Bonds have suffered as much as any other asset class in 2022. As a consequence of the Covid shocks and the interest rate hikes operated by central banks as an inflation-containment measure, to curb inflation, bond yields are at levels not seen for some time.

While stocks have sold off because of fears of a looming recession, bonds – which usually do well when investor sentiment is low – have suffered as higher interest rates push down their value.

Rathbone Strategic Bond, managed by Bryn Jones, is designed to detach itself from this dynamic, reducing risk and giving investors the lowest possible correlation to bonds and equities.

Its management team was highlighted in a recent Trustnet feature for its “aptitude to achieve a high level of risk-adjusted returns and pro-active management”.

Jones spoke to Trustnet about how he handles risk and the benefit of low correlation.

Can you sum up your process in three sentences?

We have three steps to our process.

When we launched the fund, our approach was to back-test several indices to look for the best risk-adjusted returns and to get allocation to the indices that delivered them. We introduced a mini-max on either side, so we had a way to mitigate risks and avoid excessive exposure to high-yield or emerging markets (EM).

The second step is driven by our fixed-income investment process. It involves themes, meaning that we will only own sectors that we like; fundamental work, which is about understanding the underlying companies if it's a corporate, or a government; and valuation work, where we look at relative value.

Lastly, we are always trying to find the highest yielding asset with the lowest level of volatility, because that gives you a better Sharpe ratio, which is what investors want.

Why should investors pick Rathbone Strategic Bond?

The fund acts as a diversifier within a portfolio and people are using it because it is designed to generate a long-term positive return with low correlations with equities and bonds. If you had it sitting at the bottom of the portfolio, it would slowly transit along, while other assets are much more volatile.

This year has been pretty tough for everybody and our correlations have been higher than we’d like them to be. But if we go back seven years, Rathbone Strategic Bond was generating somewhere between 3 and 5% per annum.

Performance of fund vs sector over 7 yrs
 
Source: FE Analytics

How risky is the fund at the moment?

Being priced into investment grade credit and high yield is probably some of the worst default rates for a very long time. Spreads have backed out quite a long way and prices are significantly below some of the recovery rates. So we actually put some risk on.

But in terms of the fund itself, it continues to have fairly low correlation with equities and is still significantly below the risk of an equity.

Are there areas you won’t invest in?

The underlying framework of the fund is that there are core weights of which we can either go overweight or underweight depending on the cycle.

We've been very low in retailers through the pandemic, for example. At the moment, we are backing insurance because it delivers the highest yielding in the investment grade space with low levels of volatility. We are also avoiding cyclical single-cashflow businesses.

What have been your best calls of the past years?

In 2019 we reduced our risk because we thought spreads were tight. We might have got lucky, but we were able to go into Covid with a lot of cash.

Another great call was when we added a huge amount of risk in March 2020. In fact, we had been looking at a Norwegian credit fund and then when it collapsed, we bought it at its lowest possible price.

We were also able to buy some Asian credit at its lowest possible price and some high yield.

And your worst calls?

We have an opportunity cost in not being in index-linked. But index-linked assets performed really badly since their peak because inflation expectations have dropped quite significantly and government bond yields have risen. So whilst that was a bad call originally, it turned out to be quite good.

Probably another weak call not in hindsight was not taking enough risk off early enough in March this year, when we took some losses and decided to sell down of risk in emerging markets and credit.

But it’s like running an ultramarathon. Sometimes you have to reassess your goals and change your conviction on what you're doing.

Can you elaborate on this parallel?

You know the old adage: investing is not a sprint, it's a marathon.

I run ultramarathons. Both in running and in investing you have a goal to achieve and to get there you're going to have both tough, dark periods and good experiences. But most importantly, along the way, when these periods happen, you've got to make sure that you're checking how you are, reconsider your view and maybe you’ll have to change your goal.

What’s the next marathon you’re running?

I am running for Great Britain in the Spartathlon this September, which is a mere 250 kilometres from Athens to Sparta in just over a day.

The current view that central banks can tackle inflation without risking a significant economic downturn is starting to look like “wishful thinking”, Schroders’ chief economist Keith Wade has warned.

Central banks around the world are tightening monetary policy in an attempt to drag down the highest inflation rates in decades and, in doing so, slowing economic growth.

The Federal Reserve (Fed) has hiked rates to between 2.25%-2.5% as part of a programme of increases that started in Match, while the US consumer price index (CPI) currently stands at 8.5%.

Raising rates at such a rapid pace has already began taking its toll on the US economy, with gross domestic product (GDP) declining for the first two quarters of the year.

An economic slowdown is seen as a natural consequence of bringing inflation to heel, but many investors are wondering how long and severe a recession is needed to pull inflation down to normal levels.

The market is optimistic that the Fed will begin slashing interest rates by late next year, but Keith Wade, chief economist and strategist at Schroders, is not as hopeful.

Now that US GDP is in decline and Fed chair Jerome Powell has hinted that rate hikes will be less steep moving forward, some economists have relaxed slightly but Wade anticipates that they will stay higher for longer.

“In our view it would be better if the Fed took a leaf out of the Bank of England’s playbook and acknowledged this, rather than projecting soft landings,” he said.

“A look back at history shows that such forecasts only give false hope and create a further misallocation of resources. Politically this is difficult, but the earlier households and firms can start to make the inevitable adjustments the better.”

It would take a 2% drop in US GDP for inflation to level out, according to Wade, which is less severe than previous recessions but higher than most economists’ forecasts.

He said the current economic environment is very different from the nine previous recessions since 1960 and the same approach the Fed took in the past won’t work again.

For example, inflation is far higher than previous cycles and lower US unemployment levels than average could continue to push up prices.

US inflation and unemployment today vs previous cycles

Source: Refinitiv, NBER and Schroders

If the next recession is anything like the worst two of the past 52 years, US unemployment could rise from 3.5% to 7.5%, with a 6 percentage point drop in GDP bringing inflation below 3%.

Likewise, heightened commodity prices are a huge driver of US inflation – Wade said that when these are removed from the Fed’s preferred measure (the core PCE deflator), then inflation is at 5.2%.

These price rises need to be tackled in order to bring down inflation, but that may not be so easy in the cycle. Previously, a recession would weaken commodity prices, but the world’s dependency on Russian oil could mean it will continue to rise.

Wade said: “The fundamental problem remains: the US economy and much of the world is late cycle and overheating.

“The Fed’s projected soft landing where growth slows to just below 2% and inflation falls below 3% in 2023 looks like wishful thinking.”

The global economy is in already in a fairly drastic situation and the Fed will struggle to get many on inflation’s biggest drivers under control, according to Wade.

Just a handful of investment trusts have made positive returns in 2022, after soaring inflation, interest rate hikes and geopolitical tension caused a broad-based sell-off.

The first half of 2022 was one of the worst opens to a year in recent history and, although sentiment has improved in the past few weeks, positive progress has been a challenge almost across the board.

With this in mind, we looked at how the mainstream equity and flexible investment trusts are holding up this year.

As the chart below shows, most trust sectors have posted a loss since the start of 2022 – in keeping with what has been seen in the open-ended fund universe.

Only three of the peer groups we looked are showing a positive average return for 2022: IT Latin America, IT Infrastructure Securities and IT Commodities & Natural Resources. These trusts invest in assets widely considered to offer inflation protection, which is proving especially attractive given today’s soaring inflation.

Total return of main AIC sectors in 2022

Source: FE Analytics. Total return in sterling between 1 Jan and 10 Aug 2022

Given the risk-off sentiment that has dominated markets for most of 2022, the worst average returns came from the IT Growth Capital sector, where trusts invest in unquoted shares of early to maturing companies.

IT European Smaller Companies, IT Global Smaller Companies and IT China/Greater China are also showing significant losses for the year so far but IT UK All Companies isn’t too far behind these riskier sectors.

Turning to individual investment trusts and only 41 of the 219 we looked at have managed to generated a positive return this year.

The highest return from the mainstream AIC sectors has come from Riverstone Energy, which is up 43.7% over the period under review.

Source: FE Analytics. Total return in sterling between 1 Jan and 10 Aug 2022

The trust invests in the global energy industry across all sectors and has around 20 holdings spanning oil & gas, midstream and energy services in the US, western Canada, Gulf of Mexico, Latin America and Europe.

As energy commodities have soared in price because of supply bottlenecks and Russia’s war with Ukraine, funds such as Riverstone Energy that invest in the space have generated very high returns.

Indeed, the table above – which reveals the 25 best-performing investment trusts in 2022 – shows that many of these year’s leaders invest directly in energy and other commodities companies (BlackRock Energy & Resources Income, CQS Natural Resources Growth and Income) or counties that are commodity exporters (Qatar Gulf Investment Fund, BlackRock Latin American IT).

A look at the very bottom of the performance tables, however, shows that JPMorgan Russian Securities has suffered the biggest loss. Of course, this is down to Russia being sanctioned and frozen out of financial markets after it invaded Ukraine.

Source: FE Analytics. Total return in sterling between 1 Jan and 10 Aug 2022

The bulk of the table is made up of trusts that invest in unquoted or small companies, which investors have been selling out of as they worry about higher interest rates and the risk of an economic slowdown.

Everything you need to know about building your own investment portfolio and managing your own wealth. Packed with news, analysis and commentary, Trustnet Magazine is your free, easy-to-read monthly guide to self-directed investment. 

