Mirabaud Asset Management head of fixed income Andrew Lake offers an overview of the bond market, after 2021’s first couple of months.
February has been impressive for a number of things (so far). Vaccine distribution being one, increased fears of more aggressive variants being two, surprisingly robust economic data and Q4 results being three and four, and a continuation of the rally being five.
The sell-off at the end of January really was very transitory and, despite increased talk about bubbles everywhere, the overall market sentiment has remained resilient. The new issue pipeline has been smaller than expected, which has helped the technical picture, and every new issue has been over-subscribed, usually the result of reverse enquiry and being aggressively priced.
High yield spreads have dropped below 4 per cent for the first time and any issue with a good coupon has been snapped up. Even Carnival Cruises issued another deal, upsized by $1bn, which was at the higher price range. The company now has liquidity into 2023.
Are we in a bubble?
US equity markets hit all-time highs, with volatility falling again, WTI (Western Texas Intermediate) oil close to $60 per barrel, and increased expectations of another massive stimulus package from the new US administration.
Not only is the word ‘bubble’ appearing more often in news reports, so too is the dreaded word ‘inflation’. Not perhaps scary in itself, but certainly when linked to tapering or rising interest rates. Even speculation around this would be enough to temper some of the animal spirits we are seeing at play.
Treasuries have reacted and we saw the 30-year close at 2 per cent on Friday 12 February, with the 10 year at 1.20 per cent – both recent highs. There is also a lot of data coming next week – Empire State Manufacturing, jobless claims, flash PMIs (purchasing managers index) and home builders index so we may be in for further Treasury pressure if the numbers are solid*.
Too early to worry about inflation
I think that it is too early to be even having a debate around inflation and rising interest rates in the US or anywhere else for that matter. The likelihood is that we begin to see a phased re-opening of society in most of the developed world over the next several weeks as vaccine distribution gains pace.
The economic boost we are all expecting – driven by very high savings rates – will be somewhat offset by high debt levels, unemployment, and therefore limited wage pressure. This list is not exclusive.
As I have said before, the debate will gain more traction once we head into the second half of 2021 and we begin to look to increasing societal normalisation. Do not forget, interest rates do not have to do anything for government bonds to react and it is likely that there will be upward pressure on yield curves – led by the US – irrespective of what US Federal Reserve policy actually is.
Yield curve management will mitigate this, as there is no desire for government bond yields to go to high or for curves to steepen too much. There will also be natural buyers coming in at some point, again limiting the upward trajectory. At present, the inflation story is very much still in vogue.
US dollar and the impact on emerging markets
The dollar continues to be fairly resilient in the short term, so we will have to wait to see whether the downward trajectory continues as the months unfold. For emerging markets, we have yet to see any significant effect from rising Treasury yields. We are likely to see a tightening of spreads before that happens. The average risk premium on emerging market local currency is 306bps**, so significantly above levels that precipitated volatility in 2009 and 2018. The real concern for emerging market investors would still seem to be unsustainable debt levels in some of the weaker sovereign bonds.
It still feels like financial markets are over extended and a pullback would not be a surprise. Having said that, with more quantitative easing, vaccine rollouts and the likelihood of a real boost to growth as economies re-open, perhaps valuations in the short term are irrelevant.
Things always revert to the mean eventually, the big risk remains a significant delay to the economic re-opening and recovery we are all expecting, however unlikely that might seem now. We continue to be disciplined and I remain positive on fallen angels and good quality companies that will do well as economies normalise.
Andrew Lake is head of fixed income at Mirabaud Asset Management. The views expressed above are his own and should not be taken as investment advice.
*Source: Mirabaud Asset Management as at 12 February 2021
**Source: Bloomberg, 12 February 2021
Some well-known value managers reveal which stocks they are picking to benefit from a continued value rally.
As value stocks continue to rally and growth stocks extend their decline, managers of several value investment trusts reveal what stocks they favour in what could be a moment of truth for the value investment style.
Growth stocks have been outpacing the value style for much of the last decade, but the ever-widening divergence between growth and value could be finally reverting to the mean.
Rising risks of inflation is one of the major drivers of a broader rotation from growth stocks into value stocks, according to some managers.
James de Uphaugh, manager of the £1bn Edinburgh Investment Trust, explained: “A global risk we are concerned about is that the economy accelerates so strongly in late 2021 that it puts upward pressure on inflation and bond yields forcing central bankers’ hands.
“Then, just as declining bond yields were so important in powering stocks in 2020, the reverse could happen, as policymakers cut back on liquidity. This would put pressure on equity valuations.”
This view on inflation is why Edinburgh Investment Trust holds banks such as NatWest and commodity firms like Anglo American.
Share price performance of NatWest and Anglo American year-to-date
Source: FE Analytics
Anglo American is pivoting its businesses towards commodities such as copper, which de Uphaugh highlighted as “crucial for the electrification necessary if the world is to achieve environmentally sustainable growth”.
The trust has also supported equity raises in the likes of Polypipe, a manufacturer of plastic piping systems needed for underfloor heating and energy-efficient ventilation. De Uphaugh said Polypipe sits within “the sweet spot of sustainability”.
Alasdair McKinnon, manager of the £558m Scottish Investment Trust, is also placing emphasis on stocks that can pass on price raises due to inflation.
“Even better, these ‘value’ stocks are severely out of favour,” he said. “Banks (Santander, Lloyds), energy (BP, Shell) and miners could all be beneficiaries of this.
“We have also added to some of the most impacted industries like the high street, where we find some restaurants and clothing retailers with good brands and balance sheets that we think will allow them to re-emerge from the pandemic as long-term winners.”
Scottish Investment Trust’s largest two holdings, however, are in gold miners Newmont and Barrick Gold. “You can’t print gold and we expect its value to increase in line with the ballooning money supply,” McKinnon said.
Alex Wright, manager of the £720m Fidelity Special Values trust, pointed out that although the rotation into value started in late 2020, the dispersion in returns between growth and value stocks still remains unprecedented.
“We are particularly optimistic on the medium-term outlook not only due to the number of investment opportunities on offer and their upside potential, but also because we are not having to compromise on quality,” he said.
As such, the trust has significantly increased its exposure to specialist retailers (Halfords), car distributors (Inchcape), DIY stocks (Kingfisher) as well as housebuilders (Redrow and Vistry).
Share price performance of Inchcape, Kingfisher, Redrow and Vistry year-to-date
Source: FE Analytics
“These are all areas that are seeing increased demand as households reassess their priorities and, importantly, where we believe the changing dynamics caused by the virus are likely to be longer lasting than currently factored in,” Wright explained.
“We continue to favour life insurers, which are well regulated companies with good risk management and which are seeing strong demand for bulk annuities and pension de-risking.”
Fidelity Special Values’ two largest holdings are a 5.5 per cent stake in Legal & General and a 4.5 per cent stake in Aviva. Wright continued: “The sector offers an attractive combination of cheap valuations, strong demand/supply fundamentals and growing earnings.”
Elsewhere in the broader financial sector he is less optimistic. The trust holds an underweight stake in mainstream banks: “While cheap, they lack a medium-term catalyst to re-rate given the low interest rate environment,” Wright said.
“Instead, we have bought into UK-listed emerging market financials Bank of Georgia, TBC Bank and Kaspi, which are able to generate strong returns in the current interest rate environment but have been overlooked or lumped in with the mainstream banks.”
Wright is also underweight energy having sold down his exposure to UK oil majors Shell and BP, which have cut their dividends and are embarking on a “complex” and “high-risk” transition towards a more diverse energy mix.
Gary Moglione, manager of the £64m Seneca Global Income and Growth Trust, also revealed one stock that he thinks will do well in a value rally: UK Mortgages (UKML).
“UKML had a difficult start after launch as market conditions meant they did not invest the initial capital very quickly which led to an uncovered dividend and a declining NAV,” he said.
“They took a new strategic direction last year and are now focusing on the higher yielding mortgage books whilst selling the lower yielding.
“They essentially buy or initiate mortgages and when the number of loans reaches a reasonable size they will securitise them, locking in returns and freeing up capital to initiate more mortgages.”
A second value play Moglione highlighted was Ediston Property Investment Company (EPIC), which focuses on out-of-town retail parks.
He said: “The property market has been ravaged by Covid as many retailers struggle and some use company voluntary arrangements to force landlords to accept lower rents.”
Mark Heslop and Mark Nichols started selling down the payments processor when they took charge of Jupiter European in October 2019, receiving an average price of €130 a share.
Jupiter European is one of four funds to share the top spot in the IA Europe ex UK consistent-performance table, beating the MSCI Europe ex UK index, the most common benchmark in the sector, in nine of the past 10 calendar years.
Performance of funds vs sector and index
Source: FE Analytics
Of the 79 funds with a track record long enough to be included in the study, another seven funds beat the index in eight of the past 10 calendar years.
Jupiter European is run using bottom-up analysis, with the aim of identifying high-quality, high-return businesses whose equity is mispriced or undervalued by markets.
However, while Jupiter European was dropped from many buy-lists when Darwall left, investors quickly received a major boost from the new management team. Heslop and Nichols began to sell out of Wirecard, one of the largest holdings in the fund, upon taking over and received an average price of €130 a share.
Last year, Wirecard announced €1.9bn was missing from its accounts and was declared insolvent. It now trades at €0.69 a share. The company made up 17 per cent Darwall’s European Opportunities Trust at one point.
Jupiter European returned 218.18 per cent over the 10-year period in question, compared with 118.38 per cent from the IA Europe ex UK sector and 106.67 per cent from the MSCI Europe ex UK index.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The £4.4bn fund has ongoing charges of 0.99 per cent.
As well as beating the MSCI Europe ex UK index in nine of the past 10 calendar years, Jupiter European also beat the sector in eight of these, a feat it shares with T. Rowe Price Continental European Equity.
T. Rowe Price Continental European Equity is a high-conviction, style-agnostic portfolio of around 40 to 70 mid-to-large European stocks. Manager Tobias Mueller analyses both businesses and industry dynamics in a bid to unearth quality companies that are characterised by a high return on capital employed and have the potential to deliver consistent returns.
“A disciplined approach to valuation is central to our approach,” said a statement from the group.
T. Rowe Price Continental European Equity made 161.85 per cent over the 10-year period in question.
The UK version of the fund is £3.3m in size and has ongoing charges of 0.82 per cent.
It is worth noting that current manager Mueller has only been in charge of the fund since July last year and the majority of the 10-year outperformance came under former manager Dean Tenerelli.
Next up is Schroder European, headed up by Martin Skanberg, which has beaten the sector in seven of the past 10 years. The manager is not tied to a particular style – he said the market has not priced in the enormous growth opportunities in semiconductors and healthcare and partly attributed the fund’s outperformance last year to his tech exposure. However, he said the combination of stimulus measures and economic recovery will likely cause inflation, which tends to favour more lowly valued parts of the market.
“We could see a rotation into these kinds of stocks, particularly those in the materials sector that are aligned to the commodity cycle,” he explained.
“The Q4 earnings season has so far been very strong, especially in cyclical stocks. We are starting to see dividends and share buybacks reinstated in some sectors, such as industrials, though they remain suspended for eurozone banks.”
He added: “Europe looks attractively valued compared with other regions and this is supported by the now-rising dividend yield.”
Data from FE Analytics shows Schroder European made 137.27 per cent over the 10-year period.
The £1.3bn fund has ongoing charges of 0.91 per cent.
Although Vanguard FTSE Developed Europe ex-UK Equity Index is a passive fund, it was able to outperform the MSCI Europe ex UK as it focuses on a slightly different benchmark, the FTSE Developed Europe ex UK.
