Chinese equities have recently staged a comeback after three consecutive calendar years of significant negative returns, linked to regulatory crackdowns, a crisis in the property sector and questioning around the country’s growth trajectory. 

Since the beginning of the year, the MSCI China index has outperformed the MSCI World and MSCI Emerging Markets, although it has lagged the S&P 500 and its emerging markets rival, MSCI India.

George Efstathopoulos, multi-asset portfolio manager at Fidelity International, attributed China’s rebound to a combination of factors.

“The ‘national team' [state-backed financial companies] has stepped up their involvement in markets after the capitulation earlier in the year,” he said.

“The growth outlook appears to have improved – GDP growth recently surprised to the upside, leading many analysts to raise year-end growth estimates and causing some foreign investors to cover underweight positions. Policy support has also increased recently, with the ailing property sector the latest recipient.

“Meanwhile, Chinese companies have carried out more buybacks recently and earnings beats are being rewarded in this earnings season, which hasn't been the case in the last few years, a further indication that the capitulation period is over.”

Performance of indices year-to-date

Source: FE Analytics

The question for investors now is whether this rebound is sustainable or merely a dead cat bounce.

Sandy Pei, deputy manager of the Federated Hermes Asia ex-Japan Equity fund, argued that the bounce has been “very modest” so far and that absolute and relative valuations remain attractive. She believes that investors in China have huge upside potential if Chinese equities re-rate to “normal” multiples.

David Townsend, managing director of Value Partners’ business in Europe, the Middle East and Africa, is also bullish on China and argues it is in the early stages of a U-shaped recovery.

He said: “From a fundamental perspective, we maintain our investment thesis that the stock market has reached an inflection point, supported by the recent strong market performance.

“We anticipate the start of a longer-term market upturn, supported by strong fundamentals such as healthy corporate balance sheets and large household deposits, which could sustain China’s long-term growth story.”

“From a technical perspective, it also looks like the market rally could continue for some time, especially given the very light / underweight positions for many investors in China. It does look as though some capital is starting to come back to the market to reduce the underweight exposure of many long-only investors.” 

Yet, others believe it is still too early to tell whether Chinese equities are back on track.

For instance, Efstathopoulos stressed that earnings will need to deliver for the bounce to prove sustainable and this will require an improvement in the currently fragile consumer sentiment in China.

Rob Brewis, co-manager of the Aubrey Global Emerging Markets Opportunities fund, also warned that the property market is still in the doldrums, monetary growth subdued and deflation remains predominant. He also believes that geopolitics and trade frictions are going to increase ahead of the US election, while a trade war between China and Europe seems to have started.   

For example, ministers of Germany, France and Italy called for a common front against China’s expanding export power last week during a G7 meeting.  Moreover, the European Union is investigating a range of Chinese products, including electric vehicles, to assess whether they are receiving unfair subsidies from the Chinese government or being sold below cost.

Another risk highlighted by Pei is an unexpected reversal of the monetary policy stance, which is currently centred around monetary easing, consumption stimulus and being capital friendly.

Therefore, Townsend stressed that investors will need to keep an eye on the ‘Third Plenum’ in July 2024.

He explained: “In addition to further supportive measures for the property market, the structural reform agendas – traditionally a focal point of the ‘Third Plenum’ – are worth watching as they may be necessary in navigating both cyclical headwinds and demographic challenges.

“A key risk could be that if the communication disappoints the market, in the sense that investors begin to feel that the government is starting to turn its attention to focussing on things other than the economy, there may be something of a pull back.”

Nonetheless, GQG Partners’ investment team believes that things are unlikely to get meaningfully worse from here for China.

“There is a bevy of earnings coming out of some of the largest weights in the benchmark and in our view, earnings remain like gravity and it will be individual company execution rather than macro noise that will ultimately drive the attractiveness of select Chinese equities,” GQG analysts concluded.

Nonetheless, the GQG Partners Emerging Markets Equity fund is structurally underweight Chinese equities due to their lack of durable earnings growth, heightened geopolitical risk and better opportunities elsewhere. 

Even following the market pullback in April, risk appetites have remained largely intact thus far in 2024, even as the potential trajectory of interest rates has grown increasingly murky. Persistently sticky inflation readings and more-recent signs of economic weakness have markets reconsidering how many federal funds rate cuts will happen this year – or if any will happen at all.

Evolving interest rate expectations have been a prime driver of risk assets thus far in 2024, as they were in 2023. While confidence in a potential US Federal Reserve pivot fuelled rallies across a range of risk assets beginning in late 2023, ‘higher for longer’ has re-emerged as the dominant policy narrative in 2024 as macroeconomic readings have tempered expectations around the timing and magnitude of federal funds rate cuts.

Swaps traders entered the year expecting six cuts totalling 1.5 percentage points during 2024 but now see only one 0.25% cut.

While the enthusiasm for risk assets that emerged toward the end of 2023 persisted through the first quarter of 2024 – especially for large-cap growth names – year-to-date to 30 April, the Russell 2000 Value Index is down 3.7%, lagging the 0.7% loss for its growth analogue and the 6.0% gain for the S&P 500 Index.

Yet even with dampened expectations for rate cuts, signs of market complacency remain widespread. Measures of implied equity market volatility have subsided after an April spike and tight credit spreads, upbeat corporate earnings forecasts and rich multiples for some stocks suggest optimism.

Potential for choppiness

Despite generally resilient equity markets, we believe there are reasons to be wary in the current environment. Tight labour markets and wage growth may trigger still higher inflation ahead and rates that remain higher for longer can be challenging for smaller companies with relatively limited access to capital.  

The tight-money environment can also dampen merger and acquisition (M&A) activity by private equity vehicles, historically a source of support for small-cap valuations.

Beyond monetary policy, the escalation of geopolitical risks or unforeseen local political developments – there are federal elections scheduled for more than 70 countries in 2024 – could upend positive market momentum with little advance warning.

Meanwhile, massive swells of public debt in most developed economies combined with a general lack of fiscal discipline have the potential to spark a sudden and painful reconsideration of risk premia.

Relying on investment discipline, not Fed policy

In the small-cap space, volatility may provide us with the opportunity to acquire fundamentally solid companies at valuations that may be distorted by cyclical forces.

There are a number of ways in which US-based smaller companies could receive a boost from a Fed rate cut, from greater operational and financial flexibility to an uptick in M&A activity – but even so, none of our investments are based on the assumption that a much-desired central bank pivot will come to pass.

Regardless of the Fed’s actions, it seems likely that small companies that are cheap for a reason will continue to face a challenging operating environment, while many of those with solid businesses and catalysts for improvement may progress toward fuller valuations.

By controlling what we pay for these assets, we seek to construct a portfolio that is a little cheaper than the market on a valuation basis while being well-positioned for strong upside should our investment theses play out.

Prospects for revaluation

At the end of the day, investors can control only which stocks they buy and how much they pay for them. They make these choices without knowing what the economy is going to look like down the road, the policies that will be implemented, the trajectory of interest rates or the direction of oil prices. All these factors are unknown, so investors make one real choice only – what to buy and how much to pay. If this decision proves wise, they stand to be rewarded.

We believe those who devote their efforts to identifying and investing in good businesses at attractive valuations may see the most success over the long run.

Even following strong gains over the past year, US small-cap valuations continue to suggest an environment with available opportunities. The Russell 2000 Index trades at more than a 10% discount to its historical average and a 38% discount to the S&P 500 Index.

As the chart below shows, a discount for small-cap stocks is a relatively recent phenomenon. For most of the period between 2003 and 2017, small-caps traded at a premium to large-caps, and depressed small-cap valuations have historically been followed by rallies.

Trailing price-to-earnings multiples of US small-caps vs S&P 500

Source: FactSet, data as of 30 Apr 2024

Even within an overall valuation discount for small-caps, however, selectivity remains key.  Given that 44% of the companies in the Russell 2000 were unprofitable as of March 31, 2024 – versus only 7% of the S&P 500 – we think sorting the wheat from the chaff is a worthwhile endeavour in the broad and diverse small-cap universe.

As Warren Buffett (quoting Benjamin Graham) once said, a “wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses”.  Smaller companies are one of those markets and we believe that their volatility and inefficiency create opportunities for active managers to potentially generate alpha, more so than any other equity asset class, as the table below shows.