If you find Trustnet Magazine difficult to read in the viewer above, simply click the arrow pointing down on the left-hand side of the screen to download the PDF.

Emerging market debt (EMB) has struggled over 2022 so far, as the asset class bore the brunt of Russia’s war in Ukraine and the post-Covid economic hangover.

However, Federated Hermes said EMD valuations are now at a level of attractiveness that fixed income markets seldom see, especially when a lack of idiosyncratic risks and low rate of default are taken into account.

Jason DeVito and Mohammed Elmi, lead portfolio managers at Federated Hermes, said: “EMD investors, therefore, find themselves at a fork in the road.

“Do they follow consensus and take flight, or grasp an unprecedented opportunity to build a long-term position in an asset class that has come of age and is still exposed to the structural drivers of global growth?”

Below they offer seven reasons why investors should consider emerging market debt from here.

1. Valuations

DeVito and Elmi argued that EMD could be considered the “sale of the century” as valuations are currently in line with those of equities.

“Given that fixed income traditionally outperforms equities on the downside – by virtue of being a more stable, defensive asset class – the equal valuation footing upon which they currently stand suggests that EMD has been vastly oversold,” they explained.

“As a result, investors with the bandwidth to accommodate more risk and believe in the long-term emerging market growth story, should consider current valuations as a unique buying opportunity.”

2. Global challenges priced in

The entire market has been rattled by Russia’s invasion of Ukraine, but EMD has been among the assets that were hardest hit. However, the Federated Hermes managers think markets have now largely priced-in the global economic impact of the invasion.

The other main drags on EMD performance this year are the outlook for growth and inflation, but the managers are also sanguine on these issues, especially as the Federal Reserve has offered more insight into its plans to tighten policy.

“With its tightening stance no longer an unknown, fixed income investors can begin to reassess their positions in light of the knowledge that inflation will likely be capped by Fed action in the medium term,” they said.

“Now that we know the general pace at which the Fed is likely to tighten policy, we are confident that a major global recession, similar to the global financial crisis, is unlikely. Overall, this supports the case for buying into EMD at current levels in anticipation of a more accommodative market environment in H2.”

3. Idiosyncratic strength

DeVito and Elmi’s third argument in favour of EMD revolves are the fact that although the global economy is facing several high-profile challenges, there are only a handful of idiosyncratic risks coming out of emerging markets themselves.

“Since the outbreak of Covid, and despite the great economic stress that has ensued, we have seen only one EM default on the hard currency side (Sri Lanka),” they explained.

“In line with wider evidence, this suggests that countries across the regions are increasingly well-managed and fully capable of servicing their debt. Distressed pricing in the asset class means there are potentially high returns on the table and, even if country-specific issues did arise, valuations are more than accommodating.”

4. Commodity prices pick-n-mix

Although some investors still regard emerging markets as a homogenous group that display more or less the same risks and rewards, DeVito and Elmi pointe that they are a diverse set of countries with distinct characteristics.

“In times of distress, an individualised approach to the countries that comprise the asset class is more important than ever,” they added.

The managers highlighted energy producing countries as a sub-group of emerging markets that look well-placed to continue benefitting from higher energy prices in the second half of the year.

Likewise, some of the Middle Eastern and sub-Saharan African countries that were previously under strain, such as Angola, Bahrain, Oman and Gabon, have used higher commodity prices to deleverage and reduce external vulnerabilities.

5. Tailwinds in H2

The Federated Hermes managers also argued that the main emerging market are likely to move past a number of political hurdles over the second half of 2022, which could reduce some of uncertainty around EMD.

These hurdles include the Brazilian elections and the 20th National Congress of the Chinese Communist Party.

Moving past these events could stabilise the political outlook and “many investors are likely to return to the asset class in the fourth quarter as a result”, DeVito and Elmi said.

6. The DM-EM divide

The managers believe some emerging market corporates are “very much best of breed”, only their credit ratings are lower than equivalents in the developed markets because country ceilings apply downward pressure on their ratings.

“We believe the strongest opportunities in EMD currently lie in the BB/BBB space, both on the sovereign and corporate side,” they added. “Issuers in this band of the asset class tend to display ample free cashflow, and countries are largely well-run and generate fiscal surpluses.”

7. Charting its own course in ESG

DeVito and Elmi finished by pointing out that EMD is a tough asset class for ESG integration as sovereigns and corporates are at a much earlier stage of their ESG journey.

However, they added that this could create “a compelling opportunity for investors”.

“As current global challenges ease, we expect resurgent interest in ESG-focused investments across the region and investors can benefit from identifying the most interesting names early,” they concluded.

Only 15 trusts that have made top-quartile returns over the long run have managed to stay at the top of their sectors in 2022 so far, Trustnet research shows.

The big market shift of 2022 has seen the performance rankings up-ended as the growth style lost market leadership and investors rushed to adapt to a rising interest rate environment. Against this backdrop, many long-term winners have become losers, and vice versa.

But which of the long-term winners have been resilient enough to remain undisturbed at the top of their sectors, despite this reversal of fortunes?

Of the trusts that are in the Association of Investment Companies (AIC) universe, 67 were ranked in the top-quartile of their peers over the 10-year period. Of these, only 15 – or 22% – are first quartile year to date, gaining a place in the table below.

 
Source: FE Analytics

Based on year-to-date performance, the highest-flier was the £114.4m Doric Nimrod Air Two, a Guernsey company focused on generating income and capital returns through the acquisition, leasing and selling of aircraft. It has returned 54% since year-start.

The silver and bronze medals go to the only two more trusts that scored double-digit returns: Epicure Managers Qatar Gulf Investment Fund and BlackRock Energy and Resources Income.

The former seeks exposure to emerging investment opportunities in the Gulf Cooperation Council region that have not yet been priced in by the market, predominantly investing in the financials and industrials sectors; the latter focuses on international mining and energy equities, co-managed by Mark Hume and FE fundinfo Alpha Manager Tom Holl, who has stood out for having maintained a consistently high alpha score over a proven track record in rising and falling markets.

The performance of both these trusts is evidence of the increased market interest in commodities and energy, while the more traditional sectors have capitulated, as illustrated in the chart below. As Trustnet recently reported, energy prices have gone up so steeply that some worry about an upcoming decline.

Performance of sectors over 2022
 
Source: FE Analytics

Registering a 4% growth since the beginning of 2022, the only other companies achieving positive returns were Merchants Trust and BBGI Global Infrastructure.

The £763m Merchants Trust invests in higher-yielding large UK companies and has exposure to some of the best-performing sectors of the year, which drove its performance.

Among its top-10 holdings are British American Tobacco and Imperial Brands (tobacco stocks have significantly outperformed the wider market this year) as well as energy and mining companies such as Shell, BP and Rio Tinto, which have benefitted from surging commodity prices.

BBGI Global Infrastructure is bigger in size (£1.1bn) and also profited from positive conjunctural factors, as investors have been hedging their portfolios from inflation by gaining exposure to the inflation-proof infrastructure sector.

Further down the list, the only IT Global trust in the ranking is the £4.5bn F&C Investment Trust, with a 4% loss return determined by its significant exposure to US tech companies.

Finally, with exposure to consumer products and financials that couldn’t save it from its fall, Fidelity Special Values has lost 7.6% since the turn of the year. However, it has held up better than most of its peers as the value style came back into favour.

The JPM US Equity Income fund has thrived since the start of the year while many of its IA North America peers made losses – the fund is up 5.7% in 2022 so far, with the sector down 4.2% on average.

It has been a top quartile performer over the past six and 12 months, benefiting from the shift towards value investing that came with higher inflation and tighter monetary policy.

However, it has underperformed its peer group by 12.8 percentage points over the past decade as its value portfolio struggled to keep up with a growth-biased market.

Although short-term performance is strong, Trustnet asks experts which funds could be held alongside JPM US Equity Income for if markets flip back towards growth.

Total return of fund vs sector and benchmark since the start of the year

Source: FE Analytics

Ben Yearsley, investment consultant at Fairview Investing, highlighted that the US market is not typically the first choice for income investors. On face value, the dividends paid by US companies are not as appealing as other markets, especially the UK.

That being said, JPM US Equity Income invests in companies outside of the typical large-cap stocks that most IA North America portfolios tend to hold, which means it can find higher yielding companies, according to Yearsley.

For example, many US funds hold the big technology names that dominated markets for much of the past decade, whereas JPM US Equity Income’s exposure to the sector is 18.5 percentage points lower than the benchmark’s.

Yearsley would therefore suggest the M&G Global Dividend fund for investors looking to diversify their income stream more broadly.

This £2.2bn portfolio has an underweight US position of 44% compared to the MSCI AC World index’s 61% exposure, so could offer some diversitication for those who already have large allocations to the US.

It had a lower total return compared to the JP Morgan fund, up 178.1% over the past 10 years, but succeeded in beating the IA Global Equity Income sector by 36.2 percentage points over the period.

Total return of fund vs sector and benchmark over 10yrs

Source: FE Analytics

Since the start of the year, M&G Global Dividend has continued to deliver investors a positive return of 3.5%, while the yield stands at 2.2%.

Alliteratively, investors could go for a more regional specific fund with Montanaro European Income (assuming they already have UK income exposure), according to Yearsley.

This relatively small £40m portfolio was up 155.3% over the past decade, but has fallen 17.5% since the start of 2022. It is yielding 2.9%.