There is little to choose between the two indices in terms of their focus – both hold large- and mid-cap stocks in developed Europe, excluding the UK. However, the FTSE index holds more stocks: 446 compared with 344. These 102 extra stocks are from further down the market-cap spectrum, where there tends to be more opportunity for higher growth.
Vanguard FTSE Developed Europe ex-UK Equity Index made 114.69 per cent over the 10-year period in question.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The £2.7bn fund has ongoing charges of 0.12 per cent.
Trustnet asked several fund pickers what investors could consider if they plan on selling out of the M&G Optimal Income fund.
If investors are planning to sell out of the of the M&G Optimal Income fund, what should they consider buying in its place?
The M&G Optimal Income fund is one of the best known strategic bond strategies, both for its size and flexible investment process. But more recently consistent outflows and near-term underperformance have brought the fund a different kind of attention.
Having looked at whether investors should sell out or remain in the M&G portfolio, fund pickers highlighted some alternative options.
M&G Global Macro Bond
When looking for an alternative to M&G Optimal Income, AJ Bell analyst Laith Khalaf said investors should be asking why they held it in the first place - whether for total return, income or more of a multi-asset choice.
“If you’re after a total return vehicle as a diversifier against the equities in your portfolio, I’d suggest considering another from M&G, the Global Macro Bond fund,” Khalaf said.
“The fund has a go-anywhere approach, which gives it the flexibility to seek out returns and protect investors if interest rates start to rise in developed bond markets.”
The five FE fundinfo Crown-rated fund invests across a range of different markets and issuers based on in-depth analysis on global, regional and country-specific macroeconomic factors.
Over the past five years the fund has outperformed the IA Global Bonds sector, with a total return of 29.16 per cent versus 25.55 per cent.
Performance of fund vs sector over 5yrs
Source: FE Analytics
The fund has an ongoing charges figure (OCF) of 0.63 per cent.
Baillie Gifford High Yield Bond
But if an investor held M&G Optimal Income for income then an alternative could be the Baillie Gifford High Yield Bond fund, according to Khalaf.
However, Khalaf pointed out that this portfolio will be “more highly correlated to equity markets”.
Over five years Baillie Gifford High Yield Bond has outperformed the IA Sterling High Yield sector, making a total return of 40.50 per cent.
Performance of fund vs sector over 5yrs
Source: FE Analytics
The £915.3m fund has a yield of 4.20 per cent and an OCF of 0.37 per cent.
Personal Assets Trust
Finally, if an investor is seeking out a multi-asset alternative Khalaf recommends Personal Assets Trust, which is managed by Troy Asset Management.
Run by FE fundinfo Alpha Manager Sebastian Lyon, the £1.4bn trust – which like all of Troy’s funds puts capital preservation at its core – invests in quality blue-chip equities, index-linked bonds, gold and cash.
Khalaf said that the trust’s ability to invest outside of just bonds is a positive in the current low interest rate environment.
He said: “Given where interest rates are, I’d be very wary of over-reliance in bonds in a portfolio simply because they are less volatile than equities, there’s still a large amount of risk baked into sky high prices.”
Compared to its sector and benchmark, Personal Assets Trust’s defensive positioning means it has underperformed over the past five years, shown in the graph below.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
The trust holds an FE fundinfo Crown rating of five and has ongoing charges of 0.86 per cent. It is running at a 1.1 per cent premium with currently no gearing and a dividend yield of 1.3 per cent.
Ninety One Global Total Return Credit
Picking something from the same sector as the M&G fund, Ben Yearsley, co-founder and director of Fairview Investing, highlighted the Ninety One Global Total Return Credit fund.
Although it also resides in the IA Sterling Strategic Bond sector, the Ninety One fund “is a very different position,” according to Yearsley, as unlike M&G Optimal Income it only invests in corporate bonds. It also approaches investment opportunities in a very different way to the M&G fund.
Yearsley said: “A key difference between this fund and the M&G one is this is driven by bottom-up factors, whereas Optimal Income is more of a top-down play.
“Only investing in corporate bonds sounds narrow, but the managers will look at a full spectrum globally and end up with 120 or so any one time. Each bond is considered on its own merits and has to be able to contribute towards the return target.”
Since the fund launched in mid-2018 it has made a total return of 14.17 per cent, outperforming the IA Sterling Strategic Bond sector (14.11 per cent) and the LIBOR GBP 3m+4% benchmark (13.31 per cent).
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
It has a yield of 3.46 per cent and an OCF of 0.77 per cent.
Jupiter Strategic Bond
The final fund pick comes from Teodor Dilov, fund analyst at interactive investor, who chose the £4.3bn Jupiter Strategic Bond fund.
Dilov said that he liked the Jupiter Strategic Bond especially for investors with a lower risk profile.
He said that similarly to the M&G option the Jupiter fund “has the freedom to invest across the bond market, including high-yield bonds, investment-grade bonds, government bonds and convertibles, along with the use of derivatives to mitigate the risk of falling bond prices”.
The investment process is grounded in FE fundinfo Alpha Manager Ariel Bezalel’s views of the global economy.
Dilov said Bezalel uses this to determine how much risk is appropriate and which sector and countries present the best investment opportunities, while considering factors such as inflation, interest rates and economic growth.
“As avoiding losses is the strategy’s top priority, when investing in high-yield bonds the manager prefers the most senior bonds in a company’s capital structure – typically secured on the company’s assets. Companies that are paying down their debts over time and improve their credit worthiness are preferred,” he added.
Compared to its average IA Sterling Strategic Bond peer, Jupiter Strategic Bond has outperformed over five years, returning 29.15 per cent.
Performance of fund vs sector over 5yrs
Source: FE Analytics
It has a yield of 3.70 per cent and an OCF of 0.73 per cent.
After a terrible year for UK dividends, Trustnet finds out how the coronavirus pandemic affected payouts from the UK equity income funds.
The average UK equity income fund had to cut its dividend by close to 30 per cent during 2020, analysis by Trustnet shows, as the coronavirus crisis caused companies to slash or cancel their payouts.
That said, a handful of strategies appear to have side-stepped the worst of the pandemic’s fallout, although Liontrust’s Robin Geffen believes that most UK equity income funds went into 2020 with too much exposure to companies that were already looking stretched.
According to Link Group’s UK Dividend Monitor, headline payouts from UK companies dropped 44 per cent in 2020 to £61.9bn – the lowest annual total since 2011.
UK dividends were hit harder than many of their international peers because the market is concentrated around a handful of large companies, mainly those in the oil, mining and banking sectors – which had to cut payouts heavily in 2020.
Source: UK Dividend Monitor
With this in mind, Trustnet ran the dividend payments made during 2020 from the IA UK Equity Income sector and compared them with 2019’s figures to see how badly it was hit by the coronavirus crisis.
One positive sign is that the average UK equity income fund appears to have held up better than the market. While Link Group has headline dividends as falling by 44 per cent last year, the average IA UK Equity Income fund’s calendar-year payout was ‘only’ down 29.3 per cent.
In addition, the average fund slightly edged ahead of the market when it comes to capital growth last year, falling 12.04 per cent in price performance terms compared with 12.46 per cent for the FTSE All Share.
There were 76 funds (out of a total of 84) that cut their payouts by less than the market’s 44 per cent, with nine cutting by less than 10 per cent. The 26 best performers – which all cut their 2020 payout by 22 per cent or less, below half of the market’s cut – can be seen in the below table.
Source: FinXL, Trustnet
Schroder Income is at the top of the table after lowering its dividend by just 0.3 per cent in the calendar year of 2020, although this is largely down to exactly when in the year it made its payouts.
The fund pays its final dividend in February, so in 2020 this was distributed before companies started slashing payouts. The full impact of last year won’t be clear until the final payment for fund’s 2020/21 year is made.
FE fundinfo data shows Schroder Income’s Q1 2020 payment was 24 per cent higher than the one a year before, but the interim in August – in the midst of the crisis – was almost 64 per cent lower than the previous year, one of the worst cuts of the sector for this period.
Looking at the first quarter versus the other three quarters of 2020 highlights just how much of a difference this timing could have made to calendar year payouts. The average fund in the sector grew its Q1 payment by 3.5 per cent, but the payments for Q2, Q3 and Q4 were down 39.2 per cent on average.
That said, the majority of the other 25 funds in the above table do seem to have held up relatively well during the worst part of the coronavirus crisis, with our data showing their cut to Q2, Q3 and Q4 dividends was better than average at 23.3 per cent.
Source: FinXL, Trustnet
Liontrust Income, in second place overall after reducing its dividend by just 2.4 per cent for the full calendar year, is one of those that outperformed in 2020’s last three quarters. It cut its payout by just 1.32 per cent during this period, the best result of the sector.
Manager Robin Geffen said: “There was complacency early in 2020 about the ability of many companies to maintain their levels of dividends. The spread of Covid-19, the lockdown and the consequential economic impact accelerated a trend that we had been warning clients and investors about for the previous year.
“This was the fact that some very high yielding companies in the UK did not have the earnings capacity, dividend cover or strong enough balance sheet to support their levels of income. This included many of the traditional income stocks.”
Geffen has been vocal for some time about the concentration risk found in many UK equity income portfolios, arguing that UK companies would struggle to maintain their dividends unless their operational performance improved, which would require very strong global economic growth as well as significant capital expenditure
“This is what happened in 2020, with the pandemic quickening the pace and the market experiencing three years of dividend cuts in six months,” he finished.
“Over the course of 2020, 40 FTSE 100 index companies cut, cancelled or suspended their dividends, amounting to £34.8bn in reduced payments to investors. Of the FTSE 250 index, 92 companies cut, cancelled or suspended dividends, accounting for £4bn in lost payments.
All 33 of Liontrust Income’s holdings paid a dividend last year. Geffen said this was a result of the fund’s focus on companies with strong balance sheets, high dividend cover and sustainable payout ratios (the percentage of earnings that are paid out as dividends).
The fund’s historic dividend cover is 2.12 times the level of earnings of the stocks within its portfolio, compared with an IA UK Equity Income sector average of 1.90 times and the FTSE All Share’s 1.76 times. Geffen added that it’s forward-looking dividend cover is 2.57 times, against the sector’s 2.17 times and 2.08 for the FTSE All Share.
Other well-known funds that made some of 2020’s lowest dividend cuts include M&G Dividend, AXA Framlington UK Equity Income, Fidelity Moneybuilder Dividend, BlackRock UK Income, Man GLG Income and Trojan Income.
What’s more, this was not down to them distributing the bulk of their payouts ahead of the crisis, with all of the above funds cutting their dividends by less than 20 per cent over the final three quarters of 2020.
A total return of 2,400 per cent since first investing in a trust might seem like the best of results, but as Church House’s James Johnsen explains, dealing with such success can be a two-edged sword.
As ‘big tech’ hits some regulatory and tax headwinds (a Biden presidency and US anti-trust legislation, adverse tax regulation in Europe, political clampdowns in China), many are asking whether funds like Scottish Mortgage have seen their best growth days and have only downside risks to contemplate.
We first started adding Scottish Mortgage to Church House portfolios in the aftermath of the dotcom crash in the early noughties. Scottish Mortgage was then a circa £1.5bn fund, regularly trading at around 20 per cent discount to net assets. This provided what, only in retrospect, can be seen as a unique entry point.
Side-stepping the crowded debates over valuations in the tech space, ‘new normals’ or the rotation from ‘growth’ into ‘value’; our main preoccupation relates to where a massive outperformer like Scottish Mortgage has significantly skewed preferred asset allocations, or where CGT issues have clouded essential risk management disciplines. A recent case study illustrates the issue.