Active manager success rate versus index

Source: Morningstar, data as of 30 Apr 2024

Navigating uncertainty ahead

Our focus going forward remains on separating strong businesses from those that are cheap for a reason. With the US in an election year, small businesses may have concerns about the regulatory burden, government spending and debt levels, and how these might affect interest rates.

The Fed’s success rate in its previous attempts to engineer a soft landing is an obvious reminder that uncertainty persists, and conditions are likely to become more challenging as the accumulated impacts of policy tightening continue to mount, especially among smaller companies with more limited access to capital.

In the face of these challenges and concerns, our focus remains on separating strong businesses from those that are cheap for a reason. With catalysts for growth or improvement, we look for sound businesses that may be positioned for solid returns.

Bill Hench is head of the small-cap team at First Eagle Investments. The views expressed above should not be taken as investment advice.

Sometimes good managers have a bad year that can derail their performance figures for years to come. For Siddarth Chand Lall, manager of the £465m IFSL Marlborough Multi Cap Income fund, that time was 2022.

The year was so poor that it has impacted the fund’s medium and long-term figures, with the portfolio sitting in the fourth quartile of the IA UK Equity Income sector over three, five and 10 years. It remains ahead of the sector average since launch in July 2011, however.

In the decade prior to 2022, the fund was the fourth-best among its 60 peers, smashing its average rival by more than 70 percentage points, as the below chart shows.

Performance of fund vs sector from 2012-2022

Source: FE Analytics

“The performance was top quartile over one, three five and 10 years up until the end of 2021; 2022 was the year that we struggled,” said Chand Lall.

“That is what has spoiled the three and five-year numbers. It isn’t that we have had bad performance every year.”

His fund tends to invest mainly in mid- and small-caps, with some 83.6% of the portfolio invested in this area of the market, while just 10.3% is in larger stocks.

As a result, the fund was buffeted from all sides, including the UK macroeconomic picture worsening due to rampant inflation, which had a particularly big impact on the more domestically-focused mid-cap stocks.

Couple this with a weaker pound (making imports more expensive) and the situation for the lower end of the market was difficult.

As such, his fund lost some 19.6% in 2022 alone – the worst year on record for the fund since its launch in 2011 – with the manager also noting there were some stock-specific issues as well.

Performance of fund vs sector in 2022

Source: FE Analytics

Yet the name of his fund is multi-cap, suggesting he has the option to move up the scale where appropriate – something Chand Lall admits was a lesson he learned during the course of that difficult year.

“How would we have positioned if we had known now what we knew then? We would have made much more use of the large-cap allocation. Whereas it’s almost always been between 5% and 15% to the FTSE 100 we would probably have moved up the scale,” he said.

However, it was not as easy, he noted, due to the makeup of the investors in the fund. “At the time there were specific clients who wanted us to keep the small-cap and mid-cap bias the way it was because we made up a portion of their allocation across many portfolios,” Chand Lall said.

“We were told ‘if you do underperform at least we know why you are, what we don’t want is for you to double up on where we already have exposure through other funds’.”

This is no longer an issue for the manager as these clients are no longer invested in the fund and so he has “much more flexibility” in the future should the environment change as dramatically as it did in 2022 when inflation and interest rates rose steeply.

“We will move much larger without changing the investment process,” he said, which includes looking for good companies with strong balance sheets indicated by metrics such as net debt to net assets of sub 50% (or preferably net cash) and free cashflow covering the dividends.

Chand Lall added: “In the event we get a scenario where there is potentially high inflation and interest rates, we would take advantage of the flexibility the strategy allows. That is the learning. I don’t mean 60% of the fund would be invested in the FTSE 100, but instead of 10-15% it might be 30-35%.”

Yet to change the portfolio now would be “silly”, he argued as mid- and small-caps are coming into their own. Indeed, the fund has been one of the top performers of the IA UK Equity Income sector so far in 2024 and since its nadir in October 2023 it is up some 28%.

Performance of fund vs sector over 1yr

Source: FE Analytics

“At this current juncture it would, to a certain extent, be almost silly to do it [move into large-caps]. We are getting so much alpha at this moment so I wouldn’t want to move away from that just to buy large-cap for the sake of it,” he said.

This recovery is in-keeping with previous periods, he noted, such as following the Brexit referendum in 2016 and the Covid pandemic collapse of 2020.

“What’s driving that is the aspect of beaten up valuations and also stocks trading better. We have gone past that element of caution and worries over a recession in the UK GDP figures. In the latest quarter it was 0.6% which was better than expected,” he said.

“That macro aspect does have some correlation with your micro. Also companies are trading better – we have had more good updates than bad. The multiple expansion will come.”

Liontrust Asset Management has established a new global equity group and brought in a team from GAM Investments to lead it. Mark Hawtin, who headed up GAM’s global growth equity team and managed long-only and long/short strategies, will run the new division. He will be joined at Liontrust by three GAM colleagues: investment managers David Goodman and Kevin Kruczynski, and analyst Pieran Maru.

Hawtin and Goodman are bringing their GAM Star Alpha Technology fund with them to Liontrust and have been appointed sub-investment managers of the strategy until the portfolio officially changes hands.

Ewan Thompson, Tom Smith and Ruth Chambers, who currently manage emerging markets and Japanese equity funds at Liontrust, will move internally into Hawtin’s group. All three joined Liontrust when it acquired Neptune Investment Management in October 2019.

The new global equity team will manage the Liontrust Balanced fund and the Liontrust Global Alpha fund, along with other global and regional equity funds.

This move follows Liontrust’s attempt to buy GAM last year, which collapsed when shareholders rejected the deal.

Hawtin has 40 years of investment experience. Before joining GAM in 2008, he was a partner and portfolio manager at Marshall Wace Asset Management, running one of Europe’s largest technology, media and telecoms hedge funds.

Hawtin said: “We are really excited to have joined Liontrust as it is in the process of building a strong global equity platform. We look forward to extending the product offering at a time when the global equity opportunity is so great.

“My experience of running global funds at Marshall Wace and then GAM has allowed me to see markets through many different cycles. This knowledge will serve us well as we navigate a period marked by unprecedented levels of change caused by structural disruption as well as geopolitical uncertainty.” 

Hawtin believes that, to succeed, companies must adapt their business models rapidly in response to threats that challenge the traditional world order. This dynamic should create opportunities for active managers due to the polarisation between the winners who adapt and the losers who do not, according to Liontrust.

GAM hired Paul Markham in February to replace Hawtin at the helm of its global growth equities and disruptive growth teams. He was previously head of global opportunities equities at Newton Investment Management.

The European Central Bank (ECB) will, in all likelihood, cut interest rates next week, becoming the first major central bank to ease its monetary policy.

This move is likely to support European equities, which have suffered from the poor economic outlook for the continent as a result of the Russian invasion of Ukraine, spiralling energy costs and a slowdown in global manufacturing. 

Tom Stevenson, investment director at Fidelity International, said: “Many of the headwinds for Europe are now turning into tailwinds. Inflation has fallen back rapidly towards the ECB’s target. This will enable the central bank to lead the way when it comes to interest rate cuts this summer. Monetary policy is now pulling in the same direction as supportive fiscal policy.

“Against this improving backdrop, European shares are not expensive. They trade at a significant valuation discount to their US peers. Any shift away from Wall Street could benefit Europe.”

Below, experts suggest funds that investors may want to consider to benefit from the upcoming ECB rate cuts.

BlackRock European Dynamic

Amaya Assan, head of fund origination at Square Mile Investment Consulting and Research, recommended BlackRock European Dynamic.

This fund’s unconstrained approach enables FE fundinfo Alpha Manager Giles Rothbarth to adjust the portfolio strategically, taking advantage of the current economic backdrop and the opportunities it offers.

Performance of fund over 5yrs vs sector and benchmark

Source: FE Analytics

Assan said: “Given the flexible approach employed by the manager, the portfolio is currently tilted to be overweight cyclicality which should be a beneficiary of a falling interest rate environment.

“The manager has identified areas such as construction, where volumes are recovering from their worst levels in over a decade and share prices are likely to benefit from falling rates, having been hit hard in the prior rising interest rate environment.” 

Comgest Growth Europe ex UK and Schroder European Recovery

Tom Stevenson proposed two options for investors: a fund focusing on growth and another one following a contrarian approach.

