Schroders’ Robin Parbrook has taken the highly unusual step of urging caution towards his own asset class – even though it is being heavily tipped by his peers.
Investors should beware of anyone telling them to buy Asian or emerging market equities because they are “cheap”, according to Schroders’ FE Alpha Manager Robin Parbrook, who says these areas of the market currently resemble “a pig wearing lipstick”.
The MSCI AC Asia Pacific ex Japan and MSCI Emerging Markets indices fell by 8.51 and 9.2 per cent respectively last year, which many experts say has created an attractive entry point.
Performance of indices in 2018
Source: FE Analytics
For example, Saker Nusseibeh, chief executive officer of Hermes Investment Management, described emerging markets as “the correct place to be” this year, adding: “China is slowing to around 6 per cent a year or below, but that is only natural and should have been expected. It is a very large economy and one cannot expect very large economies to keep growing at 14 per cent. Let’s not forget it is still doing much better than everyone else.
“Should we believe the Chinese economic number? It’s almost irrelevant whether it is 6.5 per cent, 6 per cent or 5.5 per cent. The growth of the Chinese consumer will continue.”
However Parbrook, the manager of the Schroder Asian Total Return Investment Company, is sceptical of this sort of assertion.
“I have been covering Asia for 30 years and a lot of the time I think Asia and emerging markets more generally get mis-sold,” he said.
“At this point, most people are saying 'buy emerging markets'. I was out marketing in France at a conference, listening to people give the usual spiel about emerging markets and it made me think, ‘are emerging markets being tickled pink or is it a pig with lipstick?’”
Parbrook has spent most of his working life in Asia, moving to Hong Kong in 1992. China has been the biggest growth story on the planet since then, with its GDP seeing a 25-fold increase – however, GDP growth obviously doesn’t equate to stock market performance and the manager called China “the most spectacular example of that”, with its stock market down by 25 per cent in dollar terms over the same period.
“That’s because most Chinese companies are very bad and went bankrupt,” he said.
“So the real story here is beware of emerging market and Asia specialists, strategists and fund managers who are just coming out and giving you the whole crappy spiel about how emerging markets have 3 billion people and rising GDP growth, because what actually matters is what is behind the growth.”
Parbrook takes a bottom-up approach to investing, aiming to pick best-in-class companies “regardless of whether they are exporters, tech companies, or domestic consumption plays”.
He said this is important as you don’t want to buy Asia for its beta – even though many people do – but for its alpha, pointing out that most trusts in the IT Asia Pacific ex Japan sector – 11 of 14 – have beaten the MSCI AC Asia Pacific ex Japan index over the past decade.
Performance of sector vs index over 10yrs
Source: FE Analytics
“I think that reiterates you can make money from this asset class, but don’t kid yourself you are miraculously catching rising middle classes,” he said.
“There have been stocks that have correlated brilliantly with the (GDP) index. The one that has correlated the best is Louis Vuitton. Because what do Chinese people buy when they get richer? They want to buy handbags. That is the key message. When you are investing in emerging markets or Asia, it is not just a case of buying the index.”
Parbrook said that assuming some sort of correlation between GDP growth and stock market performance is not the only mistake made by those backing Asia.
While many of them point to value being created by 2018’s fall, the manager said it is important to remember that the MSCI AC Asia Pacific ex Japan index was up by close to 40 per cent in dollar terms in 2017 – and a market that has risen by close to 20 per cent in two years hardly screams “buying opportunity”.
Performance of index (in $) over 2yrs
Source: FE Analytics
“As far as we see things from a valuation perspective at this point, things are pretty mixed: there are pockets of value, mostly in tech, semi-conductors exporters and financials,” he continued.
“But obviously there are quite big headwinds for some of those sectors. Whereas on the flipside, other parts of the market still look very expensive to us – consumer staples, domestic plays on China and some of the defensive sectors.
“We are also seeing quite a lot of earnings downgrades coming through as the impact of a slowing economy does impact Asian earnings.
“Historically, Asian earnings have been quite cyclical and I don’t see that really changing, but pockets of value should mean we can make some money this year.”
Data from FE Analytics shows the Schroder Asian Total Return Investment Company has made 69.17 per cent since Parbrook joined in March 2013, compared with gains of 36.71 per cent from its IT Asia Pacific ex Japan sector and 28.98 per cent from its MSCI AC Asia Pacific ex Japan benchmark.
Performance of trust vs sector and index under manager tenure
Source: FE Analytics
It is currently on a premium to NAV of 3.68 per cent, compared with a premium of 2.21 per cent and a discount of 1.94 per cent from its one- and three-year averages.
The trust has ongoing charges of 0.96 per cent and is 9 per cent geared.
Robin Parbrook and King Fuei Lee, Co-Fund Managers, Schroder Asian Total Return Investment plc advocate a cautious approach to Asian equity markets as China increasingly finds itself in an economic quagmire.
To assess the investment opportunities in Asian equities, we start by looking at stock valuations at both the broad market level and at the individual company level.
Asian equities have fallen to a broad market level that would generally lead us to turn more positive from an investment perspective.
Unfortunately, our analysts are not yet finding enough stocks trading at a significant discount to fair value at the individual company level to indicate a strong buying opportunity overall. However, this could change if markets fall further.
We also play close attention to the fundamental factors that have an impact on valuations, including earnings, sales and dividends. Today’s cheap markets can look expensive tomorrow – even if prices are unchanged – if the fundamentals deteriorate significantly.
Forecasts for Asian company earnings are currently being downgraded and we could see downgrades rising and continuing for some time to come if previous challenging periods for Asia including the global financial crisis and the Eurozone debt crisis are any guide. At its worst around the time of the Asian crisis, Asian earnings almost halved over a period of four years.
China is increasingly finding itself in an economic quagmire, with the risks of either a currency devaluation or an economic recession rising. While we not think either of these is highly likely, if one or other does materialise it will be painful for Asia. Given the size of the Chinese economy today, and the amount of intra-regional trade, the region will be lucky to escape with just a cold, and not something a lot worse, if China sneezes.
Given this backdrop we recommend investors tread cautiously and watch economic trends in China very closely. Assuming the risks highlighted do not materialise, we will continue to gradually add to our favoured names on weakness. These are primarily in those markets offering the most upside on our long-term valuation models - Australia, Hong Kong and Singapore.
Discrete yearly performance (%)
Q4/2017 – Q4/2018
Q4/2016 – Q4/2017
Q4/2015 – Q4/2016
Q4/2014 – Q4/2015
Q4/2013 – Q4/2014
Net Asset Value
Past performance is not a guide to future performance and may not be repeated.
Some performance differences between the fund and the reference index may arise because the fund performance is calculated at a different valuation point from the reference index.
New manager and reference index from 15 March 2013. Source: Thomson Reuters. With effect from 15 March 2013, the Reference Index has been the MSCI AC Asia Pacific ex-Japan Index (sterling adjusted). Prior to that date, it was the MSCI AC Asia ex-Japan Index (sterling adjusted). The full track record of the previous index has been kept and chain linked to the new one.
Source: Schroders, with net income reinvested, net of the ongoing charges and portfolio costs and, where applicable, performance fees, in GBP. Rebased to 100 as at the start of the 5 year period.
The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.
What are the risks?
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.
Investors in the emerging markets and Asia should be aware that this involves a high degree of risk and should be seen as long term in nature. Less developed markets are generally less well regulated than the UK, they may be less liquid and may have less reliable arrangements for trading and settlement of the underlying holdings.
The Company holds investments denominated in currencies other than sterling, investors should note that exchange rates may cause the value of these investments, and the income from them, to rise or fall.
The Company invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment companies that invest in larger companies.
The Company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.
Investments such as warrants, participation certificates, guaranteed bonds, etc. will expose the fund to the risk of the issuer of these instruments defaulting on paying the capital back to the Company
The fund can use derivatives to protect the capital value of the portfolio and reduce volatility, or for efficient portfolio management.
This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.
The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.
Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.
Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.
The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.
Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.
Kevin Balakrishna, senior portfolio manager at Thomas Miller Investment, considers how active stockpicking can deliver long-term outperformance.
Investing in equity markets for many can be an emotive process. Some investors may avoid certain companies or sectors where perhaps they have suffered previous losses, while others may invest in companies or names they are familiar with. Despite their preferences, investors have often told me that they only like to invest in ‘good’ companies.
Naturally this leads to the argument of what constitutes a ‘good’ company - is it an investment perceived as having low risk or a company that is expected to outperform its respective index? Is it possible to construct a portfolio with more favourable risk/return characteristics than a traditional benchmark?
Traditional finance states that financial markets are completely efficient as the market participant knows every piece of information and always makes rational decisions. Conversely, behavioural finance states emotional biases can affect investors when making investment decisions. For example, some investors might suffer from the ‘endowment’ effect of having inherited a stock position from a family member that they may be reluctant to sell. Investors may also be influenced by behavioural biases such as conservatism - not updating their view on a company after news that would contradict their current opinion. Performance figures show that managers can not only outperform a benchmark but significantly underperform as well.
So how do we construct a portfolio of these so-called ‘good’ companies? Conventional stock analysis techniques are sometimes referred to as a ‘top-down’ or ‘bottom-up’ approach, or both together. In ‘top-down’ analysis, the focus is on selecting a group of industries and investing in the best companies within that sector, while ‘bottom-up’ analysis focuses on the company and its financial performance. One way to employ a ‘top-down’ method is to take a chosen stock universe, such as the S&P 500, and by using various criteria, eliminate unfavourable companies, while investing in those we hope will perform well.
Examining a company’s financial performance provides a good starting point for this process and over a period of five to ten years such an analysis can reveal valuable indicators to potential investors. For example, gross and operating margins may indicate if management has been effective if margins are in excess of the opportunity set average, or if the sector presents high barriers or economies of scale. By looking at the free cash flow of a company, we can observe what percentage of the profits generated is converted into operating cash flows and whether these levels are consistent. Such analysis serves as a useful determinant to identify which companies look more attractive than others. By using this technique, a list of companies can be compiled with strong and consistent financial performance.
Although this provides a starting point, it still doesn’t tell us whether a company is cheap or expensive relative to its current market price. In order to determine this, we could discount future cash flows, either cash flows the investor would receive as dividends or free cash flows generated by the company itself. As with any type of forecasting model, the output is only as good as the input data, and by using sensible assumptions we can arrive at a value - or range of values – that reflects the company’s worth.
This type of analysis can also useful in determining what the market forecast is for the future financial performance of the company. When attempting to determine the value of a company we often have to assume a terminal growth rate i.e. having made financial assumptions for five or ten years, what do we expect the growth rate of earnings to be after this period to perpetuity? The lofty valuations we saw in the Q3 2018, especially in some of the US technology names and smaller UK companies, had priced in very high levels of earnings growth, so high some investors might have said those levels weren’t sustainable in the long run.
Companies that can consistently generate higher than average returns on reinvesting cash flows may trade at a premium as the market is anticipating continued financial growth. Strong financial performance should, in the medium to long term, be reflected in the stock price with short term market distortions providing a good entry point to add to portfolios.