A real-life Scottish Mortgage holder
Our client, Mr. F, had built up significant capital over his working life developing and eventually selling an engineering company. To this was added the proceeds from one or two property deals.
Having taken significant risks with his ‘working’ capital during his years in employment, Mr. F’s main priority was capital preservation. However, having significant wealth (including property assets) he felt comfortable exposing one of his main portfolios (which included a ‘joint’ £1m ISA pot) to a long-term, moderate risk mandate. He therefore chose to be invested at Risk Level 5 on the Church House scale of 1 – 10, (with 1 traditionally consisting of a portfolio of gilts and 10 being highly speculative. Most Church House clients are invested at Risk Scales 2 - 8).
In 2003, along with all other clients on this scale, 3 per cent of the then-total 18 per cent overseas equity allocation was switched to Scottish Mortgage. This fund had originally attracted our CIO’s attention because it was run by a manager, James Anderson, with a broader world view, a differentiated approach and a healthy disdain for benchmarks – all attributes that reflected our own approach and which we knew would resonate with our clients.
Scottish Mortgage’s growth record has been nothing short of stellar since, producing a total return of 2,400 per cent since 2003. But, as the graph below shows, not always in a straight line. As ever, the key has been to stick with the fund and its strategy; the manager has never wavered from it so nor should long-term investors.
There have been some notable opportunities where the fund has traded at a premium to net assets and in these instances a bit of judicious ‘top-slicing’ of profits has been undertaken, although this has often been constrained by CGT allowances. We have also added the fund continuously in newer portfolios over the years, especially when the discount opened up.
In the case of Mr. F, despite the occasional profit taking to re-balance weightings, such was the growth of the fund that his 3 per cent allocation had by 2020 grown to nearly 20 per cent of his total portfolio. This was clearly too weighty a risk for a moderate, balanced portfolio.
When Tesla accounted for 14 per cent of the fund in the summer of last year, it became time to take radical action and so a planned programme of disposal of over half the holding was made, with the resultant CGT being provisioned for within the portfolio. The tax hit is substantial (£200k+), but as the client ruefully agreed, it is only a reflection of the extraordinary success he has enjoyed (and if the chancellor is tempted to raise CGT rates, then the bitter-sweet tax aftermath will suddenly taste less bitter).
Source: FE Analytics
Where next then?
Of course, this left the problem of how to reinvest the net proceeds. Clearly, most of these have been allocated to other asset classes to re-establish the correct weightings for the risk scale. But within this section of the global equity bucket, we have favoured Monks Investment Trust over the past couple of years, as a lower risk alternative to Scottish Mortgage. Monks is a low-charging investment trust also run by Baillie Gifford and shares several stocks with its stable mate, but does not have the latter’s high allocation to unquoted stocks and is not quite so concentrated in tech.
This better reflects the risk parameters (including liquidity requirements) of many of our client risk profiles. However, Monks has also enjoyed consistently excellent performance and now regularly trades at a premium making it harder to buy too. But there are still days when even funds like Scottish Mortgage can be bought if one monitors the discount/premium situation closely (see lower graph) so there are always ways to gain exposure if you are patient and firmly fixed on a long-term holding strategy. As I write, Scottish Mortgage trades on a small discount to NAV (-1.8 per cent).
As ever, the key in running such portfolios, is not so much in worrying about funds like Scottish Mortgage but more in carefully building in the optimal blend of asset classes less correlated to equities, notably in fixed interest, absolute return and infrastructure. If these are managed correctly, then they should buttress the portfolio in times of market stress and additionally provide a stable income return on top of the capital growth generated by the equity allocations.
In summary, long-term holders of Scottish Mortgage should not worry so much about the debate surrounding valuation of ‘big tech’ or the demise of ‘growth’ as to the more fundamental question of whether their holding truly reflects their risk profile in the long term. As we often try to explain to new clients, successful investment management is mostly about effective risk management, or protecting the downside in rough weather so that your portfolio is in good enough shape to participate in the upside when the winds blow in your favour.
James Burns, co-head of the Smith & Williamson Managed Portfolio Service, reveals three of his core UK equity fund picks and explains why the firm is now underweight US equities for the first time in almost a decade.
Funds run by Ninety One, Artemis and Man GLG are three of the Smith & Williamson Managed Portfolio’s core UK equity picks for the years ahead.
After being overweight US equities for eight years, James Burns, co-head of the Smith & Williamson Managed Portfolio Service, said he is reducing US equity exposure in favour of UK equities.
“We’re making sort of decent move against the US for the first time in seven or eight years,” he said.
Much of this decision was due to the amount of money printing that has happened in the US over the last year and the potential for more as the country approves further stimulus.
This has been one of the drivers of the relative weakness of the US dollar over the last year, which has been declining in value against most other major currencies.
“We were overweight the UK because we think that market is pretty cheap and things are much clearer for the UK now than they have been in the previous three or four years,” Burns explained.
“We were overweight the US for eight years, so now isn’t a bad time to slightly tilting the portfolios underweight the US.”
As such, below are the three core UK funds Smith & Williamson prefers across all its portfolios.
The first core pick Burns highlighted is the £1.8bn Ninety One UK Alpha fund, run by Simon Brazier.
“It’s a really good core holding for the UK exposure,” Burns said. “It does takes bets against the index, but they’re not titanic bets and therefore it’s a good solid core position in a portfolio.”
The fund has 47 holdings as of January and its top stock overweight positions are in Johnson Matthey, Fevertree Drinks and Ryanair Holdings. Its biggest stock underweight positions are in AstraZeneca, HSBC Holdings and Vodafone Group.
Burns also highlighted Brazier’s long term track record of outperformance. Brazier started his career at Schroders, moved to Threadneedle and became head of UK equities before eventually moving to Ninety One.
Performance of fund versus sector & benchmark over 5yrs
Source: FE Analytics
Over the last five years Ninety One UK Alpha has delivered a total return of 35.46 per cent, versus 38.75 per cent from the FTSE All Share benchmark and 40.72 per cent from the average peer in the IA UK All Companies sector.
It has an ongoing charges figure (OCF) of 0.83 per cent and currently yields 1.85 per cent.
The next biggest UK equity allocation across Smith & Williamson Managed Portfolio Service is Ambrose Faulks and Ed Legget’s £1bn Artemis UK Select fund.
This wasn’t always one of the biggest positions but has been built up over the last few years, Burns said.
“Ed Leggett, despite being a more value-type manager, has performed very well last year,” he added. “We were happy to build this position up from being a third or fourth sized a couple years ago to being a one of the bigger ones now.
“The performance divergence was pretty significant last year, so it is doing something slightly different in the portfolio and has a manager with a good long term record.
“The way the portfolio is built, the way we the UK see market going, it could actually be pretty well positioned for a rally in the UK.”
Performance of fund versus sector & benchmark over 5yrs
Source: FE Analytics
Over the last five years Artemis UK Select has made a return of 55.58 per cent compared to 40.72 per cent from the IA UK All Companies sector and 38.75 per cent from the FTSE All Share benchmark.
It has an ongoing charges figure (OCF) of 0.94 per cent and yields 0.99 per cent.
The third core UK equity fund Burns highlighted was the £1.2bn Man GLG Undervalued Assets fund, run by Henry Dixon and Jack Barrat.
“Part of the reason our UK market has genuinely struggled in the last few years because we've had a bias towards more value-type managers,” Burns said.
“But we think this actually could be a positive for the portfolios going forward because we don't have a titanic tilt either way between value and growth in any part of the portfolio.
“In Japan we got a mixture of growth and more value for managers, but in the UK it's probably been a copy skewed more towards the value-type plays.”
He said Man GLG Undervalued Assets complements Artemis UK Select well because although they both have a similar value style, the Man GLG fund has more equities in the mid-cap space.
Performance of fund versus sector & benchmark over 5yrs
Source: FE Analytics
The fund has returned 33.57 per cent over the last five years, compared to a 38.75 per cent from the FTSE All Share benchmark and 40.72 per cent from the average peer in the IA UK All Companies sector.
It has an ongoing charges figure (OCF) of 0.9 per cent and currently yields 1.81 per cent.
The world’s largest asset management house has upped its exposure to the UK and trimmed its allocation to government bonds, eyeing a better-than-expected recovery from the coronavirus crisis.
Asset management giant BlackRock has moved to an overweight stance on UK equities on the back of an improving global outlook and the removal of Brexit uncertainty.
Investors have been avoiding the UK for some time, as uncertainty over its future relationship with the EU and a lacklustre handling of the coronavirus pandemic soured sentiment. The UK stock market has lagged its global peers in recent years, while UK funds have suffered persistent outflows.
However, in its latest update, the BlackRock Investment Institute revealed the “debut” of an overweight towards the UK.
“We are overweight UK equities,” it said. “The removal of uncertainty over a Brexit deal should see the risk premium on UK assets attached to that outcome erode. We also see UK large-caps as a relatively attractive play on the global cyclical recovery as it has lagged peers.”
Rising optimism for UK equities
Source: Bank of America Global Fund Manager Survey
There have been other signs that fund managers are starting to warm towards the UK after its long period in the cold.
The latest edition of the Bank of America Global Fund Manager Survey found asset allocators’ sentiment towards the UK has shifted from ‘max despair’ to a slightly better ‘rising pessimism’, as shown in the chart above.
While the UK remains the most heavily avoided region among BofA Global Fund Manager Survey participants, this now stands at a net 10 per cent underweight – down from 15 per cent in January and a net 34 per cent underweight just three months ago.
Meanwhile, BlackRock – which with assets under management of $8.7trn is the biggest fund manager in the world – has taken an underweight in governments bonds while broadening out its tilt towards cyclical assets, or those that would do better in an economic recovery.
The BlackRock Investment Institute said it has ‘refreshed’ the asset views that it only laid out in December 2020 in light of “major developments” such as the coronavirus vaccine rollout and the potential for up $2.8trn of additional US fiscal spending this year.
BlackRock has three themes for the year ahead: ‘new nominal’, ‘globalisation rewired’ and ‘turbocharged transformations’. The new nominal theme concerns a more muted response in nominal bond yields to stronger growth and rising inflation than in the past.
The firm estimates that a 1 per cent increase in 10-year US breakeven inflation rates (a measure of market inflation expectations) has typically led to 0.9 per cent rise in 10-year Treasury yields since 1998.
But the breakeven inflation has climbed 1.2 per cent since March last year and nominal yields are only 0.5 percentage points higher. This means that real yields, or those adjusted for inflation, have fallen further into negative territory as a result.
BlackRock noted that the unique nature of the coronavirus crisis means economic growth has restarted much faster than seen in past business cycle recessions and this could mean “unusually high growth rates” as the vaccine rollout allows a wider re-opening of the global economy.
“We expect a strengthening economy, a huge fiscal impulse and rising inflation to further drive up nominal yields this year, albeit by less than in similar periods in the past,” it said.
“We expect central banks to lean against any market concerns around rising debt levels and to keep interest rates low for now. Yet if the narrative on high debt levels, combined with rising inflation, were to change, it could eventually undermine the markets’ faith in the low-rate regime – with implications across asset classes.
“We have downgraded government bonds to underweight on a tactical basis, with an increased underweight in US Treasuries. We also downgrade euro area peripheral bonds to neutral, as peripheral yields have fallen to near record lows and spreads have narrowed. We downgrade credit to neutral on a tactical horizon, as spreads have narrowed to historical lows, but still like high yield for its income potential.”
On a tactical basis, BlackRock now prefers stocks over credit, as it sees equity valuations as more attractive.