For growth, Stevenson pointed to Comgest Growth Europe ex UK, which has a quality bias and boasts some well-known names among its top 10 holdings such as Novo Nordisk and LVMH.

“The managers look for companies with established brands or unique products or technology,” he explained.

Performance of funds over 5yrs vs sector and benchmark

Source: FE Analytics

Schroder European Recovery takes a different approach, as the managers invest in companies they believe to be undervalued relative to their long-term earnings potential. Current holdings include the likes of Sanofi, BNP Paribas and Allianz.

Premier Miton European Opportunities

Small- and mid-cap stocks are theoretically more sensitive to changes in interest rates and should, therefore, particularly benefit from the ECB rate cut. 

As a result, Sheridan Admans, head of fund selection at TILLIT, highlighted Premier Miton European Opportunities, managed by FE fundinfo Alpha Managers Carlos Moreno and Thomas Brown as well as Russell Champion. The fund offers exposure to European mid-caps with high-quality growth characteristics, he said.

Performance of fund over 5yrs vs sector and benchmark

Source: FE Analytics

“The managers particularly look for companies with high returns on capital. They believe this is a key metric determining quality, sustainable returns and long-term growth. This fund has a clear focus on stocks that can deliver long-term compound growth,” Admans explained.

“The team is lean and the managers are involved in every aspect from idea generation and research to decision-making.”

Montanaro European Smaller Companies Trust and JPMorgan European Discovery Trust

For investors comfortable with exploring opportunities lower down the market capitalisation scale, Admans also suggested Montanaro European Smaller Companies Trust.

 “The managers are small company specialists and run a fairly concentrated portfolio with a quality growth, bottom-up investment approach,” he said.

Admans also highlighted the focus on environmental, social and governance (ESG) factors in the trust’s investment process.

Performance of investment trusts over 5yrs vs sector and benchmark

Source: FE Analytics

Alternatively, investors could consider JPMorgan European Discovery Trust, which was tipped by Billy Ewins, fund research analyst at Quilter Cheviot, for its “solid, well-resourced team”, enhanced by JPMorgan Asset Management’s “strong research capabilities”.

Ewins said: “The trust is a differentiated offering and unique to other funds, many of which tend to bias to larger companies today.

“However, just because it is a small-cap investment trust, does not mean it doesn’t have exposure to leading brands, with several of the companies having a strong consumer presence, such as Italian coffee machine manufacturer DeLonghi.

“Crucially, however, the trust is well diversified and has exposure to other exciting business areas which are less reliant on the consumer, including geosciences in the shape of Dutch company Fugro.”

What can you do with $80bn leftover cash? Admittedly, it’s a nice problem to have, but the answer wasn’t a straightforward one for Google parent Alphabet, which sat on the cash for a while before deciding only this year to pay its first dividend.

What took it so long? That’s what Richard Saldanha, FE fundinfo Alpha Manager of the Aviva Global Equity Income fund, asked.

“After all its funding was done, including the capital expenditure programme Alphabet was sitting on $80bn after. In some ways, you could ask: What took it so long to paying it out as a dividend?,” he said.

But while this is an interesting development for income investors, who now gain access to a whole new set of income opportunities in US technology, the manager was more excited about the broader trend and the growth potential, rather than the dividend itself.

While this might look like a sizable amount in terms of dollars, the yield percentage is not going to set the pulse racing, at just about 0.5%. However, cash isn’t only accumulating on Alphabet’s books, but also across the industry and Saldanha sees only one direction that this trend could go.

“This opens up a new opportunity set and we expect this trend to continue,” he said. “Don't be surprised if you see more and more of these technology companies initiating dividends. Tech is a sector that now is very much within income investors’ grasp.”

Until now, the options for income investors were limited to Microsoft, which has been paying dividends for a long time and “has a very mature dividend framework”.

Like with the others, it isn’t the nominal yield that’s interesting in Microsoft’s case, but the growth profile.

“The underlying growth of these companies is quite interesting. We expect their dividend to grow in line with the cash flows. For Microsoft it's been consistently double-digits,” Saldanha said.

Microsoft historical dividend growth

Source: Company filings 

Whether there will be a large uptake of US tech within income portfolios is still to be seen and will depend on managers’ considerations around valuation and yield, but Saldanha has no doubt many funds will be increasingly looking at this sector.

“It's going to be interesting to see how that progresses. For us, it’s going to be a steady evolution,” he said.

The only large tech company currently in the Aviva Global Equity Income portfolio is Microsoft, but Alphabet is held in another fund managed by Saldanha, Aviva Global Equity Endurance and was described by the manager as the most convincing stock among the Magnificent Seven.

“Alphabet is a very strong company that is going to grow cash flows at a at a healthy rate, so it is certainly of interest now for the equity income fund too,” he said.

“For now, however, this fund gets its tech exposure via Microsoft and other routes in the supply chain. We've been very much invested in the semiconductor space, for example, where companies have much more mature dividend structures.”

Examples of these are the artificial intelligence chips suppliers Broadcom, which sells to Alphabet, and TSMC, which manufactures the chips for Nvidia.

“We're very pleased however to see this opportunity set continue to evolve and increase,” the manager concluded.

Performance of fund against sector and index over 1yr

Source: FE Analytics

The surge in investor focus on generative artificial intelligence (AI) has led to one of the most powerful rallies in technology stocks in recent memory.

In our view, generative AI has the potential to be a game changer not only in our everyday lives but also in the growth profiles of the infrastructure supporting it. We are currently seeing strong pricing power for data centre owners, accelerating load growth for public utilities, and increased demand for renewable developers and low-carbon portfolios to provide clean energy to support data centre assets.

This generative AI-related growth comes in addition to infrastructure’s broader secular underpinnings, which include the demands for global decarbonisation, energy security and modernised assets.

Infrastructure’s irreplaceable role in AI

Current data centre capacity, ramping power/cooling needs and access to power for new-build data centre assets are bottlenecks to generative AI-related growth. Today, high occupancies of data centres are already spurring pricing power and margin improvements for existing essential assets in those listed companies.

For example, vacancy rates are at a decade-low across North American markets, while 2023 data centre leasing activity is likely to have doubled 2022 levels and finish eight times above what was recorded in 2019.

Power use at existing facilities is also on the rise, as it is estimated that generative AI requires 20-100 times more power compared to data centre usage prior. For example, a generative AI purpose-built data centre requires a minimum of 250MW of capacity, compared to a historical data centre capacity size of circa 10MW.

While power use is increasing, transmission grids are unprepared and new investment is required to support generation connections. Generative AI-related demand in the power grid is expected to grow at a 30% compound annual growth rate (CAGR) over the next five years, with some estimates coming in as high as 70%.

In response to this phenomenon, major listed utilities are multiplying their forecasts for electricity demand growth. Industry-wide, current levels of anticipated power growth for the next five years double expectations as of 2022 and are more than 9 times the long-run average.

Increased load growth represents a paradigm shift for US utilities, with the potential to enhance earnings, increase required investment and further improve long-term earnings visibility.

In addition, the draw for low-carbon generation from generative AI and its data centres is immense; it is spurred by data centre developers prioritising green power to minimise carbon footprints in the face of unprecedented growth.

In fact, renewable power purchase agreements (PPAs) from Amazon, Google, Meta and Microsoft have ramped up by 6 times compared with 2018 levels, and the development backlog for leading listed renewable energy developers is currently dominated by data centre-related projects. By 2025, generative AI-led PPAs could reach levels equal to half of the current market.

Secular growth at a discount

Given the secular growth potential of infrastructure, valuations remain at a discount today. We expect high single-digit earnings growth in the future from the asset class, with the potential for upside should current trends accelerate.

Following a historic lag to large-cap tech and broader equities last year, as well as recent underperformance to private equity infrastructure indices, infrastructure’s price for its growth is compelling.

On a 2025 price/earnings to growth ratio (PEG ratio) we see listed infrastructure potentially trading at a 1.5x multiple for 2025, compared to 2x for the ‘Magnificent 7’.

On a relative valuation basis, infrastructure is at a 10% discount to global equities, compared to its history of a 10% premium. When we further consider the private market and analyse notable large-scale privatisations over the past five years, we see listed infrastructure trading at a 30% discount to private equity acquisitions.

