.
Performance of funds over 2024
Source: FE Analytics
First up was L&G All Stocks Gilt Index Trust, which tracks the broad movement in prices of all gilts currently in issue. Cook described it as a cheap and easy way to take exposure to the whole gilt market.
“It’s a great option for investors who are looking for specific exposure to gilts,” he said. “However, while it invests in lots of different gilts, as it is only invested in UK government debt, it is relatively concentrated compared to the wider bond market.”
He also pointed to Shalin Shah and Matthew Franklin’s Royal London Corporate Bond fund for investors who want to diversify a portfolio focused on shares. Most of the portfolio is in investment grade bonds, with some higher risk, high-yield bonds.
“[Shah and Franklin’s] edge comes from deep analysis of individual bonds, looking for those that offer higher returns. This can lead them to invest in bonds issued by companies that could be considered higher risk than peers,” Cook explained.
“But the individual bond analysis conducted by the managers means they are comfortable that any additional risk being taken is well rewarded.”
For investors seeking a more flexible approach to fixed income, the Hargreaves Lansdown senior investment analyst suggested Stuart Edwards and Julien Eberhardt’s Invesco Tactical Bond fund.
It invests in all types of bond and has the aim of generating both growth and income over the long term, with a focus on minimising loses during times of market stress.
“[Edwards and Eberhardt’s] focus on limiting losses has meant that their fund has typically had less ups and downs than the wider market,” Cook said. “Their active management approach also means they can stay away from areas of bond markets that they think could perform poorly, and means the fund is highly diversified.”
He said Invesco Tactical Bond could be a good option for investors seeking a fund that can take advantage of market volatility.
The Financial Conduct Authority consults on reversing the ‘unbundling’ rules for pooled funds.
The Financial Conduct Authority (FCA) plans to permit asset managers to pay for sell-side research and trade execution in a single all-in fee, reversing MiFID II ‘unbundling’ rules.
The regulator has set out proposals and launched a consultation today to seek feedback from the investment industry, which will close on 16 December. If it chooses to proceed, any rules or guidance will be published in the first half of next year.
The proposals follow recommendations from the UK Investment Research Review in July 2023, which highlighted the “paucity of research coverage of smaller-cap companies” and argued that ‘bundling’ has enabled the US to produce superior research to the UK.
As a first step, institutional investors were granted greater flexibility on how they purchase investment research in July. The FCA said it now wants to make it easier for fund managers to “buy insight and analysis across borders”.
Before the financial crisis, it was standard practice for asset managers to receive investment research from the broker/dealers they used for trade execution. Brokers would charge buy-side firms a margin on top of the actual costs of executing trades and would provide additional services such as research or technology.
According to the UK Investment Research Review, UK regulators were concerned that this system made the cost of transactions opaque and that it gave rise to conflicts of interest because fund managers might use a broker to benefit from its additional services rather than because it provided the best trade execution for their clients.
Between 2006 and 2018, the FCA banned bundled payments for anything other than research and introduced further restrictions.
Then in 2018, the EU’s revised Markets in Financial Instruments Directive (MiFID II) required asset managers to pay for sell-side research separately.
In the US, however, bundled pricing is still permitted. The UK Investment Research Review argued that this system has enabled US research to become superior to the UK because banks and brokers have been able to invest more in research, retain more senior analysts and develop broader coverage, extending to small-caps.
“There is a widely held (but not uncontested) view that the decline in research budgets for sell-side research following the introduction of MiFID II appears to have led to a ‘juniorisation’ and reduction in the number of sell-side investment analysts, which has impacted the quality of research in the UK, both by reason of the experience of analysts and the number of companies they are expected to cover,” the review stated.
This is what the FCA’s proposals now seek to address. Jon Relleen, director of supervision, policy and competition at the FCA, said: “We want UK markets to be efficient and to support economic growth. Putting more information in the hands of investors and giving investment firms greater access to research to inform their strategies will bolster UK markets.”
Cautious strategies succeeded in delivering the most bang for investors’ bucks.
Asia Pacific continues to be a volatile region for investors. While emerging market and Asian funds have been long out of favour, developments this year such as an improved economic backdrop and the recent stimulus package in China have kick-started a new wave of interest.
Year to date, emerging markets have done quite well, rising by 10.6%. By comparison, this is eight percentage points below the performance of the S&P 500, although it surpasses the Euro STOXX 50 and the FTSE All Share.
Performance of indices year to date
Source: FE Analytics
As with any region, investors are keen to ensure they are seeing the maximum returns for the risks they take. In emerging markets, the more defensive strategies thrived, achieving high returns while taking low to moderate risks.
In the final part of our ongoing series, Trustnet analyses the funds that have struck the best balance between risks and rewards over the past five years by comparing their Sharpe ratios and returns.
Today, we end the series by looking at the funds with the best risk-adjusted returns in emerging market equities and Asia Pacific.
Risk-adjusted returns of IA Global Emerging Market funds over 5yrs
Source: FE Analytics, total returns in sterling, data to 31 Oct 2024
In the IA Global Emerging Markets sector, many funds enjoyed an above-average return on investment. In particular, the £2.2bn GQG Partners Emerging Market Equity fund stood out due to its low-risk approach compared to its peers.
With a 12.7% volatility over the past five years, it was one of the sector’s most risk-averse funds, ranking in the first decile. Despite taking on relatively low risks, the fund did not sacrifice its ability to deliver strong performance, rising by 51.1% - the fifth-best performance in the 141-strong sector.
Performance of fund vs sector and benchmark
Source: FE Analytics
As a result, the fund enjoyed the sector's second-best five-year Sharpe ratio of 0.4.
Moreover, the fund’s strong relative performance has continued, with first-quartile returns over the past three years and one year.
Additionally, the fund enjoyed the second-best ranking for alpha generation in the sector, with an average of 5.5% over five years. This indicates that despite being a relatively less volatile strategy, it was still able to deliver beat the benchmark by a wide margin.
Risk-adjusted returns of IA Asia Pacific Including Japan funds over 5yrs
Source: FE Analytics, total returns in sterling, data to 31 Oct 2024
Next, we move on to the IA Asia Pacific Including Japan sector, in which the £330m Invesco Pacific (UK) fund was the only portfolio that matched our criteria.
Led by Tony Roberts and FE fundinfo Alpha Manager William Lam since 2013, the fund climbed by 49.7% over the past five years, the best performance in the peer group. Over the longer term, it has continued this record with a 10-year performance of 150.8%, also placing it as the best-performing fund in the sector.
Performance of fund vs sector over 5yrs
Source: FE Analytics
Similarly to the GQG Partners portfolio, it achieved this while being one of the most cautious funds in the sector, with a top decile five-year volatility of 12.8%. This combination of low risks but impressive returns generated a Sharpe Ratio of roughly 0.38 over half a decade.
Moreover, in this period it proved to be one of the best funds at generating excess returns, with 3.9% alpha on average, the single best result in the sector.
Risk-adjusted returns of IA Pacific Excluding Japan funds over 5yrs
Source: FE Analytics, total returns in sterling, data to 31 Oct 2024
Finally, we turn to the IA Asia Pacific Excluding Japan sector. In this peer group, it was a more aggressive strategy, the £101m Matthews Asia Discovery fund, which stood out.
The portfolio rose by 76.2% over the past five years, the best result in the sector by over 13%. Paired with a modest sixth decile volatility of 15.9%, the fund has enjoyed the best five-year risk-adjusted returns of 0.53.
Performance of the fund vs sector and benchmark over 5yrs
Source: FE Analytics
Longer-term it also achieved first-decile results, surging by 147.2% over the past decade.
Looking at its ratios, it proved to be one of the best strategies for protecting clients’ investments. With the third-best maximum drawdown of -18.3% and the fifth-best maximum gain of 21.1%, it proved to be one of the best funds in the sector over five years.
However, the portfolio has struggled recently and was the worst performer in the peer group over the past year.
In the rest of this series, we have looked at the IA European and European Smaller Companies, IA Mixed Investment and Flexible Investments, IA North America, IA Global and the IA UK All Companies sectors.
Funds are unlikely to grow large enough to become commercially viable.
M&G plans to merge three of its sustainable multi-asset funds into its Episode range, leading Square Mile Investment Consulting and Research to strip them of their ratings.
In a letter to investors, M&G said the £48m M&G Sustainable Multi Asset Cautious, £53m M&G Sustainable Multi Asset Balanced and £27m M&G Sustainable Multi Asset Growth funds will be merged away due to their small sizes.
“The merging funds have not attracted the expected level of interest from investors and as a result have not attained the size required to make them commercially viable,” M&G’s letter said.
“Following a review, we’ve concluded that there is little prospect for the funds’ growth in the foreseeable future.”
The plans are subject to shareholder approval and will be voted on at an extraordinary general meeting on Wednesday 6 November 2024.
If approved, M&G Sustainable Multi Asset Cautious and M&G Sustainable Multi Asset Balanced will be merged into the M&G Episode Allocation fund, while M&G Sustainable Multi Asset Growth will merge into M&G Episode Growth. This will take place on Friday 22 November 2024.
“The merging funds and the receiving funds included in this proposal are all globally invested multi-asset funds managed by M&G’s experienced multi asset team,” M&G said.
“The receiving funds, although not sustainability related funds, have been selected based on them sharing similar investment and risk characteristics as their respective merging funds and we believe the mergers to be the best option for investors as an alternative investment solution for the long term.”
Square Mile said it was “disappointed” to have to remove the three funds’ Responsible Positive Prospect ratings because of the plans.
In other moves, Square Mile has stripped the A rating from Jupiter Global Value Equity, following the departure of managers Ben Whitmore and Dermot Murphy earlier this year.
Whitmore and Murphy have launched a new boutique – Brickwood Asset Management – but will not run Jupiter Global Value Equity strategy on a sub-advised basis.
Square Mile explained: “Whilst the analysts acknowledge that the appointment of Brian McCormick as the fund’s lead manager represents some continuity of approach and ensures that the mandate remains internally managed by Jupiter, the fund’s A rating was predicated on the expertise of Whitmore and Murphy.”
Meanwhile, the CT Managed Equity & Bond, CT Managed Equity Focused and CT Managed Equity funds have retained their A ratings, having been under review since it was announced that manager Alex Lyle is to retire in April 2025.
Square Mile noted that the funds are managed with a team approach, co-manager Matthew Rees will continue to work on them and there are no changes to the investment approach, therefore the analysts are “comfortable retaining their ratings”.
The ratings agency has also awarded A ratings to The Diverse Income Trust (“an interesting option for investors seeking to diversify their sources of income from UK equities”) and JPM Europe Equity Absolute Alpha (“its returns are lowly correlated to stock market indices and the fund has an impressive record of protecting investors’ capital in stock market downturns”).
Schroder Global Sustainable Value has awarded a Responsible A rating. Square Mile said it offers a strong value investing proposition that is differentiated from many other sustainable funds, which tend to have a growth bias.
Finally, Fidelity UK Smaller Companies fund has been upgraded from A to AA rating while Fidelity MoneyBuilder Dividend and Fidelity Enhanced Income funds were upgraded from Positive Prospect to A ratings.
Five funds to add a bit of spark to your portfolio, according to experts.
Investors should be familiar with the risk/reward equation – you have to take risks to have any chance of getting the reward.
This Bonfire Night, Trustnet asked experts which funds they would pick to reach the sky, with the reassurance that for as daring as they might seem, none will be as risky as the infamous plot to blow up Parliament.
For investors who like to plot in the dark and are always siding with the underdogs, Laith Khalaf, head of investment analysis at AJ Bell, chose the Fidelity China Special Situations trust, which he said should be a good option to add some spark to well-diversified portfolios.