By putting these methods together, we hope these companies continue to post strong financial figures and their share price performs strongly over the long term. Such a strategy based on outperformance, often referred to as an active strategy, will not suit every investor, as many will simply want to mirror a benchmark index.
Kevin Balakrishna is senior portfolio manager at Thomas Miller Investment. The views expressed above are his own and should not be taken as investment advice.
Hermes Investment Management’s Fraser Lundie gives his outlook for the credit market and explains one aspect of it that people have been overlooking.
After a difficult end to 2018, investors may now be well-positioned to take advantage of a more favourable environment and fresh opportunities in the credit market, according to Hermes Investment Management’s Fraser Lundie.
Although there has been less issuance in the credit markets so far this year, Lundie – manager of the £844.5m Hermes Multi Strategy Credit fund – said this has not been particularly problematic for him.
“As much as new issuance is great news if you’re a banker, it’s not particularly good news if you’re the guy who’s trying to manage supply and demand,” said the Hermes manager. “If anything, supply is disappointing so far this year, which is good news.
“The reason it’s disappointing on an aggregate basis is because companies that have already been so pre-emptive and opportunistic in re-buying and churning out debt.”
Corporate debt issuance over 2yrs
The low-rate, post-financial crisis environment has encouraged companies to repurchase existing debt and reissue at lower rates in recent years, which has changed the dynamic of the market somewhat.
“Companies have made very good use of the fact that the capital markets have been so open for so long and they have reduced their cost of financing and termed-out their liability structures in an impressive way,” said Lundie.
“It’s partly why you can be a bit more constructive on the market because of the balance sheet health. As much as leverage levels might look on the high side and typical for late-cycle, interest coverage on the other hand looks extremely strong because rates are still low.”
Like all asset classes, the final quarter of the year was a challenging one for credit as fears about a potential US recession built on growing concerns over the Federal Reserve’s rate-hiking programme and the escalating US-China trade dispute.
Yet the pausing of the Fed’s rate-hiking programme in January has made conditions more favourable for credit markets than last year and the attractiveness of the asset class to allocators has significantly increased.
“You’ve got central banks across the world in pretty accommodating shape here,” the Hermes manager said. “It’s a very different picture to six months ago.”
Lundie said the relative value of credit has also greatly improved compared with other asset classes and is one thing that is often being overlooked by the market.
“We think that the average cash price phenomenon is something that people don’t focus on enough,” said the Hermes co-head of credit. “People tend to focus on spreads when they talk about credit, but cash prices are really low.”
Cash prices have fallen for a range of reasons, said Lundie, including reissuing at lower rates for the longer–term and credit spread tightening, with securities now trading at or significantly below par value.
“One of the areas most important for this is in the corporate hybrid market which is securities typically of investment-grade companies right at the bottom of the debt capital structure,” the Hermes Multi Strategy Credit manager said. “They are more complicated to appraise in the sense that they have some equity characteristics and some debt characteristics.”
He said that the securities carry a lot of risks if you own them above par value but currently they are trading “significantly below par”.
“We’ve been materially increasing our exposure to corporate hybrid bonds both in Europe and the US and would expect them to be a major driver of returns this year,” he added.
Another area where the phenomenon has been seen is in the high yield market, where debt is currently trading below par value.
Performance of index YTD
Source: FE Analytics
“For example, global high yield yields something like 6.5 per cent in dollar terms,” Lundie explained. “That is combined with the average cash price of the bonds that you’re buying being relatively low something like 95-96 cents on the dollar.
“Which means that there is nothing, from a bond market perspective, to stop it from going up and up and up.”
The combination of high yields and the potential for cash price appreciation makes for a compelling investment argument, according to the manager.
“Sometimes in the high yield market what you’ll find is that the yield might be attractive, but the convexity profile of the asset class is challenged by call options which become more of an issue if the cash price is higher,” he said. “That’s not a risk right now.”
The manager said what is likely to transpire this year – as the late market cycle continues – is a differentiation of companies at an earnings level and pressure on more challenged sectors, such as car manufacturers and retailers, which could support the asset class further.
“Companies have spent the last few years being pretty equity-friendly with regard to share buybacks and dividends they are now having to make a bit more of a choice because earnings and the macro have turned a little bit,” he said.
“The choice is ‘do I allow the balance sheet to deteriorate and take the ratings downgrade that will be associated with that or do I turn off the tap on the share buyback programme or dividend in order to preserve the balance sheet health and the ratings’?”
As such, the board and management of companies in challenged sectors are questioning whether they want to risk a rating downgrade.
“That is going to involve equity dividends being questioned more than they have in recent times and I think that will be part of the constructive story for high yield from here,” the Hermes manager said.
Lundie has managed the Hermes Multi Strategy Credit fund since launch in May 2014 and said he follows a more considered approach to portfolio construction, rather than simply picking companies.
“What binds it all together is our belief in security selection not just company selection,” he said. “So, [we’re] trying to emphasise the importance of how you access a company not just what company, which I think is often underappreciated in the asset class.
“To contrast that with equities, if you like a stock you buy the stock. If you like a company in credit you can buy it in dollars, euro, sterling, three-year, 10-year, 30-year, loans. bonds, secured, unsecured, hybrid, and so on.”
In addition, the Hermes manager said he often disregards where a company happens to be headquartered or what the rating agencies think about them.
“Often, you’ll have a situation where companies compete with one another globally where one is emerging market and [the other] developed market, or one is high yield and [the other] investment grade, and, therefore, the peer groups that people in asset management look at are nothing like the peer groups that people look at in the real world,” the manager explained.
Performance of fund vs sector since launch
Source: FE Analytics
Since launch in May 2014, Hermes Multi Strategy Credit has made a total return of 13.47 per cent compared with the average IA Sterling Strategic peer’s 15.35 per cent gain.
The fund has an ongoing charge figure (OCF) of 0.8 per cent.
Psigma Investment Management’s Thomas Becket considers the likelihood of the five main assumptions investors are making about markets.
Investors’ views on the market are being shaped by five key optimistic assumptions that may or may not turn out as they expect, according to Psigma Investment Management’s Thomas Becket.
Becket, Psigma’s chief investment officer, said investors were guilty of allowing assumptions on issues such as monetary policy, corporate earnings and geopolitics to guide their investment behaviour, even though some may be misplaced.
The first of the five optimistic market assumptions being made by investors is that the global economy is strengthening following fears of a weaker growth outlook towards the end of 2018.
“Clearly people have gone from thinking that the world was going to end and we were on the verge of a big recession to now believing what we actually saw was a mid-cycle economic slowdown and that the path of the global economy is likely to be higher as we move forwards,” said Becket.
However, investors convinced that the global economy is starting to recover might need to look again at the economic data.
For example, the most recent JP Morgan Global Composite PMI – an indicator of global economic growth – slowed to its weakest reading since September 2016 with rates of expansion easing in the manufacturing and services sectors.
The trend in new orders will have to pick up substantially in the coming months, noted JP Morgan director of global economic coordination David Hensley, if global GDP is to recover to “a level more in line with expectations for 2019 as a whole”.
“Markets might want to believe that the global economy is starting to recover but, as yet, there isn’t any tangible evidence to suggest that is taking place,” added Psigma’s Becket.
Despite the strength of the US economy, he said data from Europe and Asia remains much weaker and makes it difficult to confirm whether the market slump is now over.
The second market assumption being made by investors is that monetary policy will be looser this year, which could act as a support for financial markets.
In January, the US Federal Open Market Committee announced that it would exercise greater patience in determining the appropriate interest rate level, following fears last year that the Feeral Reserve was ‘normalising’ and hiking rates too quickly.
The move prompted much relief in markets, which rebounded following a challenging end to 2018.
“The market now believes that the Fed has done an enormous ‘volte face’ and gone a complete 180 [degrees] from its position in December and that rather than going up in 2019, interest rates are either on hold for a long time or indeed the next movement could be down,” he said.
The Psigma investment chief agrees that the Fed was likely done with interest rate rises for the time being. In addition, the European Central Bank is unlikely to be in a position to ever raise rates and is more likely to engage in a further bout of quantitative easing.
“That could well be something that which helps financial markets continue to perform well in 2019,” he added.
Becket said the third assumption made by investors is that Chinese authorities will once again “put the pedal down to the metal” and create a lot of stimulus as was seen in 2015-2016, helping to boost its economy and – at the same time – global growth.
Quarterly GDP growth 2015-2016
However, the chief investment officer said there were two reasons why the Chinese economy was unlikely to grow in such a fashion this year.
“One, the Chinese authorities are doing nowhere near as much stimulus as they were three years ago,” he said.
“The second dynamic is perhaps more important: the stimulus measures that have been put in place has done nothing to arrest the decline in credit creation in the economy and it looks to us that the authorities might well have lost control of China’s economic short-term future.”
The fourth assumption that investors are making is that a trade war between the US and China will soon be resolved, said Becket. However, here too, investors might be too optimistic.
Hopes were raised after the latest US tariffs on China were postponed for 90 days on 1 December, as both sides pledged to continue negotiations aimed at addressing trade issues.
The Psigma chief investment officer said it was unlikely that any deal struck between the world’s two largest economies would address long-term issues.
“We’ve always said there will be a trade deal, but we always said it wouldn’t be worth the paper it is written on,” the strategist explained.
“It might look like a good deal for Donald Trump and it might look like one for president Xi of China but it’s not going to be something that is longstanding or move the needle on global economic growth and global trade.”
While it is understandable that the markets have become more positive about trade given recent positive developments, said Becket, in the long term “something macabre has been let out of Pandora’s box” likely to have an impact on markets for the rest of the current decade and into the next one.
“The more concerning thing for investors is that what originated as a salvo over trade has now actually morphed into something out of control into great and longstanding concerns over national security which is going to rumble on for a long time still to come,” he added.
The final assumption made by investors is that global earnings will pick up this year, after an underwhelming 2018 during which expectations were massaged lower.
“In fairness to investors, you can say that low expectations have been beaten and weren’t as bad as many were expecting,” he said. “For now, we think that people are probably too optimistic in their outlook for corporate earnings and we’re likely to see adjustments lower than people’s expectations.
“That could well be some heavy treacle for people to move for as we move into the summer of 2019.”
Performance of MSCI World in YTD
Source: FE Analytics
Becket said after a troubled end to the year for markets, greater optimism has now taken hold. But while there are some grounds for a more positive outlook there are likely to be further challenges ahead.
“We believe that having seen really poor performance in equity markets in the last year and indeed the credit markets we saw a likely recovery in January in to the early days of February, we’ve now seen much more volatility,” concluded Becket.
“Probably, in the short term, people have become too optimistic and more volatility is likely as we move through the first quarter of 2019 and into the summer.”
We examine the IA Mixed Investment 20-60% Shares sector to see which funds have been well ahead of their peers over the past five years.
MI Hawksmoor Vanbrugh, Vanguard LifeStrategy 40% Equity and Premier Multi-Asset Distribution are some of the funds that have topped the IA Mixed Investment 20-60% Shares sector on multiple risk and return measures for recent years, FE Trustnet research shows.