Jeremy Anagnos is portfolio manager of Nordea’s Global Listed Infrastructure strategy. The views expressed above should not be taken as investment advice.

Investing in emerging markets has always meant taking on more risk, whether it be from geopolitics, different economies or currencies.

That’s also true for India, where perceived geopolitical risks include the outcome of the ongoing elections, its relationship with Russia and environmental, sustainability and governance (ESG) issues.

At the same time investors also need to think about currency, according to Gaurav Narain, manager of the India Capital Growth trust, who said they must be willing to take an average hit of 2% to 3% every year before they can break even.

The Indian Rupee has been volatile in recent years. Over 12 months it is 4% lower against the pound while over five years this rises to 17%.

Against the dollar the figures are comparable. Over one year the Rupee is just 0.7% weaker, but this climbs to 16.4% over five years and 29% over 10 years. And this depreciation might not be reversing any time soon, although it should slow down.

Rupee versus US dollar over the past 5 years

Source: FE Analytics

“Historically, the currency has depreciated between 3% to 3.5% on average every year over the past five, 10 and15 years against the dollar”, Narain said. “But my own sense is that now it will be slightly less, around 2% to 3%.”

There are three main reasons why the manager is expecting a lower depreciation trend going forward.

Firstly, the export of services is now worth $340bn and also growing at a much faster pace than before. Secondly, India is getting a lot of forex reserves in the form of remittances, last year that amounted to about $110bn. And thirdly, India is attracting a lot of foreign direct investment, almost $60-$70bn a year.

“In particular, the result of the forex reserves are very strong and provides a lot of cushion on the currency. In volatile times, the Reserve Bank of India has a lot of flexibility, so you shouldn’t see the big swings that have historically happened,” explained the manager.

“The currency has been remarkably stable against the dollar and the country is in a much better position. But if you're investing in India you must account for that 2%-3% hit.”

The other risk that has been very present on investors’ minds recently is the election, with results to be announced next week. The current prime minister Narendra Modi is expected to maintain his majority, which is good news for investors, as he is “very good for the market”, according to Narain.

“He is doing all the right things for the economy. He’s thinking long term, trying to eliminate corruption and is very strong on execution, so he's genuinely good for the economy,” he said.

On top of that, has been doing an “incredible balancing act” on the international arena, remaining friendly with the Western world while still purchasing oil from Russia.

“India is among the top-three oil purchasers in the world, mainly from the Middle East and the US, but also Russia. Imagine what would happen to oil prices if the country stopped buying from Russia,” Narain said.

While Modi is the favourite candidate, election results are hard to predict. If he loses his majority, the market will “definitely correct”, said Narain, at least in the short term, because of the uncertainty.

“But then it all boils down to what the new government does on policies,” he said. “India is a democracy and has policy continuity, you don't see someone come in and change policies completely. Which is why India over the last two decades has grown at 10% in nominal GDP in dollar terms.”

Another potential issue for investors is that the market is trading on particularly high multiples, given the substantial growth that’s recognised and already priced in by the market.

The average IA India fund has grown by 9.5% so far this year and the country has delivered strong returns for much of the past decade.

Performance of indices over the past 12 months and 10 years

Source: FE Analytics

The India Capital Growth fund has been tops amongst its IT India/Indian Subcontinent peers over the past 10 years. It mainly focuses on mid- and small-caps, which make up 38% and 50% of the portfolio, respectively.

Some investors have shunned the defence sector, considering it to be incompatible with their environmental, social and governance (ESG) principles. Yet it has been brought back to the fore following the outbreak of the war in Ukraine and conflict in the Middle East.

Purely from a stock market perspective, investors who ignored defence stocks have incurred a significant opportunity cost, as the sector has performed exceptionally well over the past three years, especially in Europe.

Performance of indices over 3 years

Source: FE Analytics  

After such a strong show of force, the question for investors now is whether defence stocks will continue to push forward.   

Graeme Bencke, co-manager of Amati Global Innovation, believes defence stocks have the potential to go higher from here, but said the initial wave is already behind us.

“Many of these companies traded on quite low valuations in the past as defence spending had stagnated, but multiples have expanded with the increase in demand as geopolitical tensions have increased,” he explained.

“This re-rating process drove the sharp rise in share prices, and price development from here will be more reliant on revenue and earnings growth.”

David Coombs, head of multi-asset at Rathbones, agreed and sees some additional tailwinds which could drive long-term returns in the years ahead.

He said: “The doctrine and needs of militaries are changing rapidly because of technological advances and the new fronts they open up. New threats require new solutions, and while large defence contractors are mostly known for the big machines they have produced in the past, a much more meaningful part of their business is now focused on cybersecurity and digital warfare.

“A kicker to this need for military investment is the potential for Donald Trump to win a second term as US President and the war in Ukraine, which both seem likely to push European members of NATO to spend more on defence.”

Alec Cutler, manager of Orbis Global Balanced, went a step further, as he believes that whoever wins the US election this autumn, the US protection guarantee is gone, which means Europe will need to ramp up its defence spending anyway.

How are managers playing the defence theme?

Defence is a broad industry made of a wide range of distinct segments. Therefore, Bencke stressed the importance of focusing on areas where spending is most likely to grow over the coming decades.

He said: “While military spending is somewhat opaque, most governments produce defence strategy-related papers outlining the direction of travel for investment.

“Outside of specific large programmes, like the US 30-year submarine fleet renewal or the 'Future Long Range Assault Aircraft' replacing the Blackhawk helicopter, there are some clear areas of attention. Most of these make intuitive sense when we think about the potential threats. Better anti-aircraft and missile defences, counter-drone weapons, improved battlefield communication and control, for example.

“However, some others are perhaps less obvious but also seeing considerable growth in funding. The nature of conflicts between powers has changed over the past decade with a much greater threat from cyber-espionage and cyber-attacks on military and civilian infrastructure. Improved intelligence gathering and secure communications means increased spending on space-based initiatives, although much of this is classified.”

As a result, Bencke holds MOOG – a provider of highly accurate electric actuators and bearing systems –  which he believes is poised to benefit from space, aircraft and missile-related spending.

He also pointed to Leonardo DRS, which should profit from mobile air defence spending through its M-SHORAD platform, as well as providing new electric propulsion systems for the navy.

Another stock Bencke highlighted is technology consultancy firm Booz Allen Hamilton, which is involved in cyber defence and also assists developments with US agencies such as the CIA and FBI.

Jacob de Tusch-Lec, co-manager of Artemis Global Income, finds European defence companies attractive in spite of their recent strong performance, as Europe still has plenty of catching up to do.

“Defence is like insurance. You don’t like paying it until you need to make a claim. Since 1992 and the collapse of the Soviet Union, the world has enjoyed a massive peace dividend and the benefits of globalisation. With that has come a huge under-investment in defence," he said.

“If you look at Europe today versus 30 years ago, we’ve got fewer than 4,500 tanks compared with nearly 19,000 then. You can’t build 15 thousand tanks in a few weeks. We’ve also got half the ground attack aircraft and submarines we once had. On top of this, a lot of materials have been sent to Ukraine.”

Therefore, de Tusch Lec is bullish on Düsseldorf-based Rheinmetall, which he expects will benefit from a big demand inflection that might last for a decade.

He added: “It’s currently sitting on an order backlog of €38bn, that is five times the size of what it sells in a year. Replenishing munitions inventory is not going to happen overnight.”

Closer to home, Cutler likes BAE Systems and Rolls Royce. The former is well-positioned in warships, has content in many of the leading weapon systems such as the US stealth fighter jet F-35 and has a large share of US research and development contracts.

As for Rolls Royce, he believes it should benefit from long-term contracts, such as the one to supply new engines for the US B-52 aircraft fleet, providing the UK company with non-cyclical cash flows.

He also mentioned some defence companies in Asia, such as Mitsubishi Heavy in Japan, Hanwha Aerospace in Korea and Hindustan Aeronautics in India, because tensions are also heating up in that part of the world.

Performance of stocks over 3yrs

Source: FE Analytics  

As for Coombs, he has long owned US-listed Lockheed Martin and French defence and aerospace company Thales to “mitigate the risks of a more stressed geopolitical age”.

 “Both Thales and Lockheed Martin have a comprehensive suite of cyber capabilities, supported by elements of artificial intelligence, machine learning and automation to deal with the complexities of today’s deployments,” he said.