Total return of fund vs sector over 10yrs

Source: FE Analytics

Andy Merricks, manager of the 8AM Global fund, on the other hand, said that JPM US Equity Income’s yield of 2% is “majorly underwhelming to most income seekers”.

He added that “like a number of non-UK equity income funds, the word ‘income’ is a little misleading”.

A good pairing could therefore be the Artemis US Select fund, because it is unconstrained by income demands.

It has a slightly growth tilt, with FAANGS such as Microsoft, Alphabet and Apple accounting for 16.5% of all assets, so it has suffered a 8.3% decline since the start of the year.

Long-term performance, on the other hand, has been strong, with returning 204.4% since the fund launched in 2014.

Total return of fund vs benchmark and sector since launch

Source: FE Analytics

Its growth bias could also diversify the portfolios of those who have value exposure in the US with the JP Morgan fund, according to Merricks.

He said: “The Artemis US Select fund may be worth considering as it is not restricted by income demands and thus holds stocks that may be more likely to benefit from style variations.”

Sam Buckingham, investment analyst at Kingswood Group, favours a value approach when investing in the US, especially with the current rate hiking cycle and inflation outlook.

JPM US Equity Income is an excellent vehicle to achieve value exposure in the region, according to Buckingham, but the style may not perform as well as it has so far this year moving forward.

“The US currently faces a recession and whilst value stocks tend to be associated with underperforming in economic downturns, we don’t necessarily believe this will be the case this time around due to the excessive premium growth stocks currently trade at in the US,” he said.

Diversity is an important aspect to consider, but an out and out growth fund could be a risky decision in the current market. Buckingham therefore went for a passive option, choosing the L&G US Index Trust.

By tracking the FTSE World USA index, it has climbed 337.2% over the past decade, outperforming funds in the IA North America sector by 50.9%. It is down 4.3% since the start of the year.

Total return of fund vs benchmark and sector over 10yrs

Source: FE Analytics

FundCalibre research analyst Christopher Salih, on the other hand, said the JPM US Equity Income fund is already a well-diversified portfolio.

He said: “It is up against the likes of the multi-cap and mega-cap names, many of which this fund won't own because of their very low, if any, dividends payments.

“The fund is usually fairly diversified, more so than many of the other popular US funds. This helps dampen volatility on the fund and allow for a range of different factors to support the dividend on the fund.”

Salih would therefore go for a more concentrated portfolio to complement it – he chose the Premier Miton US Opportunities fund to hold alongside.

The £1.3bn portfolio run by FE fundinfo Alpha Manager Nick Ford is up 280% over the past decade, beating the IA North America sector average by 49.1 percentage points.

Total return of fund vs sector over 10yrs

Source: FE Analytics

It has fallen 0.9% since the start of the year, but it is still ahead of most its peers, which were down 4.3%.

Salih added: “The manager is very nimble and will move the portfolio and exposures around depending on their prevailing market view, which allows for sector outperformance and a different return profile.”

Everything you need to know about building your own investment portfolio and managing your own wealth. Packed with news, analysis and commentary, Trustnet Magazine is your free, easy-to-read monthly guide to self-directed investment. 

If you find Trustnet Magazine difficult to read in the viewer above, simply click the arrow pointing down on the left-hand side of the screen to download the PDF.

The first half of 2022 was a bracing period for investors, with equity and bond indices registering their worst first-half returns for about half a century. Rampant inflation was largely to blame, forcing the US Federal Reserve to hike rates by the greatest margin since 1994, despite previously ruling out such a scenario. However, the market backdrop is evolving.

Over the last month, there has been a noteworthy shift in how the market perceives the ongoing battle to curtail rising prices. It appears inflation is now very much a known risk and largely priced into markets, with the risk of global recession now seemingly taking its place as the principal concern among investors.

Analysis of the US two-year breakeven rate, which provides a good indication of the level of inflation in two years’ time priced in by the market, indicates we are past the peak in inflation expectations. In March, the rate suggested about 4.7% of inflation was priced in. Today, this figure has fallen to 3.2%, indicating within the space of just three months, inflation expectations have declined 1.5% in the US for the next two years.

The commodities market also implies recession fears are trumping those of inflation. The price of copper, which is a strong indicator of industrial activity, has fallen off a cliff in recent months, while the prices of other key industrial metals including aluminium and even silver have also witnessed considerable declines.

On board with bonds

This marked shift is unearthing compelling opportunities in assets previously out of favour with growth investors. Specifically, we believe pockets of fixed income look increasingly attractive in the macroeconomic environment fast emerging.

Although high inflation and rising interest rates are generally strong hurdles for the fixed income market, a good degree of downside already being priced in means yields now offer a greater degree of protection, at around the 3% level in US 10-year government bonds, 2% in the UK, and 1% in Europe.

With the recession risk now looming large, we believe traditional bonds should increasingly act as a diversifier to equities.

In recent months, bonds have increasingly performed well when equity markets have struggled. In the first half of the year, the S&P 500 was down 20%, while the broad US aggregate bond market was down 10%. Since the 1970s, this is the first time bonds have not delivered positive returns when equities dropped by such a magnitude. With current bond yields offering a greater margin of safety, we feel a compelling opportunity has arisen, and we are subsequently allocating towards traditional bond strategies for the first time in years.

We recently initiated a holding in the Vontobel TwentyFour Strategic Income fund. We feel this strategic bond fund should provide a good degree of upside moving forward, as well as attractive levels of portfolio protection. The bulk of its exposure is tilted towards credit as opposed to government bonds – a much more natural fit for multi-asset growth strategies. The managers also have the ability to actively manage the duration in the portfolio. Meanwhile, the fund’s diverse credit exposure is looking particularly attractive at current levels.

While we only have a modest allocation at present, we will continue watching the space closely and increase our exposure incrementally should market conditions justify doing so.

Don’t forget floating rate

While a moderate allocation to traditional bond strategies seems sensible at present, it is also vital growth investors do not overlook wider areas of fixed income that remain compelling in the current inflationary environment. Specifically, investors can ensure an attractive level of portfolio diversification by allocating towards bond strategies that invest in asset-backed securities.

TwentyFour Income – another strategy managed by TwentyFour Asset Management, but distinct from the TwentyFour Strategic Income fund – is an investment trust that invests in relatively high-yielding asset-backed securities, including mortgages, credit card debt and auto loans. The quality of the credit work from the team at TwentyFour provides protection on the downside, while the fact asset-backed securities use floating rather than fixed rates – whereby coupons payable rise in tandem with interest rates – offers a meaningful hedge against rising rates.

As such, a sensible allocation to bond strategies can provide considerable portfolio protection amid an increasingly uncertain macroeconomic environment, as well as the potential for attractive capital growth over the near and medium term.

Vincent Ropers is portfolio manager of the TB Wise Multi-Asset Growth fund. The views expressed above should not be taken as investment advice.

The UK is reeling from the effects of the Covid pandemic and the cost of living crisis, but the manager of the Supermarket Income REIT trust says the resiliency of the grocery industry is cause for optimism.

By leasing out its 69 properties across the UK to various supermarket chains, the trust has delivered a total return of 59.9% since inception in 2017 and is currently paying shareholders a yield of 3.8%.

Even over the past year, the trust is up 10.6% while many other areas of the market have been in decline.

Here, manager Robert Abraham tells Trustnet how the boost in home deliveries in the pandemic has shuffled supermarket dynamics and why investing in property can be a long-term inflation hedge.

Total return of trust vs sector since launch

Source: FE Analytics

What’s your investment process?

We’re the UK’s only listed fund dedicated to supermarkets, so we've just got really good insight into how these operators work.

The real driver behind the fund is to offer long-dated, secure inflation linked income.

Who are your largest tenants?

The portfolio has a natural weighting towards Tesco and Sainsbury’s – Tesco is about 44% and Sainsbury's at 31%.

A larger proportion of their estate is held leasehold, around 40-50%. You look at Asda and Morrisons, and they're more like 15%.

We've got a weighting towards those names and I think that will always be the case, because if you've got a much smaller pool of Asda and Morrisons available, then naturally you're going to end up with more Tesco and Sainsburys.

Supermarket locations and their tenants

Source: Supermarket Income REIT

How long are your properties typically leased for?

We actually regeared two leases in the last nine months or so for two of our Tesco stores. We put new 15-year leases on those with inflation uplifts on an annual basis.

That secure, long-dated income is the really attractive aspect for us.

That's been one of the main reasons for setting up the fund and we're producing a pretty attractive dividend yield relative to our peers at the moment as well.

Our shortest supermarket lease is eight years. We do have a handful of shorter leases but they don't make up a material amount of the portfolio – they’re around 3-4%.

How has the rise of e-commerce affected sales?

In the past, online delivery sales were always quite a loss making part of the business but it became profitable during Covid for the first time.

There was a perception in years gone by I think that the large format supermarket had had its day and the online grocery was going to look like the Ocado model.

What we've actually seen is the big four have gone for this omni channel model. You may not have noticed it but some of them have got 15 to 20 delivery vans parked at the back because they're operating as both a logistics hub to fulfil online grocery but also a physical supermarket.

Before Covid, it was about 8% market share and moved to around 15% at the peak so it near enough doubled. It's back down to about 12% now.

That means if online sales start to fade off again post-pandemic (which they have done a little bit) it's still much larger than it was before and our stores are perfectly placed to benefit from it.

How is the supermarket model different from Ocado's?

We've got stores that deliver around six orders an hour, whereas it's virtually impossible for Occado to do that – their vans have to travel so much further because they've got the centralised fulfilment hubs.