The IA Mixed Investment 20-60% Shares sector has been a popular one with investors as its members offer portfolio diversification and relatively cautious positioning.
As part of our annual series, we have compared these funds across 10 metrics: cumulative five-year returns up to the end of 2018 as well as the individual returns of 2018, 2017 and 2016, annualised volatility, alpha generation, Sharpe ratio, maximum drawdown, and upside and downside capture relative to the sector average.
Each fund’s average decile ranking for the 10 metrics has then been worked out to discover which were most consistently at the very top for this wide spread of risk and return measures.
Performance of fund vs sector and index over 5yrs to end of 2018
Source: FE Analytics
Taking the top spot is MI Hawksmoor Vanbrugh, with an average decile ranking of 2.1. The £143.4m fund made a first-decile 31.5 per cent return over the period under consideration; it’s also in the sector’s top decile for alpha, volatility, maximum drawdown, Sharpe ratio and downside capture.
Managed by Daniel Lockyer and Ben Conway, the five FE Crown-rated fund-of-funds is designed to be a core long-term portfolio with a target of delivering returns in excess of CPI over the medium term.
Lockyer and Conway’s investment approach centres around finding the actively-managed funds that are best-placed to capitalise on the significant trends and themes affecting the world economy and its financial markets.
MI Hawksmoor Vanbrugh’s largest holding at present is the Polar Capital UK Value Opportunities fund, followed by Jupiter Absolute Return, Merian Gold & Silver, TwentyFour Monument Bond and Phoenix Spree Deutschland.
In second place is Vanguard LifeStrategy 40% Equity with a score of 2.3. This is a member of the Vanguard LifeStrategy range of five multi-asset funds, which hold underlying Vanguard index trackers and have proven to be consistently popular since launching in 2011.
The £3.4bn fund might be made up of index trackers, but its performance over the five years examined in this research exceeds that of the majority of active strategies in the IA Mixed Investment 20-60% Shares sector. Over the five years to the end of 2018, its 32.86 per cent total return is ranked seventh out of 120 funds.
All the LifeStrategy are automatically rebalanced to maintain their target allocations. Vanguard Group chief executive Mortimer J. Buckley explained the importance of this feature: “Over the years, I’ve found that prudent investors exhibit a common trait: discipline. No matter how the markets move or what new investing fad hits the headlines, those who stay focused on their goals and tune out the noise are set up for long-term success.
“Don’t panic. Don’t chase returns or look for answers outside the asset classes you trust. And be sure to rebalance periodically, even when there’s turmoil.”
Source: FE Analytics
In third place is the £123m LF Seneca Diversified Income fund, which is run by Richard Parfect, Mark Wright, Tom Delic, Peter Elston and Gary Moglione. It scored a 2.4 average decile ranking in this research.
Seneca Investment Managers believes “there is a real need for good income-generating investments” and this fund aims to deliver a high and growing income with the potential to preserve the real value of invested capital.
The managers invest directly in UK equities (top three holdings are AJ Bell, Marston’s and Kier Group) but outsource investments in overseas stocks (CIM Dividend Income, Prusik Asian Equity Income, BlackRock World Mining Trust), fixed income (Royal London Short Duration Global High Yield Bond, Muzinich Short Duration High Yield, Royal London Sterling Extra Yield Bond) and specialist assets (International Public Partnerships, Doric Nimrod Air Two, Sequoia Economic Infrastructure).
Of the 26 IA Mixed Investment 20-60% Shares funds to score less than 4 in this research, Vanguard LifeStrategy 40% Equity is the largest at £3.4bn.
The £1.4bn Premier Multi-Asset Distribution fund, headed up by David Hambidge, Ian Rees, Simon Evan-Cook and David Thornton, is the second largest. This fund-of-funds has built up a strong track record on the back of its valuation-based process and firm belief in the merits of active management.
Other funds that have assets under management of more than £500m and are at the top of the peer group for many of the metrics we looked at include Artemis Monthly Distribution, M&G Episode Income, Premier Multi-Asset Monthly Income, Royal London Sustainable Diversified Trust and Fidelity Multi Asset Strategic.
Source: FE Analytics
At the very bottom of this research, however, is the £555.1m Quilter Investors Diversified Portfolio, which scored 9.3. The fund is in the peer group’s bottom quartile for its five-year loss of 0.53 per cent as well as its alpha, maximum drawdown, Sharpe ratio and downside capture.
One-quarter of the portfolio is allocated to the Quilter Investors Global Dynamic, which is bottom-decile in the IA Global sector over the five years in question.
Other large funds coming with average decile scores higher than seven include Halifax Cautious Managed (£2.4bn), Investec Cautious Managed (£1.8bn) and Janus Henderson Cautious Managed (£1.6bn).
Seven funds have beaten their sector in eight of the past 10 calendar years and one of these managed the feat in all 10.
Man GLG Continental European Growth is the most consistent IA Europe ex UK fund of the past decade, beating its sector average in every single one of the past 10 years, according to a study by FE Trustnet.
Of the 79 funds in the sector with a track record long enough to be included in this study, another six beat their average peer in eight of the past 10 years.
Performance of funds vs sector
Source: FE Analytics
Rory Powe, who has managed Man GLG Continental European Growth since October 2014, focuses on what he calls “multiple preservation” – meaning he primarily seeks companies that are unlikely to de-rate rather than likely to re-rate.
A statement from Man GLG said Powe is “determined” to invest in strong growth franchises through a focused research approach.
“While many fundamental investors will place emphasis on management teams, Rory prioritises company strength, growth dynamics and product roadmap,” it added. “He seeks strong business cases – analysing companies from the bottom up – rather than coming to them as an industry expert, meaning that companies are often overlooked by sector analysts.”
The companies that Powe buys tend to fall into one of two categories: ’established leaders’ and ‘emerging winners’.
Established leaders are “formidable market leaders in their industry, with clear roadmaps for earnings and free cashflow, and a five-year expansion path”. The manager seeks an average 10 per cent per annum potential upside from these names and 50 to 100 per cent of the portfolio will typically be invested in this category.
Emerging winners are high growth names “in the vanguard of a new or existing market which already demonstrate clear competitive advantages”. Powe seeks an average potential upside of 15 per cent per annum from these names. A maximum of 33 per cent of the portfolio will typically be invested in this category.
Man GLG Continental European Growth made 243.51 per cent over the 10-year period in question compared with 113.39 per cent from the IA Europe ex UK sector and 115.07 per cent from its FTSE Europe ex UK index.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The £1.3bn fund has ongoing charges of 0.9 per cent.
Tanvi Kandlur, an analyst at FE Invest, said that while Man GLG Continental European Growth is an excellent fund, it is too similar to another name on the FE Invest Approved Funds List, Jupiter European, to also warrant inclusion.
Jupiter European was the only fund of the six to beat the sector in eight of the past 10 calendar years that also outperformed Man GLG Continental European Growth from a total return perspective over this time. Its gains of 293.16 in the decade-long period were the highest in its sector, while Man GLG Continental European Growth finished in third place.
FE Alpha Manager Alexander Darwall, who heads up Jupiter European, focuses on selecting European companies with long-term growth potential regardless of the economic backdrop. He attempts to understand a company’s business model, strength of management and financial structure – preferring those that self-finance through profits to those with excessive debt – to build in a further safety margin.
The analysts at FE Invest said Darwall has built up an impressive track record in European equity investing, and his strategy and style of buying high-quality global companies has now weathered a number of different market environments.
“It is also reassuring to see that value has been added, by successful company selection, over and above that which we would expect from just buying a general basket of these types of companies,” they added.
“The fund could sit well as a core European equity holding, should investors believe that more globally oriented, higher-growth companies will continue to outperform a more balanced approach. However, the fund does contain a significant amount of company-specific risk which, when combined with the strategy’s bias, may make it unsuitable for some investors.”
The £5.3bn Jupiter European fund has ongoing charges of 1.03 per cent.
Two of the other funds that have beaten the sector in eight of the past 10 calendar years also made the list of 10 best performers over this time: Baillie Gifford European with gains of 207.96 per cent and Threadneedle European Select with gains of 185.64 per cent.
Performance of funds over 10yrs
Source: FE Analytics
Baillie Gifford European invests in high quality, well managed businesses that are able to grow significantly.
“Companies in which we invest will typically have a strong competitive position and be managed by owner-oriented people,” they said.
“Portfolio construction is team-based, with the overall weighting of stocks in the portfolio a function of the collective conviction of the fund’s managers. We believe this approach helps us to avoid some of the behavioural challenges of group decision-making.”
Baillie Gifford European is £453m in size and has ongoing charges of 0.59 per cent.
Threadneedle European Select is headed up by FE Alpha Manager David Dudding and Mark Nichols, who invest in quality growth companies that have a competitive advantage and in sectors with high barriers to entry.
The team at Square Mile Investment Consulting & Research said that although this fund is called Threadneedle’s higher alpha European (ex UK) equities proposition, it is not an aggressively managed fund and the portfolio is constructed with some consideration for its benchmark.
“The emphasis on quality and a company's competitive position does mean that certain areas of the market where there is a lack of pricing power, such as some of the more cyclically sensitive sectors, are typically avoided,” it said.
“Conversely, sectors where there are high barriers to entry and therefore dominant incumbents, such as consumer goods and healthcare, can see sizeable overweights.”
The £1.5bn Threadneedle European Select fund has ongoing charges of 0.83 per cent.
James Donald, head of emerging markets at Lazard Asset Management, explains why the long-term case for emerging market equity exposure remains despite recent challenges.
The performance of emerging market equities in 2018 was disappointing. It also made one thing perfectly clear: investors have differentiated among emerging markets. Those countries with the highest exposure to a strong US dollar over the last year, namely Argentina and Turkey, were disciplined by the capital markets. Countries that were better positioned mostly outperformed.
The two main variables on which investor confidence and sentiment currently hinges are volatility and uncertainty. While we expect both to persist into 2019, we also hope for clarity on a number of issues. If these issues are resolved favourably – e.g. a stable or declining US dollar, a workable trade scenario, accelerating growth outside of the US – then emerging markets will likely benefit.
One area in which investors face the greatest uncertainties is trade. Donald Trump and president Xi Jinping have agreed to a trade truce at the G20 Summit, which delayed further US tariffs for 90 days. At the moment we believe that this truce, which is set to end on 1 March 2019, could be extended. Even the partial resolution – or stabilisation – of the trade war in 2019 could be a strong support for emerging markets equity performance going forward. However, should trade continue to be a major issue, as it easily could, long-term pressures are likely to be placed on markets.
At the World Economic Forum, China’s vice-president, Wang Qishan, acknowledged the risks facing major economies, including “unilateralism, protection and populism”. While China’s top officials have vowed to maintain “sustainable growth” as part of a deliberate, long-term effort to make the Chinese economy more balanced, questions are being asked about whether China can be relied upon to drive future growth in the emerging markets. The ability of Asia’s emerging markets to adapt to China’s changing economy, be it diversifying their trade partners or in some cases reinventing themselves, will be one to watch in 2019.
