UK equities manager Richard Marwood explains why avoiding certain areas of the market could see investors miss out on some interesting stocks.
The questions hanging over the UK equity market due to the uncertain macro climate have not stopped it from producing some good returns after the Q4 slump, according to Royal London Asset Management’s Richard Marwood.
Marwood, manager on the £1.9bn Royal London UK Equity Income fund alongside Martin Cholwill, said bearishness about the UK equity market as the Brexit saga continues, may have led to some investors missing out on some strong returns this year.
The FTSE All Share index fell by 10.25 per cent during the final quarter of 2018, as markets took a tumble globally, but has risen by 12.83 per cent to 20 June 2019, as the below chart shows.
Performance of index YTD
Source: FE Analytics
The UK remains the consensus underweight among international investors, as the most recent Bank of America Merrill Lynch Global Fund Manager Survey showed, due to the uncertainty of Brexit negotiations.
Where investors have taken exposure is in the more international-facing companies with less exposure to the domestic economy.
However, RLAM’s Marwood said that this might be a mistake.
Marwood said: “I think it’s worth mentioning because those are the sort of macro calls that you could easily make if you were tempted to avoid certain areas of the market.
“We try not to do that in the portfolio. We try to keep a mix of domestic and international and a good spread of sectors so that we aren’t actually trying to make a macro call within the portfolio.
“You can easily make a macro call that is wrong and it poisons your whole portfolio.
He added: “We’re just much more interested in picking individual companies and letting stockpicking being the driver of performance. That underpins the performance that we’re seeing there [at the start of this year].”
So far this year, the fund has returned 12.63 per cent.
Two domestic-oriented stocks that had helped drive performance this year were Dairy Crest, owners of the Cathedral City cheese brand, and landscaping products company Marshalls.
Dairy Crest was the only stock added to the Royal London UK Equity Income portfolio in 2018, according to Marwood, and has been a good driver of the fund’s performance. It was acquired by Canadian dairy firm Saputo earlier this year.
“I think if you had been asked at the end of 2018 what’s really going to drive your performance so far this year, would you have picked out a UK retailer and a very domestically focused building company like Marshalls?” he asked. “You probably wouldn’t actually.”
However, Marwood noted that not all stocks in the portfolio had been positive contributors to performance.
“The two that I would hold my hands up to this year have been Saga and De La Rue,” he said.
“Saga has been weak since it had to reset its expectations in the insurance business. And De La Rue, – which is the business that prints bank notes and is very heavily involved in identity cards and passports – had a profit warning on the back of the competitive nature of the banknote printing market.”
Performance of stocks YTD
Source: FE Analytics
He added: “I would say that we kept the holdings, there is value in Saga: we think that the travel business is very strong and we think that there is value in the Saga brand with their targeting of older customers.
“And in De La Rue there’s a lot of interesting tech – be it making the security features for passports, ID cards or currency – but they also have a very interesting that makes ‘track and trace’ things, such as a hologram for Nike.”
Marwood said it has also made some recent additions in the shape of tobacco company Imperial Brands, which he believes has a combination of yield and strong cash flows, which he said is crucial for producing a sustainable dividend.
Something absent in the portfolio more recently is dividend cuts, which he said was seen in the market with mobile phone operator Vodafone.
“When we’re looking at sustainably of dividends Vodafone has always been one that has looked a bit problematic for us,” the manager explained. “The things that you can look at in terms of predicting dividend cuts are some very generalised things like dividend cover and dividend cover was actually quite low at Vodafone.”
He added: “But the thing we’ve always been concerned about with Vodafone has been the cash flow. It generates a lot of cash but the problem is there’s always a way to actually spend that cash within the business.”
The fund usually hunts at the bottom end of the FTSE 100 and in the FTSE 250 as this is where he is able to find the most interesting companies. As such, he is underweight the largest companies in the UK market.
“[It’s] a very plain vanilla income portfolio,” he said. “There’s of element of barbell in the strategy we don’t own some very high yielding stocks and then have things which are very low yielding in there.”
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Royal London UK Equity Income has made a 28.03 per cent total return over the past three years, outperforming the average IA UK Equity Income peer’s 22.42 per cent but lagging the 33.49 per cent return made by the FTSE All Share benchmark.
The fund is currently yielding at 4.48 per cent and has an ongoing charges figure (OCF) of 0.67 per cent.
With growing concerns over the longevity of the post-crisis bull run, GAM’s Michael Biggs explains why investors should take a balanced approach.
Investors worried that the post-crisis bull run could be coming to an end soon should hold both equities and government bonds, according to GAM Investments’ Michael Biggs.
“Valuations appear stretched and investors are naturally concerned about the possibility of a sharp pullback,” said the macro strategist. “We have enjoyed the market’s ride into the sunlit uplands, but no one wants to be left holding risky assets if the market tips into the abyss.”
And traditional safe assets have lost their gloss, Biggs said.
“In recent months US Treasuries have rallied, and 10-year yields are now back close to 2 per cent. What is an investor to do?”
The portfolio manager’s answer to the dilemma – to cover one’s bet by holding both equities and government bonds – is based on “three crucial relationships”.
The first of these is the relationship between credit and the business cycle, he said. In the expansion phase of the business cycle, borrowing keeps increasing until “a shock of some sort,” such as an interest rate hike, applies the break. When this happens, the pendulum could swing in the opposite direction and the economy could fall into a recession.
The higher the level of borrowing, the greater the risk of recession, said the GAM strategist.
“Before each of the previous recessions going back at least to 1970, new borrowing levels were well over 10 per cent of GDP, and it did not require much of a shock for new borrowing to fall,” he explained. “In contrast, current levels of new borrowing are around 6 per cent of GDP.”
Biggs believes it’s much harder for new borrowing to fall from this lower level, making a recession unlikely in the near term.