Ocado have less than 20 sites whereas Tesco fulfil online grocery orders from 350 stores, so their coverage of the country is so much better.

They've got so much more of the country within 15 minutes of one of their locations, whereas Ocado has been in a planning battle for five years trying to get a site approved in Islington.

Tesco in that same situation can just add home delivery vans to an existing store. In terms of delivery slot capacity, they added about 600,000 slots during the pandemic in a very short space of time, which is more than tripled the size of a Ocado’s entire business.

Share price of Ocado over the past year

Source: FE Analytics

Is the cost of living crisis a concern for you? Could it tighten consumer spending in stores?

Yeah, I think it's one of those things where you have to accept that inflationary pressures are impacting the entire economy and grocery isn't going to be immune to that.

But actually, consumers are more likely to cut back on luxury type goods, whether that's clothing, or eating out in restaurants and bars.

It's a really defensive, non-discretionary sector – ultimately, people will always need to eat and there isn't an alternative other than grocery.

You don't want to look like you're profiteering from it, but actually it's just more a fact of life that these operators are on fine margins and they have to pass that on to consumers.

Have you added new names to the portfolio recently?

We're ultimately looking to reflect the UK grocery market and we’ve seen a cycle of new names in recent times, so we’ve now added a couple of Aldis. They haven't got the store networks to be able to do omni channels as well as the larger operators.

These discounters ultimately have good business models but they follow a different model to the larger operators; they have smaller format stores which means they don't really do anything online other than partnerships with the likes of Deliveroo.

They also typically have smaller lot sizes, so they’re not as wedded to these locations. They could just move two minutes up the road and build another one in many instances. What that means is you’re at risk at the expiry of that lease.

What do you like to do outside of fund management?

I signed up for the London marathon again last week so I need to get myself fit. It’ll be my fourth one in October and apparently you get better as you get older!

Investors have turned to inflation hedges in 2022 as prices continue to spiral upwards, with infrastructure being one of the few parts of the market able to make money this year.

FE Analytics shows that the average IA Infrastructure fund has made 8.6% over 2022 so far, making it the third best performing sector. The only peer groups with a higher return are IA Latin America and IA Commodity/Natural Resources, which also hold up in inflationary times.

As the chart below shows, IA Infrastructure funds have outpaced mainstream favourites such as IA UK All Companies and IA Global funds by a wide margin this year.

Performance of sectors over 2022

 
Source: FE Analytics

The rationale behind this positive run is mostly two-fold, said Jason Hollands, managing director and head of corporate affairs at Evelyn Partners.

“Firstly, infrastructure has low correlation to the ups and downs of the economic cycle, as the underlying contracts on projects are very long term in nature, typically over 25 years; and secondly, its proofs against inflation, as contracts often include annual adjustments for inflation,” he said.

On top of that, infrastructure is often considered a portfolio diversifier, a source of income with a useful yield, and is benefitting from significant public and private sector cashflows.

For investors who are looking to add infrastructure to their portfolios, below are four experts’ picks from the asset class.

FTF ClearBridge Global Infrastructure Income

Kelly Prior, investment manager in the multi-manager team at Columbia Threadneedle Investments, selected the FTF ClearBridge Global Infrastructure Income fund. It has performed very well in recent times, especially in terms of risk-adjusted returns, and outperformed its peers by 11.3 percentage points over one year, as shown below.

Performance of fund vs sector over 1yr
 
Source: FE Analytics

It is run by Nick Langley and his team at Franklin Clearbridge, who, having worked together to establish the RARE franchise nearly two decades ago, have a long history in investing in the infrastructure space.

“Unapologetically focused on core infrastructure businesses that operate in markets that are governed by strict regulation, they are looking for stable cashflows on longer-term contracts,” said Prior.

“In more exciting times such discipline could see them lag more aggressive operators in the space, but much like the business that make up their universe, they are assessing the long-term prospects and assessing what is missed in the price.”

FTF ClearBridge Global Infrastructure Income was also picked by GDMI investment manager and director Tom Sparke and Charles Stanley Direct chief analyst Rob Morgan.

What made it popular was its structural tilt towards income-generating regulated utilities (minimum 50%) combined with the flexibility to invest in more growth-oriented infrastructure assets, and its yield, which is over 4% and derives from a “truly international” portfolio of holdings including energy facilitators, toll roads, renewables and airports.

Prior did point out that the ClearBridge management team decided to move in and out of areas. This happened with airports through Covid and with UK utilities, which were traded when the threat of nationalisation caused a significant drop in their prices.

“A thorough and disciplined process always brings the team back to company fundamentals however, and marrying this up with a solid top-down strategy has bought impressive results over the life of the fund,” she said.

KBI Global Sustainable Infrastructure

Sparke also highlighted a second fund, KBI Global Sustainable Infrastructure, whose performance is outlined below.

Performance of fund vs sector over 1yr
 
Source: FE Analytics

“This vehicle is attentive to environmental, social and governance aspects and has performed very well over the last few years. It has a focused portfolio of around 35-55 securities with exposure to water, waste, recycling, food, clean energy and farmland,” he said.

The €1.4bn fund is managed by Colm O'Connor and its approach is built around the idea that infrastructure and its sustainability is an issue that is only going to grow in importance to investors and society as a whole.

“State plans such as the Biden climate and infrastructure plan in the US, the carbon neutrality plans of the EU, China, Japan or the transition to wind farms in the UK show that spending on infrastructure and sustainable development will continue to increase,” Amundi, the fund’s management group, said.

International Public Partnerships

Moving on to investment companies, Rob Morgan’s pick was International Public Partnerships.

The trust invests directly and indirectly in public or social infrastructure assets and related businesses located in the UK, Australia, Europe and North America and outperformed its sector over the past year.

Performance of trust vs sector over 1yr
 
Source: FE Analytics

“An attraction is the quality of its cash flows, which benefit from a high degree of inflation linkage and are very long-term in nature,” said Morgan.

“Unlike many of its peers, International Public Partnerships invests almost exclusively in availability-based projects, which have more predictable revenues than demand-based assets. As such, there is a higher degree of regulated activities and greater visibility in terms of cash flows.”

Further differentiating characteristics include a willingness to take some construction risk and a history of taking big stakes in very large-scale projects such as Thames Tideway, known as London’s ‘super sewer’.

HICL Infrastructure

Lastly, Hollands also chose a trust, despite noting that in the infrastructure sector, they tend to trade at hefty premiums to net asset value (NAV). His vote went to the £3.5bn HICL Infrastructure.

Performance of trust over 1yr against sector
 
Source: FE Analytics

It is overweight in UK transport and healthcare and was able to distance its peer by five percentage points in the past 12 months, as the graph above shows.

“HICL Infrastructure looks one of the better picks currently as it is ‘only’ at a 5% premium – below the sector average of 9.5% and its 12-month average of 9.7%”, he said.

A potential investor might also be interested in its “relatively attractive” 4.8% yield.

Gold has proved resilient amid the inflation crisis of 2022, as equities, bonds and crypto sank.

In a high-volatility environment, the MSCI World index lost more than 20% over the first six months of the year (in US dollar terms) and investors have been seeking less risky assets than equities.

Traditionally a safe haven, gold peaked in March. It price fell but continued to hold firm for UK investors since, as shown in the graph below.

Gold vs global stocks over 1yr

Source: FE Analytics. Total return in sterling between 4 Aug 2021 and 2 Aug 2021

BullionVault director of research Adrian Ash highlighted how physical bullion was the best-performing asset during the initial deflationary wave of the Covid crisis, when crude oil prices dropped below zero, and how it has now outperformed all major asset classes except crude oil as inflation jumps to 40-year highs.

Although the rise in interest rates does present a headwind to gold prices, as the metal pays no income, Ash believes that its success in 2022 so far is likely to attract fresh inflows if the slump in world stock markets continues in the second half of the year.

Moreover, “the risk of recession becoming longer-term stagflation is likely to see portfolio managers and other existing investors continue to hold tight to gold as a form of insurance”, he added.

Ned Naylor-Leyland, manager of the $838m Jupiter Gold And Silver fund, agreed and went further to predict a rebound in gold prices should the US Federal Reserve ease off its current hawkish path.

Many economists are already taking a recession for granted, as they believe the Fed is likely to increase interest rates a step too far, overtightening market conditions and weakening the economy.

“This is where the value of holding alternative currencies such as gold and silver will come good,” said Naylor-Leyland.

As falling real yields mean a higher gold price, “gold and silver are bets that future real rates are not going to rise as much as the market thinks because the Fed won’t be able to pull it off”.

In a scenario with a weak economy bordering recession, further rate hikes could become too painful and result in rate expectations dissolving in the yield curve more quickly than inflation expectations.

“A hard landing or recession won’t necessarily make inflation go away – think about stagflation. On the other hand, rate hike expectations would disappear pretty quickly, in my opinion. That would be good for gold and silver,” said Naylor-Leyland.

“Gold is trading around $1,700/oz and to get to $2,100/oz, as it was in March, it would again be challenging the inflation-adjusted all-time high. I think that gold has a very good chance of breaking through the $2,100/oz record. Records are made to be broken and dollar strength will not last forever.

“Looking ahead, I think the conditions are right for a move back to a more dovish environment and a Fed pivot. That’s why I believe it’s the perfect time for prudent investors to own gold and silver.”