It has broadened its cyclical tilt by upgrading European equities to neutral, as its sees room for the market to close its valuation gap versus the rest of the world with the restart becoming more entrenched. However, the slow vaccine rollout and more muted fiscal support could act as headwinds.
As well as the overweight in UK equities in the wake of Brexit, the firm stays overweight US and emerging market equities, while underweight Japan as it expects lower risk-adjusted returns.
“We expect our new nominal theme of stronger growth and a muted response in nominal bond yields to higher inflation to further play out, even after significant market moves. This supports our tactically pro-risk stance,” BlackRock finished.“A key risk is a further increase in long-term yields as markets grapple with an economic restart that could beat expectations. This could spark bouts of volatility, even though we believe the Fed would lean against any sharp moves for the time being.”
The dual investment objective of the relaunched Keystone Positive Change investment trust will benefit from widespread investor demand, according to some analysts.
The combination of Baillie Gifford’s long-term growth bias and positive impact approach will give the recently relaunched Keystone Positive Change investment trust a first mover advantage, according to analysts.
Baillie Gifford recently took over the Keystone investment trust from Invesco and unveiled plans to changes its approach from being a UK equity income strategy to an all-cap global equity strategy with a focus on growth and ESG.
“One of the most notable trends in the investment industry at present is the growth in sustainable investing,” said Simon Elliott, research analyst at Winterflood. “While there will be those that dismiss this as a fad, it appears to us that there is significant demand behind this.
“As with other Baillie Gifford mandates, the emphasis is on identifying growth companies but in particular those that have the potential to make a positive impact on society.”
The trust will be largely run in line with £2.4bn Baillie Gifford Positive Change fund, but it will also have the ability to invest in private and smaller listed companies that fit with the positive change philosophy.
Since the strategy launched to the public in January 2017, it has become the highest performing fund in the IA Global sector with a total return of 276.80 per cent. This compares with just 55.52 per cent from its average peer.
Elliott said the positive change strategy is unique within Baillie Gifford because of the fact it places just as a high importance of positive impacts as it does financial returns.
“Baillie Gifford’s Positive Change approach marries the firm’s well-known growth bias to companies that are perceived to be addressing one of four thematic global challenges,” he explained.
“The thesis is that by focusing on companies that have a sustainable competitive advantage, the strategy should generate attractive long-term investment returns.
“We believe that Keystone’s dual investment objective is unique in the investment companies sector at present and it has first mover advantage.”
Indeed, the Keystone investment trust has seen its shares go from a 14 per cent discount to net asset value (NAV) in December to a 0.4 per cent premium as of 19 February 2021.
Keystone’s premium/discount over 5yrs
Source: FE Analytics
Ewan Lovett-Turner, head of investment companies research at Numis Securities, also believes that Keystone Positive Change’s unique strategy will attract a lot of demand from investors.
“The new Positive Change approach represents a significant shift in investment approach, but we believe it has the potential to attract widespread demand given almost all investors are seeking to increase the ESG credentials of their portfolios and focus more on the impact of their investments,” he said.
“The big change in approach may see some rotation in the shareholder base, but we would expect the strategy has the scope to attract new investors and it should benefit from the marketing support and strong reputation of Baillie Gifford.”
Baillie Gifford is a well-known name to investors in the UK. The firm’s £19.5bn Scottish Mortgage Investment trust is the largest and best performing investment trust in the IT Global sector.
The Baillie Gifford Positive Change strategy has nine common investment holdings and a 20 to 25 per cent cross over to that of Scottish Mortgage.
Performance of Scottish Mortgage Investment Trust versus Positive Change
Source: FE Analytics
Lovett-Turner said: “There will clearly be some similarities with the thought process and themes that you see in Scottish Mortgage and other Baillie Gifford strategies.
“Reflecting this, around 90 per cent of holdings in the open-ended [Baillie Gifford Positive Change] fund are held somewhere else within Baillie Gifford, but overlap with particular strategies tends to be relatively low.”
However, this figure could reduce since Scottish Mortgage is reducing its holding in Tesla, which was also a significant holding in the Positive Change strategy.
“Some may sigh at the thought of yet another Baillie Gifford fund investing in global equities,” Winterflood’s Elliott said, “However, we maintain that all five funds are clearly differentiated, offering shareholders distinctive approaches.”
He highlighted the ability of Keystone Positive Change to invest in private and smaller listed companies: “We have been impressed with the investment team and it is clear to us that Baillie Gifford has considerable resource in this area.”
He believes Keystone will make good use of the investment trust structure through its investment in smaller and private companies.
With time, he believes this will prove to be a real differentiator and allow the trust’s portfolio to be more diversified than its open-ended equivalent.
Lovett-Turner agreed: “I think the unlisted holdings will be useful as a differentiator for the listed investment company compared to the open-ended fund and unlisted holdings are expected to be a driver of returns over time.
“That said, it is probably going to be a relatively slow burn, with the exposure to unquoted investments increased over a number of years.”
Although the company has the power to invest up to 30 per cent in unquoted stocks, it will likely increase 5 to 10 per cent over the next few years because the timing of investment opportunities is not always easy to predict.
Lovett-Turner added: “The managers of Keystone Positive Change will make the final investment decisions on what goes into the portfolio, but this will be based on opportunities provided by the private team, headed by Peter Singlehurst.
“It is now a pretty established team that has built a strong record in unlisted investment with a focus on minority stakes in fast growing unquoted companies.”
Meanwhile Investec analysts Alan Bierley and Ben Newell welcomed the appointment of Baillie Gifford and the adoption of “an exciting investment mandate”.
“We see extraordinary growth potential for impact investing over the coming years,” they said.
“We expect Baillie Gifford to fully utilise the inherent competitive advantages of the closed-end structure and this combined with a frugal fee structure, should enhance returns.”
The Keystone Positive Change trust is expected to have charges of 0.55 per cent when its market capitalisation exceeds £250m.
Brunner’s Matthew Tillet warns that a recovery has already been priced in to many cyclical stocks, even though they face an uncertain future.
Investors should brace themselves for a powerful economic recovery from the coronavirus crisis – but shouldn’t necessarily expect it to translate into stock market returns.
This is according to Matthew Tillet (pictured), manager of the Brunner Investment Trust.
There is a growing consensus that the roll-out of coronavirus vaccines in Europe and the US, and eventually the rest of the world, will lead to a sharp bounce-back in economic activity.
The rationale behind this is fairly obvious – the release of pent-up demand. However, Tillet said there are two other forces that will be just as important in helping the recovery to outpace those in the past.
“It is not just the fact that people have been sitting at home and haven't been able to do what they wanted,” the manager explained. “It is also that a lot of people are actually better off than they were before, because the government has provided so much support.”
The final reason is that this government support, in terms of both monetary and fiscal policy, is likely to remain in place until the recovery is well under way. For example, it was suggested last week that chancellor Rishi Sunak is set to extend the furlough scheme and business rate relief into the summer.
Tillet said this is an important difference with what happened after the financial crisis when there was a “fiscal retrenchment”, particularly in the West.
“We don't have that same consensus view among policymakers and the electorate about the drive for austerity, this belief that government debt needs to come down,” he continued.
“That just doesn't seem to be on the cards. In a way, you’ve got the perfect environment for quite a strong recovery. I find it hard to disagree with that consensus.”
However, while a strong recovery could well give people more confidence to invest in equities, it is important to remember there is an erratic relationship between the economy and the stock market.
Tillet said the connection is likely to be especially weak in the coming months and years. For example, he pointed out that while the market is always forward looking, it already seems to have priced in a perfect recovery in sectors that face an uncertain future.
“If you look at the cyclical areas of the market like travel, hotels or outdoor-event companies, some of them are already back to where they were pre-Covid,” the manager said. “Yet their business is a fraction of what it was. You’re scratching your head a bit when you look at that. Are those sorts of stocks really going to continue to outperform at the other end?
Performance of index over 1yr
Source: FE Analytics
“Then you had this huge rally in the early to mid part of 2020 in all of the companies that were beneficiaries of working from home and the Covid restrictions. Many of those companies are still at all-time highs. So it's a more nuanced picture when it comes to how the stock market might behave.”
And the manager warned that a strong recovery could even have negative implications for the market.
For example, he said that once the economy opens up and there is a surge in demand for goods and services, this will lead to inflation if supply cannot keep up. This will be exacerbated as the enormous amount of money created by central banks begins to move faster through the economy, putting upward pressure on interest rates and bond yields.
However, Tillet said the question is whether this will lead to a short-term spike in inflation or a sustained increase in prices over a longer period of time.
“Structurally, there are more reasons to think that inflation will happen now than there were, say, 10 years ago,” he continued.
“The big change is that we don't have the same kind of deflationary force from these pools of low-cost labour, particularly China, that were able to keep down the cost of tradable goods.
“If that's going to dissipate, then you'd expect the overall inflation numbers to be structurally higher going forward.
“On the other hand, technology has come a long way as well over the last 10 to 15 years. A lot of the digital economy is deflationary as technology allows you to provide cheaper products to the customer.”
The manager is not positioning Brunner for either one of these inflationary outcomes. He described it as a one-stop shop rather than a trust of extremes and said he balances the investment case between quality, growth and value when buying a stock.
Tillet added that there are many structural trends that will have a much greater impact on the market over the long term than the fallout from Covid and said it is a better use of his time to focus on these instead.
“Whether it is the digital economy, demographics or energy transition, these things will continue to be with us for many years to come,” he said. “We're more focused on actually understanding those trends and making sure that we're going to benefit from them.
“Maybe some of them will be a bit more cyclical than others and will benefit if interest rates go up, because they are financial companies, for example, while others might not. We're trying to make sure that the portfolio's performance is not going to be totally thrown off course by one of those possible macroeconomic outcomes.”
Data from FE Analytics shows Brunner Investment Trust has made 179.19 per cent over the past 10 years, compared with 183.42 per cent from its IT Global sector and 147.58 per cent from its benchmark, split 70:30 between the FTSE All World and the FTSE All Share.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
The trust is yielding 2.23 per cent. It is on a discount of 11.56 per cent, compared with 11.82 and 10.2 per cent from its one- and three-year averages.
It has an ongoing charges figure of 0.66 per cent.
The early part of a year gives investors an opportunity to take stock. Sunil Krishnan reflects on how the current environment is shaping Aviva Investors’ view for multi-asset portfolios.
Despite some clear economic challenges, we are constructive on the outlook for the economy and risk assets. Strict lockdowns have been imposed in Europe once again and at least parts of the US have followed suit. However, the distribution of vaccines to bring the global pandemic under control should have a positive impact on economic activity in the medium term.
Two other themes inform our current views. The first is that there are signs of froth in equity markets, particularly in US small-caps and some tech companies. Retail investor participation, especially from US households, is high in these names and there is evidence of speculation in short-dated options, again likely from retail investors. Signs of excess bullish sentiment are increasing across a range of markets.
Although we do not yet see them as being material enough to pose a systemic risk to the global equity market, we are watching closely for indications of contamination. Following Tesla’s entry into the S&P 500, it would be a concern if gains in a single stock became a major force in the overall index performance. Similarly, if GameStop-style speculative behaviour began to emerge further afield, in European or Asian markets for instance, we would see it as a further warning sign.
The second theme informing our views is the change of administration in the US. Following the Democrat Senate wins in Georgia, investors have been debating whether the prospect of greater stimulus would be balanced out by more investor-unfriendly measures like tax rises or tightening of regulation.