“These technologies also have civil uses, beyond the military ones that drive their creation. For example, Lockheed Martin is using its artificial intelligence capabilities and hardware to support firefighters dealing with wildfires by connecting land, air and space-based sensor and monitoring, which help predict and mitigate the spread of wildfires.”

Are defence stocks compatible with ESG?

The rapid increase in geopolitical tensions and the ensuing need for higher military spending have sparked debate on whether defence stocks are compatible with ESG principles.

For Bencke, while warfare is “abhorrent and anachronistic”, it nevertheless remains a reality.

“Sadly, the words of the Roman general Vegetius are as true today as when uttered over 1600 years ago – ‘if you want peace, prepare for war’,” he said.

“We would not endorse or invest in weapons or practices which breach modern conventions on warfare, but sadly the industry remains important for the defence of our democratic way of life.”

De Tusch-Lec agreed, adding that the legacy of the war in Ukraine is that individual countries need to revisit their priorities.

He said: “Nations are having to think about those areas at the bottom of Maslow’s pyramid of needs – the essentials in life like food, water and security. From that perspective, defence stocks are compatible with ESG and as investors we obviously avoid those companies which have links to cluster bombs or land mines.”

However, Coombs does not believe defence stocks are compatible with ESG and Rathbones does not hold them in their sustainable multi-asset funds, in which ESG is more linked to values rather than financial risk.

Finally, Cutler believes that peace is an imperative starting point to implement ESG ideals, but that defence is a necessary evil to create those conditions.

He concluded: "Peace through strength is at the base level of a society's hierarchy of needs. Peace is a have-to-have, without which higher order desires relative to the environment, society and governance will never achieve sustained traction.”

BlackRock has announced the launch of a new global smaller companies strategy, offering UK investors the opportunity to “capitalise on the high alpha potential within the smaller companies universe”.

Co-managed by Matt Betts and Dan Whitestone from the BlackRock’s emerging companies team, the fund follows a fundamentals-driven approach and invests in companies with defensible market positions, competitive products and structural growth drivers. It is benchmarked against the MSCI World Small Cap index.

According to the press release, active management is “key” for small-cap funds, particularly as dispersion of returns can be high in this under-researched universe.

Whitestone said: “As active managers, we believe small-cap stocks can present us with the most attractive hunting ground as these companies tend to operate in an inefficient, under-researched area of the market and can offer the potential to generate returns for our clients over the long term.”

Another advantage of smaller companies are their cheap valuations, Betts said, with small-caps now trading at the all-time-high discount to large-caps of approximately 26%; additionally, they are expected to provide sustainable returns in the long term too.

“Alongside the attractive valuation opportunity right now, we believe that small-cap funds can provide excellent long-term investment due to their historic outperformance compared to large-caps,” Betts said.

Finally, the investment team said interest rates coming down in 2024 will “act as a potential catalyst for investors to reappraise the valuation opportunity in both absolute and relative terms”.

The Magnificent Seven have dominated headlines, so it may come as a surprise that a handful of British companies have delivered returns close to, or even exceeding several of the American tech behemoths over the past 18 months, whilst trading on far lower multiples.

Rolls-Royce has returned 385% over 18 months, beating six of the Magnificent Seven (Nvidia being the exception) and outperforming Meta Platforms’ 317% rise in sterling terms.

Marks & Spencer, 3i Group and Intermediate Capital Group all exceeded Amazon, whose shares rose 95% in sterling terms over 18 months.

Associated British Foods and BAE Systems performed in line with Alphabet, while Antofagasta wasn’t far behind Microsoft.

Dan Coatsworth, investment analyst at AJ Bell, said: “Some 41 FTSE 100 stocks have delivered a better return over the past year and a half than Apple and 79 have beaten Tesla. That is proof that the UK market is alive and well and that strong returns are not restricted to the go-go-growth segment of the US stock market.”

Returns for well-known US and UK stocks over the past 18 months

Sources: AJ Bell and SharePad, data for 18 months to 23 May 2024, total returns in sterling

Imran Sattar, portfolio manager of the Edinburgh Investment Trust, agreed. “There is a perception that the UK market is essentially made up of low growth and lower quality businesses; we strongly disagree. It is possible to build a well-diversified portfolio of advantaged UK businesses with high returns and good growth prospects at a discounted valuation.”

Below, Trustnet explores why the UK’s strongest performing companies have done so well, highlighting the stocks that have beaten five of the Magnificent Seven over the past 18 months.

Rolls Royce

Rolls Royce is a turnaround story and its new chief executive Tufan Erginbilgic, who joined on 1 January 2023, deserves much of the credit for cutting costs and maximising profits.

Rolls Royce has also benefitted from the post-pandemic recovery in air traffic, said Stephen Anness, head of global equities at Invesco. “The resumption of international travel, as well as the management turnaround story beginning to take shape, meant it produced a total shareholder return of 221.6% for 2023, matching Nvidia.”

Coatsworth added: “The engineer continued to issue bullish trading updates and that fired up the share price.”

Marks & Spencer

M&S has beaten expectations multiple times in the past year, Coatsworth said. Earlier this month, the retailer announced strong full-year results, with a 33.8% increase in adjusted operating profit and a 9.4% increase in total sales. It also introduced a 3p dividend.

James Henderson, co-manager of the Henderson Opportunities Trust, Lowland Investment Company and Law Debenture, was an early convert. “We began adding to M&S early in its recovery, which has helped our funds as the bears have turned slowly bullish. Marks’ recent results were very good – much better than the best estimates by analysts,” he said.

M&S has generated strong cash flow, which has enabled it to reduce debt and start paying a dividend again, but now the retailer is embarking on the “next stage of the story”, he continued.

“It is now spending half a billion pounds on improving the offer – upgrading its stores and investing in the online infrastructure. After a period of rationalisation and store closures, this is the next phase and is essential if M&S is to continue its growth,” said Henderson.

3i Group

Nick Shenton, co-manager of the Artemis Income fund, said 3i Group has been the best performing stock in his portfolio over the past year. The £28.5bn investment company produced a total return of 85.5% in 2023 and has been “a tremendous performer over the very long run”.

Anness attributed 3i’s rapid growth to its stake in Action, Europe’s fastest-growing non-food discount retailer, heralding it as “one of the brightest companies on the continent”.

“The cashflow generation of this underlying company has been incredible: the payback period for each newly-opened store is roughly one year. Action currently has more than 2,300 stores and plans to open 400 a year by 2026. We think it could have a 20-year runway for further expansion in Europe alone,” he said.

Intermediate Capital Group

Intermediate Capital Group (ICG), which manages private equity, private debt and real assets funds, has enjoyed a strong 18 months and is one of Jefferies’ “top picks”, said equity analyst Julian Roberts. “We view ICG as a quality compounder with plenty of long-term potential.”

ICG released its results yesterday for the year ended 31 March 2024, surprising on the upside. “We believe new guidance of $55bn of fundraising over the next four years is likely to be taken well, and $13bn of funds raised in the past 12 months compares with $12.4bn expected by analysts,” Roberts said. This included client commitments of almost $1.5bn across three first-time funds.

The firm announced an 11% increase in its fee-earning assets under management to $70bn and a 16% increase in third-party fee income to £578m, well ahead of consensus expectations of £540m.

Associated British Foods

Associated British Foods has performed strongly as inflation cooled, with share buybacks providing further support.

Primark’s owner benefited from its conglomerate structure, Coatsworth said. “Its interests across retail, agriculture, grocery and food ingredients means risks are spread across different industries. When one segment is not doing so well, other parts of its business are there to pick up the slack, and we’ve seen that dynamic at work in recent years.”

BAE Systems

The defence sector was thrust into the spotlight by Russia’s invasion of Ukraine. With geopolitical tensions on the rise, governments around the world have been increasing their defence spending, which has driven a rally in BAE Systems’ shares.

Defence projects tend to be highly complex, involving multiple companies in different countries, said Jason Hollands, managing director of Bestinvest. This means that BAE Systems benefits from global rather than just domestic military expenditure.

Defence order books are multi-year in nature and therefore relatively insensitive to the economic cycle, he continued, which “makes defence ‘defensive’ from an investment perspective”.

GQG Partners manages $140bn in global and regional equities and its flagship emerging markets fund is the best performer in its sector, yet the Florida-based firm is still relatively under the radar in the UK and Europe.