This is an especially good entry point for investors, as participation in the gold market is at historic lows, he added.

Everything you need to know about building your own investment portfolio and managing your own wealth. Packed with news, analysis and commentary, Trustnet Magazine is your free, easy-to-read monthly guide to self-directed investment. 

If you find Trustnet Magazine difficult to read in the viewer above, simply click the arrow pointing down on the left-hand side of the screen to download the PDF.

Investment grade bonds now look more appealing to BlackRock than stocks, because attractive valuations, strong balance sheets and moderate refinancing risks suggest they could hold up better in a downturn.

The group – which is the largest asset management house in the world, running some $9.6trn –took a neutral stance on developed market stocks back in May, citing “a worsening macro outlook”.

This followed comments from Federal Reserve chair Jerome Powell, who had insisted that the central bank would hike interest rates until inflation started to fall back to a healthy level. BlackRock, on the other hand, believes that “reality will be more complex” and this approach threatens to push the economy into recession.

In its latest note, BlackRock said it now prefers investment grade (IG) credit over equities on a tactical horizon because it thinks they are better placed to cope with a new market regime characterised by higher volatility.

Citing the chart below, BlackRock chief fixed income strategist Scott Thiel said: “Yields look more attractive than at the start of the year, in our view. That’s because of a surge in government bond yields (red area in chart) and a widening of spreads (yellow area), the risk premium investors pay to hold IG bonds over government peers.”

US Treasury yield and IG credit spread, Jul 2021–Jul 2022

Source: BlackRock Investment Institute, with data from Bloomberg, Jul 2022. The yellow stacked area shows investment grade credit option-adjusted spread of the Bloomberg Global Aggregate Credit Total Return index Value Unhedged in US dollars over US Treasuries in percentage points. The red area shows the yield of US Treasuries as a portion of the overall index yield.

Since June, markets have been buoyed by the notion that slowing economic growth would cause central banks to ease up on their tightening programmes, prompting a fall in bond yields and 10%-plus rally in equities.

“We still like IG credit at these levels. Spreads have only marginally narrowed as investors lean back into equities,” Thiel continued.

“Plus, we think higher coupon income provides a cushion against another yield spike as markets price in the persistent inflation we expect. Equity valuations, meanwhile, don’t reflect the chance of a significant slowdown yet, so earnings estimates are still optimistic, in our view.”

BlackRock’s strategists also think that investment grade companies are in “good shape”, pointing to low levels of debt servicing, falling leverage and the fact that defaults are the lowest since 2014. In addition, the number of companies that are being promoted from high yield status to investment grade is outpacing those falling down the rankings.

Thiel also said that other trends in the corporate bond market are supportive of an overweight towards credit.

“First, supply is relatively low. Corporate bond issuance is down almost 20% this year versus 2021, according to S&P. Many issuers could be waiting to see if financing conditions improve before issuing more debt,” he explained.

“Second, refinancing needs don’t look pressing after a surge in issuance last year. For example, typical US IG bond issuance of around $1trn a year easily exceeds upcoming maturities of less than $600bn a year through 2029, S&P data show.”

Looking ahead, BlackRock does not agree with the market consensus that the global economy will undergo a “gentle contraction” that leads to falling rates and lower inflation – it does not believe a ‘soft landing’ is possible given the current macro backdrop.

“Central banks will have to plunge the economy into a deep recession if they really want to squash today’s inflation – or live with more inflation. We think they’ll ultimately do the latter – but they are not ready to pivot yet,” Thiel finished.

“As a result, we see lower growth and elevated inflation ahead. We see bond yields going up and equities at risk of swooning again. IG credit, in our view, benefits from relatively high all-in yields that reflect moderate default probabilities.”

Humans often see what they want to see and many times it’s down to something called confirmation bias. This is a phenomenon where we subconsciously look for data points that support a pre-existing view.

Of course, many people try to remain objective and work through the data in a fair manner. However, there are often contradictory data series. So, the claim to be ‘data dependent’ is all well and good but which data do you decide to focus on, and which do you discard?

You will remember the often-used phrase ‘following the science’ during the Covid lockdowns but which science, which scientist, which group of scientists and which scientific conclusions should you follow? It soon became a very politicised term to justify a course of action.

A more recent example in markets was when the US experienced two consecutive quarters of economic contraction in the first half of 2022. Some claimed this was evidence of a classic recession, indeed the definition of a recession. Others pointed to the National Bureau of Economic Research, who officially determine recessions in the US, and we won’t know for some time whether they classify it as a recession or not.

In some aspects, it doesn’t really matter whether there is a technical recession or not. Of course, there will be a degree of symbolic importance, but much more important is whether the contraction, if that is what it is, is shallow and brief, or deep and long lasting. Nevertheless, what is fascinating is that some already argue there has been a recession, others argue otherwise, over a topic which, on the face of it, is fairly straightforward.

Fast forward to the present, which data should investors focus on now: the corporate profits season, the macro data, for example the numerous gauges of inflation and growth, or indeed comments from central banks? Of course, where to focus is an eternal quandary for markets.

Certainly, the path of central bank interest rates remains the key determinant of the direction of financial markets, accustomed as they are to excess liquidity. Of course, inflation and growth feed into this, as do the opinions, and therefore comments, of central bankers themselves.

Market expectations for US Fed Funds

Source: Bloomberg. Estimated interest rates as at 3 Aug 2022

The graph shows market expectations for the profile of US interest rates, comparing expectations in mid-July and the beginning of August. Both periods had markets expecting a rate cut early next year and then easing throughout 2023. It’s fascinating that market expectations are for interest rates to be cut so soon after peaking, this has been unusual historically. Importantly though, expectations have become more dovish between the two dates.

Of course, these are just market expectations and markets are simply an aggregate of the same investors that sometimes see what they want to see. Either way, increasingly there is talk of a peak in both inflation and Fed hawkishness. Investors might be looking through the bad news, or only seeing good news. On the other hand, it might be that markets were too bearish and have been readjusting upwards to some better news.

Nevertheless, this more dovish stance has driven the latest up leg in the recent rally, led by growth stocks but not limited to risk assets. Bonds have had a very strong run too, across sub-asset classes. At the moment it’s not clear whether it’s a bear market rally, a degree of mean reversion, or something more sustainable.

From our perspective, it is ok to be undecided. There are some signs of inflation peaking but, equally, and probably more importantly, where is inflation going to settle? 5% would have a very different impact than 2% on economies and markets.

Our approach is to try to avoid seeing what we want to see. It’s not easy but in practice we have a number of mechanisms in our process which helps.

For example, our pragmatic approach to buying and selling is driven by positive and negative price momentum respectively. This is one of the elements of our process which leads us away from being too dogmatic about views and keeps the portfolios market relevant. For example, we are less convinced that inflation has peaked but, due to market dynamics, over recent weeks we have reduced our exposure to inflation beneficiaries and added to growth stocks, as well as adding to duration in US Treasuries.

Nevertheless, we are reluctant to read too much into central bankers’ tone, especially as their forward guidance has been generally poor of late. Importantly, if the market rally is to hold, expectations will have to be right that inflation and Fed hawkishness have peaked.

Anthony Rayner, multi asset manager at Premier Miton Investors. The views expressed above should not be taken as investment advice.

In the 15 years since the start of the global financial crisis, the best performing funds have made returns measured in the hundreds of percentage points – but the anniversary comes at a time when investors are worrying about a new potential crisis.

The global financial crisis began in earnest on 9 August 2007, when French bank BNP Paribas froze three of its US funds and highlighted problems in the US subprime mortgage market. This marked the first seizing up of the financial system and banks quickly became reluctant to lend to each other.

Investors ultimately lost trust in the banking system and governments had to bail out struggling lenders. Central banks stepped in restore confidence in the market and to shore up the global economy by dropping interest rates to historic lows and launching the first quantitative easing programmes.

This lead to a bull market that lasted more than a decade, as bond yields were pushed to record lows and investors snapped up growth stocks. As the chart below shows, the 15 years since the opening days of the financial crisis have handed some significant returns to investors.

Total return by Investment Association sector since start of GFC

Source: FE Analytics

The average fund in the IA Technology and Technology Innovations sector is up 575.2% since 9 August 2007, reflecting the fact that tech stocks were – until recently – the strongest part of the stock market.

The high return of the IA North America and IA North American Smaller Companies sectors is linked to this, as many of the leading tech names are based in the US.

But these parts of the market have come under pressure more recently as rising inflation and interest rates have made investors less interested in growth stocks such as the tech giants.

Global funds have held up well, with the average member of the IA Global sector up more than 200% since the start of the financial crisis.

UK equities, on the other hand, have been out of favour with investors for some time and are much further down the performance rankings. The average IA UK All Companies fund has made 104.7% over the past 15 years, while the IA UK Equity Income sector is up 101.5%.

At the bottom of the rankings (aside from money market funds) is the IA Targeted Absolute Return sector with an average 15-year return of 40.8% followed by IA Latin America (45.7%) and IA UK Direct Property (46.8%).

Source: FE Analytics

These trends are clear when it comes to funds that have made the highest returns since the start of the financial crisis, shown in the table above.

Invesco EQQQ Nasdaq 100 UCITS ETF leads the pack with its 1,120.3% total return. The $6.2bn ETF tracks the Nasdaq index, which is dominated by tech stocks such as Apple, Microsoft, Amazon and Alphabet.