Performance of fund against sector and index over 1yr
Source: FE Analytics
Manager Dale Nicholls looks for cash-generative companies that offer long-term growth prospects and are trading at attractive valuations. The smaller-companies tilt “adds to the risk of the fund but also opens up the possibility of higher returns from a fast-moving area of the market”, Khalaf said.
The manager draws upon the resources of Fidelity’s sizeable analyst pool, including 13 analysts specifically dedicated to China, Khalaf pointed out.
“The Chinese stock market has been on a bit of a rollercoaster ride of late, but investors have broadly responded positively to economic stimulus coming from the central government,” he said.
“The Chinese stock market can be vulnerable to government intervention, but it will also respond to global factors, in particular more defensive US and European trade policies. Investors lately seem to have turned their attention towards India, which has been seen as the next big thing, so China represents a bit of an underdog story at the moment”.
Investing in a single country, however, even one as large as China, comes with “a large risk warning” so this first pick should only be considered by investors with all the main regional bases covered, Khalaf warned.
Lovers of British traditions like Bonfire Night might also love UK smaller companies portfolios such as Tellworth UK Smaller Companies, a higher-volatility option selected by FE fundinfo deputy chief investment officer Charles Younes.
Performance of fund against sector and index over 1yr
Source: FE Analytics
The fund comprises, approximately equally, growth and value stocks with strengths in four main areas: product, market leading, margin and management team.
FE fundinfo Alpha Managers John Warren and Paul Marriage exclude a few areas, such as oil and gas, mining and biotech, but otherwise don’t follow a benchmark closely, preferring a bottom-up selection of 40 to 60 stocks in the portfolio.
Younes likes their bottom-up style, with an emphasis on meeting management teams and “understanding the businesses they invest in deeply”. This is further differentiated from peers as they are looking “outside typical growth stocks” at more unloved areas of the market.
For higher-risk, higher-return opportunities across the globe, Younes picked the Baillie Gifford Global Discovery fund.
Performance of fund against sector and index over 1yr
Source: FE Analytics
The team, led by Douglas Brodie, focuses on companies’ fundamental characteristics, favouring strong management teams and innovative products, which can generate sustainable profits to fund future growth opportunities, Younes said.
The fund has a high number of positions below 0.5%, which represent the riskier ideas in the portfolio that may or may not work out.
“It doesn’t add to these names, but lets them climb or fall based on performance, which helps to mitigate some of the risks associated with investing in smaller companies by minimising the impact from a potential bad investment,” Younes said.
Although in isolation the fund is high risk, it could be suitable as an addition to an already-diverse global-equity allocation that is lacking smaller company exposure, the CIO concluded.
Still within global equities, Rob Burgeman, investment manager at RBC Brewin Dolphin, said that from weight loss drugs to vaccines, healthcare is currently undergoing “radical changes”.
According to him, an ideal way of participating in this revolution is through the Janus Henderson Global Life Sciences fund.
Performance of fund against sector and index over 1yr
Source: FE Analytics
It invests at least 80% in shares of life-sciences companies of any size and in any country, preferring those that are addressing unmet medical needs or seeking to make the healthcare system more efficient.
Managers Andy Acker and Daniel Lyons aim to maintain a balanced portfolio across subsectors such as biotechnology, healthcare services, medical devices and pharmaceuticals.
“Picking winners in this space can be very difficult, so this fund is an ideal way to gain exposure to the wider industry and the tail winds propelling it forwards,” said Burgeman.
Finally for a more specialist pick, Momentum Global Investment Management senior research and portfolio analyst Gregoire Sharma went for the Global Evolution Emerging Markets Blended High Conviction fund.
This high-conviction, blended EMD strategy is a best-ideas collection form various portfolio managers at Global Evolution, with a statice 25% allocation to sovereign hard currency debt, sovereign local currency debt, corporate hard currency debt and frontier local currency debt.
Since inception in 2022, it delivered a 33.7% return gross of fees, beating many of its peers.
“The strategy has been very successful, outperforming both in bull months and bear months. When the market turns negative, frontier positions tend to outperform, whereas when it turns positive, hard currency tends to outperform,” Sharma said.
“Given frontier markets are so under-researched relative to more ‘vanilla’ EMD asset classes, they offer significant opportunities for outperformance.”
As cash becomes less attractive, Pictet’s Shaniel Ramjee encourages investors to be more adventurous and explore new asset classes.
Investing is a delicate balancing act. Many investors try to walk a careful tightrope between risk and reward, but for Shaniel Ramjee, co-head of multi-asset at Pictet Asset Management, the balance has tipped too far in one direction.
For Ramjee, investors have become too cautious and unwilling to take the chances necessary to thrive in difficult environments. As investors continue to search for greater returns, they will find themselves struggling if they continue to avoid the more volatile sectors.
“Investors need to be aware that investing for real returns is the only way to secure long-term financial security, and being too defensive will hinder that,” he said. “We do think that investors, by and large, have become too risk averse.”
He attributed this caution to several factors, particularly people’s fixation with cash.
Rising interest rates have made cash more attractive in recent years, but interest rates will dampen the returns available, Ramjee commented, making other asset classes far more appealing.
Indeed, while funds in the IA Standard Money Market sector have seen modest growth year-to-date (YTD), rising by an average of 4.39%, other asset classes have enjoyed similar or even better growth, with the IA UK Equity Income sector up by 8.2%.
Performance of sectors YTD
Source: FE Analytics
For Ramjee, overreliance on cash has blinded investors to the significant opportunities available from other, more volatile asset classes.
“While cash rates may have looked appealing, it was not the best decision for many investors, who should have been looking at investing in the wider financial markets and across the capital structure,” he said.
“Not only is cash not king, but it could also prove to be the joker in the pack”.
What other asset classes should investors turn to?
Despite recent surges in volatility, it has been a good year to be an equity investor. The S&P 500 is up by 19.4% despite experiencing one of the largest sell-offs on record in August.
Performance of indices YTD
Source: FE Analytics
Additionally, with further rate cuts expected from central banks this year, Ramjee expects a wider variety of companies to benefit, leading to more varied long-term opportunities for investors willing to venture into the stock market.
Moreover, for Ramjee, equities provide investors with exposure to the “real economy” and serve as an essential diversifier despite being relatively high-risk. As he puts it, returns from equities reflect real market activity and developments.
For example, if inflation is persistently high, that will be reflected in dividends, earnings and capital appreciation of companies. Similarly, when inflation declines, returns on equities will shift in response.
“We think all investors, over the long run, should have some exposure to the real economy. Equities are still one of the best places for long-term savers to invest their money,” he stated.
Ramjee also drew attention to the fixed income market, in particular corporate bonds. As a higher-risk asset than cash, bonds remain a great diversifying addition to a portfolio, providing market exposure without taking on too much risk.
Spreads (the additional yield on corporate bonds compared to government bonds) are tight but nonetheless, corporate bonds have still outperformed government debt this year.
Funds in the IA Global Corporate Bond peer group enjoyed growth of 2.8% YTD, while portfolios in the IA Global Government bonds sector slid by 2.3%.
Performance of sectors YTD
Source: FE Analytics
Ramjee attributed this to corporations’ fiscal caution compared to governments, which have accrued significantly inflated balance sheets. Take for example the US, which is facing a national debt of over $35.8trn.
“The creditworthiness of corporates we believe, will remain much stronger than that of governments around the world,” he added.
Ultimately, higher returns can only be achieved by taking more risks and diversifying away from cash. "Investors just don't invest enough," Ramjee concluded.
Even if we assume that presidents influence economies, they aren’t a decisive factor in driving stock markets.
Do elections matter? Of course they do. Elections can change all sorts of things: how we live, access to healthcare and education, the regulations businesses must abide by and how much money is in our pockets at the month’s end.
For equity managers, the critical questions are: what do elections mean for stock picking? Do they influence whether the market goes up or down? By how much?
However, evidence shows that a selective stock-picking manager can thrive, whatever the political climate.
Reviewing returns
The average annual price return for the S&P 500 going back six decades is about 8%. In the year after a presidential election, the number is… just under 9%. In the year prior, it’s about 8%. There is significant volatility year by year, but nothing suggests these years stand out from any other.
Even volatility isn’t significantly different from the norm in these years: the average standard deviation from the annual price return is about 15%, with the number before an election 16% (i.e. a little more), and after 13.5% (i.e. a little less).
Perhaps these averages mask something important.
What about Republicans versus Democrats? It may be tempting to assume low-tax, low-regulation Republicans are a stock market winner, but the data doesn’t show that.
The average annual price return during a Republican presidency is about 5%. During a Democratic presidency, it’s 11%.
In the year after a Republican victory, the average price return is 3%. After a Democratic win, it’s 15%.
However, these figures are distorted by big one-offs. George W Bush’s election coincided with the dotcom bubble’s burst, leading to a 22% market drop over the year following the result. In the 12 months after Joe Biden’s win, the market surged 38% in a trading environment distorted by the lifting of Covid lockdowns.
Challenging assumptions
The argument above implicitly implies it is the economy that drives markets, which in turn is driven by politics.
But the relationship between the strength of economic growth and market returns is shaky at best. Between 1900 and 2022, the US economy grew more than any other country. However, that didn’t translate into the best stock market returns.
The US market returned about an average of 6.5% a year over the period. However, South Africa’s stock market beat it, achieving a 7.2% return despite pedestrian economic growth. When translated into US dollars, the returns of the two countries are about the same. But on this common currency basis, Australia comes out on top.
If you switch the starting point to 1998, the S&P 500 has made an impressive gain, returning just shy of 500%. However, over this timespan, it’s trounced by the Dow Jones Denmark, which returned just over 1,500% in US dollar terms despite slower economic growth.
Of course, starting points matter when making such comparisons. This is a key point: one reason index returns deviate from economic performance is that the former depends on starting valuations, which are a proxy for investor sentiment about a country’s stock market prospects.
However, there are two further reasons. First, much of a stock market’s return is driven by overseas revenues. For the S&P 500 today, international sales are approaching 40% of the total. Second, the stock market mainly accounts for large public businesses, ignoring private and smaller companies, let alone government spending.
Therefore, even if we assume that presidents influence economies, they aren’t a decisive factor in driving markets. Which begs the question: what does matter?
The short answer is innovation and entrepreneurship. The stock market is, after all, merely a collection of companies. Furthermore, it tends to be driven by the outsized successes of a few big winners.
What is game-changing from a long-term perspective?
Perhaps the sharpest way to demonstrate this is to take hotly contested issues of the past and contrast them with important technological advances and company launches.
What mattered more in 1976, the fallout from Watergate or Apple’s founding? In 1996, was it the role and size of the federal government or Larry Page and Sergey Brin launching Google? Should investors have paid more attention to 2004’s immigration debate or wondered about Facebook’s potential?
Politicians may debate the appropriate level of taxation or regulation for already profitable businesses. This can affect discounted cash flows (which some investors use to determine an asset’s current value based on forecasts of how much money it will make in the future).
However, for a company such as Novo Nordisk, which derives most of its revenue from the US, it is its impressive collection of accumulated diabetes and obesity knowledge stretching back over 100 years, and the enormous size of this market, that matters most to long-run stock returns. Not who sits in the White House.
Another example is Aurora, a company pioneering autonomous trucks. Adapted vehicles can drive through the night without risk of driver exhaustion and in the most fuel-efficient manner. As this technology matures, the implications are profound for the efficiency and safety of our transport networks. Regulations may take time to catch up, but the long-term result is as inevitable as an Aurora vehicle reaching its destination.
Infrastructure outliers
Some sectors seem more susceptible to politics than others. Finance, for instance, is heavily regulated. Infrastructure also counts politics as its ultimate source of demand.
Policy often determines the exact dollar amounts and timings regarding infrastructure investments. However, that policy is often the product of long-term trends.