Stimulus and regulation
On balance, we see the election result as constructive. While there may be appetite to consider changes in the tax regime, it is unlikely to be high on the US administration’s priority list in the middle of a pandemic, whereas president Biden has already put forward a $1.9trn rescue plan and is talking of an ambitious recovery plan to follow. This proposal may be watered down in the legislative process, but even a programme of half the size would have been unthinkable before the Georgia Senate election results given the recent passage of a smaller programme. We expect to see increases in near-term fiscal stimulus.
With regards to regulation, the environment is a stated priority for the new administration. President Trump passed a raft of executive orders to roll back environmental regulation over the last four years, and the Biden administration has already begun to restore some of it. However, this is a return of the inevitable rather than a major surprise, especially in light of the global trend towards decarbonisation.
The second area of debate concerns the tech sector and whether regulation there could pose an existential threat to the largest companies. There is growing interest in trust-busting measures in China, Europe and the US, but without international coordination regulators will struggle to force major changes in tech companies’ business models. For example, large US tech firms may be tempted to address European Union rules by simply creating a standalone European entity.
Regulators are also looking at whether companies’ past acquisitions were made for anti-competitive purposes. It would be difficult to unwind those decisions, but it signals greater scrutiny of such deals in future. The real question is to understand which companies’ business models are most dependent on being able to acquire assets defensively and which benefit from organic growth and innovation. We may see more differentiation between the two in the medium term. But we do not see the current regulatory pressure as a major challenge for tech earnings as a whole in 2021.
The final element of pressure on tech relates to content moderation due to public and political criticism over the seeming inability of platforms to address hate content. Regulators aim to put social media platforms in the position of content editors. It is to some extent inevitable, and we expect the distinction between platforms and content publishers to diminish over time, but this is more likely to require platforms to refine rather than upend their business models. They may need to invest in moderation or editorship, but it is not quite the same as having to shut down large parts of their business.
If the threats to big tech were more existential, they would lead us to challenge the US market as an investment. At the moment, they do not look quite so severe but could still be a headwind for those companies. That is one of the reasons we prefer to remain diversified in terms of geographies, despite the relative US outperformance over the last year and decade.
Diversified exposure in equities
We otherwise remain constructive on equities, particularly since investor expectations do not yet fully reflect the positive medium-term impact of vaccine rollouts in some sectors (despite signs of froth elsewhere). For instance, in industries suffering most from the pandemic, such as airlines, or areas that are highly dependent on global economic demand like energy, prices remain well below pre-pandemic levels.
Despite the uneven price recovery between sectors, we prefer to keep our equity positions broad-based across developed and emerging markets. This is partly because of the potential regulatory headwinds for US tech stocks and general signs of froth, and partly because focusing solely on sectors where stock prices are lagging can become bound up in style and factor risks.
The exception we make is in European oil and gas, as a cyclical play which has not recovered very strongly. Even allocations to energy can be influenced by environmental, social and governance (ESG) considerations. Our ESG team’s analysis shows European firms are much more advanced than their US counterparts in responding to engagement and adapting their business models to a net-zero future.
In terms of valuations, one of the key drivers for energy companies is oil prices. The pandemic continues to limit the potential for increases for now, but the medium-term outlook for demand is more positive in light of vaccine rollouts. In addition, at a meeting in early January 2021, OPEC surprised the market by deciding against a widely expected rise in production levels, to which Saudi Arabia added a unilaterally expressed willingness to take on more of the burden in terms of output reduction to protect prices. Suppressed production and a more favourable demand outlook in the medium term could combine to support oil prices.
Credit is more sensitive to US Treasuries
Credit has been a preferred allocation for us over recent quarters as the economy recovered and central banks pledged support, helping underpin corporate bond markets.
However, alongside high yield and hard-currency emerging-market debt, investment-grade credit has seen significant spread compression since the wide levels reached in March 2020 when the pandemic first hit. As spreads have tightened and total yields converge on equivalent government bonds, these markets have become more sensitive to interest rate moves and the US Treasury market. In this regard, they have become less compelling.
In contrast, local-currency emerging-market debt is not as sensitive to US Treasuries and could benefit if emerging-market currencies rally against the US dollar.
This did not happen strongly in 2020 despite dollar weakness versus developed peers; perhaps reflecting investor caution towards emerging economies given the progress of the pandemic. However, that could change in 2021 if economic activity rebounded in emerging markets at the same time as in the US – especially as a more dovish Federal Reserve will not tighten policy in a hurry, creating less supportive conditions for a strong dollar.
‘Risk-neutral’ Japanese yen
In terms of currencies, we continue to like being long Japanese yen versus the US dollar, although it may be less of a risk-reducer than it once was. Indeed, as more investors short the US dollar, the currency’s correlation with risky assets could become more negative. In other words, episodes of weakness in risky assets could see the dollar rally as investors unwind their levered positions.
In the current context, being long Japanese yen and short US dollars is not a risk-off position but, with the Japanese yen being a traditional safe-haven currency, it could be somewhat sheltered from risk-on/ risk-off movements.
The currency is also supported by domestic investors bringing more investments back into Japan. There is some evidence reshoring began towards the end of last year, especially in equities, and we expect it to gather pace in 2021.
Sunil Krishnan is head of multi-asset funds at Aviva Investors. The views expressed above are his own and should not be taken as investment advice.
Janus Henderson’s latest Global Dividend Index report looks back at impact Covid-19 had on global dividends last year and the outlook for 2021.
Global dividends showed “remarkable resilience” in 2020 despite going through their worst crisis since the second world war, according to Janus Henderson’s latest Global Dividend Index.
In the worst global crisis since the second world war which saw $220bn in dividend cuts within nine months “global dividends showed remarkable resilience”, according to Janus Henderson’s latest Global Dividend Index report.
Last year was a brutal one for income investors, with some $220bn in dividend being cut in the space of nine months. Janus Henderson’s figures show that global dividends fell 12.2 per cent on a headline basis in 2020 down to $1.26trn
There was a 10.5 per cent decline on an underlying basis, which was smaller than the cuts after 2008’s global financial crisis.
Source: Janus Henderson
This exceeded Janus Henderson’s initial ‘best case scenario’ projection for the year ($1.21trn headline). This was mainly down to a “less severe fall” in Q4, which saw some suspended dividends either fully or partially restored.
Dividends fell by 14 per cent in Q4 on an underlying basis to a total of $269.1bn and the headline decline was ‘just’ 9.4 per cent.
The Janus Henderson Global Dividend Index is a long-term study of global dividend trends. It measures the progress companies globally are making towards paying investors an income with its capital.
Jane Shoemake, investment director for global equity income at Janus Henderson, said: “Although the pandemic has changed the lives of billions in previously unimaginable ways, its impact on dividends has been consistent with a conventional, if severe, recession. Sectors that depend on discretionary spending have been more severely impacted, while defensive sectors have continued to make payments.
“At a country level, places like the UK, Australia and parts of Europe suffered a greater decline because some companies had arguably been overdistributing before the crisis and because of regulatory interventions in the banking sector.
“But at the global level, the underlying 15 per cent year-on-year contraction in payouts between Q2 and Q4 has been less severe than in the aftermath of the global financial crisis. The disruption in some countries and sectors has been extreme, but a global approach to income investing meant the benefits of diversification have helped mitigate some of these effects.
“Crucially, the world’s banks (which usually pay the largest share of the world’s dividends) mostly entered the crisis with healthy balance sheets. Bank dividends may have been restricted by regulators in some parts of the world, but the banking system has continued to function, underpinned by robust capital levels, which is vital for the smooth operation of economies.
“Finally, as is usual in challenging economic environments, dividends are exhibiting stability relative to profits. This is one reason why dividends are such an important consideration for investors.”
The Covid-19 pandemic and the measures companies had to take to cope with its financial impact were the ultimate cause of the widespread dividend cuts seen last year.
The first dividend cuts in response to the pandemic were made at the beginning of Q2. Therefore, to determine the full impact of Covid-19 on global dividends the report compared results from April to December 2020 (Q2-Q4) with the same period in 2019.
Janus Henderson’s Global Dividend Index found that dividend cuts and cancellations totalled $220bn between April and December last year.
But the report said: “We want to emphasise that despite the worst global crisis since the second world war companies in our index for the most part continued to pay dividends to their shareholders.”
Indeed, looking at 2020 overall $965bn worth of dividends were paid out, with two-thirds of companies able to increase or at least maintain their dividend. This meant
As a result, 2020’s payouts “far outweighed the cuts”, Janus Henderson said.
But that the end picture for dividends in 2020 was not as bad as expected doesn’t mean the rate of cuts wasn’t serious.
The Janus Henderson Global Dividend Index fell to 172.4, a level last seen in 2017. The index uses 2009 as a base year, with an index value of 100.
According to the report, one in eight companies globally cancelled their dividend payout completely and one in five made a cut. Six out of 10 consumer discretionary companies cut or cancelled payouts.
Banks accounted for one-third of the reductions in total. The impact on banks was felt especially in the UK, where they were put under pressure from the Bank of England ordering them to cancel all shareholder payouts for 2020.
Source: Janus Henderson
Banks were the biggest contributor to both UK and Europe’s dividend decline, which was so significant they alone contributed more than half of the world’s dividend cuts.
The index fell below its 2009 base level for the UK.
But not all areas suffered as much. North America for example saw a 2.6 per cent increase, on a headline basis, setting a new record. The report found that just one in seven companies in the US was affected.
Source: Janus Henderson
Looking ahead at the state of dividends in 2021, the report said that Q1 will see payouts fall, but the decline will be smaller than the one experienced between Q2 and Q4 last year.
Janus Henderson said: “A slow escape from the pandemic, and the drag caused by the first quarter”, could mean in a worst case scenario headline dividends fall by 2 per cent, and fall to minus 3 per cent on an underlying basis.
But in its best-case scenario, underlying dividends could increase by 2 per cent and rise 5 per cent on a headline basis.
Janus Henderson said: “The outlook for the full year remains extremely uncertain. The pandemic has intensified in many parts of the world, even as vaccine rollouts provide hope. Importantly, banking dividends will resume in countries where they were curtailed, but they will not come close to 2019 levels in Europe and the UK, and this will limit the potential for growth.
“Those parts of the world that proved resilient in 2020 look likely to repeat this performance in 2021, but some sectors are likely to continue to struggle until economies can reopen fully.”
February’s edition considers the fate of Brazil, Russia and India and asks why they were lumped in with China in the first place.
The latest issue of Trustnet Magazine attempts to find out what happened to the BRICs. In 2001, Brazil, Russia, India and China were tipped to reshape the world economy, but while the latter has gone from strength to strength, the other three countries have faded away. Anthony Luzio establishes why their paths diverged to such an extent and reveals what investors can learn from the experience. Staying on this theme, Danielle Levy looks for the frontier markets that can power emerging market growth over the next 20 years and Cherry Reynard finds out if China’s dominance means it should be treated as a class apart.
Meanwhile, this month’s sector focus falls on the Asia Pacific region as Adam Lewis says it is likely to be at the epicentre of middle-class growth over the coming decades.
In the magazine’s regular columns, John Blowers has a stab at creating the perfect investment platform, Waverton’s Tineke Frikkee names three UK stocks that are making the most of the opportunity to deliver their services online and Cerno Capital’s Fergus Shaw reveals which trust he is using to benefit from the trend towards delivering cheaper, cleaner and more reliable energy.
As always, Trustnet Magazine is free – you do not even have to enter any details. Simply click here to start reading, then click the arrow pointing down on the right-hand side of the screen if you want to download the PDF.
Trustnet asked market experts for the funds they would consider if the US market is in the late stages of an epic bubble.
Veteran investor Jeremy Grantham recently said the US market has all the characteristics of a bubble that is primed to burst, warning we could be on the verge of another crash like the one seen in 1929.