US new borrowing
Source: GAM Investments
The implications of this growth outlook for asset prices are captured in the second relationship.
The second relationship underpinning Biggs’ argument is the correlation between the ISM purchasing managers index – which monitors changes in production levels from month to month –and year-on-year returns to the S&P 500.
While correlation holds, decent growth is sufficient condition for positive equity returns, he said. As such, a level above 50 should be positive for equity markets.
However, this has not always been the case.
“Equities and growth have not always moved together,” Biggs noted. “In the two decades before 2000 the correlation between the ISM and equities was around zero. What has changed?”
The answer, he said, lies in the third relationship: the correlation between equity and bond returns. As the chart below show, this correlation was positive from 1965 to 2000, but has turned negative since then.
5yr correlation between bond and equity returns (S&P 500 and 10-year US Treasury).
Source: GAM Investments
Biggs sees this correlation as dependent on the concerns of central banks and whether they are more worried about inflation or growth.
When central banks are worried about inflation (1965-2000), he said, bond and equity returns have been positively correlated.
“An increase in inflation causes central banks to hike rates and bonds to sell off, while the weaker growth outlook causes equities to decline,” he explained.
If growth is the bigger worry of central banks (2000-2019), he added, the correlation tends to be negative.
“Weaker growth causes equities to fall, but central banks often respond by cutting rates, and bonds rally as a result,” Biggs noted.
The implications for portfolio management are obvious. If bonds and equities are negatively correlated, then the volatility of a portfolio holding both asset classes declines.
“An investor should be willing to pay a higher price for such a lower volatility portfolio and valuations for both bonds and equities should increase,” the GAM strategist said. “An analysis of asset price valuations that does not take this correlation into account will tend to find that assets are expensive, even if they are not.”
But it also has implications for the ISM/S&P relationship because tighter correlations between the two have only held while the correlation between equity and bond returns has been negative.
Or, to put it differently, positive GDP growth is only correlated with positive equity returns when central banks are not too concerned by inflation, said Biggs.
There is one big risk to this relationship: a sustained rise in inflation, however.
“If central banks become concerned about inflation, then the correlation between equity and bonds returns could turn positive again,” he said. “The ISM/S&P relationship could therefore break down, and equities could fall even if growth is fine.”
While Biggs sees little evidence of inflation at present, he believes there are good reasons to be concerned about this risk in the medium term.
As the chart below shows, the US budget deficit and the unemployment rate are usually positively correlated: recession causes unemployment to increase, which causes the government to respond with fiscal stimulus to try to kick-start the economy. Conversely, as the economy recovers, unemployment decreases, and the budget deficit goes down.
The US budget deficit and unemployment
Source: GAM Investments
“In this cycle, in contrast, the US has put in place a fiscal stimulus even though unemployment rates are low and falling,” said the strategist.
“The last time this occurred was in the late 1960s and, as the next chart shows, this coincided with a sharp rise in core inflation. The pick-up in inflation happened before the oil price increases of the 1970s.”
However, the strategist cautioned about confusing correlation with causality, saying it is difficult to gauge the extent to which inflation has been driven by fiscal stimulus.
“It seems reasonable to assume that such a boost to demand could cause inflation when an economy is operating at full employment. If this occurs, then both bonds and equities could sell off sharply,” Biggs concluded. “This risk appears low at present, but we should be ready to change our views if inflation takes hold.”
With growth expectations starting to wane, investors are waking up to how income funds can help boost their returns.
As the current economic cycle continues to confound investors and fears of a recession grow, the quantitative easing-fuelled levels of growth of the past decade seem unlikely to be repeated in the coming years.
The renewal of the US-China trade spat has made investors increasingly wary of a potential downturn for both economies and the possible negative impact for global markets.
Indeed, the latest edition of the Bank of America Merrill Lynch Global Fund Manager survey revealed that trade war was the top tail risk for investors, while both economic and corporate earnings growth forecasts over the next year have weakened.
With the post-crisis era of loose monetary policy also drawing to a close, it is likely that investors will find it more difficult to find drivers of growth for their portfolios.
Source: BofA Merrill Lynch Global Fund Manager Survey
However, the solution might be found in income stocks and strategies.
Companies with a good dividend yield play an important in the £2.7bn Pyrford Global Total Return strategy. Pyrford international chief investment officer and fund manager Tony Cousins said its ‘value indicator’ – which combines the current dividend yield plus five-year forecast annualised real earnings per share growth – helps it identify stocks that should help it deliver stable total returns.
“We like stocks that have a decent dividend yield, because that obviously means you need to be less heroic on your earnings forecast,” said Cousins, who oversees the £2.7bn Pyrford Global Total Return fund. “But you can’t just buy stocks solely on dividend yield. You need to be convinced that there is some growth in income.
“If you look at long-term returns half comes from initial income, the other half comes from growth and income of total return.”
In addition, dividend-paying stocks have a strong track record of outperforming those that reinvest cash flows, according to Allianz Global Investors’ Simon Gergel.
Gergel (pictured), who oversees the four FE Crown-rated Merchants Trust and is chief investment officer for UK equities at Allianz, said there was ample evidence of dividend-paying stocks outperforming their peers.
“If a company pays lots of money to shareholders each year, is that going to be better than a company that retains the money in the business and reinvests it?” he asked. “Well, actually there’s evidence that will move to this company’s pay out their income as a high yield on average outperform in terms of total returns.”
Gergel added: “If you take, for example, the UK, if you’d bought the highest yielding company you would have outperformed the lowest yielding stock by about 3 per cent per annum over 40 years, which is really quite a remarkable result in terms of compounding.
“It may not sound a lot, but over such a long period it’s significant and this effect isn’t just over the long term, it’s actually happened since the year 2000.
“And it hasn’t just happened in the UK – it happened in the US and has happened in pretty much all the major markets with the exception of one or two very smaller markets, where particular stocks that might distort it.”