Part of the reason infrastructure investment is a broadly bipartisan issue today is because the effects of its deterioration are widespread. Things will change, no matter who’s in the Oval Office. Still, it pays to be selective and to look for companies with the best potential for outperformance.
Where does burgeoning, long-term demand meet other stock-specific attributes? One answer is Stella-Jones, a maker of telegraph poles, among other wooden products. Stella controls most of North America’s supply, making it vital to upgrading and maintaining power and telecommunication networks.
Even if demand for its poles moderated to only a sustainable replacement level, there would be a shortage. Moreover, supply can only expand slowly, so Stella-Jones can charge good prices.
A stock picker’s advantage
We have no special insight into who will win this week or in any other election. But we do regarding revolutionary medicine, autonomous trucks and telegraph poles.
Indeed, it is much easier to step back and ask: what’s really changing? Where are the fires of innovation and entrepreneurship burning the brightest?
The selective stock picker can follow that light to outsized returns and leave the political crystal ball gazing to others.
Michael Taylor is an investment manager at Baillie Gifford. The views expressed above should not be taken as investment advice.
Half of UK equity income funds hold Shell in their top 10 and the same is true for BP; Trustnet investigates whether they remain good investments after a tough year.
The price of Brent crude oil has fallen significantly in the past 12 months, oil stocks have lagged the broader market and the sector has been shunned by investors concerned about environmental, social and governance (ESG) factors.
Despite this, more than half (56.8%) of funds in the IA UK Equity Income sector count Shell as a top 10 holding while 45.9% can say the same for BP. Retail investors are piling in as well; BP was the most bought stock on interactive investor’s platform in October.
BP has had a particularly bad year, culminating last week in its worst quarterly results since the pandemic. Its share price is down 18.4% year-to-date, according to Google Finance. Shell has fared better and is up 1.6% year-to-date, as of mid-morning today.
Both stocks rose this morning on news that OPEC would delay hikes in output through December, giving oil prices a lift, said AJ Bell investment director Russ Mould.
With geopolitical tensions on the rise, supply/demand imbalances working in energy companies’ favour and valuations outside the US at attractive levels, this might be a good time for contrarian investors to take a fresh look at the sector, he suggested.
Demand for oil is growing but supply is constrained
Demand could surge in the US especially, Mould argued: “The US Strategic Petroleum Reserve is still diminished, at 385 million barrels, way below its 714-million-barrel capacity, after the Biden administration’s liquidation of assets to try and cap fuel and gasoline prices for US consumers. At some stage it would make sense to top this back up, especially at a time when energy supply could be a matter of national security.”
But while demand is robust, supply is constrained. “Drilling activity remains subdued, thanks to the pricing environment and the combination of political and public pressure,” he noted.
Redwheel’s Ian Lance, who manages the Temple Bar investment trust, said the capital expenditure of the 50 largest oil companies in the world today is half that of 2013, so companies are investing less, even though “demand for fossil fuels this year is at an all-time high”.
“We sometimes refer to this as a capital cycle thesis, where supply is not growing, but demand continues to grow,” he said.
The energy transition is weighing no BP
Long term, the transition to renewable energy should dampen demand for oil but that has not happened as quickly as expected, Lance said.
Of all the oil majors, BP “went heaviest on the energy transition”, said AJ Bell's head of financial analysis, Danni Hewson. Paradoxically, it has been penalised for this.
US oil majors, which have performed better, have taken a “more pragmatic approach”, making no plans to move out of hydrocarbons, having no interest in renewables and focusing instead on complimentary areas like carbon capture and hydrogen, she said.
Lance added: “US companies have been merging and buying other oil and gas producers, so they have not invested so much in the transition. They've continued to invest in oil and gas and therefore they've remained very profitable. They've been using that money to buy back their shares.”
Recently, BP and Shell have started to move in the direction of their US peers, he continued. They have dialled back their spending on renewable energy, invested in upstream oil and gas, and bought back shares.
Shell has outperformed BP, Hewson said, because it built a long-term strategy around natural gas, which is seen by some as a bridge between more polluting fossil fuels like coal and oil and renewable energy.
Reasons to invest in oil companies
Imran Sattar holds Shell in the Edinburgh Investment Trust but admits it is not his highest conviction idea. Oil companies are price takers – they are dependent on commodity prices which they do not control – whereas he prefers to invest in price-making businesses. However, Shell plays two roles in his portfolio – to generate income and diversify the trust’s economic exposure.
Another compelling reason to revisit Shell and BP is their valuations. They are trading on 7x earnings, with a 15% free cash flow yield and dividends of 4.2% and 6.5%, respectively.
Jonathan Waghorn, portfolio manager of Guinness Global Energy, said another way to look at valuations is the implied oil price as a barometer of the expectation priced into oil companies.
“At the end of September, we estimated that the valuation of our portfolio of energy equities reflected a long-term oil price of around $66 a barrel,” he said. This is significantly lower than the ‘normalised oil price’, which would allow supply and demand to be broadly in balance going forward, and which he believes is around $80 per barrel.
“If the market were to price in a long-term oil price of $80 a barrel, it would imply around 50% upside [to his fund’s portfolio]. Assuming an average Brent oil price of $80 a barrel in 2024, we estimate a free cash flow yield of over 10% for our portfolio.”
Guinness Global Energy is overweight European integrated oils, Canadian integrateds, equipment and services. “We believe that a new investment cycle in oil and gas is required and that our overweight service exposure will be a key beneficiary of increased spending in the sector,” Waghorn explained.
In Europe, the fund is overweight Eni, Repsol, OMV, Galp and Equinor, which are trading at valuation discounts to their global peers and are offering significant free cash yields at current share prices, he continued.
Canadian integrated oil stocks are cheaper than US counterparts thanks to lower Canadian regional oil prices. Conversely, the fund is underweight Exxon and Chevron, which trade at a significant premium to European majors.
The latest fund flow data from Calastone shows outflows from every category of equity fund last month.
A record amount of money was pulled out of equity funds in October as UK investors were spooked by the capital gains tax (CGT) hike in the Labour government’s first Budget, data from Calastone reveals.
The global funds network’s latest Fund Flow Index shows investors withdrew a net £2.71bn from funds in October, with every category of equity fund posting outflows during the month.
Calastone noted that October’s outflows followed a weak September, which itself had seen the first net redemptions since October 2023. Sell orders surged 36% month-on-month but then dropped 40% overnight as the CGT hikes took effect on 30 October, the day of the Budget.
Net flows – equity funds
Source: Calastone Fund Flow Index – Oct 2024
Buying activity also rose sharply in October, which suggests the reinvestment of some of the proceeds of fund sales after the capital gain had been booked.
Edward Glyn, head of global markets at Calastone, said: “Fears of a capital gains tax grab in last week’s Budget spurred investors to book their profits and crystallize a lower tax bill well before the chancellor rose to her feet in the Commons. Unease in September meant the early birds took fright first, but by October investors were flocking for the exits.”
In the Budget, chancellor Rachel Reeves increased the higher rate of CGT from 20% to 24%, while the lower rate for basic-rate taxpayers was lifted from 10% to 18%. She emphasised that the UK still has the lowest CGT rates among European G7 nations, even after these increases.
The hike is intended to help address the government's fiscal challenges but has been viewed as a blow for investors. The chancellor’s increase has not aligned CGT with income tax rates, which had been a widely discussed possibility before the Budget announcement.
Sell order value – equity funds
Source: Calastone Fund Flow Index – Oct 2024
Glyn added that there were “no major catalysts” in global markets that could have sparked such flight from funds. While indices drifted lower in the second half of October on the back of rising bond yields, “there were no alarming moves”.
“Instead, sharply higher selling by investors based here in the UK suggests the net outflow (the difference between the buying and selling) was driven by a motivation to book profits after strong market rises this year,” he explained.
“Moreover, October’s robust buying activity indicates that investors were also happy enough to reinvest much of the proceeds of their sales back into funds. The startling change in behaviour between 29 October and Budget day is a clear indication that tax was the main motivation for all this activity.”
The Calastone Fund Flow Index shows that UK assets were hardest hit by October’s outflows. Some £988m – more than a third of the total – was pulled out funds focused on UK equities. This was their fourth worst month on record.
Another quarter (£733m) came from equity income funds, which are skewed towards the UK stock market. It was the third worst month for income funds.
What’s more, October was the first month in more than two years when UK investors withdrew cash from global equity funds and the first month in more than a year for money to come out of US equity funds.
“With US markets and global markets having risen strongly over the last year, this is a further indication that booking gains for tax purposes was a key motivation,” Calastone added.
However, fixed income funds had their best month since June 2023 even though bond yields have surged in recent weeks. This follows investor caution of the depth of interest rate cuts now expected from the Federal Reserve and concerns around higher government borrowing in the UK.
Higher bond yields mean lower bond prices, but also creates an opportunity for newly invested capital to lock into these yields.
There were few days of outflows from fixed income funds in mid-October when bond yields rose fastest but investors added £631m over the whole month, the best result for bonds funds since June 2023.
Money market funds, the classic safe-haven asset class, also saw higher inflows, rising to £402m in October.
Glyn finished: “The suggestion that interest rates may stay higher for longer in the wake of the Budget made interest-earning assets like bonds and cash funds more attractive to investors.”
Mirabaud’s John Plassard offers an in-depth analysis of what would happen if Donald Trump won this week’s US presidential election.
Donald Trump, the 45th president of the United States, is the Republican candidate in the 2024 presidential election. This despite multiple run-ins with the law; indeed, he is the first former president to have been convicted of a crime. Known for his real estate empire, Trump made a name for himself as a businessman, reality TV star and public figure before entering politics.
His 2016 presidential campaign emphasised a populist, ‘outsider’ message and his term in office was marked by major controversies, including two impeachments: one over Ukraine-related issues and the other following the 6 January attack on the Capitol. After losing to Joe Biden in 2020, Trump claimed widespread voter fraud and continued to rally his base, calling the legal proceedings against him political persecution. His 2024 primary campaign enjoyed strong support despite these controversies, positioning him as a polarising figure with dedicated supporters.
Trump's businesses and brand have often been at the centre of public attention, contributing to his image as a self-made billionaire, despite frequent legal and financial problems throughout his career.
On what platform was Trump elected?
Here is a summary of Trump's positions on the main issues of his 2024 campaign:
Education: Trump is proposing radical reforms for schools, with measures such as the election of head teachers, or ‘principals’, by parents; the withdrawal of funding for schools teaching ‘critical race theory’; and an end to tenure for teachers. He also wants to encourage prayer in schools and allow teachers to carry concealed weapons. This approach aims to give power back to parents and promote ‘patriotic’ values within the education system.
Universities: Trump plans to revoke universities' current accreditations and replace them with bodies imposing values in line with those of his party. He is also proposing substantial fines for universities that he considers discriminate against students, with the idea of funding a free online academy covering a wide range of knowledge.
Climate change: Trump wants to take the US out of the Paris Agreement again and undo Biden's climate policies, including reducing emissions and the target of 67% electric vehicles by 2032. He plans to massively increase oil and gas production.
Department of Justice: Trump is promising to appoint 100 like-minded prosecutors and to investigate some progressive local prosecutors. He also wants to create a unit within the DOJ to defend the right to self defence and combat alleged anti-conservative bias in law schools and law firms.
Crime: Trump wants to increase police numbers and supports practices such as ‘stop-and-frisk’, the dismantling of gangs and drug rings, and the use the National Guard if local police fail to respond. Trump also advocates the death penalty for drug and human traffickers.
Immigration: Trump wants to ban illegal immigrants from receiving aid, abolish birthright citizenship for their children, reinstate a travel ban for certain countries and suspend visa programmes, including the lottery and family visas. He also plans to close the southern border to asylum seekers.
Economy: Trump is proposing to cut taxes and lift federal regulations. He also wants to introduce basic tariffs on foreign products to encourage American manufacturing, with increases in these tariffs for countries practising ‘unfair trade’ (see below).