Often an oracle at calling market crashes, he cited overvaluation and extreme investor behaviour as two preceding hallmarks of the biggest collapses in market history - two things which have been well-documented in recent weeks.
“I believe this event will be recorded as one of the great bubbles of financial history,” said Grantham. “Right along with the South Sea bubble of 1720, the Wall Street Crash of 1929 and the dotcom bubble of 2000.”
The veteran investor is convinced that this bubble will burst in due course, with devastating effects on the economy and portfolios.
“Make no mistake – for the majority of investors today, this could very well be the most important event of your investing lives,” he said. “It is intellectually exciting and terrifying at the same time, and a privilege to ride through a market like this one more time.”
With that in mind, Trustnet asked a selection of market commentators for the funds which investors could use to weather the storm of a market collapse.
“Regardless of whether you subscribe to Grantham’s view that the US market is heading towards a 1929-style crash, there are investment opportunities closer to home that are compelling, particularly for those investors with a long-term investment horizon,” said John Monaghan, head of research at Square Mile Investment Consulting & Research.
“We believe that the Jupiter UK Special Situations fund is just such an opportunity.”
The £1.8bn fund has been managed by Ben Whitmore since 2006. Monaghan noted that Whitmore is a high conviction, long-term contrarian investor who seeks opportunities in companies that are out of favour. He has managed money in this style for most of his lengthy career.
Monaghan added that stock selection is determined by conviction, driven by the manager’s view of the quality of the company's underlying business and the attractiveness of its valuation.
The final portfolio, which normally consists of between 35 to 45 holdings, is constructed with less emphasis on the FTSE All Share index.
“This means that the portfolio can look and act very differently to the market at times and display short-term volatility,” he said. “However, risk relative to the index is not a major consideration for the manager who prefers to measure risk simply in terms of the potential loss of investor capital.
“For those investors with a longer-term horizon looking for a value-focused UK equities fund, the Jupiter UK Special Situations fund is certainly one worth considering.”
Performance of fund vs benchmark over 5yrs
Source: FE Analytics
Over a five-year period, the fund has made a total return of 38.98 per cent, compared to 46.13 per cent for the average fund in the IA UK All Companies sector. It has an ongoing charges figure (OCF) of 0.76 per cent.
The second pick, from AJ Bell analyst Laith Khalaf, is the Personal Assets Trust, managed by FE fundinfo Alpha Manager Sebastian Lyon.
“The S&P 500 is such an influential market that any steep falls are likely to be replicated in other equity markets,” said Khalaf. “Perhaps to a lesser extent if any sell-off is valuation-led, though bear markets don’t tend to be triggered simply by high stock prices.”
He explained that the traditional place to seek refuge if equity markets are falling would be in government bonds but argued that if an investor thinks US equities are in a bubble, they will likely take a similar view of US Treasuries.
“Tightening monetary policy is often a candidate for sparking a market sell-off, but in an environment of rising interesting rates, bonds wouldn’t be a great asset to own,” he said.
For investors worried about market levels, Khalaf suggested a mixed asset approach and recommended the Personal Assets Trust.
“These funds contain a mix of assets, so cover a lot of bases, and have a professional fund manager at the helm who can navigate switching between assets as market conditions dictate,” he said.
“I’d suggest having a few such funds so that you’re returns aren’t solely reliant on the decisions of just one manager.”
Performance of trust vs benchmark over 5yrs
Source: FE Analytics
The five FE fundinfo Crown-rated Personal Assets Trust has been managed by Lyon since 2009.
Over the past five years, the £1.4bn trust made a total return of 36.69 per cent, while the FTSE All Share made 44.81 per cent.
According to data from the Association of Investment Companies (AIC), it is trading at a 1.4 per cent premium to net asset value (NAV) and has ongoing charges of 0.86 per cent. It is not currently geared.
“As tempting as it is to try and pick something that could make money in a 1929-style collapse, I think that’s a challenge and therefore minimising losses or preserving capital might be a better approach, said Ryan Hughes, head of active portfolios at AJ Bell.
His pick is the £1.4bn Janus Henderson UK Absolute Return fund, run by FE fundinfo Alpha Managers Ben Wallace and Luke Newman.
“While absolute return funds have rightly had a bad press, the Janus Henderson UK Absolute Return fund is one of the good ones and has a good record of navigating its way through sharp corrections,” he said.
Hughes said the managers long/short approach is flexible enough to allow them to go net-short if they feel the need. They successfully used that flexibility in navigating the last financial crisis.
“Key to the approach is the management of risk and adjusting the net and gross positions accordingly, which is where many absolute managers have got it wrong in recent years,” he added.
“While the return may not be spectacular, preserving capital in a market crash is a fantastic way to make money in the long run.”
Performance of fund vs benchmark over 5yrs
Source: FE Analytics
Over the last five years, Janus Henderson UK Absolute Return has made a total return of 11.49 per cent, compared to 11.99 per cent for the average IA Targeted Absolute Return sector peer. It has an OCF of 1.05 per cent.
Staying with absolute return, FundCalibre managing director Darius McDermott has gone with the £491m SVS Church House Tenax Absolute Return Strategies fund.
“While it sits in the much maligned IA Targeted Absolute Return sector, it is one of the funds that actually does what it is supposed to do,” he said.
The fund has relatively low exposure to equities with a 25 per cent ceiling, as the managers want to minimise the volatility of the fund.
Managed by James Mahon and FE fundinfo Alpha Manager Jeremy Wharton, the fund places a heavy emphasis on capital preservation and it is one of the few absolute return funds with a track record which goes back beyond 2008 and the global financial crisis.
“During the Covid-19 sell-off the fund fell 6.6 per cent, while global stock markets fell more than 25 per cent. Since the lows in March, it has returned 10.2 per cent,” said McDermott.
"It really came into its own in the fastest bear market in history when everything became temporarily correlated and really showed its worth in a portfolio. It’s also not vulnerable to any more shorting ‘wars’ between social media/retail investors and hedge funds because it doesn’t use shorting.
"If we are going to have another correction, this is a fund I’d like to have in my portfolio mix."
Performance of fund vs benchmark over 5yrs
Source: FE Analytics
Over five years, SVS Church House Tenax Absolute Return Strategies posted a total return of 17.75 per cent, against a return of 11.99 per cent for the average fund in the IA Targeted Absolute Return sector. It has an OCF of 1.47 per cent.
The latest edition of Bestinvest’s Spot the Dog report found that the number of ‘dog funds’ has decreased over the past six months, but is still up on a 12 month basis.
The number of underperforming funds in Bestinvest’s bi-annual ‘Spot the Dog’ report has fallen from the record high seen six months ago, although they still run close to £50bn of investor cash.
The latest edition of the report identified 119 so-called ‘dog funds’ that have underperformed in each of the past three years, with £49.6bn worth of assets currently invested in these underperforming portfolios.
“These include funds managed by some of the City’s most prestigious names who will no doubt soon be howling out their excuses as usual,” Bestinvest said.
This was a decrease from the record 150 funds in the previous report. This decrease was mainly down to UK funds recuperating in the second half of 2020 following the positive vaccine news, according to Bestinvest.
But this is still a 33 per cent overall increase compared to this time in 2020.
The ‘Spot the Dog’ report looks for open-ended funds that have underperformed a representative benchmark for three consecutive 12-months periods across various sectors through statistical analysis. It applies a second filter to identify funds which have underperformed the benchmark by 5 per cent over the past three years.
Jason Hollands, managing director at Bestinvest, said: “If your savings are tied-up in an investment fund that is repeatedly delivering worse returns than the market it invests in then, then you really owe it to yourself to take a closer look and think about whether you might be better off moving it elsewhere.
“The differences between the best and worst performing funds are enormous and so it is essential to choose funds very carefully and then keep a beady eye on them or opt for low-cost trackers instead. The latter won’t beat the returns of market but will closely mimic them.”
Hollands added that it’s not so straight forward for investors to realise that their money is invested in a ‘dog fund’, because not all of them lose money. For example, while 32 of the funds in the report did lose clients’ money, most of them didn’t.
“That’s because stock markets in general have delivered very strong returns over the last decade and so nearly all ships have been lifted by the rising tide, even those with leaks in their hulls,” Hollands (pictured) said.
“If the value of your investments has gone up over the years, it is easy to assume that the fund manager has done an OK job. In reality, their decisions may not be adding any value whatsoever, though you’ll be paying them fees nevertheless.”
One key finding was that very few smaller companies’ funds appeared on the list, despite them being riskier strategies.
“We couldn’t find any smaller companies dog funds in the UK, North America, European or Japanese markets,” Bestinvest said. “Dog funds that invest specifically in smaller companies appear to be an extinct breed.”
In comparison there were 15 funds over £1bn on the list, so called ‘Great Danes’.
“These include funds that are widely held by private investors and managed by groups such as Invesco, St. James’s Place, Schroders and Hargreaves Landsown,” the report said.
Invesco took the title of ‘top dog’ for the sixth consecutive report, with 11 funds running a total of £9.2bn in the doghouse. This was a decrease in both the number of funds and assets versus the previous report.
Schroders also had 11 dog funds, but a lower value of assets (£4bn).
As mentioned above the biggest contributor to the drop in total dog funds came from the UK sectors, “as positive news about coronavirus vaccines fuelled a sharp recovery in some of the hardest hit parts of the market”.
There were just 14 UK equity funds on the list this time, down from 51 in the previous report, with seven dogs apiece in the IA UK All Companies sector and IA UK Equity Income sectors.
Five of the IA UK All Companies funds were repeat offenders from last time: Invesco Income, Invesco UK Equity High Income, Jupiter UK Growth, Jupiter Growth & Income and Legal & General UK Special Situations.
Bestinvest added that “Woodford also casts a continued shadow over the HL Multi-Manager Income & Growth trust, by far the biggest UK equity income dog at £2.1bn,” as it had backed his flagship fund – LF Woodford Equity Income - before it was wound down.
The report noted that 2020 had been “especially challenging for UK equity income funds” as UK dividends were savagely cut to help businesses cope with the effects of Covid-19.
“[But] it looks like the worst is now over,” the firm said, with banks and some other companies resuming payouts.
“But it will likely take a few years before dividends return to the levels seen before the crisis as profits need to be rebuilt,” it added.
*Three-year underperformance is the extent to which a fund lagged the market it invests in, not the absolute return delivered by the fund. All data is total return (including dividends reinvested) for periods to 31 December 2020.
IA North America had more dog funds than the UK, with 21 in total. This is because the US market is notoriously difficult to outperform, hence why tracker funds have become so popular in the sector, Bestinvest said.
“This has especially been the case in an environment where a relatively narrow group of companies has driven much of the US market’s recent returns,” they said.
The funds that did underperform were those invested outside of the dominant growth stocks the market is currently favouring, investing in dividend-generating companies or targeted undervalued shares instead. This includes funds such as M&G North American Value, GAM North American Growth, Jupiter North American Income, Liontrust US Income and Merian North American Equity.
As usual the IA Global sector had the highest number of dog funds, totalling 28.
Bestinvest explained that with the US making up a large proportion of the MSCI World index, any funds taking a diversified approach are more likely to perform benchmark, leaving more room for underperformance.
“This makes the global funds sector a regularly packed haunt for investment canines,” it said.
This is where many of the ‘Great Dane’ funds were found, such as Schroders Personal Wealth MM International Equity, M&G Global Dividend, St James’s Place Global Equity, St James’s Place Global and Invesco Global Equity (UK).
Both growth and value strategies have cause to be optimistic in Japan as Covid-19 has accelerated the need for domestic reform.