If US growth continues to be strong but Europe and China falter, then investors face the potential for slower growth in emerging markets and a rising US dollar. Outperformance will likely compel the Fed to raise interest rates at a quicker pace or higher than expected, thus attracting investors in search of higher yields. An economic contraction, on the other hand, will drive investors to seek safety – typically in US assets. If, however, other regions narrow the growth gap with the United States, or if global growth overall is sluggish but sustainable, then the US dollar will likely face downward pressure. The dollar’s strength this year will go a long way towards determining how risk assets fare.
Given the many variables and challenges, it can be easy to overlook the positives. The rising dollar in 2018, while a challenge for individual countries, did not result in contagion. Emerging market fundamentals remain relatively sound – country balance sheets have been stronger than expected, and fiscal deficits generally remain in good shape. Real interest rates are relatively high compared to developed markets. Interest rates were last at these levels in 2016, just before a two-year rally in emerging markets assets.
The growth premium between the emerging markets and developed markets narrowed in 2018 as the US economy outperformed, but we believe this premium will start to widen again in 2019. Looking forward, we expect US earnings growth will moderate and decline in 2019, potentially to a level below emerging markets.
Is it time to buy emerging markets again? Equity declines in 2018 have significantly lowered valuations. The emerging markets discount relative to US equities has widened beyond the 20-year average. At the end of the year, the MSCI Emerging Markets index was down to 11.8x trailing earnings, from 15.0x, a discount of about 35 per cent compared to the S&P 500 index.
In addition, this discount offers exposure to potentially greater growth opportunities – 8.0 per cent earnings per share growth versus 7.6 per cent for the US in 2019 – as well as relatively attractive free cash flow yields (6.5 per cent versus 4.8 per cent in developed markets and 4.3 per cent in the US). Emerging markets equities also offer opportunities to pick up dividends for yield-hungry investors – the emerging markets dividend yield is about 2.9 per cent compared to 2.1 per cent for the S&P 500 index.
Investors can hold emerging markets for tactical reasons, but we believe the emerging markets “story” – characterised by higher growth potential, stabilising institutions, a rising middle class of consumers – remains valid, regardless of higher volatility and relatively short-term changes in investor confidence. We believe that emerging markets companies with strong prospects, effective management, and relatively attractive prices remain one of the best ways to access this long-term investment opportunity.
James Donald is head of emerging markets at Lazard Asset Management. The views expressed above are his own and should not be taken as investment advice.
The broker’s analysts argue that infrastructure looks like it has recovered from the difficult first few months of 2018.
Last year created some challenging conditions for infrastructure investment trusts, with sentiment towards the space reaching a low ebb during the first half of 2018.
As analysts at Numis Securities pointed out, issues like the Labour Party’s suggestion that areas such as railways, water and energy should be nationalised as well as the focus on counterparty risk sparked by the collapse of outsourcing giant Carillion caused investors to avoid infrastructure investments.
However, Numis added: “Discounts proved short lived as the takeover of John Laing Infrastructure at a 20 per cent premium to net asset value [NAV] led to a re-rating, and in our view, highlighted the peer group’s conservative portfolio valuations.”
The IT Infrastructure sector is currently trading on an average premium to NAV of 12.4 per cent and none of its six members are on a discount. In their 2019 outlook, Numis analysts highlighted what they think are the most attractive options in the infrastructure space.
Performance of trust vs sector over 10yrs
Source: FE Analytics
The group’s core recommendation is International Public Partnerships, based on its primary origination capability and its high inflation correlation.
Numis places great emphasis on the understanding the different origination strategies of infrastructure investment trusts and said that International Public Partnerships benefits from the strong origination capabilities of its manager, Amber Infrastructure.
“Amber has a preference for being the primary owner of equity, enabling it to decide key contract terms. Unlike acquiring assets in the secondary market, price is not always the only driver of winning a project,” the analysts said.
“This approach has facilitated access to less competitive areas and has enabled International Public Partnerships to collaborate on innovative infrastructure procurement methods.
“Notably, International Public Partnerships was one of the first investors in the OFTO sector [which covers the transmission of electricity generated by offshore wind farms], is a co-investor alongside the UK government in its Digital Infrastructure fund and a key part of the innovative Education Aggregator project.”
The analysts also noted that there is potential for NAV progression once the next portfolio valuation takes place. The trust’s most recent key valuation assumptions did not reflect the John Laing acquisition because it happened after the balance sheet date, but it did lead a re-rating in the rest of the space.
International Public Partnerships has ongoing charges of 1.48 per cent, is trading on a 7.5 per cent premium to NAV and yields 4.5 per cent.
Second on Numis’ list is HICL Infrastructure, which is also described as a ‘core’ buy because of its attractive long-term cashflows.
Performance of trust vs sector over 10yrs
Source: FE Analytics
The broker pointed out that HICL’s interim results for the six months to 30 September 2018 were “strong”, which offers reassurance on the quality and predictability of the trust’s cashflows.
It also noted that the trust’s management has offered an honest review of the key issues that negatively impacted HICL’s share price performance last year.
“We have been comforted on a number of points including low risk of early termination, as well writing back some of the previous adjustments made to former Carillion assets,” analysts said.
“We also feel that much of the bad news is out in respect of its Affinity Water investment, suggesting that NAV total returns should remain stable. Accordingly, we retain HICL on our recommended list reflecting its attractive valuation compared with the more expensive BBGI.”
HICL Infrastructure has ongoing charges of 1.26 per cent, is trading on a 6.5 per cent premium and yields 4.9 per cent.
Numis also has two infrastructure trusts that reside in the IT Infrastructure – Renewable Energy sector among its 2019 recommendations: Bluefield Solar Income and Greencoat UK Wind. Both are deemed ‘core’ buys thanks to being pure plays on their respective niches.
“We are attracted to Bluefield Solar Income’s strong pricing discipline, which has led to the manager building a high-quality portfolio which has delivered strong cash flows against a volatile power price backdrop,” Numis said.
“This has resulted in the highest dividend payment of the peer group, with the manager exceeding its stated dividend target in three of the last five years.”
The broker also argued that the trust’s current premium reflects quality of the business, while there is scope for the NAV to grow into this as the manager works to optimise the portfolio’s value through measures such as assumed asset life extensions.
Performance of trusts vs sector over 5yrs
Source: FE Analytics
When it comes to Greencoat UK Wind, Numis also likes the fact that it is a high-quality business.
Analysts added: “The fund has a simple and low geared capital structure, albeit shorter in term than the wider peer group (5.9 years average maturity).
“Although the shorter-term, interest only nature of the facility potentially leaves it exposed to refinance risk, the manager is confident that the quality of the asset base remains a key attraction to potential lenders.”
Bluefield Solar Income has ongoing charges of 1.05 per cent, is trading on a 16.2 per cent premium and yields 6 per cent. Greencoat UK Wind’s ongoing charges are 1.28 per cent while it trades at a 10 per cent premium to NAV and yields 5.2 per cent.
Fixed income managers are concerned by the outlook for some parts of the investment grade and high yield market, despite their strong recent performance.
Investors should be wary on the outlook for corporate bonds as the market adjusts to higher interest rates, according to a number of managers who are focusing on higher quality assets.
Although 2018 saw most fixed income sectors post losses as the Federal Reserve continued to hike US interest rates, the new year has seen every Investment Association bond peer group generate a positive average return for their investors.
Sentiment towards bonds has been bolstered by Federal Reserve chair Jerome Powell, who recently suggested that the external factors such as China’s slowdown and a hard Brexit has caused the central bank to pause in its plan to hike interest rates.
Performance of sectors in 2018 and 2019
Source: FE Analytics
But while this U-turn from a hawkish Fed to a dovish one might have benefitted bonds in the short run, Seven Investment Management (7IM) chief strategist Terence Moll warns that interest rates will have to rise at some point – and this means the possibility of a bond catastrophe remains “worryingly high”, particularly to cautious investors who tend to have greater fixed income exposure.
7IM’s investment team has held fewer bonds in recent years in a bid to protect portfolios from this risk, arguing that it is better to give up the 1.1 per cent coupon offered by gilts to avoid a potential 5 per cent capital loss.
“For a long time at 7IM, we have been talking about the impact that rising interest rates will have on portfolios that are heavily weighted to bonds. The maths is simple and inescapable: a 1 per cent rise in the yield of a 10-year bond results in a (roughly) 10 per cent loss of capital,” Moll said.
“For cautious investors, a permanent loss of capital is the key thing to avoid – they have less time and fewer risky assets that can generate gains to compensate. But in seeking to avoid equity market volatility, cautious investors may be taking a far greater unseen risk. Interest rate increases haven’t finished and bonds are still exposed.”
The market had expected the Fed to implement four rate rises in 2019, but this outlook has softened after the dovish statement of its recent Federal Open Market Committee meeting. It has so far taken the Fed more than two years to raise interest rates by 2 per cent and they remain much lower than the long-term average of 5 per cent.
However, Moll pointed out that while interest rates outside of the US remain low, they won’t stay this way forever. Europe is expected to start exiting its negative rate environment in a year or two and Japan is increasingly finding that low rates are unsustainable, the strategist added; there are no major central banks looking to cut rates.
In this environment, 7IM has maintained its underweight position in fixed income. Exposure is taken through quality instruments to reduce volatility and as tail-risk protections, with holdings tending to be high grade government bonds such as gilts, US Treasuries and Japanese and European government debt.
“The global financial crisis wasn’t just about interest rates. The money pumped into global bond markets is in the double-digit trillions. Removing it is not going to be without consequences, no matter how gradual,” Moll concluded.
FOMC ‘dot plot’ for December 2018
Source: Federal Reserve
“Bonds have been in a bull market for the past 35 years, ever since the high interest rates of the early 1980s started to decline. We often hear the comment that ‘interest rates have gone up, and nothing bad has happened to bond markets’. That statement is missing a word – ‘nothing bad has happened to bond markets...yet’. So far, that pain hasn’t happened. But that doesn’t mean the risk has vanished.”
For Man GLG Strategic Bond lead manager Craig Veysey, one of the biggest risks of quantitative tightening centres on BBB-rated corporate bonds. The number of BBB-rated corporate bonds has “exploded” since 2008 as companies used ultra-low interest rates to issue debt then buy back stock and finance other equity-friendly activity.
However, the manager is concerned that large swathes of BBB-rated corporate bonds could fall into the high yield index as volatility rise and worsening fundamentals prompt widespread credit downgrades in this part of the market.
Indeed, the recent Bank of America Merrill Lynch Global Fund Manager Survey found that asset allocators believe corporate balance sheets are overleveraged and believing more action should be taken to de-lever at the expense of cash being used for capital expenditure, dividends and buybacks.
“The suppression of volatility we’ve seen in recent years due to quantitative easing is reversing direction with quantitative tapering likely to amplify volatility. At the same time the economic cycle is not as constructive as it was, with leading indicators weakening in many parts of the world,” Veysey said.
“We are very, very cautious of those cyclical BBB- issuers that lack the flexibility to reduce the size of their balance sheet or increase their cash flow – we think a large number of these could quickly find themselves in the high yield index.”