Healthcare: Trump plans to require federal agencies to buy only drugs and medical devices made in the United States. He also wants the government to pay no more than the best price offered to other nations for drugs.
Foreign policy and defence: Trump is proposing to ask the European allies to reimburse the United States for the depletion of their arms stocks as a result of shipments to Ukraine. He also takes a tough stance against China, calling for new restrictions on Chinese-owned infrastructure in the United States and wants to build a missile defence shield.
Social Security: Unlike former Republicans, Trump says there will be no cuts to Social Security or Medicare.
Homeless: Trump is proposing to ban public camping by the homeless, offering them a choice between treatment or arrest, and to create ‘tent cities’ where they would be rehoused, with access to healthcare and social support.
Big Tech: In response to allegations of bias against conservatives, Trump is considering issuing an executive order banning any collaboration between federal agencies and other entities to ‘censor’ Americans, as well as prohibiting the use of federal funds to fight disinformation.
How much will the deficit increase over the next 10 years?
Trump's tax plan could add $7.5trn to the national debt by 2035, taking it to 142% of GDP, according to key estimates. In particular, he proposes to make the Tax Cuts and Jobs Act (TCJA) permanent, further reduce corporate tax and increase military spending.
These tax cuts and spending growth would considerably increase deficits. In the best-case scenario, Trump's plan would increase the debt by $1.45trn, but in the worst-case scenario, the debt could rise to $15.15trn.
Despite some proposed measures to compensate, such as new customs duties and cuts in certain government programmes, his plan does not sufficiently tackle the increase in the national debt, making the budgetary outlook precarious.
What attitude to adopt towards China?
When it comes to China, Trump adopts an intransigent stance, advocating economic decoupling, the imposition of high tariffs and the revocation of China's permanent trade status. He also proposes to limit Chinese acquisitions of US industries, maintain military deterrence by modernising nuclear weapons and strengthen ties with Taiwan.
Trump holds China responsible for problems such as fentanyl trafficking and the genocide of the Uyghurs, advocating punitive measures and strict negotiations with Chinese leaders.
What impact would Trump's triumph have on Europe?
With Trump in the White House, European products could face significant challenges, as the former president has made it clear that he would impose vast tariffs, potentially ranging from 10% on all imports to much higher levels on countries such as China, which could also affect European products. The European Union (EU) is preparing for a scenario in which Trump carries out his threats by creating a list of American products that it could target with retaliatory tariffs.
Although these new levies are not the EU's baseline scenario, they are seen as a necessary response to Trump's potential trade measures against the Union. Trump has a habit of surprising the EU with unexpected tariffs, as he did in 2018 by imposing duties on European steel and aluminium. The EU retaliated by targeting politically sensitive US companies such as Harley Davidson motorbikes and Levi Strauss jeans. Trump's return to power could be a copy and paste of 8 years ago.
In addition, Trump could also zero in on European taxes on digital services, which often affect American technology giants, further straining transatlantic trade relations.
The EU, already weakened by competition from cheaper Chinese electric vehicles and the end of its dependence on Russian gas, is facing a precarious situation. A trade war with the United States could further accelerate the continent's economic difficulties, particularly in its manufacturing sector, which has already been hit hard.
While the EU preferred to resolve trade disputes with the US through diplomatic channels, it is fully aware that the Biden administration has also maintained an ‘America First’ approach. His administration has introduced substantial subsidies for green technologies that encourage companies to shift their investments from Europe to the US, exacerbating the challenges facing Europe. The EU is therefore preparing for tough trade negotiations with the United States over the coming months ...
How much will higher tariffs cost?
Candidate Trump has proposed significant tariff increases as part of his presidential campaign; Taxfoundation estimates that if imposed, these tariff increases would raise taxes by an additional $524bn per year and reduce GDP by at least 0.8%, the capital stock by 0.7% and employment by 684,000 full-time equivalent jobs.
Taxfoundation's estimates do not take into account the effects of retaliation or the additional damage that would result from the outbreak of a global trade war.
Will tax cuts have an impact on the S&P 500?
During the election campaign, Trump's political approach, particularly with regard to corporate tax, could have a significant impact on the financial markets. If elected, Trump proposes to cut the corporate tax rate from 21% to 15% to stimulate business investment, increase profits and potentially boost job creation. This proposal is part of his wider economic philosophy of deregulation and tax cuts to fuel growth.
If Trump's proposals were implemented, it would likely lead to an increase in corporate after-tax profits, which could boost share prices, particularly in sectors such as energy, manufacturing and financial services. However, the markets have not yet fully priced in the possibility of a tax cut, probably because they are unsure of Trump's ability to obtain the Congressional approval needed to pass such legislation. Without a strong majority in Congress, Trump could find it difficult to implement his entire programme, particularly in key areas such as tax cuts.
In short, while Trump's proposed tax cuts could benefit markets by improving corporate profitability, political realities and legislative hurdles could limit the scope of these changes. Investors are keeping a close eye on whether his policies will gain ground in Congress.
All other things being equal, Bank of America estimates that Trump's proposal to lower the corporate tax rate from 21% to 15% would increase S&P 500 EPS by 4%.
How would the markets react to a divided Congress?
While investors do not yet have a clear view of how the markets will react after the elections, they can nevertheless take note of the historical performance of equities when Congress is divided between the parties. In fact, perhaps counter-intuitively, equities perform well when Congress is divided, with the S&P 500 averaging annual gains of over 17% in such scenarios.
According to analysts at LPL Financial, stocks have risen each of the last 11 times Congress has been divided, and 2024 could be the 12th. The reason is that Congressional gridlock reduces the likelihood of disruptive political changes, to the benefit of equities, generally.
In the current context, a divided Congress could also minimise the risk of major tax increases under a Harris administration. A divided government generally reassures the markets by providing a more predictable political environment. Analysts also note that while checks on power can be beneficial, cooperation is essential to meet the current economic challenges posed by the pandemic.
Since 1929, the most common configuration in Washington has been Democratic control of the White House and both houses of Congress, resulting in an average annual rise of 9.4% in the S&P 500 over 34 years. The second most common configuration saw Republicans in the White House and Democrats running both houses, with a lower annual return of 4.9% over 22 years. The best performance under divided government occurred with a Democratic President, Democratic Senate and Republican House, with an average rise of 13.6%, although this only lasted from 2011 to 2014 under Barack Obama.
How would the markets react to an entirely Republican Congress?
Historical performance shows that under an all-Republican Congress, the S&P 500 recorded an average year-on-year rise of 13.4%. This is often attributed to a more stable political environment, favouring pro-business policies. However, a divided Congress tends to outperform, with an average return of 17.2% over one year. This scenario is well received by the markets as it reduces the risk of disruptive political changes, thereby minimising the potential impact of tax hikes or strict regulations, particularly under a Harris administration.
Such legislative gridlock favours a more predictable political framework, which tends to reassure investors. Indeed, a divided Congress has historically led to annual gains for the S&P 500 in the last 11 similar scenarios, with increases observed on each occasion, creating a favourable environment for the financial markets and reducing the likelihood of economic disruption.
Which sectors could theoretically benefit from Trump's arrival?
The prospect of a second Trump term could significantly influence investor sentiment. It is estimated that a Trump win could have a slightly positive impact on economic growth in the short term, but this effect could be quickly cancelled out by imported inflation and tensions over monetary policy.
In terms of sectors, here's what we can say:
Fossil fuels: Trump is also likely to rescind the Environmental Protection Agency's (EPA) mandates for electric vehicle sales, which currently require 56% of new vehicles sold to be electric by 2032. He could also remove the tax incentives for electric vehicles under the Inflation Reduction Act.
Pharmaceuticals: Reducing the cost of drugs and boosting domestic production of essential medicines is another initiative that Trump could undertake, which could be advantageous for US pharmaceutical companies, particularly biotechs.
An end to conflict (really?!): Trump's desire for an ‘immediate end’ to the conflicts in the Middle East and Ukraine could benefit US construction companies but could have a negative impact on arms-related businesses.
Education: Trump plans to transfer control of education from the federal Department of Education to state governments, which he believes are better placed to tailor education policies to their communities. Education technology players could well benefit from this.
Small- & mid-caps: Small and mid-cap stocks should benefit from a Trump presidency because of his pro-business policies, which stimulate economic growth and create opportunities for these companies. In addition, small-caps benefit from the prospect of lower interest rates, which reduce borrowing costs for the many unprofitable companies in the sector that rely on debt finance.
Prisons: After Trump took office in 2017, then-attorney general Jeff Sessions signed an executive order rescinding an Obama-era directive to phase out the use of private prisons. This sent shares in the two largest private prison companies - CoreCivic and GEO Group - soaring, both reaching post-election peaks in April 2017. That sort of momentum could return.
Finally, European and Chinese equities could be initially negatively impacted. The European automotive industry would be particularly vulnerable to a potential trade war with the United States, because of tariffs. In addition, the luxury goods sector and European high-tech companies could also suffer from US trade retaliation. The short-term reaction of sectors in the event of a divided government under Trump is likely to be more or less the same. Consumer discretionary could come under negative pressure, as could renewables and ESG leaders.
A stock to follow
There will be plenty of companies to watch when the US markets open on Wednesday, but there may be one to keep a very (very) close eye on: Trump Media & Technology Group.
Trump Media & Technology Group Corp (TMTG) is an American media and technology company headquartered in Sarasota, Florida. It manages the Truth Social social media platform and Trump is its biggest shareholder. Founded by Andy Litinsky and Wes Moss in 2021, it went public on 26 March 2024, after merging with Digital World Acquisition Corp (DWAC), a special purpose acquisition company (SPAC). Trump owns nearly 57% of the company...
And what about the long term?
It is often difficult to separate investments from politics, but it is important not to attach too much importance to election results when making financial decisions. Indeed, election results have little impact on long-term investment returns. Despite the alarmist rhetoric surrounding presidential campaigns, financial markets tend to perform well, regardless of which party is in power.
To illustrate this, since 1950, the S&P 500 has generated a cumulative return of 359,416% (with dividends reinvested), covering 14 presidents, including seven Republicans and seven Democrats. In other words, a $1,000 investment in the S&P 500 in January 1950, with dividends reinvested, would be worth around $3,594,160 today. This figure shows that investors should not base their strategies on election results, but rather take a long-term view.
How will the dollar and cryptocurrencies evolve?
Once again, this is a difficult question, as there are many factors that explain the greenback's performance (the economy, debt and interest rates). While we can imagine that with a Trump victory the dollar will rise in the short term, in the medium term things don't seem quite so obvious. A further analysis of the past reveals the following trends:
Over the last six administrations, the dollar performed best under president Bill Clinton, gaining 19.61% of its value.
The dollar had its worst performance under president George W. Bush, losing 22.00% of its value.
Over the course of the Republican presidencies during this period, the dollar lost 36.17% of its value.
A Trump win should have a significant impact on the cryptocurrency market (in the short term) by fostering a more favourable environment for these currencies, as Trump has expressed a new enthusiasm for digital currencies. His administration could roll back some of the regulatory crackdowns of the Biden era and create initiatives such as a "strategic national Bitcoin stockpile", positioning the US as a global leader in the crypto space.
This relaxed regulatory approach could attract more investment and innovation to the crypto-currency sector, but it also raises concerns about increased fraud risks and insufficient consumer protection, as evidenced by the Securities and Exchange Commission's (SEC) scrutiny of the sector.
How will raw materials behave?
A Trump return to power could have a significant impact on commodity prices, not least because of his pro-coal, pro-mining and protectionist policies. If Trump repeals Biden's Inflation Reduction Act, it could benefit traditional energy commodities such as coal and oil, while potentially boosting demand for platinum group metals (PGMs) used in internal combustion engines. However, China's economic policies and growth trajectory remain a key driver of global commodity prices, meaning that while Donald Trump's policies could influence some sectors, the greater strength of China's economic dominance will continue to play a major role in shaping global commodity demand and price movements.