Japan recovered well from Covid-19 due to stringent testing and effective lockdowns. However, an impressive virus response also exposed a few areas in need of reform and, under a new prime minister, long-term opportunities in the country have emerged.
Earlier this week, Japan’s Nikkei 225 breached 30,000 for the first time since 1990, reflecting improving investor sentiment in the region.
As virus-related headwinds fade amid successful vaccination programmes, Japan looks well placed to enjoy in the global recovery, argued Fidelity Japan Trust manager Nicholas Price.
“Overall, I remain cautiously optimistic on the investment outlook for Japanese stocks,” he said.
“The Covid-19 pandemic clearly still poses near-term risks, but the gradual roll out of vaccines and continued monetary and fiscal policy stimulus are positive for the global growth outlook and will be supportive of Japanese equities.”
Performance of Japanese and global equities over 5yrs
Source: FE Analytics
With that, Price outlined that the markets are in an earnings driven phase, in particular individual stocks as oppose to the multiple expansion seen in 2020.
He also identified that digital infrastructure and clean energy are two important long-term opportunities in the country.
When prime minister Shinzo Abe stepped down in September of last year, market concerns regarding the transfer of power were abated with the election of Yoshihide Suga – an appointment that represented a continuation of the macroeconomic and foreign policies of the previous administration.
Suga also put the focus on domestic reform and, in particular, the digitalisation of the public sector which has severely lagged behind.
It was purported that government offices were reporting Covid-19 statistics on fax machines such was the level of antiquity in the sector.
“Radical changes in government infrastructure usually elicit strong opposition, but the Covid-19 crisis provided cover for an overhaul of the current system,” said Price.
“The digitalisation drive is also creating opportunities in the private sector, as the pandemic highlighted the need for companies to enhance their digital capabilities after years of underinvestment in their information technology IT infrastructure. “
The Fidelity Japan Trust has exposure to these technology holdings and software as a service (SaaS) companies.
“Going into 2021, the portfolio had a relatively large technology tilt, with a focus on globally competitive companies with strong balance sheets, reasonable valuations and a secular growth story,” he said.
Performance of trust vs sector & benchmark in 2020
Source: FE Analytics
Over 2020, the £310.3m trust made a total return of 24.58 per cent, while the average fund in the IT Japan sector made 22.76 per cent and the TSE TOPIX index made 9.14 per cent.
With an eye on the next few years, the manager said that Suga’s commitment to reduce overall greenhouse gas emissions to zero by 2050 has the potential to throw up new investment opportunities in areas such as renewable energy and infrastructure spending.
“Clean energy and environmental efficiency are areas where Japan has some very competitive companies that can supply solutions to the regulatory and productivity needs of customers globally,” said Price.
“This is a core part of the portfolio and I expect related names to do well for the trust going forward.”
The IPO (initial public offering) environment in Japan picked up the second half of 2020, with more than 90 companies coming to market over the 12-month period.
Price said that this represented a modest uptick from 2019 as is in line with the average over the past five years.
“Being on the ground means that we see a lot of these new ideas and business models first-hand,” he added. “Continually meeting with pre-IPO companies enables us to identify the most attractive opportunities.”
Additionally, there was an uptake in M&A, or mergers & acquisitions activity, especially in terms of companies buying their listed subsidiaries.
Market reforms by the Tokyo Stock Exchange and enhancements to the Corporate Governance Code is expected to drive further consolidation in 2021.
“There are opportunities to invest in companies, particularly conglomerates and industrials, where business reorganisation could drive a rerating or at least act as a share price catalyst,” Price concluded.
Rob Morgan, pensions and investment analyst at Charles Stanley Direct, said: “The Baillie Gifford Japan Trust captures many of the growth areas available among Japanese corporates.
“The managers believe the Japanese economy is undergoing structural transformation, with companies being run more efficiently and the service sector becoming larger and more dynamic.”
Morgan added that the focus on growth results in a higher risk collection of holdings, which is exacerbated by gearing of up to 20 per cent and an ability to invest in nascent unlisted companies, so investors need to be aware of this.
Similarly, the Baillie Gifford Shin Nippon portfolio contains 40-80 listed companies, often smaller and earlier stage, with up to 10 per cent allowed in unlisted investments.
“The fund has a more specific focus on innovative, disruptive business models representing the ‘New Japan’,” said Morgan.
Performance of trusts vs sector over 5 years
Source: FE Analytics
Over a five year period, the Baillie Gifford Shin Nippon trust made a total return of 189.64 per cent, while the Baillie Gifford Japan Trust returned 169.09 per cent. The average IT Japan sector peer posted a return of 126.51 per cent.
For a value-seeking approach, he suggested the Man GLG Japan Core Alpha fund.
“The fund applies a deep value approach to the Japanese market where some of the lowest valuations in developed markets can be found.”
Morgan added that it would be worthy of consideration to an investor looking for exposure to especially out-of-favour Japanese firms that could enjoy a rebound later this year.
“A cyclical upturn would favour the fund as the biggest sector overweight is banks, as well as iron & steel and autos,” he said. “If these areas really get going then it should be among the top performing funds in the sector.”
Performance of fund vs sector over 3yrs
Source: FE Analytics
Over three years, Man GLG Core Alpha made a loss of 6.17 per cent, while the average fund in the IA Japan sector made a total return of 25.20 per cent.
One year after the market started to tank because of the coronavirus pandemic, Trustnet finds out what returns look like by asset class, investment style, market cap and a range of other viewpoints.
One year ago today, the stock market peaked and was hit by the coronavirus crash – which ended up being one of the fastest bear markets on record.
Equities across the globe tanked as investors weighed up the likely impact of Covid-19’s spread and the unprecedented lockdowns that were to follow. However, vast injections of liquidity from policymakers halted the rout and the market bottomed out on 23 March before embarking on a spectacular rally.
So 12 months after the start of the sell-off, Trustnet looks at the market from several different viewpoints to see how things panned out for investors.
While the heavy falls that hit stock markets in February 2020 appeared to set investors up for a year of lacklustre returns, the rapid and massive response by monetary and fiscal policymakers meant they were soon rallying again.
As the chart below shows, global equities – represented here by the MSCI AC World index – have made a total return of just under 12 per cent in the year since the February peak. This includes the maximum drawdown of 24 per cent that was endured between 19 February and 23 March.
Performance of asset classes over 1yr
Of course, the coronavirus crash and following rally means that investors didn’t have the smoothest conditions to navigate over the past year and this is reflected in the performance of the VIX index, which is known as ‘Wall Street’s fear gauge’.
The chart also shows that safe havens, such as gold and government bonds, are relatively flat over the past year as the stimulus liquidity led investors to embrace risk.
However, coronavirus lockdowns across the much of the globe means that demand for commodities dried up last year and caused price falls, especially in oil.
While equities had a decent year on the global stage, things are a bit more nuanced when we look at some of the major regional indices.
Emerging markets and Japan were the strongest parts of the market, with the MSCI Emerging Markets index made a total return of more than 25 per cent.
China, the largest constituent of the emerging market index, came out of lockdown first and has staged a strong economic rebound since, while many parts of Asia appear to have initiated a better response to the pandemic than the West.
Performance of geographies over 1yr
The S&P 500 also rose by just under 10 per cent, despite a flawed response to the coronavirus pandemic and chaotic end to Donald Trump’s presidency. The US launched massive stimulus efforts, however, pumping trillions of dollars into the economy.
At the bottom of the rankings is the UK with the FTSE All Share, posting a 5.7 per cent loss over the past 12 months. The UK has been unloved for some time because of Brexit and, before the vaccine rollout, was criticised for its handling of the pandemic.
The past year proved to be another when the growth style of investing had the firm upper hand in the growth versus value debate. The global growth equity index has made a total return of 24.5 per cent since 19 February while its value counterpart is in negative territory.
Performance of investment styles over 1yr
Growth investing has dominated the market for the past decade, after central banks dropped interest rates to record lows and launched huge quantitative easing programme to tackle the global financial crisis. These conditions favour growth stocks, as investors are more willing to pay for growth in a low interest rate, low inflation environment.
That said, value stocks – which tend to outperform when the economy is in a cyclical upswing – rallied when the first coronavirus vaccines were announced and many investors think they could outperform if a decent economic recovery takes hold this year.
The fact that growth stocks outperformed is reflected in the performance of the various MSCI industry sub-indices since 19 February, with consumer discretionary and tech stocks rising more than 30 per cent.
Although consumer discretionary made the highest returns over the past year, the focus has been on tech as many companies rallied strongly as locked-down populations used tech to work, shop and socialise from home.
Performance of industries over 1yr
Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said: “The wheels of the US tech stocks in particular have been greased by the liquidity washing around the financial markets thanks to the huge dose of quantitative easing released by central banks. The tech giants are still on an upwards trajectory, with expectations that our digital way of living will not unravel.
“However, the spectre of regulation is hanging over the sector and could prove to be the fright which could derail the juggernaut, especially if central banks take the monetary easing pedal off unexpectedly.’’
As the chart below shows, global small-caps have outperformed their larger peers over the past 12 months with a total return of close to 19 per cent. Global large-caps, on the other hand, made a total return of less than 12 per cent.
Performance of market caps over 1yr
However, it’s important to note that this hasn’t been the picture over the full period. During February’s initial coronavirus crash, small-caps – which are seen as a riskier part of the stock market – fell harder than large-caps. They also recovered slower as investors continued to be nervous about the health of the global economy.
Small-caps surged past their larger rivals from the end of 2020, when several coronavirus vaccines were announced in November and investors started eyeing the end of the pandemic. They have continued to outperform in 2021 as vaccine roll-outs gather pace in many parts of the globe.
Many of the trends highlighted above are apparent when we examine the average performance of the various Investment Association fund sectors over the past year.
Performance of equity fund sectors over 1yr
As the chart above makes clear, the best performing geographic equity sector was IA China/Greater China, with its 51.72 per cent average return. The Chinese economy continued to grow in 2020 despite the country being the first to lock down because of coronavirus.
UK equities are at the bottom of the rankings, with the IA UK Equity Income sector being hit especially hard by the large numbers of companies that cut, postponed or cancelled their dividends last year.
Performance of bond fund sectors over 1yr
When it comes to fixed income, IA Sterling Strategic Bond funds handed the best returns to their investors thanks to their ability to shift between different kinds of bonds depending on the market backdrop.
High-yield bonds came in second place as investors felt confident taking risk in a market awash with liquidity, although emerging market debt funds have given investors the poorest result.
Performance of multi-asset & ‘other’ fund sectors over 1yr
Of the remaining Investment Association sectors, IA Technology & Telecommunications came out best with an average return of 42.2 per cent. As noted above, tech stocks have enjoyed a strong 12 months and this sector is home to the funds that specialise in them.Property sits at the bottom, with both fund sectors making losses as lockdowns and working from home hit the commercial property space hard.
Trustnet examines how sectors and funds have performed 12 months on from the start of the coronavirus sell-off last February.
Asian equity strategies, one UK small-cap portfolio and Baillie Gifford-managed funds have emerged as the best performers one year on from the coronavirus sell-off, FE fundinfo data shows.
Although the outbreak of Covid-19 was declared a public health emergency as early as January, financial markets did not start to fully appreciate the severity of the global pandemic until late February.
The first two months of 2020 saw global equities gradually rise despite the escalating health crisis, with the MSCI World ticking up by roughly 5 per cent before the crash.
It was not until 20 February 2020 that global markets began what was one of the fastest market sell-offs in financial history.
Governments and central banks around the world then promptly responded with massive monetary and fiscal support, which has allowed markets to recover and break new all-time highs.