Due to this, Veysey’s Man GLG Strategic Bond fund has been focusing on defensive opportunities including special situations, particularly where companies are seeking to deleverage, improve their credit quality and avoid shareholder-friendly activity. An example is Tesco, which has been turning around its business and is now only one rating agency upgrade away from moving from sub-investment grade to investment grade.
It’s worth pointing out that not every bond manager agrees that BBB-rated bonds look at risk of being downgraded. Bond specialist TwentyFour recently published a white paper arguing that concerns that there is a wave of downgrades for companies rated BBB could be overdone.
Chris Bowie, manager of the TwentyFour Absolute Return Credit fund, said: “BBBs do have inherent risks, and some are indeed elevated compared to other assets within fixed income. But being actively invested in BBBs can enable an investor to capitalise on their virtues, while avoiding the small subset of BBBs that become ‘fallen angels’ as far as possible.
“The risks are manageable and far outweighed by the benefits, in our view. Our research shows these bonds have consistently produced the very best risk-adjusted returns across the global fixed income market. Avoid them at your peril.”
There have also been warnings that investors should be cautious on the high yield space, despite its strong start to 2019, as the credit cycle matures.
Andrea Iannelli, investment director at Fidelity International, pointed out that high yield credit benefitted from the Fed’s change in stance and rebounding oil prices. Credit spreads tightened by nearly 100 basis points during the past four weeks, undoing the widening seen in December 2018 and taking them back to mid-November levels.
“Looking ahead the performance of the asset class will be driven by the resurging demand for income as the Fed takes a more dovish stance and the performance of oil prices. We are wary, however, that the credit cycle continues to advance, increasing room for idiosyncratic bouts of volatility amid a still challenging market liquidity backdrop,” he concluded.
“The buoyant market conditions have seen some resurgence in bond supply, after December saw little to no issuance coming to market. With plenty of refinancing still pending, a ramp up in supply could become a headwind for returns. From a valuation standpoint, our models indicate that current spread levels still fail to provide appropriate compensation for rising defaults at the lower end of the rating spectrum.
“On balance, we favour a neutral stance towards the asset class, looking for opportunities to increase the average quality of our exposure.”
More than 50 names were added to the FE Alpha Manager list for 2019 taking the total to 200, with a significant number of first time appearances.
BlackRock has taken the top place as the group with the most FE Alpha Managers following the annual rebalance of FE’s list of top-performing fund managers, which saw more than 50 names added.
The list represents the top 10 per cent of managers in the UK retail-facing investment industry; it is based on performance dating back to 2000, with extra weighting for managers with the longest track records.
Other criteria taken into account include a manager’s ability to create risk-adjusted alpha, outperformance in both rising and falling markets, and those who consistently beat their benchmarks.
This year there are 200 individuals holding FE Alpha Manager status with BlackRock taking 10 spots, narrowly seeing off Fidelity International’s nine, as the below table shows.
Four new BlackRock names were added, allowing the group to take the top spot, while Fidelity dropped to second place after its manager count fell by one from last year’s showing.
Comgest Asset Management soared towards the top of the rankings with seven FE Alpha Managers – all first-timers – after becoming eligible for sale in the UK and, therefore, a rating.
The French group sits alongside M&G, which added three managers to its total from last year, and was followed by Janus Henderson Investors, JP Morgan Asset Management, Marlborough Fund Managers, Polar Capital and Schroders on five each.
Top sector this year was IA Japanese Smaller Companies with the highest percentage of FE Alpha Managers (57 per cent), knocking the winner of the last two years, IA UK Smaller Companies, down to second place with 47 per cent.
IA UK Index Linked Gilts had just one top-ranked manager, while there were none to be found in the IA UK Direct Property and IA Volatility Managed sectors.
“The volatility in 2018 has had an impact on these figures, even with the long-term focus of the rating,” said Rob Gleeson, head of FE research.
“It’s not surprising that sectors that typically have a high average active share have the most FE Alpha Managers, as there was opportunity for the right active strategy to do very well through this period.”
In total, 54 names were added to the list this year, including 38 first time FE Alpha Managers, while 52 lost their rating mostly due to non-investment related reasons such as retirement.
“Several managers with a focus on smaller companies have lost their place,” said Charles Younes, research manager at FE. “This is reflective of the underperformance of smaller companies compared to large-caps since Brexit. Managers with a preference for smaller companies have been struggling to generate alpha across the board.”
As already mentioned, seven first-time managers making it onto the list came from Comgest, which did not previously have any managers on the list, making it the group with the most new FE Alpha Managers and the most first-timers.
Dobler, Weis, Cosserat, Fronadi and Kaddoum work across several European equity strategies, while Narboni and Piquemal-Prade manage global and non-European mandates.
BMO Global Asset Management and Hawksmoor Investment Management also made it onto the 2019 list with more than one new top-rated manager.
There were several other first-timers who represented their firms’ sole representative. These included: AllianceBernstein’s Sammy Suzuki, Tom May of Atlantic House Fund Management, Lombard Odier’s Odile Lange-Broussy, and Sanlam’s Pieter Fourie.
In addition, several firms with a presence on the FE Alpha Manager list already saw multiple first-timers joining at the latest rebalance.
They were joined by Baillie Gifford’s Mark Urquhart and Torcail Stewart, Fidelity’s Bryan Collins and Hyunho Sohn, JP Morgan’s Mark Davids and James Elliot, and M&G’s David Fishwick and Richard O’Connor.
Meanwhile, GLG Partners, Majedie Asset Management, Matthews Asia, Merian Global Investors, Miton Asset Management, PIMCO, Royal London Asset Management, Schroders and T. Rowe Price each saw one first-time manager given the rating.
While there was a substantial number of first-time managers there were also a number of familiar faces returning in 2019 after a period of absence.
One of the biggest names returning to the FE Alpha Manager fold was hedge fund manager Crispin Odey, who has now featured in the list 10 times.
Odey’s globally focused, multi-asset LF Odey Opus fund – which he manages alongside Freddie Neave – made a loss of 3.1 per cent last year against a 3.04 per cent fall for the benchmark MSCI World index.
Over 10 years to 14 February, the fund has made a total return of 151.73 per cent outperforming the average IA Flexible Investment peer’s 124.96 per cent gain but below the benchmark s 239.33 per cent return.
Fixed income investor Dickie Hodges – who manages the Nomura Global Dynamic Bond fund – makes his sixth appearance, as does MFS Investment Management’s Barnaby Wiener and Matthew Ryan. M&G’s Leonard Vinville also stands out for his fourth appearance in the list.
Another name making a return as an FE Alpha Manager is Stephen Yiu, whose LF Blue Whale Growth has been a strong performer since launching with backing from Hargreaves Lansdown founder Peter Hargreaves.
The £98.2m fund, which Yiu manages alongside Rob Lloyd, has recorded a 24.11 per cent gain since launching in September 2017, while the average IA Global peer has managed a return of just 7.06 per cent.
Prior to launching investment firm Blue Whale Capital in 2017, Yiu had worked at Artemis Fund Managers and on Hargreaves Lansdown’s multi-manager offering.
Another veteran investor making a return to FE Alpha Manager status is small-cap specialist Paul Mumford, manager of the five FE Crown-rated TM Cavendish AIM and flagship TM Cavendish Opportunities funds.
Since launch in February 1988, the £121m, UK smaller companies-focused TM Cavendish Opportunities fund has made a total return of 1,874.12 per cent.
Meanwhile, the £65.6m TM Cavendish AIM fund has made a return of 213.65 per cent, slightly underperforming the average peers 213.65 per cent return and a 2.36 per cent loss for the benchmark FTSE AIM All-Share index.
The Fidelity Special Situations manager says there are four criteria he applies to domestically focused stocks to see if their potential returns outweigh the risk.
UK-focused fund managers have repeatedly trumpeted the value available in domestically focused parts of the FTSE over the past few months, and Fidelity’s Alex Wright (pictured) is no different.
The FE Alpha Manager, who runs the £2.9bn Fidelity Special Situations fund, said the deeply unpopular status of this area of the market has created an “exceptionally fertile period” for contrarian stockpicking.
“I am struck by the sheer number of stocks across different sectors whose valuations suggest significant asymmetry of risk and reward over the next two to three years,” he added.
“I believe my investment style is well-suited to this environment and I have backed this belief by making a large personal investment into my funds at the end of 2018.”
Wright said that opportunities can be found across the market, in both international and domestic businesses. However, following further deterioration in sentiment towards the UK in Q4, he increased exposure to domestic stocks, primarily recycling capital from US-facing companies.
As a result, the portfolio derives 37 per cent of its revenues from the UK, a 7 per cent overweight relative to the FTSE All Share.
“I don’t have a differentiated view on the UK political or macroeconomic outlook,” said Wright, admitting that while there are risks in domestic companies, he believes they are worth taking if they satisfy the following criteria:
• A low valuation that reflects a worst-case outlook. “It is not difficult to find stocks that meet this criteria,” the manager said.
With this in mind, here are the domestic sectors the manager is currently buying – and avoiding.
Wright continues to avoid UK housebuilders, pointing out that most have all-time high profit margins, which gives them significant operational leverage to any deterioration in demand for new houses.
Performance of housebuilders since June 2016
Source: FE Analytics
Instead he prefers the two Irish builders Cairn and Glenveagh.
“These enjoy significantly better industry fundamentals, rising returns, and lower valuations,” he said.
“An Irish recession caused by Brexit remains a risk, though given most of Ireland’s trade with the UK is in agricultural products, the Irish economy may prove more resilient in the face of Brexit than many seem to think.”
Wright continues to tread cautiously among the retailers, where he said low valuations offer no comfort if he feels the business is structurally compromised. Just 2 per cent of the fund is invested in this sector, and this is across a number of small positions in companies which are relatively insulated, or benefit from, the shift online.
The manager added that protection from disruption could be provided by a cost advantage, or the provision of an ‘in person’ service in the shops.
“Some clients seem to expect me, as a contrarian, to have a higher weighting to this sector,” he said.
“However, with such a wealth of valuation opportunities across the market, there is no need to buy structurally compromised businesses – there are much more attractive opportunities elsewhere.”
Wright owns three UK life insurers – Phoenix Group, Aviva and L&G – where the average dividend yield for 2019 is more than 7 per cent.
He noted this is well above historic averages, reflecting the market’s concerns around asset quality and the effect of widening credit spreads on balance sheets.
“The work done by Fidelity’s insurance specialist suggests that the assets held by UK life insurers are significantly higher quality and more internationally diversified than the market is discounting,” said Wright.
“The dividends should be payable even in a downturn, and the long-term growth opportunities for the life insurance sector remain attractive, both in terms of organic growth and consolidation.”
The manager also continues to hold UK banks, saying that position sizes reflect the fact that while trading at attractive valuations, they are cyclical and have been in a relatively benign environment for loan loss provisions.
His preferred choice in this area may raise some eyebrows, however.
“With a lower loan-to-deposit ratio of 85 per cent, I now believe RBS has the most attractive balance of risk and reward in the sector,” he said.
Performance of stock since pre-financial crisis peak
Source: FE Analytics
“It trades at a P/B of under 1 and has a core tier 1 capital ratio of 17, meaning it holds significant excess capital which would provide a buffer in the event of any future losses. I don’t hold any challenger banks, where balance sheets are weaker and risk appetite seems to have been higher.”