As would be expected, tech is a common theme among the funds in the above table with the likes of AXA Framlington Global Technology, Fidelity Global Technology, Candriam Equities L Biotechnology, Polar Capital Global Technology and L&G Global Technology Index Trust making more than 800% over the past 15 years.

But it must be kept in mind that many of the funds on the above list have struggled in 2022 as the market has turned away from growth investing. Invesco EQQQ Nasdaq 100 UCITS ETF, for example, is down 18.2% in 2022 so far and sits in the bottom quartile of the IA North America sector.

With markets selling off over 2022, Hargreaves Lansdown senior investment and markets analyst Susannah Streeter said there are obvious comparisons between now and the situation 15 years ago.

“On the face of it, there are parallels to be drawn with today, given the volatility wracking equities, movements in the bond markets signifying potential recessions and red-hot property prices showing signs of cooling,” she said.

Streeter highlighted some good news during the current volatility, such as banks being better capitalized and able to cope with a sharp deterioration in economic outlook and households being less likely to “dig themselves deeper into more debt”.

“The not-so-good news is that central banks have fewer tools at their disposal to deal with today’s looming economic storm. Back in August 2007, interest rates in the UK were at 5.75%, which provided the Bank of England with plenty of room for manoeuvre. In the years that followed, the rate dropped rapidly to stimulate demand in the economy and a mass bond buying programme was launched to reduce borrowing costs,” she continued.

“Today those levers can’t be used as they are creaking under the strain of being pulled to get us through the pandemic. With interest rates lowered to ultra-low levels, the era of cheap money has helped fuel the fires of inflation which central banks are now desperate to put out. So, instead of heading into a downturn with the expectation there will be another lifeline thrown to pull the economy out of a crisis, the aids currently deployed are being withdrawn rapidly.”

Streeter pointed out that the Bank of England appears to be willing to slow economic growth to bring down inflation, which is making investors nervous. At the same time, higher interest rates increase the risk of the housing market rapidly deflating and many homeowners are reliant on ultra-cheap yet short-term mortgage deals that will need to be renewed in a higher rate environment.

Furthermore, she noted several other “clear and present dangers on the horizon” that could threaten stability such as emerging markets being hit by continued increases in commodity prices, fresh Covid waves creating additional headwinds for growth and more turmoil in China’s fragile property market.

“Economic uncertainty and market volatility can be unnerving for investors, but tough times have been shown not to last forever, and markets eventually recover,” Streeter finished.

“With inflation appearing to run rampant and a recession looming there are clearly tougher times ahead for consumers and companies but it’s important for investors to think about their long-term strategy and stay resilient when markets are jittery. We don’t know exactly what is round the corner but keeping calm and carrying on, instead of impulsively selling, might benefit you in the long run when prices eventually recover.”

DIY retail chain Kingfisher cemented its place as the UK’s most shorted company in July as a further 0.78% of its shares were targeted by short-sellers, the Financial Conduct Authority’s short register shows.

Short positions on Kingfisher – which owns B&Q and Screwfix – rose to 9.18% over the month as WorldQuant became the eighth firm to bet against the company, buying 0.5% of its shares.

An additional five firms also increased their pre-existing positions in Kingfisher while shorted shares in its closest contender, Cineworld, dropped 0.27% from where they had stood in June.

The cinema chain held the top position for several months until Kingfisher leapt to the front, with DIY sales down from their pandemic highs.

Many consumers took to home improvements to fight lockdown boredom and make their immediate surroundings more pleasant, but sales have slowed now that Covid restrictions have been rolled back - first quarter sales were down 5.4% year on year and Kingfisher’s share price fell 31.1% over the past 12 months.

Share price of Kingfisher over the past year

Source: Google Finance

However, it’s not all doom and gloom, according to Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, who pointed out that first quarter sales were up 16.2% on a three-year basis.

She said: “A sizeable chunk of customers that picked up a hammer for the first time have kept coming back, thanks to their new skills and a shortage of labour in the building trade.”

Likewise, Kingfisher successfully overcame the supply chain issues that have plagued many industries this year, according to Streeter.

“It’s managed to deftly manage ongoing supply chain issues, with product availability improving even as the price of raw materials has stayed volatile,” she added.

This was echoed by Adam Vettese, analyst at eToro: “There are concerns about whether global supply chain issues will affect stock availability and if product price inflation will hit sales, but Kingfisher seems to be managing these issues well to date.

“The housing market in the UK is still strong so we expect demand for DIY products to remain resilient.”

Kingfisher also announced in May that it will be buying back £300m of its own shares, potentially a good sign for shareholders who could see the value of their holdings increase.

Elsewhere on the UK’s most shorted list, travel and aviation companies have seen some improvement throughout July.

Airlines such as Wizz Air, easyJet and British Airways owner International Consolidated Airlines had a surge in short-sellers taking an interest in June as airports descended into chaos.

Worker strikes in major UK airports have led to many flight delays, cancellations and refunds, with further strike action throughout the busy summer period likely to add additional strain on airlines.

These pains have arrived just as aviation companies are emerging from a two-year period of depressed revenues, where lockdown travel restrictions meant very few people were flying.

Higher fuel prices are also dragging on the industry’s recovery and limiting profit margins, but a glimmer of hope shines through as several firms reduce their short positions in UK aviators.

Over July, the amount of shorted shares in Easy Jet dropped by 1.44%, International Consolidated Airlines fell 1.08% and Wizz Air by 0.85%.

This is a positive sign for the industry, but the share prices of each are still significantly lower than they were 12 months ago.

Share price of Wizz Air, easy Jet and International Consolidated Airlines over the past year

Source: Google Finance

Despite a number of setbacks, eToro’s Vettese said that budget airlines will be able to weather the storm, even if revenues take a battering in the short term.

He added: “While there are a myriad of issues facing the sector, we expect low-cost carriers like Wizz to outperform their more premium peers as inflation soars and travellers tighten their belts. That said, a return to profitability in the short-term will be challenging.”

The outlook for some other transport sectors also improved in July, with shorted shares in coach company, National Express, lowering 0.32% after AKO Capital reduced its position in the company.

Although bets against the company declined, its share price is still down 31.9% since the start of the year as higher fuel costs become a larger expense for the company.

Share price of National Express over the past year

Source: Google Finance

Train services remained the same in July despite strike action causing major delays and leaving many customers stranded.

Train unions have caused major disruptions on their mission to increase workers’ pay and conditions, but the number of shorted stocks in Trainline remained the same at 0.7%. That being said, its share price has jumped 40.3% since the start of the year.

Share price of Trainline since the start of the year

Source: Google Finance



Source: Financial Conduct Authority

The Federal Reserve’s hesitancy to tackle inflation promptly could ruin the interest rate cycle for much of the next decade, according to US veteran investor Richard De Lisle.

The central bank began raising rates in March when US inflation reached 7.9%; several hikes later, interest rates are currently between 2.25% and 2.5%.

Despite the Fed raising rates by a steep 0.75 basis points at its past two monetary policy meetings, US inflation has continued to climb to a 40-year high of 9.1%.

De Lisle, manager of the VT De Lisle America fund, said the delay in starting to lift rates means central bank has had to hike too high and too quickly, which will have a knock-on effect for many years to come.

“All that is an overreaction,” he said. “They're constantly playing catch up because they used the word ‘transient’ for too long. They did for so long that they became a bit of a laughing stock, and we’re now seeing them in fierce mode.”

Now that the Fed has reacted so aggressively, De Lisle expects interest rates to swing up and down over the next few years as the central bank tries to lower inflation whilst also attempting to prevent a recession.

“A pendulum has been set swinging and it can’t be prevented. We’ll see rates rising and falling over much of the next decade much like we did in the 1970s. It’ll swing from one side to the other and it'll be a disaster,” he warned.

In fact, the Fed’s choppy interest rate cycle might not be successful in stopping either inflation or a recession, with De Lisle stating: “We could hit the jackpot and have both high inflation and a recession at the same time. That's the fear that the markets are discounting really and that dominates everything.

“We’ve got this fragility which means that if something can go wrong, it will and it will cause a lot of trouble when it does. You can have a relatively little thing happen and all hell could break loose.”

BlackRock suggested that it is also bracing for such a scenario in its 2022 mid-year report; it said that the Fed must choose to reduce inflation or save economic growth, as both won’t be able to be saved.

It stated in the report: “[Central banks] are not acknowledging the stark trade-off: crush economic growth or live with inflation.

“We will likely see real economic pain – halting the ongoing restart – before the Fed changes course, and there isn’t enough time for incoming data to stop the Fed in its tracks. We see this resulting in the worst of both worlds: persistent inflation amid short economic cycles.”

BlackRock has reduced exposure to developed market equities for the time being as it anticipates “an increasing risk of the Fed overtightening, growth to stall and earnings estimates to be overly optimistic”.

The European Central Bank raised interest rates for the first time for over a decade in July, trailing behind the Fed and Bank of England in tackling inflation.

However, Thomas Donilon, chairman of the BlackRock Investment Institute, said the eurozone’s central bank could trip up on monetary policy and put too much pressure on growth, much like the Fed.

He said: “The ECB looks on the brink of a potential policy misstep – insisting that growth can hold up to justify higher rates. We think the ECB will realise its mistake sooner than the Fed.”

Although the Fed is in a tight spot, Capital Group fixed income manager Tim Ng suggested that the central bank didn’t have much of a choice but to be fierce in the face of rampant inflation.