The power of compounding – the so-called ‘eighth wonder of the world’ – can be seen in the chart below, with the price return and total return (with income reinvested) of the FTSE All Share compared.
Performance of index over 10yrs
Source: FE Analytics
“If you look at most asset classes over the last 20 or so years, then even with equities more than half of their returns have come from dividends,” said Investec Asset Management’s Jason Borbora-Sheen.
And it’s not only equities this applies to, he added.
“In the case of fixed income assets it’s more than 80 per cent – and sometimes more than 100 per cent – coming from their coupons,” said the fund manager.
“So really, we’re trying to get investors to focus on this concept of the importance of compounding yield rather than just viewing assets which have got an income as a way of generating cash flows.”
This message appears to be filtering through to investors, with other equity income managers beginning to see greater interest in their strategies from investors as the outlook for growth fades.
“For me, income funds are about two things,” said Chris Murphy, manager of the £979.8m Aviva Investors UK Equity Income fund. “There’s the obvious thing of providing a yield premium to the end client to the market. And it’s important, in the long run, that yield and dividend grow, even in a low inflation world.”
He added: “But I think there’s another aspect to income funds as to why people buy them and that’s the make-up of the total return that they get, particularly if they don’t take out the dividend.
“Actually, by choosing consistent businesses with good cash flows that generate yield, you get lower volatility of returns and more consistent returns.”
Borbora-Sheen, co-manager of the £942.3m Investec Diversified Income fund, said investors have increasingly sought out his fund for the total return rather than just an income vehicle.
“If we look at the distribution of unit sales, we’re now seeing more flows coming into the fund as an accumulation investment, meaning that investors don’t actually take the income from it,” he said. “We’re trying to get across the use of income as an engine as opposed to an outcome.”
Performance of fund over 3yrs
Source: FE Analytics
While income stocks can play an important part in portfolios, value investor Gergel warned that investors should not focus too much on yield alone, arguing that the total return is paramount.
“We never buy a share because it’s got a high yield,” he explained.
“We buy a share because we think we can make money: a total return. The income might be a part of that but it’s never the only answer; we’re always looking at the total return we’re going to get.”
The manager says investors could have analysed Amazon’s products and markets to death when it started and still would not have identified what made it so valuable.
Investors should not “waste their time” looking at what a company does today, according to Baillie Gifford’s Kirsty Gibson, who says they would be much better off thinking about where it could end up in the future.
Gibson, a manager on the Baillie Gifford American fund since January 2018, previously dismissed the contention that active managers cannot beat the S&P 500 as “fundamentally wrong”, calling the US market “wonderfully inefficient”.
To prove this point, she pointed to professor Hendrik Bessembinder’s paper “Do Stocks Outperform Treasury Bills?”, which shows that all the wealth created by the US market from 1926 to 2016 came from just 1,000 – or 4.3 per cent – of its stocks, with just 90 responsible for half of this.
Source: Baillie Gifford
Additional research from Baillie Gifford found that in rolling five-year periods over the past three decades, 30 per cent of stocks on the index fell and around 50 per cent rose marginally, with these two groups cancelling each other out.
However, the remaining 20 per cent went up at least 2.5x times and this is where Gibson (pictured) and the team focus their efforts.
The manager said that while spotting these companies is no easy task, she believes they have a number of characteristics in common that hint at what they are capable of.
“The first thing would be strong competitive advantages,” she explained. “We’re looking for companies that have, or have the potential for, a strong competitive advantage – they have a deep ‘moat’. And it’s probably getting deeper over time.”
Gibson is not the first investor to extol the benefits of “the moat” – this is one of the cornerstones of Warren Buffett’s value investing approach, for example, and the “Economic Advantage” strategy used by Liontrust’s Anthony Cross and Julian Fosh.
The second common characteristic of exceptional growth companies that Gibson searches for – large market opportunities – may also sound obvious. However, Gibson said the most important point here is that these opportunities are not static.
“We would argue that it’s largely a waste of time analysing the company’s current products and markets when trying to ascertain its future value,” she explained.
“In the late 1990s, Amazon was an online bookseller. I would challenge anyone to describe what Amazon does now neatly in a couple of words, I think it’s evolved so much since that time.
“Further to this, when it first started, you could have analysed Amazon’s products and markets to death and you probably would still not have identified everything that makes the company valuable today. And consequently, we’ve really tried to focus on and think about what a company could be.”
Source: Baillie Gifford
According to Gibson, what a company could be or achieve in the long run depends on a third characteristic that exceptional growth stocks share: a clearly defined culture.
The manager said culture is often underappreciated as it only really matters if you take a genuine long-term outlook – she pointed out that if you are only worried about whether you should own a company for six to eight weeks, you are not going to spend much time thinking about the management’s long-term vision.
“It’s difficult to measure, it doesn’t fit neatly into DCF [discounted cash flow] or other financial models,” she added.
“But how a company is run makes all the difference when it comes to unlocking future growth opportunities. And we’re looking for companies whose culture makes them willing to invest in the future and embrace change, rather than focusing on quarterly earnings targets.”
So, if this culture is difficult to measure, how does Gibson do it?
The manager said obtaining the necessary level of insight into a company is not just a case of reading a couple of broker notes – Baillie Gifford’s use of this sort of research is minimal.
Instead, she and her colleagues aim to immerse themselves in the businesses: Gibson moved to the US for a month last year with her son and husband for an extended research trip to build “a fountain of knowledge”.
The manager said it is not just about visiting current holdings or even prospective ones, either.
“I spent quite a lot of time with a variety of different companies in the industrial biotechnology area,” she continued. “This is an area where at the moment, there are no investable companies for us in the public space.
“But we believe it’s a significant opportunity longer term, so that should things come to the public markets, we’ve got that knowledge-base in place before we decide whether or not we want to participate or buy into these companies.”