Data from FE Analytics shows Fidelity Special Situations has made 39.84 per cent since Wright took charge at the start of 2014 compared with 31.15 per cent from the FTSE All Share and 27.22 per cent from the IA UK All Companies sector.
Performance of fund vs sector and index under manager tenure
Source: FE Analytics
The £2.7bn fund has ongoing charges of 0.91 per cent.
Fidelity International’s Dhananjay Phadnis explains why China isn’t the only factor influencing emerging Asia.
Emerging Asian equities have suffered in the short term because of China’s slowing growth and trade tension with the US but Fidelity’s Dhananjay Phadnis believes there are long-term reasons for confidence in the region.
Last year, the MSCI Emerging Markets Asia index dropped 10.2 per cent (in sterling total return terms) compared with a 9.27 per cent fall in the broader emerging markets index and a 3.04 per cent slip in the developed markets-focused MSCI World.
Of course, one of the biggest factors affecting markets in 2018 was the trade war between the US and China, while the Chinese economy has started to slow. Both of these factors have dented sentiment towards emerging Asia.
Performance of indices in 2018
Source: FE Analytics
Phadnis, who runs the UK-domiciled Fidelity Emerging Asia fund, noted that China is indeed a major driver of sentiment towards the rest of the region and has affected its markets for much of the recent past.
“After implementing a massive stimulus package in 2015, the Chinese authorities have shifted emphasis since the middle of last year and actively pursue deleveraging with a clampdown on shadow banking, curbs on property sales and significant restrictions on off-balance sheet debt in infrastructure project,” he explained.
“These measures, along with fears of an escalation in trade war, have led to a decline in corporate earnings and impacted equity markets. My view is that we are now closer to the end of this phase as China is reversing its deleveraging process and trade war concerns will potentially ease over time.
“With aggregate valuations attractive - even after discounting the current expectation for a likely slowdown in earnings growth - I see potential for strong returns once the near-term overhang of trade wars clear.”
However, the Fidelity Emerging Asia manager is also keen to point out that China isn’t the only factor that affects the direction of the region’s markets. In fact, he highlighted seven themes that could influence the long-term outlook for both good and bad.
The first is the tech hardware sector, which saw strong growth thanks to rising smartphones penetration; however, sales volumes are now starting to decline in many markets as ownership plateaus. Phadnis noted that this theme has “significant” implications for Taiwanese, Korean and Chinese companies that derive earnings from supplying components into the global supply chain.
India’s ‘twin disruptions’ – in the form of demonetisation and the goods & services tax – have caused temporary setbacks to the recovery in the country’s economic cycle. The manager believes that initiatives such as the tax are long-term positives for the Indian economy, but thinks its full recovery may be delayed by issues such as the recent liquidity crisis and the upcoming national elections.
He added that investors in emerging Asia cannot ignore the impact of reforms, which is the third theme highlighted. “Elections in India, Indonesia, Philippines, and more recently in Malaysia have highlighted public preference for a reform and growth-minded governments focused on clean governance,” he said. “Under president Xi, China has also undertaken major anti-corruption and financial system reforms.”
Performance of index over 5yrs
Source: FE Analytics
The fourth theme that Phadnis drew attention to is increased regulatory intervention, which are leading to leading to earnings uncertainty and could potentially delay corporate capital expenditure plans.
Examples include Chinese regulators intervening in areas such as peer-to-peer loans, education, gaming, content production and healthcare while the Korean government increased regulatory oversight of sectors such as banking and finance.
The manager also pointed out that the “re-wiring” of global supply chains has recently accelerated because of fears of escalating trade wars. “Global and Chinese companies alike are beginning to relocate their manufacturing chains to countries such as Vietnam, Cambodia, Bangladesh and India,” he said. “This has material implications for job creation and consumption in these countries.”
Asian companies are at the forefront of areas such as artificial intelligence and machine learning, meaning new technologies are another theme that could affect the region. This trend is clear in China, where companies likes Meituan Dianping, Tencent, Alibaba, Sensetime and Bytedance are pioneering new products and services; these can add significant value to some industries while disrupting many others.
The final theme highlighted by Phadnis is the development of China’s A-share market. “Perhaps the biggest change from an investible universe standpoint has been the gradual opening-up of the Chinese A-share market,” he said.
“Although the fund has been exposed to the A-shares for some time now via QFII [Qualified Foreign Institutional Investor] quotas, access has now become much easier with the North-South connect programme. There are some very strong businesses in China, and easier access to this market and to their management teams continues to throw up more and more attractive investment opportunities.”
Given this backdrop, Phadnis said he is seeing an “array of opportunity” in emerging Asia as a favourable valuation backdrop has combined with strong structural growth prospects and drivers such as rising consumption, urbanisation and innovation.
The manager has made recent investments in Hong Kong-based insurance company AIA (“at the cusp of a major opportunity in China”), A-share listed Guangzhou Baiyun International Airport (“will see a recovery as earnings improve from a favourable base”) and India’s Axis Bank (“gone through a dramatic clean-up of non-performing and risky loans”).
Performance of fund vs sector over 5yrs
Source: FE Analytics
Phadnis’ £88m Fidelity Emerging Asia has made a 108.21 per cent total return over the past five years, which puts it in the top quartile of the IA Asia Pacific Excluding Japan sector.
The fund has an ongoing charges figure of 0.98 per cent.
The Aberdeen Standard Investments manager says these organisations are no longer in control of the situation they have created.
Central banks now pose as big a threat to capitalism as communism once did, according to Bruce Stout, manager of the Murray International Trust, who says these organisations no longer have any credibility in what they are trying to do.
Stout said the decade-long experiment started by central banks across the world following the global financial crisis has distorted valuations to such an extent that investors now need to look further afield for ‘normal’ markets.
And he added that extraordinary levels of monetary support are continuing to have an impact on valuations, despite tentative moves to withdraw stimulus.
Stout (pictured), an economics graduate, said actions by the Bank of England, Federal Reserve and European Central Bank have created an environment “that we haven’t really seen before”.
“When you were studying economics, it was always assumed that the end of capitalism would’ve been caused by communism – that was the popular prognosis of the day,” he said.
“But the end of capitalism is every bit as likely to be caused by central banks because they have now got to a point where they have no credibility at all in what they’re trying to do and they’re not in control of the situation in terms of the way they would’ve been in past cycles.”
Short-term interest rates (Total, % per annum, Jan 2009-Jan 2019)
Interest rates remain at low levels in developed economies around the world and the sole flagbearer for raising rates – the Federal Reserve – has been forced to suspend its own hiking programme recently.
Stout added: “Nobody is allowed to go bust, markets are not allowed to have any sustained periods of pain without some reaction from the central banks and, therefore, the chances of normalising rates – whatever normalisation is, and I have no idea – is getting slimmer and slimmer.”
“From a practical point of view, you’re working in an environment of very fragile growth, but more importantly you’ve got lots of zombie companies that are only alive because of low interest rates and the debt loans that would have put them out of business a long time ago,” said the Aberdeen Standard Investments manager.
“That means they are cutting prices and pricing at marginal cost to raise cash to pay bondholders and therefore distorting the markets they operate in.”
Stout, who was appointed manager of the £1.5bn Murray International trust in June 2004, said that companies are struggling to make significant margins and therefore giving their products and services away at cost price.
“If you want examples, it’s like that in the retail industry, it’s like that in the banking industry and many other manufacturing industries where you just can’t make the margins anymore,” the manager said. “It’s because the cycle is not allowed to clear like it used to in the past.”
As such, Stout said central banks have been making the situation worse, not better, with their approach to setting rates.
He noted that the Nasdaq fell by almost 25 per cent – in US dollar terms – between the end of August until Christmas as investors became fearful that the Federal Reserve would raise rates faster than initially anticipated, although these fears were allayed last month.
Performance of index over period
Source: FE Analytics
However, Stout said there is a growing belief among investors that – despite the extraordinary levels of support for markets over the past decade – many industries have not been fixed.
Belief in the cyclicality of markets has also broken down, having been absent for much of the post-crisis period, resulting in investors paying greater sums for lower earnings.
“In the US, the people that most accept higher prices for lower earnings are the companies themselves because they are the biggest buyers of stock by a long way,” he said.
“Stock buybacks have become a fundamental prop for the US market, but for ordinary investors looking to invest in companies, the effect of low interest rates and great walls of money going into the stock market mean they’re paying higher and higher prices for lower-quality earnings.”
He added: “We’re 10 years into a business cycle expansion, so under any other metric we’re getting pretty long in the tooth. It wouldn’t be abnormal to expect a slowdown in earnings.”
The manager noted that while growth is low and poor in the UK, Europe and Japan, the US has been “slightly out of kilter with the rest of the developed world” due to president Donald Trump’s tax cuts and fiscal incentives 18 months ago.
“But they’re all gone now,” he said. “So we may well see that the US starts to slow down in line with the rest of the developed world and it will be interesting to see what the reaction is in aggregate to lower earnings.
“At the moment, individual companies are punished when they come up short with earnings or trading statements, but the market as a whole isn’t.”
With the developed economies likely to continue suffering the effects of the ongoing monetary experiment of central banks, Stout said investors should turn to countries and businesses in countries where the economic environment is “familiar”.
“The economic environment is familiar in something like India or Indonesia or Mexico where you have a positive real interest rate – the interest rate is higher than the inflation rate – so you have better returns,” he said. “You have lots of monetary flexibility because nominal interest rates are high relative to funding rates, so you can cut.
“And you have – in that environment – financial services companies, banks or retailers or whatever that can make a margin because you have normal macroeconomic conditions and you don’t have zombie companies or high debt levels that are distorting market pricing.”
He concluded: “In general those businesses tend to be realistically priced for potential profits for the simple reason that they’ve been off the radar of large global fund managers because they have been concentrated in indexes like the [technology-focused] Nasdaq.”
Since June 2004, the five FE Crown-rated Murray International trust has made a total return of 459.85 per cent against a 281.3 per cent gain for the average IT Global Equity Income peer.
Performance of trust vs sector & benchmark under Stout
Source: FE Analytics
The trust is 11 per cent geared, is currently trading at a premium of 4 per cent to net asset value (NAV) and has a 4.3 per cent yield. It has ongoing charges of 0.64 per cent, according to data from the Association of Investment Companies (AIC).
Hargreaves Lansdown’s Laith Khalaf explains why fears over the impact of a weaker UK economy on the stock market might be misplaced.
Investors concerned about a slowing UK economy shouldn’t allow themselves to be put off the domestic stock market, which remains home to a number of international names, according to Hargreaves Lansdown’s Laith Khalaf.
Since the EU referendum in June 2016, a Brexit-shaped cloud has been cast over the outlook for the UK economy as the future relationship with the bloc – its largest trading partner – remains uncertain.
The lack of a deal just under two months before the scheduled exit date – 29 March – is reflected in the economic figures: the latest data from the Office for National Statistics showed that the UK economy grew by just 0.2 per cent during the final quarter of 2018, below Bank of England forecasts.