In addition, the intensification of trade tensions with China under Donald Trump could push prices even higher by disrupting global supply chains. Finally, it is conceivable that the uncertainties associated with the arrival of the ‘controversial man’ could benefit gold.
The crucial summary
Below is a summary of the potential trends for different assets/regions if Trump takes the White House:
Source: John Plassard, Mirabaud
A Trump victory could lead to significant changes for the financial markets, with tax cuts for businesses, increased support for fossil fuels and a protectionist approach to trade. This policy could benefit certain sectors, notably energy, pharmaceuticals and small-caps, while posing risks for trade, particularly with Europe and China. Cryptocurrencies could benefit from Trump’s favourable stance, with potentially relaxed regulations. However, his programme of tax cuts and increased military spending could add to the national debt. Finally, a president Trump could also boost commodities such as coal and oil, while increasing demand for gold due to uncertainty.
John Plassard is senior investment specialist at Mirabaud Group. The views expressed above should not be taken as investment advice.
Advisers suggest multi-asset funds to lower the drawdown risk and volatility of investors’ portfolios.
Shoot-the-lights-out equity funds are all well and good in a bull market but they can drop dramatically and suddenly when the tide turns. Therefore many fund selectors seek to balance high-octane investments with more conservative and diversified multi-asset funds.
Although defensive funds won’t necessarily maximise returns, they should protect capital during downturns. To that end, Trustnet asked fund selectors which multi-asset strategies they use to complement equities and bring down portfolio volatility.
Troy's Trojan fund and its ethical sibling
Laith Khalaf, head of investment analysis at AJ Bell, said Troy Asset Management’s Trojan fund is a good option for cautious investors who want some growth to combat inflation while mitigating market volatility.
FE fundinfo Alpha Manager Sebastian Lyon and Charlotte Yonge build the fund around four pillars of quality: equities, index-linked bonds, gold and cash, with – like all of Troy’s funds – an emphasis on capital preservation above all else.
“Within the equity portion of the portfolio, the managers take a conservative approach, opting for large, liquid companies with robust balance sheets and quality characteristics,” Khalaf said.
IBOSS Asset Management added stablemate Trojan Ethical to its global equity portfolio a year ago to add some downside protection and lower the portfolio’s beta, which had been rising. Trojan Ethical has a beta of 0.28 to the IA Global sector due to its diversified portfolio, including a 29% allocation to money markets.
Chris Metcalfe, chief investment officer of IBOSS, said Trojan Ethical tends to perform well in relative terms during weeks when global equity markets stumble and complements higher octane strategies such as Rathbone Global Opportunities.
Metcalfe also wanted to gain more exposure to gold, which he correctly anticipated would perform well once monetary policy easing got underway (because gold doesn’t have an income so is sometimes seen as less appealing than other asset classes when interest rates are rising).
Trojan Ethical has 13% in gold – IBOSS’ second-largest exposure to the yellow metal, after the Ninety One Global Gold fund.
Gold is being propped up by buyers who are not price sensitive, such as central banks trying to diversify their exposure away from the US. As geopolitical tensions increase, it is the ultimate safe haven, he said.
Performance of funds vs sector over 3yrs
Source: FE Analytics
Latitude Horizon
Latitude Horizon has a structural equity weighting of 50% with the remainder invested in a variety of fixed income securities, commodities and currency exposures.
Joe Holland, assistant investment manager at Tyndall Investment Management, said: “The equity portion of the portfolio focuses on defensive global equities with low unit sizes; currently no equity holding exceeds 3%. These companies tend to be firms that are able to maintain or grow earnings despite wider financial conditions.”
For instance, the fund recently invested in United Health, a market leader in a defensive growth industry, which grew its earnings at 18% per annum from 2000 to 2023.
The other half of the portfolio is flexible and its exposures vary, depending on where manager Freddie Lait finds the best risk-adjusted returns. He also attempts to hedge some of the risks within the equity part of the portfolio. The fund currently holds 11% in long-dated bonds, 12% in short-dated gilts and 28% in short-dated bonds.
Performance of fund vs sector over 3yrs
Source: FE Analytics
“We like it because the equity element provides a defensive exposure to equity movements, whilst the non-equity element of the portfolio should help insulate it from the worst of any falls,” Holland concluded.
Winton Trend
Winton Trend employs a rules-based investment strategy, designed to profit from medium-term price trends, both up and down, in equity indices, government bonds, interest rates, currencies and commodities.
Performance of fund vs sector over 3yrs
Source: FE Analytics
Rob Burgeman, investment manager at RBC Brewin Dolphin, said: “The fund aims to generate capital appreciation over the long term, regardless of whether markets are rising or falling, making it complementary for traditional stock market and bond investments.
“It is reasonably uncorrelated with traditional equity markets and can suffer drawdowns when markets switch suddenly. However, these tend to be relatively modest, making this a good diversifier for portfolios and a reasonable source of liquidity when required.”
Trustnet finds out which funds posted the highest returns last month… and which faced the biggest losses.
October was gold funds’ time to shine after a new record high for the yellow metal caused them to surge up the performance tables, FE fundinfo data shows.
Ben Yearsley, director at Fairview Investing, described October as “another fascinating month”, with the UK Budget causing volatility in the gilt market, banks like HSBC and Standard Chartered reporting strong earnings, and mixed results from the US tech sector putting their “sky high valuations” under the spotlight.
“Looking at indices, it was a pretty drab affair last month. It was all a bit turgid with the only bright spot being Japan where the Topix gained 2.19% despite an inconclusive general election result with the ruling LDP under new prime minister Ishiba recording the second worst result in their history,” he said.
“The FTSE, in anticipation of this week’s Budget, fell 1.45% placing it mid table. After the Chinese supercharged September, it was no wonder October was a bit flat – Beijing can’t keep up the stimulus the market demands.”
Source: FinXL
When it comes to the best and worst fund sectors of the month, the IA Financials and Financial Innovation peer group led the Investment Association universe with an average return of 5.3%. This was in part due to those strong earnings from banks during October.
IA Financials and Financial Innovation is the strongest Investment Association sector over 2024 so far thanks to an average return of 17.3%.
The IA Technology & Technology Innovation came in second place during October, followed by three peer groups focused on US assets (IA North America, IA North American Smaller Companies, IA USD High Yield Bond).
Yearsley put this down to “a strong dollar and weak pound boosting returns” in US-focused funds. “Currency was an important factor in returns last month with the US dollar performing strongly after a weak few months,” he added.
The IA Europe Excluding UK sector comes at the bottom of October’s leaderboard, as its average member made a 2.7% loss, while IA European Smaller Companies was the third worst. Europe has struggled of late, with the German economy flirting with recession and companies such as VW closing factories.
IA UK Gilts and IA UK Index Linked Gilts were also among the worst sectors after the gilt market was hit with volatility around the Autumn Budget, which saw chancellor Rachel Reeves hike taxes by £40bn while promising higher government spending.
In the investment trust universe, IT Global Equity Income led the month with an average return of 7.1% driven by the stronger dollar. Like in the open-ended peer groups, strategies investing in tech and US stocks also performed strongly.
Property, Europe and Indian trusts were among the worst performers.
Source: FinXL
Turning to individual funds, WisdomTree Blockchain UCITS ETF made October’s highest returns with a gain of 15.6%. Similarly, Invesco CoinShares Global Blockchain UCITS ETF was up 11.8%.
The outperformance of these ETFs is linked to the strong gains made by cryptocurrencies last month, with bitcoin passing $71,000 and nearing a new record high.
However, the big story among funds for Yearsley was gold and other precious metals, which have been rallying in recent months. Gold started October at $2,654 an ounce but passed the $2,800 mark; it fell back slightly to end the month at $2,749.
“Gold funds were the pretty clear winner in October – unsurprising with gold hitting another new all time high. Silver has joined in the rally too meaning it was gold and precious metals that delivered. Four of the top 10 funds were gold and precious metals with more in the top 20,” he noted.
“Gold has been a clear winner in 2024 with falling interest rates and geopolitics a clear driver. Gold equities had felt like they were lagging the actual price of physical gold, but it does seem as if equities are coming to the party now.”
Jupiter Gold And Silver, WS Charteris Gold & Precious Metals, HAN AuAg ESG Gold Mining UCITS ETF, SVS Baker Steel Gold & Precious Metals, WS Ruffer Gold and BlackRock Gold & General are among the month’s best funds.
The strong performance of financials is reflected by the presence of Guinness Global Money Managers and Jupiter Global Financial Innovation in the top 20 while WisdomTree Cloud Computing UCITS ETF and Dow Jones Internet UCITS ETF show investors’ continued interest in tech stocks despite high valuations.
Among investment trusts, Tetragon Financial was the best performer in October with a 35.5% total return. The trust focuses on alternative assets, investing in opportunities such as private equity stakes in asset management companies, venture capital and hedge funds.
British & American was up 23.9% while Atrato Onsite Energy gained 18.6% after a takeover bid was announced.
Source: FinXL
A couple of themes are also apparent among the worst performing funds of October.
Invesco Solar Energy UCITS ETF has hit with the heaviest loss, falling 7.8% over the course of the month. Other funds investing in similar stocks can be seen in the list of last month’s worst performers, including iShares Global Clean Energy UCITS ETF and Schroder Global Energy Transition.
There are also plenty of property funds among the month’s worst performers, such as iShares UK Property UCITS ETF, abrdn European Real Estate Share, Xtrackers FTSE Developed Europe Real Estate UCITS ETF, Janus Henderson Horizon Pan European Property Equities and abrdn UK Real Estate Share.
Pension funds are no longer a tool for passing wealth to the next generation.
Nothing is certain except death and taxes, and now the Budget has “put up death taxes too”, according to Charlene Young, pensions and savings expert at AJ Bell.
Unspent pension funds will form part of people’s estate from April 2027 onwards, ending pension funds’ previous immunity to inheritance tax (IHT).
This change has the potential to transform how people invest and manage their pension funds, as well as how they pass on money to the next generation.
Alex Cummings, a wealth planner at Succession Wealth, said his clients had been “using alternative assets to fund retirement spending, with pensions being used for passing on wealth”, but that approach “could be turned on its head”.
“I can see trust-based whole-of-life and gifting strategies becoming a bigger focus going forward,” he added.
His colleague Hayley Burns, also a wealth planner, advised people to discuss succession planning with their families and to consider gifting money earlier.
“From a long-term care planning perspective, it may become more attractive to purchase long-term care annuities to remove funds from the estate”, she continued, “especially if that would mean keeping the estate within allowances”.
Everyone can pass on £325,000 before IHT is due but this amount has been static since 2009 and the chancellor has extended the freeze until 2030. The allowance is therefore shrinking in real terms (once inflation has been taken into account).
If any part of the £325,000 threshold is not used, the remaining allowance can be passed on to a surviving spouse or civil partner, potentially amounting to a £650,000 allowance per couple.
What’s more, unused pensions can still be transferred to a spouse or civil partner without incurring IHT, but pension money will be taxed if given to anyone else.
In light of this, Chris Flower, chartered financial planner at Quilter Financial Advisers, said “it is imperative to review and, if necessary, update any existing expressions of wishes to ensure your pension goes to the correct beneficiary”.
There are many other ways to save for the next generation other than pensions, said James Norton, head of retirement and investments at Vanguard Europe. He suggested using junior ISAs to invest up to £9,000 tax-free on behalf of a child under 18.
AIM-listed stocks were previously exempt from IHT and, for some people, were an integral part of intergenerational wealth planning, but that has changed too.