“And we think about the US in a global context. My colleague Helen, when I was in the US for a month, decided to move her family out to China for two months to spend some time with the internet giants there.
“I think this is really important, this idea that ultimately, if we want to learn as much as we can about a company like Amazon, we should probably be spending some time learning about some of the Chinese companies like Alibaba, and that’s what she spent two months looking into.”
Data from FE Analytics shows Baillie Gifford American has made 840.56 per cent since launch in 1997, compared with 433.72 per cent from the S&P 500 and 321.66 per cent from the IA North America sector.
Performance of fund vs sector and index since launch
Source: FE Analytics
The £2.4bn fund has ongoing charges figure (OCF) of 0.52 per cent.
In the "battle of the bays" featuring locations such as Tokyo, New York and San Francisco, our money is on China's Greater Bay Area becoming the pre-eminent economic region in the world.
The most productive urban locations in the world are found in bay areas, for example Tokyo, San Francisco and New York. Now, there is a new kid on the block - China’s Greater Bay Area, or GBA for short.
On a recent trip to Shenzhen, the Global Cities blog looked at the scale and speed of the development of the GBA, the population of which will soon exceed that of Germany.
The GBA benefits from China’s willingness to invest in transport infrastructure, as an effective high-speed public transportation system will be critical in determining whether a city achieves global dominance in the future.
Generally, people’s tolerance for commuting has been found to be about one hour in either direction. High speed transport lowers the cost of housing as a city can expand from its centre while ensuring that travel times remain within this tolerance band.
So, in the ‘Battle of the Bays’, will the GBA be the next winner?
China’s progression from a manufacturing hub to an ideas hub is the catalyst behind its rapid urbanisation. We see this happening all over the world: certain locations evolving into knowledge clusters and providing economies of scale as ideas are monetised. The best example of this is the GBA, which the Chinese government hopes will become the world’s pre-eminent tech development centre.
The GBA comprises four cities or economic zones that will serve slightly different purposes. The interlinking of large cities through transport infrastructure means that the sum becomes economically more powerful than the parts. This leads to high per capita levels of productivity.
We wrote about the phenomenon of Meta-Cities on the blog last year (of which the GBA is one).
Which bay area will win?
Although the GBA’s productivity is currently half that of its nearest rival (see chart above), we think this could change rapidly. Companies such as Tencent and DJI in Shenzhen are market leaders and the pace of knowledge transfer is set to increase. This is because the Chinese government has recognised the importance of cities in generating ideas. Unlike the other bay areas, it is prepared to spend heavily on transport infrastructure to facilitate the movement of people around the GBA, as well as ensure affordability for employees and tax breaks for highly skilled workers. In the GBA, a combination of higher density housing and rapid infrastructure also helps to contain house price inflation.
This willingness to invest is demonstrated by the rail network connecting the GBA. This is in stark contrast to the San Francisco Bay Area, home of Silicon Valley, where housing has become unaffordable within the commuting tolerance zone, mainly because the transport infrastructure is so poor and because of the city’s low density housing. This leads to skilled workers leaving the city as even pay inflation is unable to keep up with the higher costs.
We know that cities are the most efficient way for companies to grow, as ideas and people cluster together. The investment in the GBA shows that investment into this region will reap rewards for China. In the ‘battle of the bays’ our money is on the GBA becoming the pre-eminent economic region in the world. Moreover, according to Oxford Economics the GBA will be the seventh largest economy in the world by 2030.
Abhinav Mehra and Andrew Draycott, co-managers of the CC Indian Subcontinent fund, explain why the next five years will allow India to benefit fully from reforms introduced by prime minister Narendra Modi in his first term.
After an uncertain start to the year, Narendra Modi’s BJP party emerged victorious in this year’s Indian elections. We believe the next five years will allow India to benefit fully from the reforms introduced by Modi in his last term, which are only now starting to bear fruit properly. As investors in high-quality Indian companies that are best positioned to benefit from the unprecedented pace and scale of the reforms undertaken such as the Goods & Services Tax (GST) and the Real Estate (Regulation and Development) Act (RERA), amongst many others, we are very excited about the next five years.
Over the last five years, the government has brought in numerous progressive reforms focused on improving India’s long-term productivity. Alongside the state-wide roll-out of GST and RERA, the reforms also include the introduction of a monetary policy committee and a high-profile programme of demonetisation.
Although these policies have made progress in combatting India’s inflationary issues, such success has some initial limitations. Indeed, due to the very nature of bureaucracy, India’s efforts to adapt to Modi’s reforms has disrupted some areas.
For example, the introduction of a monetary policy committee in India has helped to reduce the country’s inflation from high single and double digits to a target rate of between 2-4 per cent. This is much more amenable to long-term growth. However, it has also reduced prices across-the-board, meaning a lower income for India’s vast population of farmers that had previously benefitted from minimum support pricing on their crops.
Similarly, since the implementation of GST on 1 July 2017, there has been a constant tweaking of all aspects of the tax from the varying rates of GST across different products to the systems and processes around the registration and actual monthly online filing of GST returns. This constant state of flux led to a lot of business disruption and uncertainty and it is only now that things are stabilising and companies are beginning to see the benefits. Even on the fiscal front, the benefits of higher compliance (and better tax collection) is also just kicking in, with April 2019 seeing the highest ever GST collection. We think this trend will continue and have a twofold benefit – it will ease pressure on the fiscal front and give the government more firepower to drive investment and it will accelerate consolidation around the dominant and tax compliant sector leaders across categories that we are invested in.
History shows that reforms enacted in one parliament bear fruit for the next and after a brief election-related hiatus, we anticipate growth to accelerate again. It, therefore, seems likely that the benefits of Modi’s reforms on India’s GDP will become increasingly apparent over the next 18 months to five years. What’s more, the BJP are expected to introduce further changes focused on streamlining Indian bureaucracy and judicial reform. As such, the next five years could be as exciting as the last five.