Source: Office for National Statistics
Meanwhile, capital expenditure fell for the fourth consecutive quarter – the first time since 2009 and the height of the credit crisis – as businesses have become more cautious ahead of the departure date.
That has worried investors, with the UK market emerging as the most underweighted region by international asset allocators, according to the latest Bank of America Merrill Lynch Global Fund Managers Survey.
“The UK economy is slowing, and no-one needs three guesses why – the continued political deadlock over Brexit is damaging business investment,” said Khalaf, senior analyst at Hargreaves Lansdown.
“Add in a weaker global outlook too, and you have a pretty unpleasant cocktail of economic news.
“This is clearly concerning for investors, though it’s important to recognise the economy and the stock market are two very different beasts.”
Khalaf said the UK stock market is made up of internationally diversified companies and is also forward-looking, so weaker expectations for economic growth are already largely factored into prices.
Yet since the vote, the blue-chip FTSE 100 has significantly lagged the developed markets-focused MSCI World index, with a total return of 24.26 per cent against the latter’s 45.77 per cent.
The analyst said investors should understand, however, that dips in economic performance and stock markets are “part and parcel of a normal financial cycle” and that a weaker outlook for the economy may not matter anyway.
“There’s actually little correlation between the performance of the UK economy and the UK stock market in any given year,” he explained.
“The chart below plots GDP against the return from the stock market in each year back to 1966, and the trend line shows there is close to zero correlation between the two, if anything there is a very slight negative correlation.”
Source: Hargreaves Lansdown
The analyst added: “Indeed, of the seven years in this period which have witnessed economic contraction, the stock market has risen in five.”
Some of this lack of correlation can be explained by the level of UK listed companies’ overseas earnings, which represent around two-thirds of revenues.
Another reason is the quick adjustment of stocks to changes in economic expectations, compared with official data.
“As such,” he said, “a slowing UK economy is already factored into market prices. These can still change of course, based on a further deterioration, or improvement, in expectations. For the UK, the Brexit outcome will play a big part in forming these expectations.”
However, with Brexit uncertainty continuing to drag on and broader macroeconomic and geopolitical concerns, some experts have asked whether the FTSE 100 could be due a further fall.
“The FTSE 100 currently stands above 7,000, which may lead some to believe it’s expensive, as this was the level it almost reached in 1999, at the height of the tech boom,” Khalaf said.
“This view doesn’t hold weight though, as the FTSE 100 is a price-only index and doesn’t take account of the earnings of UK companies, which are a critical factor in determining its value.
“Factoring earnings in, the UK stock market looks somewhere near the middle of its historical range, even on the cheap side according to some indicators.”
On its own preferred measure – the cyclically-adjusted price-to-earnings ratio (CAPE) – the Hargreaves Lansdown analyst said the UK stock market stands at 16.5x compared with a long run average of 19.3x.
“This signifies the market is on the cheap side, but not compellingly so,” he said, adding that “a more persuasive buying signal” for UK equity markets is the dividend yield on offer.
“At 4.3 per cent, it’s close to the highest it’s been since the financial crisis – having hit 4.5 per cent at the beginning of the year, and fallen back slightly as markets have rallied.”
Valuation measures, Khalaf said, suggest that the UK stock market “is reasonably valued at present, neither extremely cheap nor expensive”.
“In the short term it could go up or down without defying the laws of statistics, but for investors the motivation for putting money in the stock market remains its long-term potential, particularly when compared with cash,” he added.
Performance of indices since the EU referendum
Source: FE Analytics
As such, investors should not allow short-term moves to de-rail their long-term savings goals, particularly when it comes to trying to make post-Brexit predictions.
“Investors can’t control the direction of Brexit, or the economy, though they do need to consider where their money is best placed for the next 10 years and beyond,” he said.
“Indeed, if the economy is stalling, that’s not going to persuade the Bank of England to raise interest rates any time soon, so cash savers could find themselves facing a longer wait before their returns are beating inflation.
“Brexit is likely to continue to dominate headlines and sentiment towards UK shares for the foreseeable future, so investors need to step back and take a longer-term view.”
Markets are forward looking so investors should be too, according to Fisher Investments chief executive officer Damian Ornani.
2018 tested many investors with a more turbulent course than 2017 – and disappointing returns to boot.
One recent study showed that, in US dollar terms, 90 per cent of major asset classes posted declines in 2018 through mid-November.[i] And that was before December’s swoon.
Such drops tempt many to think 2019 will be similarly bleak, as investors extrapolate recent market movement into the future. In my view, though, this mindset risks your financial health.
Markets look forward, not back, and yesterday’s market movement doesn’t predict today’s or tomorrow’s. One of investors’ greatest challenges is to think like markets – assessing the road ahead – uninfluenced by recent angst.
The recent past often colours investors’ emotions and memories, causing them to view the future through the lens of what they just experienced. Psychologists call this recency bias.
For investors, I would also call it a risk. The last day’s, week’s or month’s experience – returns, volatility, fears – is often front of mind. Whilst this is normal and understandable, if you let your emotions sink or swim with the market, it can lead to reactionary investment decisions: to dump what has hurt and chase what held up better, seeking safety after markets fall.
If markets were serially correlated – meaning yesterday’s movements impacted today’s and tomorrow’s – then this wouldn’t be an issue.
Trouble is, they aren’t. Take 2017’s smooth ride to stellar returns and 2018, for example.
Just the same, projecting last year’s experience into 2019 fails to take markets’ lack of serial correlation into account. This can set you up for repeat disappointments: missing rebounds after dips; perpetually chasing better returns; sitting sidelined and uncertain about how to put your retirement savings plan on a sustainable and viable track. Recency bias can jeopardise your financial goals.
Whilst the past isn’t predictive, history is an instructive guide. From a bird’s eye view, it shows how recency bias trips up investors and how to overcome it.
Similar bouts of volatility erupted in 2011 and 2015 and also coincided with meagre global equity market annual returns. Yet world equities resurged thereafter.
Using the S&P 500 in USD for its long available history, there have been 26 distinct periods since 1925 when cash has outperformed equities and fixed interest on a trailing 12-month basis – the last ending January 2016.[ii]
During bull markets (10 of those 26 times), shares subsequently rose – quite strongly, 22.8 per cent on average over the next 12 months, as measured by S&P 500 total returns.[iii] During bears (16 of 26), shares still rose half the time over the next 12 months, edging cash on average.[iv] So in all year-long periods when ‘cash was king’, nearly 70 per cent of the time after it was dethroned.
Of course, this doesn’t mean cash will necessarily falter relative to equities and other assets in 2019. But it should be a sharp reminder cash’s historical reigns have been short-lived – and you shouldn’t extrapolate.
So instead of automatically presuming worse times lie ahead in 2019 because 2018 was disappointing, ask yourself: What forward-looking reason do you have to expect continued poor returns?
Then ask yourself if your reason actually constitutes new news. If not, a third question: To what extent do markets already reflect this information?
These questions should force you to think forward and strike most widely discussed, backward-looking information.
The future is what matters now. Markets are always evaluating the next thing – its probable impact on future scenarios against what has already been priced in.
They aren’t infallible; after all, they are moved most by surprise. But most often, they do efficiently price in all widely known information. Weighing events as they evolve – and how everyone else is weighing them, too—bears more fruit than pondering what has passed. It is past.
It can be difficult to shake jarring events fresh in memory, but markets don’t dwell.
Acting on what already happened – when markets have moved on – isn’t a great way to invest going forward. To keep the past from carrying you away from your financial goals, always look ahead, no matter how compelling the rearview.
Damian Ornani is chief executive officer of Fisher Investments. The views expressed above are his own and should not be taken as investment advice.
[i] “No Refuge for Investors as 2018 Rout Sends Stocks, Bonds, Oil Lower,” Akane Otani and Michael Wursthorn, The Wall Street Journal, 25/11/2018.
[ii] Source: Global Financial Data, Inc., as of 20/12/2018. S&P 500, 10-year Treasury Note and 3-month Treasury Bill (cash) trailing 12-month total returns, January 1925 – November 2018. To group cash outperformance into distinct periods and avoid double-counting, we took the 145 rolling 12-month periods of cash outperformance and grouped them into 26 distinct periods. Some contain months in which cash briefly stopped outperforming over the trailing 12 months—for at most 3 months—but resumed outperformance thereafter.
[iii] Ibid. Average forward 12-month S&P 500 total return after cash outperforms during bull markets, January 1925 – November 2018.
[iv] Ibid. Average forward 12-month S&P 500 total return after cash outperforms during bear markets, January 1925 – November 2018.
The FE Risk Scores show that the majority of equity fund sectors have been more volatile than the UK market in recent years.
The IA UK Equity Income sector is the only peer group where the average member has been less volatile than the FTSE 100 over the past three years, according to the FE Risk Scores.
FE Risk Scores are a measure of relative risk, rather than absolute risk, and measure a fund’s volatility against the UK’s largest 100 companies. A score of 100 means that a fund has displayed the same risk as the FTSE 100 while a higher score means it has been more volatile; pure cash scores zero.
The scoring system uses a minimum of 18 months and a maximum of three years of weekly total returns in its calculations and with markets just going through a volatile year, we reviewed the Investment Association universe to see if any sectors had an average FE Risk Score of less than 100.
Performance of funds vs sector over 3yrs
Source: FE Analytics
Only one equity peer group achieved this but it’s a major one: the IA UK Equity Income sector. Our data shows that the average IA UK Equity Income fund has an FE Risk Score of 95. Some 66 of the peer group’s 87 eligible members have a risk score of less than 100.
The fund with the lowest is VT Tyndall Real Income (which scored 70). This £2.2m fund, which is managed by Alex Odd, is in the sector’s bottom quartile over three years but jumped into the top quartile in 2018’s challenging conditions.
LF Miton UK Multi Cap Income and Trojan Income come next with respective scores of 71 and 76. They too have lagged their average peer over the past three but moved towards the top of the sector in 2018 thanks to their more defensive approach.
The fund from the peer group with the highest FE Risk Score is JOHCM UK Equity Income, standing at 114. While this £3.3bn fund – which is run by James Lowen and Clive Beagles – is in the bottom-quartile over one year, the higher-risk approach has worked over the long run as it is top-decile over three and 10 years.
As the table below shows, the other UK equity sectors have performed relatively well – on average – when it comes to the FE Risk Scores. The IA UK All Companies peer group has an average FE Risk Score of 107 while 91 of its 262 members scored less than 100; in the IA UK Smaller Companies sector, these stats stand at a 108 average risk score and 10 of 46 members.
The IA UK All Companies funds with the lowest FE Risk Scores are Invesco Income (76), Invesco High Income (79) and Schroder MM UK Growth (80). With a score of 160, Allianz UK Mid Cap has been the riskiest relative to the FTSE 100.
Source: FE Analytics
LF Gresham House UK Micro Cap is the IA UK Smaller Companies fund with the lowest risk score at 77, followed by MI Downing UK Micro-Cap Growth (78) and Liontrust UK Micro Cap (84). Marlborough Special Situations has the highest at 140.