AIM stocks now have a 50% reprieve from IHT, which is better than the full removal many experts had feared, but this still means that AIM stocks will be subjected to a new 20% IHT levy.
Anthony Cross, head of Liontrust’s economic advantage team, encouraged investors to look at AIM on its own merits. “There remains a huge valuation opportunity and upside in investing in AIM – these companies are not valuable because of their tax treatment but because of their underlying fundamentals,” he said.
"With interest rates reducing, growth returning, a stable government and [the tax] question now resolved, we believe the headwinds that have been plaguing AIM have now turned into tailwinds.”
Oliver Bedford, fund manager at Hargreave Hale AIM VCT, was encouraged by the continuation of tax benefits for venture capital trusts (VCTs) and enterprise investment schemes (EIS).
“Whilst the past few months have been very difficult for AIM – and by extension, AIM VCTs – confirmation that the government remains committed to the VCT and EIS schemes through to 2035 and news that AIM investors can still benefit from business property relief, albeit at a lower level, demonstrates the government’s continued support for two important constituents of the AIM investor community,” he said.
The ‘bed, spouse and ISA’ manoeuvre could save couples thousands of pounds in taxes.
What impact will this week’s Budget have on your finances?
The answer – joked Douglas Scott, investment manager at Aegon Asset Management – depends on whether you are a “chain-smoking private equity fund manager who will be flying to their soon-to-be-purchased third home by private jet to catch up with the four kids on a break from boarding school”.
Yet many people with far less lavish lifestyles could be liable for a much larger tax bill.
Capital gains tax (CGT) was hiked in Wednesday’s Budget from 10% to 18% for basic rate taxpayers and from 20% to 24% for those on a higher rate. This follows the previous government’s decision to reduce the annual CGT allowance from £12,300 to £3,000.
However, investors have a few tricks up their sleeve to guard against the chancellor’s tax grab.
First and foremost, they should be making full use pension funds and ISAs to invest in equities and other asset classes tax free.
Second, a manoeuvre called ‘Bed and ISA’ or ‘Bed and SIPP’ involves selling assets that are outside of a tax wrapper and rebuying them within an ISA or self-invested personal pension (SIPP) so that any future gains are tax free.
Selling the assets could potentially incur a CGT liability now, said Laith Khalaf, head of investment analysis at AJ Bell, but “investors can mitigate this by judicious use of their annual £3,000 CGT allowance”.
“Investors who feel they might breach the £3,000 annual CGT allowance using this approach might consider pairing the sale of a profitable investment with a loss-making one. Losses can be used to offset gains, thereby reducing the capital gains tax liability, then either or both investments can be rebought within the ISA to avoid tax on future gains,” he explained.
People in a committed relationship who are happy to plan their finances jointly have even more tools at their disposal to avoid the ravages of higher taxes.
A couple has recourse to both partners’ annual £3,000 CGT allowance on profitable share sales.
“By doing a ‘Bed and Spouse and ISA’, it’s also possible to use two sets of the annual ISA allowance of £20,000 to shelter those assets from future capital gains,” Khalaf noted.
Furthermore, transferring assets to a spouse or civil partner can be done free of CGT and is especially useful if one person is a higher rate taxpayer and the other is not. Even when capital gains exceed the annual CGT allowance of £3,000, it is better to pay 18% than 24% tax.
Another option for wealthy, adventurous investors who have filled their pension and ISA allowances would be to invest in early stage, fast-growing businesses through venture capital trusts (VCTs) and enterprise investment schemes (EIS).
“Capital gains on investments held within both VCTs and EIS are free from tax and in addition, an EIS investment provides the opportunity to defer capital gains made elsewhere, whereas a seed enterprise investment scheme (SEIS) investment comes with a 50% exemption on gains made elsewhere,” Khalaf explained.
Nonetheless, “investors should ensure they don’t let the tax tail wag the investment dog”, he warned. “VCTs and EIS invest in small, early stage companies which might fail and have low levels of liquidity.”
Another move investors may wish to consider is shifting money into multi-asset funds or investment trusts because fund managers can buy and sell assets and rebalance their portfolios without incurring tax.
Investing in gilts is a further option because capital gains on government bonds are tax free. “A theoretical gilt yielding 4% entirely through capital gains is equivalent to a cash account yielding 6.7% in the hands of a higher rate taxpayer and 7.2% in the hands of an additional rate taxpayer,” he noted.
The increase in CGT was less than some experts had anticipated but was problematic for four reasons.
First, basic rate taxpayers face a far more severe CGT hike than for those on a higher rate, which seems unfair.
Second, CGT smacks of double taxation. “For most people, capital gains build up on assets purchased with money that has already gone through the income tax wringer, so capital gains tax represents a second wave of taxation,” Khalaf explained.
In addition, “both the complexity and rate of capital gains tax serves to discourage investment in the stock market”, he continued, although “this is mitigated to a large extent by the protection afforded by pensions and ISAs”.
Last but by no means least, hiking CGT is unlikely to bring in much money for the Treasury.
Rachael Griffin, tax and financial planning expert at Quilter, said: “While this move is aimed at boosting revenue, is likely to have the opposite effect, as it discourages investment and leads to reduced economic activity across key sectors.
“In statistics produced by the government which model the revenue impact of certain policies, this is laid bare. For example, it found that a 10 percentage point increase in the higher CGT rate shows a significant negative impact, reducing revenue by £400m in 2025-26, £985m in 2026-27, and £2.25bn in 2027-28.”
High tax rates discourage people from selling their assets, which “has the effect of locking wealth into certain asset classes, reducing the flow of capital into the economy”, she explained. “This behavioural shift could undermine the government’s revenue-raising objectives, as fewer transactions mean less CGT collected overall.”
This paradox makes the CGT increase all the more frustrating.
Invesco’s new ETFs aim to capture long-term growth trends in the artificial intelligence, cybersecurity and defence sectors.
Invesco is adding three new products to its range of thematic exchange-traded funds (ETFs), offering exposure to the “powerful long-term trends” of artificial intelligence (AI), cybersecurity and defence.
The Invesco Artificial Intelligence Enablers UCITS ETF will focus on companies that drive the technology, infrastructure and services behind the growth and functionality of AI.
Invesco Cybersecurity UCITS ETF will hold firms specialising in protecting business and devices from unauthorised access via electronic means.
Finally, Invesco Defence Innovation UCITS ETF will invest in companies working on advanced weaponry and defensive systems to secure national borders.
All three will have an annual charge of 0.35%.
The ETFs will track indices developed by Kensho, a division of S&P Global Indices, which uses artificial intelligence and other ‘next generation’ technologies in constructing thematic benchmarks.
Gary Buxton, head of EMEA and APAC ETFs at Invesco, said: “While the potential of AI has really captured people’s imagination, solutions for cybersecurity and defence are now gaining traction as threats emerge across the globe.
“For investors, the question is how best to capture these opportunities today and into the future. We chose to work with Kensho for their intelligent approach to applying AI but also their expertise in understanding these rapidly evolving new technologies.”
Kensho’s methodology for index construction begins with a global pool of stocks screened through natural language processing (NLP) to identify companies associated with each thematic concept. Analysts at Kensho then classify companies based on their relevance to each theme, sorting them into ‘core’ and ‘non-core’ categories.
Core companies generate a significant portion of revenue from theme-aligned products and services, while non-core companies contribute indirectly, supplying essential components or infrastructure but not delivering the end-products themselves.
An overweight factor is applied to core companies to enhance pure-play exposure to the theme. Both categories use equal weighting, subject to diversification and liquidity constraints.
The AI and Cybersecurity indices also apply environmental, social and governance (ESG) filters, excluding companies with low ESG scores, involvement in controversial activities or non-compliance with principles from the United Nations Global Compact.
These new funds expand Invesco’s thematic ETF range, which already includes portfolios focused on blockchain, biotechnology and clean energy stocks.
With alternative energy stocks, AIM-listed companies, investment trusts and zero-dividend shares, Law Debenture is far from a typical UK equity income fund.
Law Debenture may be one of the Association of Investment Companies’ Dividend Heroes but income is not the managers’ top priority. Instead, FE fundinfo Alpha Manager James Henderson and Laura Foll focus on growing the overall pot, first and foremost.
They have the luxury of investing for capital growth because alongside its equity portfolio, Law Debenture houses a professional services firm. Worth 20% of the trust’s assets, it contributes more than one-third of the income, providing a cushion.
Henderson said: “My view is that income funds should always focus on growing the capital first. If you grow the capital and have a bigger pot of money, it's much easier to produce sustainable income growth. If you try too hard on the income and you bleed the capital to produce the income, you [hit] a brick wall.”
This approach has paid off. Law Debenture is the best performing investment trust in the IT UK Equity Income sector over both five and 10 years. Not only that, but it has pulled ahead of every single trust in the IT UK All Companies sector and beaten the FTSE 100 and FTSE All Share indices over five and 10 years as well.
Performance of trust over 10yrs vs UK sector averages and FTSE All Share
Source: FE Analytics
It has also increased its dividend for 14 consecutive years, with a five-year annualised dividend growth rate of 11.1% as of 12 March 2024. The trust’s dividend yield was 3.7% as of 30 September 2024.
Below, Henderson told Trustnet why he is increasing his exposure to AIM-listed shares and which stocks have been his best performers.
Please describe your investment process
We use a contrarian approach to investing by focusing on value, but always with the belief that things are not just cheap, they are going to grow. Growth is what helps you avoid value traps.
How does having a professional services firm within the trust impact your investment approach?
Law Debenture’s professional services firm amounts to 20% of the trust’s assets but contributes 35% of the income. This allows us to have a lower-yielding portfolio than most income funds and a bigger universe of stocks we can look at.
In 2020, when a lot of companies were cutting or stopping their dividend because of the pandemic, half the income from the quoted sector disappeared. The professional services business contributed 65% of the trust’s overall income that year.
The board made a bold decision that year to put £70m into the UK equity market. I had the freedom to buy zero-yielding shares that had sold off without worrying about the income, which was the main reason for the trust’s strong five-year track record. We were able to hold companies such as Ceres Power Holdings and Rolls-Royce, which have been our biggest contributors over five years.
Performance of trust vs sector over 5yrs
Source: FE Analytics
What changes have you made recently?
We are increasing our AIM weighting, which is at 7% and I wouldn't go beyond 10%. We own small- and mid-cap stocks too but the real valuation anomaly is on AIM, because people have been so nervous about tax changes.
Before the Budget, people were saying that scrapping inheritance tax (IHT) relief on AIM stocks would see them fall as much as 30%. The market went up straight after the Budget, which tells you the doom had been priced in.
Some investors have concerns about the liquidity of AIM stocks but we can buy less liquid things and that's a real privilege we need to use. It's what you do differently that makes you perform differently.
We’ve been buying some alternative energy stocks. You wouldn't normally see them in an income fund because they're not going to pay dividends for another 10 years, but they should help grow the trust’s overall pot, which produces the income.
I’ve also been buying investment trusts that have fallen to very large discounts including Grit, which invests in African properties, and VH Global Sustainable Energy Opportunities.
What have been your best and worst performers recently?
In the past year, the biggest contributor by quite a considerable amount is Rolls-Royce and, after that, Marks & Spencer. NatWest and Barclays are up there.
Performance of shares vs FTSE 100 over 1yr
Source: FE Analytics
Ceres has been dreadful this year, but on a five-year view it has been a top contributor. I sold quite a lot of the holding in 2022 and 2023 and I've been buying it back recently.
Ceres Power vs FTSE 250 over 5yrs
Source: FE Analytics
With Ceres, the market got over-excited about how quickly hydrogen would replace more traditional fuels in fuel cells and people thought hydrogen might even go straight into cars. When things didn't happen as quickly as people had hoped, disappointment set in.