Making the most of opportunities
As investors looking for domestically-focused growth businesses, we invest in low penetration sectors influenced directly by reform. Within these areas, we then identify those boasting the highest growth and quality. It is these leading names that will fare best under change, growing ever stronger and consolidating their slower-to-adapt rivals.
To demonstrate, one theme we have focused on, in particular, since launch is the increasing discretionary spend among Indian consumers. As it stands, the penetration of sectors like automobiles, insurance, and property is below 10 per cent across categories but growing fast. As India crosses the $2,000 in GDP per capita, we see the average Indian consumer having more disposable income allowing them to spend more in these areas. Our job, then, has been to find the leading consumer-facing names ahead of the curve.
A good example is Godrej Properties, which is a top real estate developer in India. The business has posted two consecutive quarters of record property sales while many of its competitors have struggled against reform and tightening liquidity. We also invest in United Spirits and United Breweries, which are subsidiaries of drinks behemoths Diageo and Heineken respectively. India’s per capita consumption of alcohol has doubled over the last decade and at $38bn, the market is among the world’s fastest growing. This is evidence that India is moving from the basic level of consumption into discretionary spending and is backed further by the fact that United Breweries has delivered volume growth of 17 per cent in 2018.
We have already seen early signs of our strategy’s success in the first quarter of earnings since we launched the fund, with many of our stocks growing at three times the average rate of growth within their sector. We think this is just the beginning of a theme under India’s reform agenda where the biggest and best companies will continue to outperform.
Abhinav Mehra and Andrew Draycott are co-managers of the CC Indian Subcontinent fund. The views expressed above are their own and should not be taken as investment advice.
Legal & General Investment Management’s Gavin Launder takes a closer look at three UK companies he believes could conquer the US.
Consumer-focused UK businesses have often failed to translate their success over to the bigger – and more competitive – US market, mainly due to their failure to understand the market and elevate their business enough to compete.
But there are three possible exceptions according to Legal & General Investment Management’s Gavin Launder (pictured) that might be worth considering.
“Type ‘Brits abroad’ into Google and it’s fair to say that the content and imagery is hardly flattering,” said the fund manager. “Let’s face it, we don’t have the best reputation overseas.
“I’m not just referring to the wretched perception of our travelling football fans and the quality of our cuisine. For a number of consumer-focused businesses, UK companies have tried but miserably failed to light up Broadway.”
He added: “Competition for consumers’ attention is fierce in the US, with buyers uncompromising in their demands.
“For me, capturing market share early is crucial. This is exactly why it makes more sense for a company to seek an acquisition as a route to market.”
As such Launder – who oversees the £203.8m L&G Growth Trust – has highlighted three companies he believes have the potential to succeed: Fever-Tree, JD Sports and Cineworld.
First up is soft drinks manufacturer Fever-Tree, where the firm has a huge opportunity for expansion into the US premium mixer market.
Founded in 2003 by Charles Rolls and Tim Warrillow, the company – which has a market capitalisation of around £2.8bn –has been a big success story since its initial public offering, although it has struggled since peaking last September.
Performance of stock since September 2018
Source: FE Analytics
In the US, the firm recently underwent a distributor change in line with its recent collaboration with Southern Glazer’s Wine & Spirits, a partnership which Launder said will push them forwards in the US expansion.
He said: “While the ink on this deal has only just begun to dry, this will significantly bolster Fever-Tree’s attempt to create a premium market for on- and off-trade mixers.”
Rolls and Warrillow’s ethos is a ‘no compromise on quality’ attitude and a ‘single-minded mission’ to produce their premium tonics.
Looking at the company’s performance in the US Launder said early indications from the first-quarter earnings season, indicates that current trading is clearly positive for market sentiment.
He added: “Future growth from disciplined capital allocation, alongside the benefit from a marked improvement in the product mix and offering, should help drive demand and spending. Importantly, this helps build conviction on the asset quality and growth credentials.”
Next up is sports fashion retailer JD Sports, the Manchester-based company which offers brands such as Adidas, Nike, Puma alongside their own labels Pink Soda and Supply & Demand to fill the high street's ‘athleisure fashion’ trend.
The LGIM manager said market commentators had been wrong to write off the company following its acquisition of sportswear retailer Finish Line in 2018.
“While it was clear that both deals represented transformational strategies, history provided a reasonable rationale for caution,” said Launder.
“Despite this wider uncertainty, the deals struck me as a great opportunity for a strong UK business to turn around these stale US franchises.”
Performance of stock over 1yr
Source: FE Analytics
He added: “Of course, it’s likely that the value created by the acquisitions of the number-two American players in the sporting-goods markets will need a degree of shareholder patience and investors may require a longer time horizon to see these deals truly bear fruit.”
Whilst the UK remains their biggest source of revenue, opening 44 stateside stores have proved to be a success generating 21 per cent of its 2018 profits.
Launder’s final tip for UK companies to crack America is cinema chain Cineworld, which like JD Sports he believes was wrongly pushed aside by investors and market analysts last year.
Describing themselves as “the best place to watch a movie” they have almost 800 sites spread over 10 countries, with the majority of these sites (555) located in the US.
But Launder said this aggressive US approach is worth it for the potential opportunities where – as in the case of JD Sports – supportive consumer trends can be found and it can leverage the strength of its existing business model.
“From our recent conversations with management, such a huge opportunity in the US represents a potentially lucrative market for both companies,” said Launder. “They are applying sensible aspirations for improving these businesses, seeing ample scope for both evolution and growth through capital deployment and greater operational efficiency.”
Calling the three companies the “latest British invasion,” the LGIM manager said that the signs for their success are positive and the opportunities are vast.
“While these businesses weren’t born in the USA, they could well conquer it,” he concluded.