“We are seeing a significant deviation from the standard Fed playbook we’ve become accustomed to over the past few cycles,” he said. “And the reason is clear: inflation is far too high.”

Ng forecasts several more hikes at the Fed’s next few meetings leading up to the end of the year, but at a slower rate of 0.25 basis points each.

Estimated Fed hikes by 2023

Source: Capital Group

The Fed may be powering on with their interest rate hikes, but Jacob Manoukian, US head of investment strategy at JP Morgan, said the central bank is nearing the end of its monetary policy tightening.

“We are probably closer to the end of the Fed’s rate hiking cycle than the beginning,” he added.

“The Fed acknowledged this backdrop of slowing growth in their policy statement. And while their primary focus is still on getting inflation back to target, in the press conference they hinted that the worst of the tightening cycle is probably over.”

He was optimistic about the Fed’s outlook – the hikes carried out this year may seem like a steep rise, but rates are now at a neutral point that neither stimulates nor smother economic activity.

Rate hike expectation vs neutral rate

Source: JP Morgan

Now that hikes are entering restrictive territory, Manoukian felt confident that the Fed would deescalate its aggressiveness and raise rates in smaller hikes moving forward.

“This aggressive rate hiking cycle has been the primary reason for the poor performance from both equities and bonds so far this year, so smaller rate hikes should be welcomed by investors,” he added.

Similarly, Madison Faller, global markets strategist at JP Morgan, said the central bank was past the hump and easing the rate of rate rises could be good for the equity market.

She added: “We don’t know whether or not the bottom is in, but there have been enough glimmers of hope on the inflation and Fed tightening front, and so much damage already done to markets, that even a modest change towards better news can mean gains for markets.”

Everything you need to know about building your own investment portfolio and managing your own wealth. Packed with news, analysis and commentary, Trustnet Magazine is your free, easy-to-read monthly guide to self-directed investment. 

If you find Trustnet Magazine difficult to read in the viewer above, simply click the arrow pointing down on the left-hand side of the screen to download the PDF.

So far, 2022 has been a bruising year for equities. The first quarter was dominated by rising bond yields, as the Federal Reserve backtracked on its prior assertion that inflation would be transitory, prompting a sharp decline in equity valuations. However, earnings expectations remained fairly robust.

This all changed in the second quarter – the worst sell off since the onset of the pandemic in early 2020 – as the fundamental impact of inflation began to filter through into earnings. Company outlooks became more downbeat – in some instances dire – and the downgrades started to come through. In a market full of uncertainty and volatility, what should investors do?

Back to basics

During periods of growth uncertainty, it is important to find companies that can deliver today. It’s often better to just go back to basics rather than seek the next big idea. At a time when share prices are under pressure as earnings and valuations retreat, dividends become an increasingly important driver of returns. Yet the type of dividend-paying stock that is purchased is crucial. Often, an investor’s instinct is to buy the highest yielding business at a point in time because that – in theory – will deliver the highest return, but for us, the high yield on offer often represents a red flag or ‘yield trap’.

In periods of stress – such as the one we’re in now – these high yielding traps often cut payouts because they either stem from temporary high earnings, high unsustainable payouts or falling share prices. That lead to disappointing total return profile. A much better strategy is to focus on companies that generate enough cash to not only reinvest for growth but also have the ability and confidence to distribute a growing dividend despite the challenging environment. Over the same time period, such dividends compound and deliver a much healthier growth profile with much less volatility.

Own the right type of tech

Having been the darling of the equity market for the past few years, technology has been very much out of favour so far in 2022. Yet it is still possible for a portfolio to deliver robust returns through holding technology; it just has to be the right type of technology. For us, this means those high-quality incumbents that have business models which are strong enough to deliver today.

Potential disruptors such as Klarna in the private market, Robinhood or Wish that experienced exorbitant valuations during COVID – have what we deem to be unsustainable business models. They are good examples of companies that are not profitable, and this led to them trading on speculative valuation multiples, with longer-duration cash flows potential that are vulnerable to higher interest rates. Now we are seeing the cost of capital increase, these shares have seen extremely sharp sell offs, which causes significant damage to portfolios.

In contrast, established companies such as Visa, Automatic Data Processing or Broadridge have strong enough balance sheets to contend with higher rates, and are therefore outperforming the more speculative tech that grabbed a lot of headlines and the market over the last two years. Competition from new entrants has also decreased, given that capital is now more expensive to access, which is a further benefit of being invested in the strongest incumbents.

Confidence for the future

Focusing on dominant companies exposed to very strong growth themes means they are better insulated from a downturn in the market; the growth theme will still be there. What’s more, the sell off in the market this year has made a number of these companies cheaper, and therefore growth is available to buy at a more attractive price.

An example of how attractive these businesses are can be found in the tobacco space, where Philip Morris recently offered to buy smokeless tobacco producer Swedish Match at a 40% premium compared to what the market was prepared to pay at the time. So, when quality companies are discounted excessively, they can become attractive acquisition targets.

Against a deeply challenging backdrop, we believe that the conditions are fertile for a quality approach to outperform the wider market. Robust performance can be generated due to companies trading at attractive valuations, having more durable earnings in terms of profitability and cash flow, with solid balance sheets able to cope with the cost of capital rising. This should enable such an approach to protect portfolios at a time when the average company in the market is beginning to deliver ever more grim earnings reports.

Abrie Pretorius is portfolio manager of the Ninety One Global Quality Equity Income fund. The views expressed above should not be taken as investment advice.

More than £10bn is currently held in funds that have consistently underperformed over the past three years, Bestinvest has revealed in its latest Spot the Dog research.

However, the £10.7bn in ‘dog’ funds represents something of an improvement from the last time the firm ran the research six months ago. Then, £45.4bn was invested in ‘dogs’.

The Spot the Dog report looks for equity funds that have underperformed an appropriate benchmark in each of the past three discrete 12-month periods. To be labelled a ‘dog’, funds also will have underperformed the benchmark by 5 percentage points or more over the entire three years under consideration.

In the latest report, just 31 funds met this criteria – down from 86 when the research was carried out earlier in the year and well below the 150 ‘dog’ funds that were identified in January 2021.

“All sectors saw a drop in the number of dog funds. While Spot the Dog aims to identify serial underperformers rather than those that are temporarily out of fashion, it has undoubtably been tougher for value-orientated funds to stay out of the kennel in recent years,” the report said.

“This flipped in the first part of this year as growth sectors such as technology, communication services and consumer discretionary were hardest hit and investors started to turn to previously unloved parts of the market and value strategies in particular.”

Of the £10.7bn currently in ‘dog’ funds, £5.5bn came from products in the IA UK All Companies sector while £2.1bn is in the IA UK Equity Income sector.

“This could seem unexpected as the London stock market has held up reasonably well compared to some of the other major developed markets this year, particularly the US,” Bestinvest said. “But just as the relative stability of the UK market is down to just a few sectors, so there are funds whose approach has not worked well under any of the conditions experienced over the last three years.”

There has been a big turnaround in global strategies, however. In the previous edition of the report, £8.5bn of underperforming assets were in the IA Global sector and £10bn was in IA Global Equity Income funds.

This time, both peer groups have only contributed a collective £873m to the ‘dog’ fund total.

Bestinvest also pointed that £6.7bn of the total came from just three funds: Halifax UK Growth, Halifax UK Equity Income and Scottish Widows UK Growth.

“These have been on the list so long, it seems nothing can bring these dodgy dogs to heel,” the firm added. “It may be the mandate, it may be the manager or the market, but the underperformance is now so entrenched, it is clear that these pooches need some radical behavioural therapy.”

Schroders was singled out as the asset management house with most funds on the report’s list: two-thirds of the ‘dog’ funds are managed by the group. This includes Halifax UK Growth, Halifax UK Equity Income and Scottish Widows UK Growth mentioned above, which are all advised by Schroders.

Bestinvest also drew attention to Jupiter, which has three dog funds on the list including Jupiter UK Growth. This is down from six funds last time around, but the group still contributed £774.7m to the total.

Fidelity only has one fund highlighted for consistent underperformance but Bestinvest noted that the £776.5m Fidelity American fund runs a lot of money. “Managers Jonathan Guinness and Samuel Thomas have only been in place a relatively short time, so may need to be given some time to re-engineer the portfolio,” the report added.

The 10 biggest funds highlighted in the Spot the Dog report

Source: Evelyn Partners Investment Management

Jason Hollands, managing director of Bestinvest, said: “While short-term periods of weakness can be forgiven, as a manager may have a run of bad luck or their style may be temporarily out of fashion, there can be more concerning factors at work: important changes in the management team; a fund becoming too big, which might constrain its flexibility or a manager straying from a previously successful approach.  

 “We have been producing Spot the Dog for nearly three decades in order to raise awareness of the poor performance of many investment funds and to encourage investors to regularly check on how their investments are doing and take action if necessary. While there can be reasons to persevere a little longer with a poor performer – such as a change of manager or outlook – in other cases it may make sense to switch to a different fund with a stronger team and track record.”

Funds that offer investors some protection against inflation have increased their lead in 2022 as investors continue to worry about rising prices and interest rate hikes, although a strong July saw most sectors improve their year-to-date numbers.

While the opening half of 2022 featured heavy losses for most parts of the market bar a few, July represented something of a turnaround and risk assets rallied as investors started to think that economic weakness would cause central banks to slow aggressive monetary tightening plans.