The $3bn GQG Partners Emerging Markets Equity fund is the top performing strategy in the IA Global Emerging Markets sector over one and five years and the sixth best performer over three years. It has left both its benchmark and sector in the dust since inception, as the chart below shows.

As such, its managers Rajiv Jain, Brian Kersmanc and Sudarshan Murthy have just won the FE fundinfo Alpha Manager of the Year award for Asia and emerging market equities. GQG’s global and US equity strategies were also nominated for awards.

Fund versus benchmark and sector since inception

Source: FE Analytics

One of the reasons for its stellar track record is GQG’s ability to spot risks, avoid the downside and, essentially, win by losing less. Here, GQG has a secret weapon: journalists, accountants and former private equity professionals.

The global equity manager has built a team of people with experience atypical of buyside analysts and charged them with identifying risks and patterns, and helping the firm to avoid groupthink. Their research dovetails with another team of more traditional stock-picking analysts.

Financial journalists were writing articles about issues in the US subprime mortgage market as early as 2006, which triggered GQG founder Jain’s interest in working with reporters and non-Wall Street professionals.

Chulantha De Silva, a client portfolio manager at GQG and former investment banker, said: “Wall Street does have a lot of smarts but it does have a herd mentality.”

Jain had a team of former journalists at his previous employer Vontobel, but expanded this function at GQG, which he established in June 2016, to include accountants, private equity specialists, technologists and healthcare experts.

“We have multiple different eyes from different vantage points on the same franchise,” De Silva said. He thinks following conventional wisdom is a huge problem in fund management and to outperform, managers need an “outside advantage”.

Accountants are adept at tracking patterns and can provide insights into the quality of companies’ management teams by studying corporate accounts. “Accounting is the language of business,” he observed.

Professionals with a background in private equity, meanwhile, can analyse the capital structures of companies.

“Tech folks double up as disruption specialists. The catalyst for that tool was to make sure none of our companies got ‘Amazoned’ out,” De Silva continued. With the advent of generative artificial intelligence (AI), “every stock in every sector is at risk of disruption”.

All of these “non-traditional folks” assist GQG with wealth preservation by identifying major risks to companies in the portfolio, so GQG can sell them before their share price tanks. “Every manager does a great job of buying stocks. Where most people falter is knowing when to get out,” he explained.

Another element of the firm’s sell discipline is that analysts and portfolio managers are afforded the flexibility to change their minds and challenge their own investment thesis. “At most firms you are frowned upon for changing your mind. At GQG you are incentivised to change your view on a stock,” he said. “We’d rather be found out wrong in a conference room at GQG than by the market.”

Another unconventional hiring strategy was to deliberately introduce a younger cohort three years ago – not junior analysts per se but young people specifically.

The Florida-based firm had always prided itself on its diversity (half of its staff were born outside the US and 40% are women) but one key area in which it was not diverse was age. As a result, no-one in the firm was using certain apps that have a younger audience. “How do you manage risk when you are not in the disruptive ecosystem?” he asked.

The new wave of recruits proved themselves invaluable when GQG re-entered the energy sector in 2021, De Silva recalled. He and his contemporaries had a jaded perspective on energy having burned their fingers previously but their new junior colleagues were able to look at energy with a fresh mindset.

The same teams of analysts, which GQG calls its ‘research mosaic’, cover emerging and developed markets simultaneously. “I think we’re better investors in Apple because we know China. We’re better investors in Meta because we know India,” De Silva said, adding that in India, 750 million people use WhatsApp. “Put another way, how can you invest in Apple if you don’t know China?”

Every investor with a passing knowledge of equities is likely to have heard of the ‘small-cap effect’: over the medium to long term, the returns from owning smaller companies have far exceeded those derived from owning larger ones. This is because smaller companies have more ‘white space’ to expand into, benefit from economies of scale as they grow and tend to be run by management teams with more ‘skin in the game’ in terms of share ownership.

Data from Deutsche Numis shows that £1,000 invested in UK small-caps for a new-born in 1955 would have grown to £9m by the time he or she reached retirement, aged 67, in 2022 – assuming all dividends were reinvested. The same amount invested in UK large-caps would have grown to just £1m.

Yet ever since the UK voted to leave the European Union in June 2016, the small-cap effect seems to have ground to a halt.

Data from Bloomberg shows the renamed Deutsche Numis Smaller Companies (ex-investment companies) index made a total return of 47% between the date of the referendum result and the end of March 2024 – well below the 65% made by the FTSE All-Share.

As international investors have shunned the UK and multiples have fallen, there has been a waning appetite among smaller companies to list on the domestic market. With merger and acquisition (M&A) activity at heightened levels, analysis from Peel Hunt shows the number of FTSE Smallcap constituents fell from 160 at the end of 2018 to 114 at the end of 2023. If the decline continues at its current rate, the FTSE Smallcap index will cease to exist by 2028.

Even though it may appear as if the direction of travel for UK smaller companies is only going one way, we disagree.

Brexit’s impact on business fundamentals

It is true that Brexit has caused small-caps to de-rate. Investors started pulling money out of the UK equity market on the day of the referendum result and the direction of flows is yet to reverse.

However, it is perhaps worth asking who the marginal seller is from here? Domestic pension funds are now all but out of the UK market. Momentum investors would have sold out long ago. International investors that remain have already weathered the threat of Jeremy Corbyn and the debacle surrounding Liz Truss. One would imagine they are here to stay. 

What of fundamentals? It is difficult to find much evidence that Brexit has affected listed small-caps’ day-to-day operations. We have 300 to 500 meetings a year with company management teams and few mention it as an issue.

At the same time, the UK economy, to which small-caps have a higher exposure than their larger counterparts, is improving. Consumer confidence and the Asda Income Tracker have both been rising for several months now. Government debt levels are low relative to other G7 countries. And, for all the scepticism towards the UK, its Purchasing Managers Index is currently top of the developed economy league table.

Outperformance not dependent on a re-rating

You are probably sick of hearing the argument that UK small-caps are cheap. Yet even if there is no re-rating, the valuation differential should be enough for UK small-caps to outperform from here.  

Take two theoretical companies: both grow at 7% a year and pay out 50% of their income. Company A trades on a price to earnings ratio (P/E) of 15x and Company B trades on 10x. Over a 10-year period, without a re-rating of Company B, it will make 17 percentage points more than Company A. Why? Because the benefit of reinvesting dividends at a lower valuation compounds over time.

In addition, many UK small-caps are turning depressed valuations to their advantage through the use of share buybacks. Eleven of our portfolio holdings bought back their own shares in 2023, with six more already announcing plans to do so this year.

When companies buy back shares, it increases potential dividends and earnings per share (EPS) for remaining investors. The lower the valuation, the greater the impact.

As an example, we recently spoke to Simon Emeny, the chief executive of pub operator Fuller’s, who pointed out that the company would have to spend twice as much buying a new pub as it would by buying back its own shares (effectively buying its own pubs at a discount).

And, as mentioned, small-caps remain the target of heightened M&A activity: 28 of our fund’s holdings have been taken over since 2019, at an average premium of 50%.

To Peel Hunt’s point about the FTSE Smallcap index eventually ceasing to exist: while it now only numbers 114 companies, there are more than 1,000 to choose from in the Deutsche Numis Smaller Companies index, including those quoted on the AIM market.

We believe a combination of low starting valuations, the growing use of buybacks and continued M&A activity should be enough to drive outperformance in the coming years. But if we are right, another factor is likely to come into play.

The point of maximum pessimism

The steady de-rating of the UK small-cap sector is like a piece of elastic that has become more and more stretched the further away it gets from the historical average. When small-caps start to outperform, investors that have reallocated to other areas will be harmed by their underweight and will likely re-evaluate their exposure. At this point, greed will come back into the market and the elastic that has been stretched over the past eight years will suddenly snap back.

It has happened before. The Numis Smaller Companies (ex ICs) index made 73% across 2003 and 2004, and 107% across 2009 and 2010. These two-year periods followed the bursting of the dotcom bubble and the end of the global financial crisis – periods when the point of maximum pessimism had been reached. Are we close to the point of maximum pessimism right now?

Mark Niznik is co-manager of the Artemis UK Smaller Companies fund. The views expressed above should not be taken as investment advice.