Something out of left field that hurt us was Morgan Advanced Materials, which had a cyber-attack. Everyone came to work one morning to see a pirate flag on their screens and, shortly after that, they couldn’t see where any of their stock was or what they'd sold. That caused a lot of disruption, which led to share price weakness.
What do you enjoy doing outside of investing?
I train racehorses. I used to ride in jump races, but I now just ride my horses at home.
Brunner’s Bishop dissects the arguments for and against owning Nvidia.
Semiconductor manufacturer Nvidia has been the most successful company of the past few years. Portfolio managers who own it have seen their returns skyrocket and those who don’t say it’s a controversial stock to buy.
Julian Bishop, co-manager of the Brunner investment trust, belongs to the latter cohort, but if he could go back, he would certainly buy it, he admitted, as not owning Nvidia has had the greatest negative impact on the trust over the past year.
“When calculating the combination of percent declines and position size, the worst active contributor for us was not holding Nvidia. That cost our relative performance quite a lot,” he said.
A natural question could therefore be why he still hasn’t bought it, and Bishop said this conversation has been “talked about to death” at Brunner.
The pros are fairly evident and self-explanatory. According to Bishop, Nvidia is “incredibly profitable” and far from being a “dot-com bubble-type, nonsense stock”. It also has “a very high market share”, and what it does is “absolutely critical” to the build-out of artificial intelligence (AI) infrastructure.
“These are all things that we would typically look for in a company,” admitted the manager. “On top of that, there is also the exceptional growth in the past few years, as AI has exploded onto the scene.”
But there are quite a few cons that stopped the Brunner portfolio from welcoming the semiconductor darling.
Firstly, people are spending “an absolute fortune” on AI already. Next year, Nvidia is expected to sell $100bn worth of chips, which is “by any stretch of the imagination, a vast amount of money”.
Around that, one must also take into account the data centres needed to make AI work which “would probably add another $100bn” to the amount tech companies are spending.
“With $200bn of costs in a year, they would need to generate at least $400bn of sales to get an adequate return,” he said.
“But at the moment, we're not even close. Let's not forget that at the moment, no one is actually making any money with AI.”
Beyond this question mark over demand, there are also barriers to entry to consider, as “everybody is trying to break the moat around Nvidia”.
Because it only sells to a few customers (the likes of Meta, Google, Microsoft, Amazon and Tesla), it is even more vulnerable, as they are all trying to develop their own versions.
“When Microsoft is spending $10bn a year on these chips, its procurement department has every interest of breaking down Nvidia’s moat,” Bishop said.
“There is a saying in technology that at the end of the day, all hardware is a toaster. Ultimately, everything, no matter how complex it looks, can be replicated by somebody somewhere, and it becomes commoditised. With time, prices deflate and profit pools get eroded.”
The second question mark was therefore: How much in the ecosystem is built around Nvidia? Or, to use an analogy: Is Nvidia Apple, or is it Samsung?
Apple makes great profits selling smartphones for the only reason that it has been able to create an ecosystem around them – the apps, all the software, the brand, the retail network. But most smartphones are commoditized, the manager explained.
“You would be amazed at how little money Samsung makes making smartphones,” he said. “Even though it is probably making as many smartphones as Apple, they're the commoditised end of the spectrum.”
Nvidia does have some software and systems around what it does, it isn't just a microchip that might get commoditised with time. So for Bishop, the real debate is how much of an ecosystem is around Nvidia, and whether that will protect it against competition.
Finally, the manager was also mindful of previous technological revolutions. All the top companies at the time of the dot-com bubble, for example, “just faded to nothing”.
Bishop recalled Cisco Systems, which built all the routers that were used to sort internet traffic, or Global Crossing, which laid the fibre optic cables across oceans that exist to this day but went bankrupt because “loads of other people had cables too”.
“Companies such as these did the world a favour by building incredible infrastructure that allowed all this technology, but it is companies down the road, such as Amazon and Google, that made use of this technology and the most of the money. We think it might be similar this time,” Bishop said.
“I have no doubt that AI’s influence will be probably overestimated in the short term and underestimated in the long term. But it's not quite clear to us that the people who build it will be the ones that make money.”
Performance of trust against sector and index over 5yrs
Source: FE Analytics
So far, these considerations have stopped Bishop from buying Nvidia, preferring instead “guaranteed winners” such as Taiwan Semiconductors, the trust’s best contributor over the past year (which makes up 3.3% of the portfolio), and Microsoft, the trust’s top holding at 6.4%.
But he “certainly wouldn't rule out” buying it in the next 12 months or so.
“It's part of our job to protect our clients from the madness of crowds when bubbles develop and irrationality can settle in. But Nvidia is not in that class, and the valuation, if it can prove that the moat is strong enough, is not crazy. It is possible we could buy it in the year to come, absolutely,” he concluded.
GCP Infrastructure is improving its risk-adjusted returns and is on track to narrow its discount.
You could argue that investing in infrastructure is boring. Long-term contracts, predictable cash flows, must-have assets, availability rather than demand-linked revenues, inflation-linked income and counterparties with strong credit ratings ought to make for ‘sleep at night’ investments.
For many years, the ratings on listed infrastructure funds reflected these characteristics. That all changed in 2022 as interest rates started to rise. Money was diverted into cash deposits and bonds. Selling pressure allowed discounts to open up, that left some investors disillusioned, which compounded the problem.
Today, even though rates are coming back down again, every London-listed infrastructure fund is trading on a discount. However, the security of income from these funds was not really in doubt. Trusts kept hiking dividends and now they all trade on attractive dividend yields.
While all of these funds look too cheap to my eyes, one rating appears particularly anomalous – that of GCP Infrastructure, a £700m market cap investment company. Managed by Phil Kent and Max Gilbert, supported by an experienced team at Gravis, the company invests across a range of different infrastructure sectors, although its focus has shifted more towards renewable energy infrastructure over the last few years, which gives it strong environmental, social and governance (ESG) credentials.
The main difference between GCP Infrastructure and the bulk of its peers is that it structures its investments as loans. That means they are protected by a ‘cushion’ of equity that takes the first hit if anything goes wrong. However, that margin of safety is not reflected in its rating.
Barring Digital 9 Infrastructure (which took a number of wrong turns and is now in wind up mode), GCP Infrastructure’s shares trade on the widest discount (currently almost 30%) and the highest yield (9.2%) within its infrastructure subsector.
My belief is that the company was particularly badly affected by selling pressure related to the cost disclosure problems that have plagued the investment company sector but, fortunately, are now being addressed.
In an effort to remedy its discount, the board of GCP Infrastructure launched a capital recycling programme in 2023. The ambition was to release £150m (roughly 15% of the portfolio) to rebalance sector exposures, apply funds towards a material reduction in the revolving credit facility and support the return of at least £50m in capital to shareholders before the end of 2024.
GCP Infrastructure’s first disposal, raising £31m, was of its interest in loan notes secured against a 52.9MW Scottish wind farm. The price was a 6.4% premium to asset value and the money was used to reduce the outstanding balance on its revolving credit facility. By the end of September 2024, that balance was down to £57m (from £154m as at end December 2022 and £104m as at 30 September 2023).
However, the company has dropped a heavy hint that something more substantial is in the works. On 24 October 2024, it announced its net asset value as at end September 2024. The figure (105.22p per share) came in a little lower than the value at end June.
Normally, GCP Infrastructure would provide a detailed breakdown of the underlying movements that contributed to this, but this time it declined to do so. The statement said the company is in active due diligence and negotiations on disposals of material components of its investment portfolio and does not wish to risk such processes through publication of further detail on the constituent movements in the NAV.
It sounds to me as though we could be on the verge of a disposal large enough to restart its buyback programme. Currently, this has not been reflected in the share price, which feels like an opportunity too good to pass up.
There is more to GCP Infrastructure than the short-term discount narrowing opportunity and the chance to lock in an attractive yield. The manager sees the potential to use the capital recycling programme as a way of improving the quality of GCP Infrastructure’s portfolio, reducing the portfolio’s sensitivity to factors such as volatile power prices and removing exposure to supported living accommodation (thereby reducing the duration of the portfolio).
At the end of June 2024, supported living accounted for around 12% of the portfolio, around a quarter was exposed to private finance initiatives, public-private partnerships and similar assets, and the balance to a broad spread of renewables assets. These range from onshore wind and solar, through to geothermal (it financed a well that is being used to heat the Eden project in Cornwall) and electric vehicle charging.
In addition to the disposal activity related to the capital recycling programme, there is a natural pattern of loan maturities and reinvestment. The advent of higher interest rates is allowing the managers to improve the portfolio’s risk-adjusted returns. Once the disposal programme is complete, I would expect that the improved quality of the portfolio will be easier to appreciate. That should support a more permanent narrowing of the discount.
James Carthew is head of investment companies at QuotedData. Thew views expressed above should not be taken as investment advice.
Trustnet examines which European funds delivered the best risk-adjusted returns during the past five years.
Contested elections, geopolitical tensions, the Covid-19 pandemic and investor apathy have tested European equity managers to the limit in recent years.
While this is true of many regions, Europe has also struggled by dint of being less exciting than the US. The Euro STOXX 50 has gained a relatively lacklustre 53% over the past five years, compared to the S&P 500's 89.8% rise, as the chart below shows.
For active managers in this challenging market, striking the right balance between risk and reward has been crucial.
Performance of indices over 5yrs
Source: FE Analytics
As part of an ongoing series, Trustnet is focussing on funds with top-decile returns as well as top-decile Sharpe ratios over five years. Below we look at funds in the IA Europe Excluding UK, IA Europe Including UK and IA European Smaller Companies sectors.
First, in the IA Europe Excluding UK sector, a range of strategies achieved top decile risk-adjusted returns over the past five years.
However, it was the £1.5bn Liontrust European Dynamic fund, led by James Inglis-Jones and Samantha Gleave, which stood out.
Risk-adjusted returns of IA Europe Excluding UK funds over 5yrs
Source: FE Analytics, total returns in Sterling, Data to 30 Sep 2024
Over five years, this portfolio enjoyed best-in-class returns of 90.3%. Given its seventh-decile volatility of 16.5%, it was one of the more 'gung-ho' approaches in the peer group. This higher risk, higher reward strategy resulted in a five-year Sharpe ratio of 0.64, better than its nearest competitor by 0.14.
Moreover, the strategy has enjoyed long-term success with consistent top-quartile returns across other periods. For example, over three years the fund was up by 24.2% and over 10 years it surged by 214.3%.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
Due to its consistent success, the portfolio has been awarded an FE fundinfo Crown Rating of five. Analysts at FE Investments said: “The combination of deep quantitative underpinnings combined with intelligent execution and stock picking from two highly experienced investors is very attractive.”
Inglis-Jones and Gleave “have proven their ability to outperform independent of whether the value or growth style is in favour, providing a compelling core offering for investors in European equity”, the analysts continued.
Turning to the IA European Smaller Companies sector, just three portfolios matched our criteria.
Risk-adjusted returns of IA Europe Including UK funds over 5yrs
Source: FE Analytics, total returns in Sterling, Data to 30 Sep 2024
While the differences between risk-adjusted returns were minimal, this was another sector where more aggressive strategies, such as the £220m Invesco European Smaller Companies portfolio, shined.
Over the past half a decade, it surged by 62.9%, the best performance in the peer group. With an eight-decile volatility of 20.2%, the strategy paired a higher-risk approach with high rewards, leading to the best risk-adjusted returns in the sector of 0.33.
It has replicated these results more recently, ranking in the top quartile for returns over the past one and three years.
Performance of fund vs sector over 5yrs
Source: FE Analytics
However, it has not been smooth sailing for the Invesco strategy over the past five years. Its high volatility approach has led to frequent fluctuations in performance, which may have tested investors' patience. For example, in 2023 and 2021, it slid into the second and third quartiles for calendar year performance.