Launder has overseen the L&G UK Growth Trust – which invests in companies the manager believe has strong growth prospects – since September 2014, during which time it has made a total return of 51.80 per cent compared with a gain of 31.61 per cent for the average IA UK All Companies peer.
Performance of fund vs sector under Launder
Source: FE Analytics
The fund has an ongoing charges figure (OCF) of 0.78 per cent.
The June edition examines how human fallibility can harm your portfolio.
This month’s issue of FE Trustnet Magazine, out now, looks at the seven deadly sins, with Danielle Levy finding out how human weaknesses cited in early Christian teachings are still behind many of the biggest mistakes made by investors today. On the subject of sins, Pádraig Floyd looks at the latest scams being developed by fraudsters, which unfortunately seem to be growing ever-more sophisticated by the day, while Anthony Luzio weighs up the pros and cons of taking emotion out of investing altogether through the use of robo-advisers.
In the magazine’s regular columns, Hargreaves Lansdown’s Laith Khalaf highlights three stocks with steady – if unspectacular – dividend yields, MGIM’s James Klempster reveals which trust he is using to access the niche asset-backed security sector and John Blowers finds out that platforms appear to be increasing their prices, rather than cutting them as he expected.
Finally, amid all the talk of sins and scams, Adam Lewis looks at one of the most virtuous areas of investing as he runs the rule over the IT Biotechnology & Healthcare sector.
With the late-cycle environment stoking fears of a recession amid growing geopolitical tensions, Walker Crips portfolio manager Andrew Morgan explains what action it has taken to protect investors.
With recession indicators flashing amber rather than red, now might be a good time for investors to start thinking about how their portfolios are positioned for the late-cycle environment, according to Walker Crips Investment Management’s Andrew Morgan.
The overwhelming majority of asset allocators now believe that the global economy has moved into the late-cycle stage, according to the latest Bank of America Merrill Lynch Global Fund Manager Survey.
“We have witnessed one of the longest periods of economic expansion – and one of the longest bull markets – on record,” explained Morgan
“Meanwhile, unemployment rates in the US and UK are now at half-century lows below 4 per cent, a classic characteristic of the late cycle.”
Source: BofA Merril Lynch Global Fund Manager Survey
Morgan believes the business cycle got a new lease of life from fiscal largesse across the Atlantic.
“It can be argued that the maturity of the global economic cycle was delayed by Donald Trump’s tax cuts 18 months ago,” he said. “However, that massive fiscal stimulus is beginning to fade, and the Federal Reserve is bringing interest rates higher.”
While near full employment has been welcomed by some, comes with two downsides, said Morgan.
The first is increased demand, which manufacturers normally struggle to keep up with, and which therefore leads to rising prices and inflation.
The second is higher wages, which reduce companies’ profitability, and which in turn make companies’ share prices look expensive or cause them to fall.
Indeed, investors need to be careful not to be caught out by rising inflation at this stage of the cycle, cautioned Morgan.
“Given the pressures on prices that come from high numbers of people in work, a major risk at this stage is a sudden uptick in inflation,” he said.
The Walker Crips portfolio manager also warned about the risk of increasingly correlated assets in the late-cycle environment.
“Correlation between shares and bonds tends to increase at this time, as both traditional asset classes tend to respond negatively to inflation surprises,” he said. “So, what might have seemed like a well-diversified portfolio during the bull market, can quickly look like a one-way bet on benign inflation.”
To this end, Morgan’s team would aim for a greater bias towards investments which have low (or negative) correlations to equities and bonds.
They also aim to reduce portfolio volatility and raise liquidity in portfolios, both through higher cash balances and through the avoidance of illiquid or unlisted holdings.
“Given that demand tends to outstrip supply at this stage of the cycle, energy and materials shares tend to perform well. Quality also tends to outperform late in the cycle, whilst momentum underperforms,” he said.
Performance of style indices over 10yrs
Source: FE Analytics
A focus on corporate governance can also help steer investors towards quality stocks.
“Our portfolio’s environmental, social & governance screening pays particular attention to governance; we believe the quality bias within our portfolios will serve them well during this late-cycle period,” he added.
The team’s preference for quality stocks at this stage of the business cycle means that the Walker Crips team are more overweight large-caps than small-caps, which also provides greater liquidity if they need to react to market events quickly.
Morgan said he is also wary of sectors where labour costs are high, such as consumer discretionary, noting that as wage growth climbs, these companies find profitability is hit.
“As part of our strategy of countering the risk that shares and bonds will perform similarly, we aim to buy genuinely uncorrelated assets, many of which can be found within the alternatives sector,” he added.
“Within absolute return funds, we like the Natixis H20 MultiReturns fund, as it demonstrates low correlation with traditional asset classes.”
The £427.3m H20 MultiReturns fund was launched in 2013 and is managed by Jeremy Touboul and Vincent Chailley. It aims to outperform the LIBOR GBP 1m index by 4 per cent over a time horizon of three years. Since launch, it has made a total return of 72.53 per cent.
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
The Walker Crips manager also likes gold, which he said tends to outperform during risk-off episodes.
“We have been increasing our exposure to the commodity since the autumn of last year,” the portfolio manager explained. “We would expect gold to outperform during periods of rising inflation expectations, along with rising recession risk.”
Morgan said investing in bonds during the late-cycle usually delivers fewer diversification benefits to portfolios, as the correlations between the traditional asset classes tend to increase.
“We have long been underweight fixed income,” he explained. “A period when central banks are raising interest rates and pursuing quantitative tightening is obviously not conducive to fixed income investing.”
He said the ending of austerity in many major economies is also likely to increase the supply of government bonds at precisely the moment that buyers of these bonds (i.e. central banks pursuing quantitative easing) are disappearing.