The Association of Investment Companies (AIC) is to reduce the number of venture capital trust (VCT) sectors from eight to just two following a sector view.

The trade body will divide VCTs into two sectors: VCT and the already existing VCT AIM Quoted.The changes will apply from 31 May 2024.

The VCT sector will contain 50 constituents, while VCT AIM Quoted will retain its current seven members. 

Richard Stone, chief executive of the AIC, said: “We regularly review our sectors to ensure they are as clear and useful as possible for investors.

“The newly streamlined VCT sectors do away with distinctions that had become less relevant over time, and will make it easier for investors to find and research VCTs.”

The VCT industry has combined total assets of £6.2bn.

The managers of Capital Gearing Trust have expressed concerns about the outlook for US equities, noting that they have rarely been so expensive.

The cyclically adjusted price-to-earnings ratio for the US equity market currently stands at 34x, which is close to the 38x valuation seen during the ‘everything bubble’ of 2021.

In the investment company’s latest annual report and financial statements for the year ended March 31, 2024, Peter Spiller, Alastair Laing and Chris Clothier warned against justifying these high prices with the outperformance of US earnings, both compared to the rest of the world and their own historical performance, as they believe that ‘American exceptionalism’ is only part of the explanation for this outperformance.

They said: “More significant in recent years has been the contribution from collapsing interest expenses and corporation tax rates. Having termed out their debt, it may be some years before interest expenses rise meaningfully, but it seems unlikely they can fall.

“With the US running ever larger fiscal deficits, we would not expect corporation tax to continue to fall. But with the possibility of a Trump presidency, nothing should be ruled out. In any event, it seems that this large tailwind to earnings will become a headwind.”

The managers of the investment company are also wary of the shrinking of the market breadth, as returns are increasingly concentrated in the ‘Magnificent Seven’ (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla).

Those seven stocks, viewed as beneficiaries of the artificial intelligence revolution, are currently trading at particularly high valuations. This has led several experts to believe that the only direction for these tech shares is downward.

Spiller, Laing and Clothier used Microsoft as an example to illustrate their concern. The US tech behemoth, which trades on a free cash flow yield of 1.7%, would need to grow its free cashflow between 8-10% per annum in perpetuity to deliver acceptable returns from its starting valuation, they said.

While their stance on US equities is bearish, the managers are bullish on investment trusts thanks to the wide discount across the market.

They said: “Discounts on investment trusts are the widest they have been since the global financial crisis. Furthermore, these discounts are broad based and include the larger, more liquid high quality trusts.

“In response we have added to our investment trust holdings, partly financed by sales of ETFs and partly from cash. We are optimistic that these holdings will provide better returns than broader equity markets.”

In addition to US equities, Spiller, Laing and Clothier are also bearish on the outlook for nominal bonds, as they believe the world will stay in a structurally more inflationary environment and are worried about the fiscal situation in developed countries.

They said: “The average budget deficit across the G8 is forecast to be 4.6% in 2025, so the supply of bonds will increase while central banks continue to reduce their balance sheets.

“Added to which there is no imminent sign of recession, nor any discernible term premium in longer dated bonds.”

Their outlook for index-linked bonds is more nuanced. Although the sustainable growth rate of the US economy has significantly increased, suggesting that US real yields above 2% across the length of the Treasury curve are close to fair value, they consider the fiscal position to be poor and set to deteriorate.

They said: “Real interest rates at these levels will not be sustainable if there is no prospect of bringing fiscal deficits under control.  Left unchecked, financial repression – characterised by negative real interest rates – will be necessary.

“What is less certain is the path. Index-linked bonds trade in sympathy with nominal bonds. If nominal bonds are weak, as seems plausible, index-linked will most likely suffer with them. Yet the long-term prospects look fair or, should financial repression be enacted, excellent.”

Performance of the trust over 1 year (to 31 March 2024)

Source: FE Analytics

Although the trust’s net asset value and total return appreciated over one year, they were both outpaced by the rise in the UK Consumer Price Index. As a result, Jean Matterson, chairman of Capital Gearing Trust, assessed the performance as “far from satisfactory”.

Although the trust paid an additional special dividend to shareholders in the previous year, Matterson highlighted that the company intends to continue to pay a single annual dividend in July of each year.

The company is proposing a dividend of 78p per share payable on 5 July 2024 to shareholders on the share register as at 6 June 2024, subject to approval at the investment company’s annual general meeting.

At the year end, the share price discount to net asset value per share reached 2.4%.

Prime minister Rishi Sunak has proposed an upgrade to the pensions system, changing the current ‘triple lock’ to a ‘quadruple lock’ or ‘triple-lock plus’, which would increase the personal allowance for those over the state pension age by either average earnings growth, inflation or 2.5% (whichever is higher).

This proposal would increase the amount people can earn before they pay tax but would not apply to those under the age of 65, potentially creating a tax gap between older and younger people.

Currently, the state pension is £221.20 per week or £11,502.40 per year, leaving around £1,000 of the personal allowance spare for other incomes.

Kirsty Anderson, retirement specialist at Quilter, said the present situation will “no doubt see a considerable number of pensioners who have additional retirement income dragged into paying tax”.

Indeed, the most recent set of figures from HMRC showed there were 6.7 million taxpayers of state pension age for the 2021/22 tax year, a rise of 4.3% compared to the year before, she noted.

“With this in mind both parties must act and while the Conservatives are dressing up their action as ‘triple-lock plus’, if Labour plans to maintain the triple lock they too will need to raise the personal allowance,” said Anderson.

The current system means the state pension already rises in line with the higher of inflation, the average wage growth or by 2.5%. In April it was upped by some 8.5%. The latest addition would mean pensioners can keep more of their earnings tax free.

Tom Selby, director of public policy at AJ Bell, said the policy was a “fairly naked grab for pensioner votes” by the Conservative party, which remains far behind Labour in the polls.

But he warned the policy would “drive a wedge between generations via the tax system”, adding that it was “hard to think of a good reason to increase the personal allowance for pensioners alone” other than “election tactics”.

Data from AJ Bell suggested the move would polarise the population. In a survey of 2,000 people, two-thirds of those aged 65 or older were less likely to vote for a party that proposed ditching the triple lock.

This flips for younger voters. Some 37% of those aged between 18 and 35 were more likely to vote for a party that proposed scrapping the triple lock.

“Older voters continue to hold the keys to Downing Street, so we should perhaps not be surprised that Sunak has moved to super-charge the triple-lock to win them over. However, there is a serious generational divide when it comes to the policy, with older people attracted to the pledge and younger voters much less keen,” said Selby.

“This likely reflects the vested interests of both cohorts, with those in receipt of the state pension keen to keep bolstering their incomes, while younger people are perhaps fearful of the impact hiking the state pension today could have on their future state pension entitlement or other areas of public spending.”

Anderson also noted the growing divide the policy could create. She highlighted frozen thresholds as causing an “ever-bigger tax burden” for people and said the latest proposal “further increases intergenerational inequality”.

One solution could be to link pensions more closely to average earnings, which would “create a more predictable and sustainable pension system”, she said.

“This approach would mitigate the financial unpredictability associated with the triple lock, creating an easier way to effectively budget and ensure that pension increases do not disproportionately benefit one demographic at the expense of another.

“However, the truth is, given older generations vote in much larger numbers than their younger peers it would be too politically damaging for either party to take a more long-term view of the triple lock.”

Investors’ flirtation with money market funds has started to abate as looming interest rate cuts prompt a look towards riskier assets, analysis of Trustnet fund research trends suggests.

With millions of pageviews a year, the research trends of the Trustnet audience can offer useful insights into what both professional and retail investors are interested in as well as an indicator of shifts in sentiment.

A look at the 10 most read fund factsheets on Trustnet over the past 90 days shows there continues to be plenty of interest in familiar names – Fundsmith Equity, Vanguard’s LifeStrategy range, Baillie Gifford Managed and Rathbone Global Opportunities consistently attract the most views.

Source: Trustnet

However, a more interesting exercise is to examine the changes in funds’ popularity over time. To do this, we have compared each fund’s share of pageviews over the past 90 days with a baseline of the preceding 12 months to determine which are garnering more or less interest among investors.

The fund with the biggest fall in research activity between the two periods is Royal London Short Term Money Market, which has the 25th most-viewed factsheet for the past 90 days – down from 16th place over the preceding 12 months.