Ultimately the best performing equity markets depended on how well individual nations and regions managed the pandemic.
Source: FE Analytics
The IA China/Greater China peer group was the highest performing sector, with the average fund delivering a total return of 51.72 per cent one year on from the market’s peak in February.
The country had a ‘first-in, first out’ experience with dealing with coronavirus and has had the chance to recover quicker than much of the world. Its stock market is also dominated by big technology firms such as Alibaba and Tencent, which fared well during the pandemic.
IA Technology & Telecommunications was the second highest performing sector, with a total return of 42.16 per cent. The sector is made up of funds focused on investing in technology companies, which have thrived and seen their products embraced during the global lockdown.
IA Asia Pacific including Japan and IA Asia Pacific excluding Japan were two notably high performing sectors. The main countries within the sector were amongst the first hit by the pandemic but were also the nations that seemed to manage the health crisis relatively more efficiently than the rest of the world.
Indeed, around two-thirds of the MSCI Asia Pacific index is made up companies listed in China, South Korea and Taiwan, which were hit earlier by the pandemic and haven’t experienced as severe second or third waves.
The IA North America sector was another high performer despite its severe health crisis and extended lockdowns. It is worth, noting, however that the sector has a high weighting to companies such as Amazon, Alphabet and Microsoft whose products and services enabled many global economies to continue as most other sectors came to a standstill.
At the other end of the table, the worst performing sectors were the IA Property Other and the UK equity sectors.
Source: FE Analytics
The average fund in the property sector lost 11.43 per cent over the period. Commercial property was hit especially hard by the pandemic and ensuing government-mandated lockdowns forcing workers to stay at home.
UK strategies have also had a tough year after the country was hit particularly hard by the pandemic, as well as the uncertainties surrounding Brexit.
The IA UK Equity Income sector came off the worst, largely due to the swath of companies cutting dividends and the high concentration of dividend payers amongst sectors such as energy, which were most severely affected by the pandemic and the oil price collapse that happened earlier in the year.
Looking at the top 20 performing individual funds, they were mostly in the global, north American, Chinese and Asia Pacific sectors.
Source: FE Analytics
The £170m Premier Miton UK Smaller Companies fund, managed by Gervais Williams and Martin Turner, was the best performer of the entire Investment Association universe with a total return of 111.08 per cent over the period. The fund profited in the sell-off from a put option on the FTSE 100 and had several individual stocks surge over the following year.
Given the severe shock the pandemic had on the UK domestic economy and the fact that UK stocks were out of favour in the eyes of many global investors, the strategy has begun to accelerate its performance after the conclusion of Brexit.
Indeed in December of last year, Williams told Trustnet that he believed the end of Brexit presented the best risk-reward ratio he has seen in his entire career.
But one notable trend in the table is the fact that almost half of the top performing funds were managed by Baillie Gifford. The firm has experienced a stellar year for many of its equity strategies.
The £7.9bn Baillie Gifford American fund is in second place on the table with a total return of 110.23 per cent a year from the 20 February 2020 crash.
The fund did well on the back of rallying share price performance from companies such as Tesla, Zoom and Shopify, of which were heavily weighted in its portfolio and are deemed to be ‘coronavirus winners’.
The £92m New Capital China Equity fund was the third strongest performer over the period, which should come as no surprise given the high returns from the Chinese equity market.
Looking at the bottom of the performance table, it mostly features Latin American and UK equity strategies.
Source: FE Analytics
The suspended LF Equity Income fund sits at the bottom with a loss of more than 60 per cent. The fund is being wound down.
The economies of Latin America were hit hard by the global health crisis and received relatively less government support compared to many of the economies of the developed world.
The $110m Brown Advisory Latin American fund was the worst performer of the non-suspended funds on the list, suffering a 29.64 per cent loss over the period.
Since Brazil is the largest country within the regional benchmarks, several Latin American strategies were also dragged down by a hefty sell-off in the Brazilian equity market.
The £312m Quilter Investors Equity 2 fund was the worst performing UK strategy on the list (aside from the Woodford fund), posting a loss of 25.09 per cent.
It has large holdings in oil giants BP and Royal Dutch Shell, both which suffered dramatically after an oil price collapse and slowing demand for energy during the crisis.
Baillie Gifford American made 121.84 per cent in 2020, but still has 18 of its top-20 positions from this time last year.
The managers of Baillie Gifford American are refusing to take profits from their biggest winners of last year, even though their surging share prices propelled the fund to the number-one position in the Investment Association universe.
Baillie Gifford American made 121.84 per cent in 2020, compared with 16.17 per cent from its IA North America sector and 14.12 per cent from its S&P 500 benchmark. However, while most professional investors would look upon such short-term numbers as a reason to take some money out of their best performers to crystallise their gains, the Baillie Gifford American managers are resisting the temptation to quit while they are ahead, maintaining 18 of their top-20 positions from this time last year.
Performance of fund vs sector and index in 2020
Source: FE Analytics
“It would be all too easy to sell a stock simply because it has gone up a lot, like many share prices did last year,” said Kirsty Gibson (pictured), who co-manages the fund.
“However, [I want] to avoid knee-jerk reactions. In times of dramatic change, what we must do is double down on our philosophy and process. While we cannot predict returns in the future, what we can control is how we react today. We remain resolute in our search for exceptional growth companies.”
Gibson defines “exceptional growth companies” as those that can deliver a 2.5x return over a period of five years. Baillie Gifford carried out research into the distribution of returns in the S&P 500 over the past three decades and found that, over rolling five-year periods, 20 per cent of stocks delivered the sought-after 2.5x gain while, on average, the rest of the index’s constituents barely budged.
Yet even though Baillie Gifford American almost delivered the targeted five-year return in 2020 alone, Gibson said this does not mean the underlying holdings are now overvalued.
“It is commonly assumed that growth investors are not interested in valuation, but for us, that is certainly not the case,” she explained.
“That's not to say that we focus on the short-term numbers or the spot P/Es. We see valuation discipline through a long-term lens: we consider the next five to 10 years and we look to ascribe a probability to our investment hypothesis of how we can make at least 2.5x our money over that time.
“Given fundamentals and share prices have seen significant moves over the past year, we have been revisiting the upside case for a number of our largest holdings in order to try to get our bearings in what has been a very unusual environment.
“It might be surprising to hear that for the most part, this did not lead to many changes in the portfolio. While share prices have seen significant increases, fundamentals have also shown huge progress, and most of our long-term investment hypotheses remain intact.”
Gibson went further, pointing out that last year reinforced an argument about “exceptional growth companies” that she already suspected to be true: even after a period of spectacular growth, their opportunity set is not necessarily exhausted. “In fact, many of them are just getting started,” she added.
There are three main reasons for this, which the manager said are also among the same characteristics that define exceptional growth companies in the first place.
“The first is that exceptional growth companies are addressing vast market opportunities and they have the headroom to grow unimpeded for very long periods of time,” she explained.
“The second is that these businesses have strong competitive advantages, which get stronger as they scale. As you scale in the digital space, your ability to sustain or even accelerate your growth rate increases. As we have seen before, businesses are able to go faster when they scale and this is due to inherent flywheels within their business models.”
For example, she said that if an online platform gains more users, it allows it to gather more data. This data gives it the opportunity to build better products, which attract more users, and the cycle starts again.
The final characteristic Gibson looks for in exceptional growth companies, and another reason she believes they can continue to grow after periods of supernormal growth, is culture.
“Exceptional growth companies have distinctive cultures,” she continued. “They are run for the long run, often by founders who have skin in the game, and who have an attachment to the company rather than the share price.
“And this enables them to unlock new growth and opportunities, some of which we cannot even imagine when we first invest.”
Data from FE Analytics shows Baillie Gifford American has made 947.24 per cent over the past 10 years, compared with 294.82 per cent from the S&P 500 and 250.69 per cent from its sector.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The £8bn fund has ongoing charges of 0.52 per cent.
Asian shares have benefited from the region’s effective handling of the pandemic, but what comes next, ask Schroders’ Matthew Dobbs and Richard Sennitt.
It seems ancient history now, but 2020 opened with a high degree of optimism for Asian markets. True, valuations were no more than reasonable given the share price gains of the previous 12 months, but conditions appeared favourable and there was a widespread consensus on a global economic recovery and a strong year ahead for corporate earnings. Well, it is obvious in hindsight that Mr Market was wrong – or was he?
The fact is that for those who held their nerve in the spring (and even more for those who used that turmoil to pick up cheap bargains and great companies being thrown out in the panic), it turned out to be a vintage year. All in all, 2020 was an extreme example of cutting through the noise and focusing on the long term.
Of course, it is never that simple. The spring months seemed to present an existential threat perhaps even to humanity itself, a ‘Day of the Triffids’ moment. As it turned out, Asia has proved well up to the challenge.
Many of the more advanced Asian economies have dealt with the pandemic efficiently and effectively. Those who cite different culture and a more conformist mindset might want to reflect on the full stadia at sporting events in much of Australia as we write. If the US had emulated Taiwan in the minimisation of fatalities, only some 100 US citizens would have died against the over 400,000 that have.
Of course, not every Asian country has the resource and institutional depth to respond, but in the case of India and much of the ASEAN region, young populations are proving resilient (ASEAN is the Association of Southeast Asian Nations).
Asia was also remarkably adept at re-invigorating and adjusting supply chains. While economies exposed to services (fluff rather than stuff) suffered as travel, tourism, bricks and mortar retail collapsed, hard exports (i.e. goods) have been surprisingly strong. With inventories lean, corporate earnings have proved at the least resilient, and in some cases remarkably robust. This has been particularly true in the information technology complex as the world has gone virtual: virtual work, virtual play, virtual shopping, virtual everything.
Adding to the mix has been a very benign global liquidity backdrop, led by the US Federal Reserve whose asset purchases and low interest rates have helped support the financial system. This has been accompanied by extraordinary levels of fiscal activism with governments supporting people’s incomes.
A weak dollar has added to the fuel, as has a rise in thematic investing, driven in part by the fact that the pandemic has only served to further accelerate digitalisation trends already firmly in train. Asian stock markets have ample representation of companies that benefit: computer gaming, e-payments, e-commerce, electric vehicles, as well as the enablers of the new trends such as specialists in robotics, artificial intelligence and semiconductor testing and production.
The above perhaps is history. But to understand where we are going, it helps to understand where we have been. We remain convinced of the long-term case for Asia, and that is in the knowledge of the less good things that have intervened including continued tension between the US and China (a fact of life) and the many political fissures (Hong Kong, North Korea, Myanmar).
The shorter-term outlook looks less enticing. Valuations are overall somewhat stretched, so the expected recovery in corporate earnings appears to be already well recognised by the consensus. And as we know, earnings very frequently disappoint. Furthermore, the very fact that Asia has had a ‘good war’ over Covid means there is not the same degree of recovery potential as is possibly present elsewhere.
We would also expect most regional monetary and fiscal authorities to continue a relatively conservative stance, led by China which has recently signalled some concern over exuberant markets. In our view, they are right given distinctly ‘bubble-like’ valuations in areas such as bio-technology and electric vehicle manufacturers.
In summary, we are working on the assumption of more measured progress for the region in 2021. Investors may have to work harder for positive returns as some of the long-term growth companies need to grow into their valuations. There are also pockets of value and we see opportunities in areas that have not captured the imagination of the Robinhood brigade. As ever we are prepared to be patient, think differently from the crowd and focus on long-term sustainability.Matthew Dobbs is manager of the Schroder Asia Pacific Trust and Richard Sennitt runs the Schroder Oriental Income Trust. The views expressed above are their own and should not be taken as investment advice.