“So, we seek low-volatility returns elsewhere, such as alternatives,” he added. “Within the allocation that we do have for fixed income, we are biased towards high-quality, investment-grade bonds, and for shorter maturities, which are less sensitive to interest rate and inflation shocks.
FE Trustnet looks at the best and worst performers of last year and finds out how they have performed 2019-to-date.
Around 98 per cent of funds from the Investment Association universe have made a positive total return in 2019 so far, as strategies continue to benefit from the strong rally in markets at the start of the year.
Last year proved a difficult one for active managers as volatility returned to markets after a fairly benign 2017. Markets were shaken by the pace of the Federal Reserve’s rate-hiking programme as well as US president Donald Trump’s increasingly hostile trade stance with economic rival China.
Concerns that the US economy could tip into recession in 2019 saw investors become more risk-off, leading to falls in markets around the globe.
Indeed, the blue-chip S&P 500 index recorded its first annual loss – in US dollar terms – since the global financial crisis, ending the year 4.94 per cent down.
Other markets struggled in 2018 as the ongoing Brexit saga saw the FTSE All Share index fall by 9.47 per cent, while high growth emerging markets were impacted by talks of a US-China trade war with the MSCI Emerging Markets index down by 9.27 per cent, both in sterling terms.
However, the decision by the Federal Reserve to pause its path to normalisation early on in the year, as well as the prospect of a new US-China trade deal, restored confidence to markets.
While renewed optimism has been tempered somewhat by the resumption of US-China trade tensions more recently, market returns across 2019 have been broadly positive.
Performance of indices in 2019 in sterling
Source: FE Analytics
So far this year, the S&P 500 is up by 17.19 per cent in US dollar terms while the FTSE All Share has made a flattish total return of 0.52 per cent in sterling.
The more positive market backdrop has been good for fund managers, particularly after a difficult 2018 where just 11.2 per cent of the universe was in the black.
So far this year, however, 97.9 per cent of funds in the Investment Association have made a positive total return.
Given the much-changed investment backdrop, FE Trustnet decided to revisit the best and worst performers of 2018 to find out how they had performed in 2019 so far.
The top 20 best performers of last year were concentrated in a number of different specialist areas, as the table below shows. Indeed, strategies focusing on healthcare, technology and US growth areas were among the best performers.
Last year’s top performer was the $1.5bn, four FE Crown-rated Polar Capital Healthcare Opportunities fund, overseen by Daniel Mahony and Gareth Powell, with a return of 15.51 per cent. Its returns have been more moderate in 2019, nevertheless it is up by 8.11 per cent in the year to 19 June.
Almost all of the top-20 funds from last year have made a positive total return, apart from TM Sanditon European Select, the £127.9m European equity strategy managed by Chris Rice, which has recorded a 3.95 per cent loss.
The long/short European equity strategy target returns that are 2 per cent per annum in excess of the EU Harmonised Inflation benchmark
Source: FE Analytics
Of last year’s top performers, Morgan Stanley US Growth has had the best 2019 so far.
The $2.8bn, five FE Crown-rated fund has made a total return of 33.58 per cent this year and is also the best performing fund of the whole Investment Association universe.
US growth-oriented funds have been among the top-performing strategies so far this year, reflecting the strong rise in US markets and the continued dominance of the growth style.
The Morgan Stanley US Growth fund seeks out high quality established and emerging companies with sustainable competitive advantages, strong free cash flow yields and favourable returns on invested capital. However, the firm notes that it has a focus on long-term growth rather than short-term events.
While last year’s top performers have largely continued to make solid returns in 2019, for some of the funds that were at the bottom of the table last year things have got slightly tougher.
Last year, the worst performing fund from the Investment Association universe – TC South River Gold and Precious Metals – was down by 28.86 per cent. While performance has improved, it remains in negative territory having made a loss of 2.36 per cent in the year to 19 June.
Source: FE Analytics
Other loss-making funds of 2018 that have continued to make losses so far this year include the L&G UK Alpha Trust and Invesco Korean Equity.
The £105.6m L&G UK Alpha Trust is overseen by Rod Oscroft, who took over from previous manager Richard Penny at the start of 2018 following his departure to CRUX Asset Management. Having made a loss of 25.05 per cent, the fund is down by 3.06 per cent so far this year.
The other loss-making fund from last year’s worst performers is the $69.7m Invesco Korean Equity fund – managed by Simon Jeong – which has lost 5.29 per cent following a fall of 23.41 per cent in 2018.
However, most of last year’s top 20 worst performers were in positive territory, with GAM Star China Equity and Guinness Global Money Managers standing out as the best of the bunch.
Despite the challenges of renewed hostilities between the US and China, the $356.9m GAM Star China Equity fund has risen by 19.95 per cent following a loss of 23.90 per cent last year.
The Chinese equity fund had been managed since launch in 2007 by manager Michael Lai, who is to leave the firm and hand over to successor Rob Mumford. The fund takes a style-agnostic approach that combines bottom-up stock selection with top-down analysis.
Guinness Global Money Managers meanwhile has made a total return of 19.24 per cent after a loss of 22.67 per cent last year. The $6.5m strategy, which is overseen by Guinness Asset Management chief investment officer Tim Guinness and Will Riley, invests in asset managers, which it believes have the ability to grow very rapidly in rising markets.
Ocean Dial’s David Cornell and JP Morgan’s Rukhshad Shroff say earnings have been in a recession for five years – but there is light at the end of the tunnel.
Investors looking to increase their exposure to India in a bid to take advantage of its powerful demographics should be warned – they need to take the country’s official GDP growth figure with a heavy pinch of salt.
And rather than coming from fund managers focused on other regions who have a vested interest in talking down the world’s second most populous country, this is the message coming from India managers themselves.
In an article, published on FE Trustnet earlier this year, Janus Henderson’s Sat Duhra said: “India’s growth story doesn’t make sense.”