This 16th place ranking was in itself a bit of anomaly as investors had largely ignored money market funds when interest rates were at record lows and only became interested in them when central banks started to hike rates.

More recently, investors have started to price in rate cuts from the world’s central banks – with the Bank of England among those expected to move first – which would reduce the appeal of cash while boosting the attractiveness of bonds and some parts of the stock market.

Source: Trustnet

Other signs that investors are looking further up the risk scale include a fall in research into more cautious strategies, such as Trojan, Vanguard LifeStrategy 20% Equity and Liontrust Sustainable Future Defensive Managed.

Meanwhile, investors seem to have been spending less time researching some of their favourite funds – such as Fundsmith Equity, Baillie Gifford Managed, Vanguard LifeStrategy 60% Equity and Baillie Gifford American – suggesting they are looking to other parts of the market.

This is backed up by examining the funds that have benefitted from the largest increase in Trustnet pageviews over the past 90 days.

At the top of the table is the £1.5bn Jupiter India fund, which has become the fifth most popular fund on Trustnet; over the previous 12 months, it held 15th place. This came as the Indian stock market surged to new highs, thanks to a business-friendly reforms and a robust economy.

The fund, which is managed by Avinash Vazirani, has been the IA India/Indian Subcontinent sector’s best performer over the past 12 months with a 58.8% total return (its average peer is up 29.7% while the MSCI India index gained 32.8%).

However, this is not the only Indian equity that has been getting researched more with Liontrust India, Ashoka WhiteOak India Opportunities, FSSA Indian Subcontinent All-Cap, Franklin FTSE India UCITS ETF, Nomura India Equity and Franklin India being among those attracting more interest (none to the extent of Jupiter India, however).

Source: Trustnet

A similar trend has been noticed over at interactive investor, with the platform reporting a 21-fold increase in trading volumes (by value) into India-centric funds, investment trusts and exchange traded funds over the past year.

Alex Watts, fund analyst at interactive investor, said: “India has cemented its status as one of the largest and fastest growing economies in the world, bolstered by a suite of business-friendly reforms enacted by president Narendra Modi from an investment standpoint.

“The re-election of president Modi, something the market believes is a forgone conclusion, could serve to strengthen the nation’s long-term investment story. His victory would mark one of the longest periods of political stability since the nation’s independence and his election pledges, including growing India’s GDP to $5trn (from $3.7trn) by 2027 and making further investment in infrastructure, bodes well from an investment standpoint.”

However, Watts noted that the strong recent returns of the Indian stock market mean some valuations are looking expensive. The 12-month price-earnings ratio for MSCI India are above the 10-year average and by far exceed valuations of other emerging market regions, he said.

A few other trends are apparent from the above table.

Global equities remain in favour. While investors might have been researching the likes of Fundsmith Equity and Lindsell Train Global Equity less, they have been looking more at the Trustnet factsheets of Fidelity Index World, GQG Partners Global Equity and Royal London Global Equity Diversified than they were.

The appearance of Artemis Income, Artemis Global Income, Royal London Global Equity Income, Aviva Investors Global Equity Income, Artemis Monthly Distribution, Man GLG Income and Fidelity Sustainable Global Equity Income shows investors continue to research income, as they seek ways to make their money work harder.

Meanwhile, value funds continue to attract more interest as evidenced by the rising pageviews of Man GLG Income, Ninety One UK Special Situations and Artemis UK Select.

Finally, BlackRock Gold & General and Jupiter Gold And Silver reflects high precious metal prices while Janus Henderson Global Technology Leaders and L&G Global Technology Index Trust show tech stocks remain attractive.

The main reason why investors choose active over passive funds is the hope of making more money than by investing in a simpler, cheaper index fund. This is particularly pertinent for thematic funds, where unfortunately, only a handful of active funds consistently beat their benchmarks.

In this series, we are looking at the funds with the highest (and lowest) average outperformance against their benchmarks to establish which packed more punch for investors.

We took each fund’s one-year rolling alpha every month for the past five years, accounting for 61 year-long rolling periods, and found the average. This time, we take a look at thematic funds, where the highest scores were in the IA Technology & Technology Innovation sector.

The only fund with an alpha score higher than 4 was Pictet Robotics, which achieved a 4.3 score against the MSCI All Country World index since 2018.

This $10.2bn strategy focuses on companies that contribute to, or profit from, developments in robotics and enabling technologies. The portfolio mainly includes stocks in the automation (52.4%), technology enabling (33.8%) and services (12.7%) sectors.

The largest holding is Alphabet (7.9%), followed by Salesforce (6.3%) and Taiwan Semiconductors (5.8%).

Source: Trustnet

The Fidelity Global Technology fund had the second-highest score of 3.76%. It is managed by FE fundinfo Alpha Manger Hyunho Sohn, whose bottom-up approach is designed to select companies either with growth prospects (focused on innovations or with disruptive technology), cyclical momentum (found in sub-sectors and typically with strong market positions) or special situations (mispriced businesses with recovery potential).

The funds’ top-10 holdings include industry favourites such as Taiwan Semiconductors, Microsoft, Apple and Alphabet, but also Texas Instruments, Swedish telecom Ericsson and US software company Autodesk.

Unfortunately, a sector as rewarding as technology can be, can also represent a challenge for active investors who are looking to make money beyond the established routes. In fact, every other fund in the peer group had a negative average alpha, meaning active decisions penalised returns.

Paying the highest price for trying to break away from the herd were T. Rowe Price Global Technology Equity (average alpha: -8), Liontrust Global Technology (-2.9) and AXA Framlington Global Technology (-2.2).

Next up is IA Financials and Financial Innovation, where the rewards weren’t as large but the pitfalls also not as deep.

The best alpha scorer here was the £2.2bn Polar Capital Global Insurance, with 3.

Managed by Dominic Evans and Nick Martin, this fund was highlighted by Square Mile analysts for its “sensible” strategy in a sub sector of markets that is not widely covered.

“Martin has built a deep pool of company knowledge and is well informed as to the intricacies of investing in these markets. We believe he should be able to achieve his objectives over the long term, but there will be times where he may struggle to meet these, such as during falling markets when stocks are sold off indiscriminately and irrespective of company fundamentals,” they said.

“Nonetheless, we like the clear performance objective on the fund to deliver investors an annualised 10% total return over the long term and pleasingly the fund's management team has, on an annualised basis, been able to consistently deliver returns in line with this.”

Source: Trustnet

Jupiter stands out for occupying two positions in the table with Jupiter Financial Opportunities and Jupiter Global Financial Innovation, both managed by Guy de Blonay, scoring well.

The manager screens for companies to best play out themes identified at the macro level, as explained by Rayner Spencer Mills Research analysts.

“By having a mix of companies with different opportunity sets and being flexible in his adherence to the benchmark, the manager seeks to maintain a portfolio that can perform across the full market cycle,” they said.

“This is quite a specialist mandate and therefore likely to appeal to only a limited investor base, however the manager has developed a clearly defined process and proved he can run the fund successfully through changing economic environments.”

On the negative side of alpha were AXA Framlington Fintech (-5.8), Guinness Global Money Managers (-3.7) and Polar Capital Financial Opportunities (-0.5).

Finally, there were more risks than rewards in the IA Healthcare sector, where only two funds achieved a positive average alpha, barely staying above the MSCI ACWI/Health Care index.

AB International Health Care Portfolio scored 1.4 by investing in companies that are expected to attract healthcare spending, generally through the introduction of new treatments and therapies or by offering customers cost reduction opportunities.

Its main holdings are pharmaceutical companies Eli Lilly (8.6%), Novo Nordisk (8.3%), Merck & Co (6.3%), GSK (4.7%) and Roche Holding (4.66).

Source: Trustnet

Just above zero was Fidelity Sustainable Health Care. Manager Alex Gold invests in companies that are set to benefit from long-term health care trends such the ageing of the population and increased health care needs – the average alpha was 0.1.

The worst alpha in the sector were those of Invesco Global Health Care Innovation, Wellington Global Health Care Equity and Polar Capital Healthcare Opportunities.

This was the final instalment in a series that previously covered: UK Equity Income, UK All Companies, Global, Global Equity Income, Sterling bonds, smaller companies, global bonds, cautious funds, balanced and adventurous funds, European funds, Asia funds, emerging markets.