Of all the Investment Association’s equity peer groups, IA China/Greater China has the highest average FE Risk Score of 177. Every one of the peer group’s 36 members has a score in excess of 100.
Three of its funds scored more than 200: GAM Star China Equity (235), Matthews China (210) and GS China Opportunity Equity Portfolio (206). Matthews China Dividend has the lowest risk score in the sector, but this still came in at 135.
The IA Japanese Smaller Companies, IA Technology & Telecommunications and IA North American Smaller Companies all have an average risk score of more than 150. Every Japanese smaller companies and North American smaller companies fund is above 100 as is all but one fund in IA Technology & Telecommunications; the exception here is Fidelity Global Infrastructure.
Looking at the fixed income sectors and, as the table below shows, IA Sterling Strategic Bond comes in first place with an average FE Risk Score of 24. Every one of the 86 funds have a risk score below 100, with two scoring just 10.
Royal London Short Duration Credit is one of these two; the £735.8m fund is manged by Paola Binns and aims for a combination of mainly income with some capital growth over the medium-to-long term. The four FE Crown-rated fund has a pure short duration approach and is designed to protect investors against surprise or longer-term rises in interest rates.
The £72.4m BlackRock Fixed Income Global Opportunities fund, which is managed by Bob Miller, Rick Rieder and Andreas Doerrenhaus, also scored 10. The managers aim for returns that are uncorrelated with the broader bond market and use a risk-focused process that takes many small bets rather than a few large ones.
IA UK Index Linked Gilts has the highest average FE Risk Score at 97. Three funds scored above 100 here: Baillie Gifford Active Index-Linked Gilt Investment, AXA Sterling Index Linked Bond and iShares Index Linked Gilt Index (UK).
Source: FE Analytics
In the case of the multi-asset funds, the average IA Mixed Investment 0-35% Shares member has an FE Risk Score of 32. This means it beat the IA Targeted Absolute Return sector, where the average fund scored 40.
IA Mixed Investment 20-60% Shares scored an average of 50, IA Mixed Investment 40-85% Shares averaged 72 and the risk score was 80 for the IA Flexible Investment sector.
Research by Natixis suggests that multi-asset strategies did little to aid investor portfolios during the turbulent conditions of the past year.
Investors need to carry out more detailed research into multi-asset funds after many of these failed to offer portfolios some much-needed diversification in 2018.
That’s the recommendation from the latest piece of research by Natixis Investment Managers, which found that multi-asset funds did not protect investors from the impact of volatile equity markets last year.
The Natixis Investment Managers 2018 Global Portfolio Barometer analyses the performance of 421 moderate risk model portfolios from financial advisers based in the UK, France, Germany, Italy, Latin America, Spain and the US.
According to the barometer, adviser portfolios across all regions delivered negative returns last year, driven by falls in equity markets. Over the course of 2018, the MSCI AC World index lost 3.79 per cent due to issues such as global trade tensions, slowing economic growth and tighter monetary policy.
Average correlations to portfolio of different asset classes, by region
Natixis noted that many advisers have been allocating more to multi-asset funds, in a bid to add diversification into their clients’ portfolios. “Many investors over the past few years have shifted allocations away from traditional equity and fixed income assets in to multi-asset funds, also known as allocation or patrimonial funds,” it explained.
“The promise of such funds is that professional managers will be able to pick the best opportunities across all asset classes and as a result provide a source of diversification whilst hopefully complementing advisers’ own portfolios.”
However, the firm added that multi-asset funds did not provide diversification as expected in 2018. Instead, they had “very high” correlations to adviser portfolios, which suggests multi-asset funds largely replicated what advisers were already doing themselves.
This can be seen in the chart above, which illustrates the average correlations of different asset classes to adviser portfolios. High correlations (which indicate low diversification potential) are in purple while low correlations and high diversification potential are in blue.
In the UK, multi-asset funds (labelled as ‘allocation’ in the table) had a 0.83 correlation with the average balanced adviser portfolio. This is the second lowest correlation in the research, but still represents quite low levels of diversification potential.
While Natixis believes it is clear that the average multi-asset funds is not providing much diversification, it asked whether they have been able to compensate for this by delivering high returns to portfolios.
The below chart shows the average returns in adviser portfolios for different asset classes last year. Natixis noted that multi-asset or allocation funds on average performed a little, but not much, better than equities.
Average 2018 performances of different asset classes within actual portfolios, by region
“In a year like 2018, it would have been great to have an investment that mitigated losses from equities and provided diversification to portfolios,” the fund group added.
“Allocation funds were not this investment. This is not to say that all such funds are the same but, in our opinion, advisers should be careful when using these funds.”
Of course, multi-asset funds were not the only investments to fail in protecting portfolios last year.
Geographical equity diversification offered little in the way of protection as most parts of the global suffered falls in 2018 given the macroeconomic nature of the year’s biggest headwinds. Fixed income or alternative strategies gave barely positive contributions at best.
The failure of non-equity asset classes to mitigate portfolio losses could offer some investors a reason to give up on diversification but Natixis added that it has not come to this conclusion and maintained that true diversification should be strived for in client portfolios.
“Many advisers sought diversification through multi-asset funds, which didn’t work in 2018. However, many of these funds simply replicate what the advisers are doing themselves, and as a result have very high correlations to adviser portfolios,” the research concluded.
“When we compute the diversification benefit of all the portfolios in our sample, we find a strong negative correlation with portfolio risk, and a moderate positive correlation with returns.
“That is to say that the most diversified portfolios had lower risk and higher returns than the least diversified portfolios. Advisers with truly diversified portfolios fared much better than those with only pseudo-diversification.”
Performance of UK multi-asset sectors vs equities and bonds in 2018
Source: FE Analytics
In the UK, the average fund in three of the four Investment Association multi-asset sectors failed to outperform global equities last year. While the MSCI AC World was down 3.79 per cent, the average IA Flexible Investment member dropped 6.72 per cent while IA Mixed Investment 40-85% Shares fell 6.11 per cent.
Natixis does not say this suggests investors should be avoiding multi-asset entirely, only that they need to be more mindful of the multi-asset funds they are adding to client portfolios.
“Of course, there are some fantastic multi-asset funds available, but investors need to check whether those that they invest in are truly diversifying their portfolios, or just ballast where they are paying management fees for what they could do themselves,” it said.
“In fact, we have seen many advisers reducing allocation to these funds in 2018 in recognition of this fact.”
The private bank outlines the major themes that it believes will affect portfolios over the course of the coming year.
The start of 2019 offers a “knottier environment” for investors to contend with although taking a nimble and flexible approach should allow them to navigate this year’s challenges, according to analysts at Coutts and Co.
In its outlook for the coming year, the private bank and wealth manager highlighted four areas of the market it has a positive view on but also warned that there are four key challenges that investors cannot ignore.
Mohammad Syed, managing director at Coutts, said: “Looking at the year ahead we see a world in flux. New forces are rising to challenge the economic trends of the previous decade as people process the consequences of technological innovation and global economic deregulation.
“In the meantime, the divergence of global growth and monetary policy between the US and all other nations that shaped 2018 is a naturally unstable situation that can’t endure for long.”
Syed added that there are a number of positions that appear attractive at the start of 2019 – three of which performed strongly in 2018 and one that struggled. He added that “these ideas look good right now” while noting that the bank is ready to change them if the market mood shifts.
Performance of indices over 5yrs
Source: FE Analytics
The first position Coutts is standing by in 2019 is Russia. As the chart above shows, Russian equities have lagged broader emerging and developed market stocks over the past five years; that said, MSCI Russia was down just 0.70 per cent (in sterling) in 2018, compared with an 8.71 per cent fall in the MSCI World and a 14.58 per cent drop in the MSCI Emerging Markets index.
“Coutts’ positive view on Russia performed well in 2018 while maintaining a relatively low allocation to the broad emerging markets, which struggled against dollar strength and trade jitters this year,” Syed said.
“The year ahead will be about finding the opportunities like this within sectors rather than taking broader sectoral positions. But the market backdrop is febrile – Coutts’ view on Russia remains positive, but portfolio managers are watching oil prices where a change in direction could see a change position.”
The private bank also likes Japan, although this was an underperforming area of the market in 2018 as the Topix fell close to 16 per cent. Much of this was put down to external issues such as monetary tightening and the US-China trade war rather than domestic factors.
However, Coutts continues to have confidence in the long-term outlook for the country, which is still working through the wide-reaching reforms of prime minister Shinzo Abe. Fans of Japan note that the country has an expanding economy, stable government and improving returns on equity.
“Japanese companies are very profitable, earnings growth is positive and corporate reform is advancing, albeit at a gradual pace,” Syed added. “Japanese equities are also cheap compared to other developed markets.”
Healthcare is another area favoured by Coutts at the start of the new year. As the chart below shows, this was one of the few global equity sectors to make a positive return last year.
Performance of indices in 2018
Source: FE Analytics
“Healthcare has been another positive contributor in 2018 that will continue in to 2019,” the managing director said. “The long-term drivers remain in place and there is substantial innovation coming that will drive returns for investors.”
The final position that the bank is positive on is gilts. The Bloomberg Barclays Sterling Gilts index made a 0.50 per cent total return in 2018, compared with the 9.47 per cent fall that hit the FTSE All Share.
“While potential long-term returns are still low, Coutts see two advantages to holding gilts for the start of 2019,” Syed explained.
“Firstly, they are a hedge against certain unpredictable events, for example an Italian budget crisis or a difficult Brexit. Additionally, they provide liquidity in portfolios to allow portfolio managers to move quickly to take advantage of opportunities as they become apparent.”
Turning to the challenges facing investors this year, Coutts starts with the ‘tug of war’ playing out between the US and China. The bank pointed out that an escalation of the trade conflict between two superpowers could dent global growth in 2019 and 2020.
This would create an obvious headwind for equity markets, with cyclical sectors – or those with high exposure to global growth – and emerging markets being most at risk.
Coutts believes European stocks, which are heavily exposed to emerging markets, to suffer in this scenario while regions like Japan that have a stronger internal market could prove more resilient.
When it comes to emerging markets, the bank noted that there are other challenges that the US-China trade war. The strong dollar and slowing growth in China are also factors that could further dent sentiment towards the asset class.
The third headwind highlighted by the bank concerns “a spectre stalking the eurozone”.
“It is impossible to completely rule out political risk in Europe and 2018 was a good reminder why,” Syed said. Last year saw a number of political issues in Europe, with the Italian government’s stand-off with the EU over its budget being the one that drew the most attention.
Finally, Coutts pointed out that Brexit will continue to cast a shadow over investors until the March deadline. However, assuming a Brexit deal is agreed, some uncertainty will be lifted and the UK economy could rebound slightly.
“This would naturally benefit domestically orientated companies, but also encourage global investors to reconsider UK equities,” Syed concluded.
“Valuations are attractive and Coutts thinks that UK equities have the potential to do well in the scenario of a slowing but resilient economy, partly because the market is composed of a relatively high proportion of the defensive companies. The biggest risk to this outcome is a rapidly rising pound that would hurt the earnings of UK companies that derive earnings from overseas.”