Moreover, 2019 proved particularly challenging for the fund, which rose in value by just 0.3%, one of the worst results in the sector.
Finally, in the IA Europe Including UK sector, two funds enjoyed the best five-year risk-adjusted returns: the £2.6bn Wellington Strategic European Equity and the £44m GAM Star European Equity funds.
Risk-adjusted returns of IA Europe Including UK funds over 5yrs
Source: FE Analytics, total returns in Sterling, Data to 30 Sep 2024
While both funds boasted a five-year Sharpe ratio of 0.51, Wellington Strategic European Equity stood out as one of the most cautious strategies on our list.
At 13.9% volatility, it ranked in the third decile for risk over the past half-decade. Despite a comparatively low-risk approach, it enjoyed some of the best results in the whole sector, climbing by 64.8% over the past five years.
Moreover, the portfolio generated 2.4% in alpha, one of the best results in the sector. This indicated that during periods of strong performance, the fund delivered supranormal returns compared to its benchmark.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
The portfolio successfully replicated these results in the near and longer term. Over 10 years, it rose in value by 184.9%, the fourth-best return in the peer group.
It has enjoyed further top-quartile performance over the past one and three years, rising 22.4% and 27.9%, respectively.
Previously in this series, we have looked at the IA Mixed Investment and Flexible Investments, IA North America, IA Global and the IA UK All Companies sectors.
“There is nothing that combines the quality, value and income attributes of the tobacco sector”, said Troy Asset Management’s James Harries.
Tobacco is making a comeback. In the past six months, tobacco companies have risen above the rest of the global equity market, as the chart below shows.
They are also going through an evolution, offering less harmful products such as ‘heat not burn’ and vapes, and becoming more sustainable businesses, all of which might make them more palatable to investors, said Trojan Global Income manager James Harries. In the future, he thinks they will become known as “nicotine consumer products companies”.
Performance of indices over 1yr
Source: FE Analytics
“Although people are smoking less, you could argue that consumption of nicotine is increasing,” Harries said. At 5.1%, British American Tobacco is the third-largest holding in his portfolio.
Harries is not alone in backing the revival. Imperial Brands, formerly Imperial Tobacco, is the largest holding in Fidelity Special Values, taking up 4.2% of the portfolio.
But while FE fundinfo Alpha Manager Alex Wright, who manages the trust, considers tobacco to be a defensive play, cigarette manufacturers have made it into growth funds as well.
Stephen Yiu, who runs the £1.1bn Blue Whale Growth fund, has built up a “sizable” 4% position in Philip Morris this year.
“Everyone wants to talk about Microsoft, but the stock has gone up just about 15% this year, so it has been tracking the market,” the Alpha Manager said. “And yet interestingly, Philip Morris, this little boring consumer staples company, has gone up about 30% this year.”
Yiu was impressed by Philip Morris’ plans to return to the US (a market it exited in 2008) and expand the reach of its ‘I quit ordinary smoking’ (IQOS) machines, which use ‘heat not burn’ technology and have been approved for sale in the US.
“On top of that, two years ago the company acquired Swedish Match, meaning that over 50% of the business is now in non-traditional cigarettes,” Yiu noted.
BNY Mellon Multi Asset Income manager Paul Flood took profits from British American Tobacco’s corporate bonds in June and re-invested the proceeds in the company’s shares.
“The equity valuation was very low and the company was paying a 9% to 10% yield, so it seemed like a sensible thing to do from an income fund perspective. It has also helped us to bring the duration down a little bit as the year went on,” he explained.
To address potential concerns around environmental, social and governance (ESG) principles, Yiu said that Philip Morris is “trending towards being more environmentally-friendly than one could expect”, given the less harmful products it now focuses on.
Harries agreed that “these companies are able to offer products without tobacco, which would be attractive to some investors”.
The ethical version of the Troy fund, Trojan Ethical Global Income, excludes tobacco companies and other sectors. For this reason, it has a marginally lower yield, although its income is growing at slightly faster pace. The ethical version might therefore be suitable for younger investors with more of a total-return mindset, he explained. On the other hand, the non-ethical version is a more classic income fund that might appeal to an older cohort.
As Halloween approaches, it’s time for the Bond Vigilantes’ yearly round-up of the spookiest charts in global finance.
It’s not just ghosts and ghouls that are causing fear this Halloween – financial markets are also giving us plenty of reasons to be spooked. From crumbling consumer confidence to rising debt burdens, the economic landscape is littered with eerie signs of instability.
The five charts below from M&G Investments' Bond Vigilantes reveal unsettling trends in global markets. While surface-level data may look reassuring, a deeper dive shows that the scariest threats could be the ones lurking just out of sight.
Cars and houses? … Too scary a proposition
According to University of Michigan surveys, consumers view this as the worst time in 40 years to buy a house or car – a worrying sign for consumer intent. Big purchases like these can be crucial drivers of economic growth and with buying intent so low, we could be underestimating the severity of the slowdown.
Sources: M&G, University of Michigan, Bloomberg, data to Oct 2024
As consumer intent wobbles, could the labour market be telling its own tale of uncertainty?
Employees frightened to quit; companies frightened to hire
The US labour market appears healthy, especially after September’s non-farm payrolls exceeded economists’ expectations and unemployment fell to 4.1%. However, beneath the surface, both hiring and quits rates have dropped to levels typically seen in recessions.
Sources: M&G, Bloomberg, data to Oct 2024
Companies are hesitant to hire full-time workers, and employees are reluctant to quit due to job security concerns and fewer opportunities available. These signs of weakness suggest that the effects of restrictive monetary policy may be more severe than the headline labour market numbers imply.
It may not be just the labour market – economic fragility is reverberating through the economy, driven by the enduring grip of monetary policy.
The howl of restrictive rates reverberating through the economy
Monetary policy was restrictive for a long time and since it works with a lag, its effects are only now becoming evident.
Although central banks have begun easing, policy remains more restrictive than what might be deemed neutral and this is impacting both businesses and consumers. In the US, Chapter 11 filings are rising steadily, while credit card delinquencies over 90 days are climbing to levels last seen following the global financial crisis.
Sources: M&G, Bloomberg, data to Oct 2024
Until monetary policy significantly loosens, these trends may continue to persist.
While economic and financial pressures mount, are all risks being priced into credit markets?
‘Not so high’-yield vs investment grade
Despite the unsettling warning signs, credit markets are pricing in minimal risk of a major slowdown, let alone a recession that could significantly impact credit fundamentals. In fact, the spread between investment grade and high-yield bonds has narrowed to just under 2.7% — the lowest level since 2006.
Could investors be underestimating the potential for economic turbulence ahead?
Sources: M&G, Bloomberg, data to Oct 2024
Beyond the bond markets, another haunting issue brews in the form of rising government debt…
The growing cauldron of global government debt is ferociously bubbling
It’s no surprise that global government debt levels have been steadily rising, but it’s worth highlighting how concerning this trend is. In the UK, for example, public sector net debt as a percentage of GDP is alarmingly high.
Sources: M&G, Bloomberg, data to Oct 2024
High debt can impact growth by diverting government spending away from productive investments toward debt servicing. It may also force central banks to consider fiscal risks when raising interest rates, as aggressive hikes could destabilise public finances.
With current debt levels resembling those seen during recessions, will governments be able to respond when the next downturn hits?
Joe Sullivan-Bissett is a fixed income investment director at M&G Investments. The views expressed above should not be taken as investment advice.
Government bond markets have taken fright but equity investors seem remarkably complacent and that could come back to haunt them.
Government bond markets appear well and truly spooked this Halloween. Yields on US treasuries have surged in the past six weeks in reaction to concerns about Donald Trump’s potential return to the White House, US fiscal irresponsibility, the sceptre of rising inflation and geopolitical tension.
Equity markets, on the other hand, have been remarkably complacent but that could come back to haunt investors, according to Emma Moriarty, a portfolio manager at CG Asset Management.
Asset valuations are divorced from what’s happening in the real world
The valuations of equities and corporate bonds are starting to look unrealistic given the latent risks, Moriarty said. “Asset valuations have become way out of alignment with what is actually happening in the real economy. There does seem to be this de-linking going on,” she said. Valuations are “starting from a really inflated place”.
US equity valuations are the most obvious example of an expensive asset class but the same is true of corporate bonds. “We've now been in a situation where interest rates have been elevated for some time. We know that there's this wall of refinancing that has to happen in the US and the UK next year and yet, credit spreads are at historical lows at exactly this point when, actually, risk sentiment should be a little bit more elevated,” she explained.
The Bank of England’s Financial Policy Committee recently said that valuations across several asset classes, particularly equities, were “stretched” and “markets remain susceptible to a sharp correction”.
The question then becomes whether there is an imminent catalyst for a correction – and if the US election could be it.
“One thing we can say is that a Trump victory would crystallise this path of much wider fiscal deficits so that is probably a potential moment for a treasury market repricing,” Moriarty observed.
The impact of a Trump victory on equity markets is much harder to forecast, especially because Trump's policies are “not necessarily clear or consistent with each other”, she added.
Complacency has been building up
In a similar vein, Chris Metcalfe, chief investment officer of IBOSS Asset Management, said financial advisers and their clients are all focused on the potential upside from equity markets. While everyone is asking questions about further stock market gains to make sure they aren’t missing out, very few people are asking about downside risk, drawdowns or volatility, he said.
Complacency has been increasing because “equities have been going up so well for so long”, he observed.
It is not complacency per se that could spook investors but the disappointing returns it presages. “There is always complacency” just before market corrections, Metcalfe observed. “You don’t tend to get markets with a lot of fear [leading into] sell-offs”.
Nick Clay, manager of TM Redwheel Global Equity Income, thinks investors are pinning all their hopes on a soft landing in the US and are under-prepared for any other scenario. “What scares me is when markets are convinced that a particular outcome is a foregone conclusion, as this is invariably when risk is most elevated,” he said.
“Today, markets continue to push through all-time highs on the conviction that the Goldilocks outcome is a certainty that nothing can derail, impervious to geopolitical tensions, upcoming US elections or slowing growth in many areas.”
US equities could flatline in real terms
All this complacency is setting the scene for disappointment. Goldman Sachs reckons that the S&P 500 will return just 3% per annum over the next decade. After accounting for 2% inflation, fund managers’ fees and foreign exchange risk, those meagre gains could be eroded to almost nothing.
The investment bank’s forecasts are more pessimistic than its peers because it has factored in the extreme concentration of US equity markets. The S&P 500’s 10 largest stocks now amount to 36% of the benchmark. An extremely concentrated index reflects a less diversified set of risks so will probably be more volatile, said David Kostin, chief US equity strategist at Goldman Sachs.
Yield on 10-year treasuries could spike to 5%
Turn to the bond markets and everything looks much more frightening.
The yield on 10-year treasuries has surged by about 60 basis points since the US Federal Reserve cut interest rates by 50 basis points on 18 September.
Arif Husain, head of fixed income at T. Rowe Price, thinks the bond market sell-off could gather momentum and that the 10-year treasury yield could “test the 5% threshold in the next six months”.
Gael Fichan, head of fixed income at Bank Syz, said yields have risen due to “multiple forces at play: stronger-than-expected US macroeconomic data, commodity price inflation fuelled by Chinese stimulus measures, and recent statements by Fed policymakers advocating a higher terminal rate”. The increasing probability of a Republican ‘sweep’ (taking the presidency, Senate and House) is also fuelling market anxieties.
The MOVE index, a barometer for bond market volatility, hit a one-year high on 7 October 2024 – surpassing levels seen during the Silicon Valley Bank collapse and the Fed's 75-basis-point rate hike in June 2022.
“According to MOVE creator Harley Bassman, this marked the first time that one-month options extended beyond the election date, reflecting heightened political anxiety around future yields,” Fichan said.
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