As the chart below shows, a strong July wasn’t enough to completely reverse the losses posted by funds over the course of 2022, when issues such as rising inflation and rates, concerns over the health of the economy and the war in Ukraine have hammered sentiment.

Performance of Investment Association sectors in 2022 so far

Source: FE Analytics. Total return in sterling between 1 Jan and 31 Jul 2022

There are just nine Investment Association sectors where the average fund made a positive return over 2022 to the end of July, but this is an improvement from one month earlier when only seven peer groups had avoided a loss.

As has been the case for most of the year, the best sectors have been the likes of IA Commodity/Natural Resources (where the average member is up 13%), IA Latin America (up 8.8%) and IA Infrastructure (up 7.5%).

All of these sectors can be seen as inflation plays: commodities funds give exposure to raw materials, which have shot up in price recently; Latin America funds benefit from this as they are commodity exporters; and infrastructure assets tend to have a link to inflation through regulation, concession agreements or contracts.

At the bottom of the rankings are the IA UK Index Linked Gilts, IA UK Smaller Companies, IA European Smaller Companies and IA Technology and Technology Innovations, with average losses of around 20%.

However, this represents something of an improvement – one month ago, all of their year-to-date returns were about 25%.

Source: FE Analytics. Total return in sterling between 1 Jan and 31 Jul 2022

There has been relatively little change in the individual funds topping 2022’s performance rankings.

iShares S&P 500 Energy Sector UCITS ETF, SSGA SPDR S&P U.S. Energy Select Sector UCITS ETF and Xtrackers MSCI USA Energy UCITS ETF were the top three funds in the year to the end of June but have added 14 percentage points to their year-to-date return during the month since then.

Even a cursory glance at the table above shows how much of a powerful theme investing in energy has been in 2022. Although most commodities have been going up this year, oil and gas have rocketed as bottlenecks and the sanctions on Russia squeezed supply.

Only a few funds on the table – AQR Systematic Total Return UCITS, Winton Trend (UCITS), AQR Managed Futures UCITS, Winton Diversified (UCITS) and Invesco Emerging Markets ex China (UK) – are not commodity strategies.

Source: FE Analytics. Total return in sterling between 1 Jan and 31 Jul 2022

Again, there’s little change in the funds at the very bottom of the Investment Association performance rankings over 2022 so far, with Liontrust Russia’s 60.2% fall being the worst. The fund – along with other emerging and eastern Europe funds – suffered after Russia was frozen out of financial markets following its invasion of Ukraine.

The other dominant theme among 2022’s worst funds is a focus on the growth style of investing, especially tech stocks. As is well known now, these stocks surged in the decade of ultra-loose monetary policy after the financial crisis but are less attractive to investors when interest rates start to rise.

Comparing a fund’s performance against that of its rivals is one of the first pieces of research carried out by investors, but how much weight should really be put on relative performance?

Murray International’s Bruce Stout told Trustnet earlier this year that “relative performance is destroying our industry” as too many investors look for the funds at the top of the table without understanding the individual nature of their portfolios or what is driving returns.

Charles Stanley Direct chief analyst Rob Morgan agrees that relative performance shouldn’t be the main focus of research.

“The problem with relying on relative performance is that shorter-term movements are often driven by style factors. A manager can outperform through luck just as much as they can through skill, so past performance can only ever tell part of the story,” he said.

“Relying on it means judging decisions based on the results rather than the quality of the process itself. This overemphasises the outcome and de-emphasises the circumstances that led to that outcome.”

With this in mind, Trustnet asked five experts how important relative performance is to their fund selection process and what other considerations should carry more weight.

Charles Stanley’s Rob Morgan: “Flip-flopping between styles wouldn’t be useful”

“Fund managers should have a set process that is consistently applied. Flip-flopping between styles wouldn’t be useful as investors would have no idea about what sort of environment they might outperform or underperform in,” Morgan said.

Periods of underperformance are inevitable, as all styles go through bad as well as good periods, so it is important to look over long periods to see whether managers add value or not, he added.

“Not losing focus or being distracted by short-term past performance or noise is really important. More experienced managers, who have witnessed multiple investment cycles in real time, may find this comes more naturally. There isn’t really a metric for this. A qualitative look at the consistency and an investment process and decision making is the most useful tool, and evaluating experience is one part of it.”

Investors who want to participate in long-term growth but don’t want to suffer big drawdowns along the way should look for funds with a capital-preservation mentality, said Morgan.

“Strategies that do this include Ruffer Investment Company and Personal Assets Trust by Sebastian Lyon. Although they are not going to maximise stock market returns, and thus often lag in relative terms, having complete freedom to invest according to their principles and put not losing money and controlling volatility ahead of beating a benchmark does align them with the requirements of a lot of investors.”

Manager’s performance over 10yrs against peer group
 
Source: FE Analytics

Evelyn Partners’ Jason Hollands: “In the real world clients do not set out to beat a benchmark”

Jason Hollands, managing director and corporate affairs head at Evelyn Partners, takes a similar approach and favours managers with satisfying long-term relative performance who also have a strong belief in capital preservation and, above all, have a clear and well-articulated investment process.

“In the real world clients do not set out to beat a benchmark index: they want to preserve and grow their capital in real terms over time. There are a number of ways fund managers can do this, but a key one is preparing to raise cash weightings when they consider markets are overpriced or the outlook is concerning or position in more defensive asset classes or sectors,” he said.

Like Morgan, Hollands also mentioned Sebastian Lyon’s Personal Asset as an example of a trust with a strong emphasis on capital preservation which invests across equities, index-linked bonds, gold and liquidity.

“While it won’t shoot the lights out in a bull market, it will protect on the downside.”

Tyndall’s James Sullivan: “Fund managers good and bad get chewed up and spat out on a regular basis”

James Sullivan, head of partnerships at Tyndall Investment Management, thinks a benchmark “empowers the asset allocator and gives guidance and visibility on portfolio structure and direction of travel”. But fund managers should not deviate from their process if they start to slip behind it.

“It is always too easy to blame an underlying manager for underperformance, whether it be relative or absolute. What destroys our industry is a lack of accountability at portfolio manager level. Fund managers must invest with conviction in line with their stated philosophy and be ready to stand by their processes when they face headwinds and fall behind a peer group benchmark.”

Performance and process are two of the four P’s of Sullivan’s portfolio selection strategy, with potential and pedigree completing the list.

Pedigree means favouring managers who exhibited longevity: “The market is very unforgiving and fund managers good and bad get chewed up and spat out on a regular basis. Value can be achieved by backing managers that have seen more than one cycle and one monetary policy backdrop.”

“That said, we also want to identify managers who still have the hunger and the desire to deliver real returns rather than protect historic performance. We want every inch of their performance to matter. Hunger is a little like the elastic in your socks – once it’s gone, it’s gone.”

Asked to pick a favourite, Sullivan also selected FE Alpha Manager Sebastian Lyon. “I have been fortunate to have known him since I was 20 and to badly paraphrase Mark Twain: ‘I am astonished at how much he has learned in 20 years.’”

Quilter Investors’ Sacha Chorley: “If we were to buy a UK equity fund, we want to know that it performs as UK equity does”

When Sacha Chorley, portfolio manager at Quilter Investors, allocates to a manager, he is generally trying to get exposure to their relative performance.

“If we were to buy a UK equity fund, we want to know that it performs as UK equity does, and on top of that we’d like to see incremental alpha from the underlying manager,” he said.

In Chorley’s view, periods of underperformance are inevitable. When they occur, it is important to understand whether the underperformance is consistent with the expectations made during the research stage: namely, of what the process is and when that should mean underperformance could occur.

“We need to have confidence the manager will execute on their process, as that is really what we're buying, and that allows us to build the positions into the portfolio.”

As for a specific manager, Sacha highlighted the Economic Advantage team at Liontrust, headed up by Alpha Manager Anthony Cross.

“They are very clear with the types of companies they will buy because they have shown that those kinds of businesses have a good chance of delivering incremental growth over time. There will be down periods from time to time but the clarity of philosophy means that we are able to form reasonable expectations as to when they may out/underperform,” he said.

“Finally, they are very open with commentaries and updates to talk through decisions made and reasons why, and ultimately all of the above has been proven out through a very long track record of (positive) excess returns.”

Manager’s performance over 10yrs against peer group
 
Source: FE Analytics

GDIM’s Tom Sparke: “Relative outperformance is very important”

Preferring to hold funds for long periods, GDIM investment manager and director Tom Sparke too likes a manager who can perform throughout different market cycles and environments.

“We tend to look for managers who take on less risk and that have a defined philosophy. Relative outperformance is very important – moving down less in difficult periods means less ground needs to be made up and often leads to outperformance in the long term. We tend to look more at risk-adjusted returns for this reason, delivering 90% of an upswing but with 75% of the risk is much more attractive to us than the alternative.”

When it comes to manager appreciation, Sparke has had “long-held regard” for the VT Castlebay UK Equity’s team, run by David F Ridland.

Manager’s performance over 10yrs against peer group
 
Source: FE Analytics

Co-managed by Ben Edwards and Simon Blundell, BlackRock Sustainable Sterling Strategic Bond was also highlighted.

Lastly, Bryn Jones and his team on Rathbone Strategic Bond Fund have shown “an aptitude to achieve a high level of risk-adjusted returns and pro-active management”.

That said, one should be wary of blindly following a manager on prior reputation, “as investors in Neil Woodford, Philip Gibbs and Anthony Bolton have found to their cost”, warned Sparke.