“This is a country that is allegedly growing at 7 per cent,” he explained. “If you look at everything underlying in that economy, if you look at industrial production, if you look at credit growth, if you look at the state of the big banks there, if you look at job creation – they should be creating 12, 13 million jobs, but they are only creating about 5 million jobs.
“If you look at the fact that private enterprise has not started doing any capex since [prime minister Narendra] Modi came in,” he added. “I mean, none of that correlates with an economy growing at 7 per cent.”
Instead of trying to defend these figures, JP Morgan Indian IT’s Rukhshad Shroff – who claims to be able to “sniff out a dodgy deal in 10 minutes” – agreed with Duhra, calling the GDP figures a “fudge”, while David Cornell of Ocean Dial’s India Capital Growth trust said: “The guys at Janus Henderson are right.”
While GDP growth is in of itself of little consequence to equity investors, both managers point out earnings have also disappointed and that from this point of view, India has been in a recession for the last five years.
Cornell said there are two reasons for this.
“India came out of the global financial crisis smelling of roses: no leverage in the banks, no leverage in the consumer, no mortgage finance issues, no toxic loans in the banks that suddenly went pear-shaped,” he explained.
“So when the price of money collapsed as [Federal Reserve chair] Ben Bernanke tried to reflate the global economy, India went on a massive private sector lending splurge, with a huge investment cycle in infrastructure and heavy assets like utilities, oil & gas, power, telecoms and mining companies.
“Then in 2011, global GDP growth slowed and India’s GDP growth went from 8 per cent per annum to 4 per cent per annum. So they have been left with this massive excess capacity in the economy, because they built all this capital in 2010 and then the economy slowed. And that’s why there’s been no growth and why there’s been no jobs.”
The second reason is the immediate impact of the reforms introduced by prime minister Modi. For example, Cornell described the policy of de-monetisation as “like a heart attack to the economy” – Shroff noted that more than 100 per cent of India’s money supply was returned to banks due to the proliferation of counterfeit notes – while he said the implementation of the GST (the goods & services tax) has also stressed out a lot of businesses.
However, both managers believe the long-term value of these reforms will far outweigh the short-term disruption, with Shroff saying the digitalisation of India will accelerate and multiply the benefits.
“Just think about a vendor in in a little village,” he added. “Previously, there’s no question he’s not in the system. It is a cash-based system, he doesn’t pay a central tax, sales tax or income tax.
“Today if he’s not in the GST system, if he’s supplying metal parts to Suzuki or to someone who’s supplying to Suzuki, for example, you can’t get the tax set off. If I’m a partner of them I am not transacting with you anymore, because I need you to give me a receipt saying this is how much I have paid you.
“That person has a choice of going out of business, which is economically depressing, or coming into the system. As he comes into the system, you might have low margins because he is going to be paying 15 or 20 per cent tax, but he’s now got a monthly record.”
“No one used to give him any credit, no bank, because it used to ‘say where are your books, how big or small or profitable are you?’ Now he just gets his own phone and says ‘look, every month I have £1,000 of turnover, will you give me a £200 loan?’
“And the answer is yes, because I can see the data. So that data availability has transformed that person – his revenues can now double because he’s expanding. So that’s the benefit. Now you’ve got that person in the net.”
Both managers believe there is light at the end of the tunnel following the problems with overcapacity and the initial shock from Modi’s reforms. They say the recovery is likely to be exponential rather than gradual, with Shroff noting that consensus earnings forecasts for next year predict a jump of 19 to 20 per cent due to the normalisation of the banking sector.
Cornell added that Modi strengthening his majority in the recent elections and gaining control of the upper house will be crucial for passing new laws, helping him tackle corruption and other causes of inefficiency in the economy. He said the prime minister’s progress is being noted by the international community – India jumped from 137th position in the World Bank’s Ease of Doing Business Index in 2016 to 77th in 2019.
Regardless of this, Shroff is confident India’s demographics – where the average age of its 1.3 billion people is 29 – should allow it to match or surpass its performance over the past quarter of a century.
“In those 24 or 25 years, every conceivable Indian problem that you can think of, and not think of, has occurred,” the manager continued.
“We have had economic ups and downs, we have had governments come and go, we have had a government for 13 days, which collapsed.
“We’ve had a nuclear test, we’ve had a nuclear neighbour respond to that test, and soon after you’ve had the sanctions.
“We’ve had two days – driven by politics – where the Indian market moved more than 15 per cent, once up, once down. That is not supposed to happen in 900 years: it’s happened twice in my career.
“By the way, we haven’t talked about the currency impact: the rupee has depreciated probably by 50 per cent in these 25 years.
“So after that – this is including the global financial crisis, the Asian financial crisis, we had our own Indian mini events – after all that, the index in sterling has compounded at 7.4 per cent annualised for 25 years.”
Performance of trusts vs index over 5yrs
Source: FE Analytics
Data from FE Analytics shows JP Morgan Indian IT and India Capital Growth have made 87.74 per cent and 70.1 per cent respectively over the past five years compared with gains of 75.47 per cent from the MSCI India index.
John Bilton, head of global multi-asset strategy at JP Morgan Asset Management, reflects on the performance of markets so far this year and discusses the outlook for markets in the months ahead.
So far, 2019 has been a year of superlatives. The strongest January equity rally since 1987, the lowest weekly US jobless claims since 1969, the lowest German Bund yield ever and, if we make it unscathed to the end of June, the longest US economic expansion on record.
Less constructively, we have the weakest eurozone manufacturing data since the sovereign debt crisis, the flattest US yield curve since the global financial crisis and tariffs at their highest level in half a century. Smoot-Hawley it isn’t (at least not yet), but the trade dispute is having a tangible impact on asset markets and the global economic outlook.
Our base case remains that global growth will be positive but unspectacular and that a recession is unlikely over the next 12 months. However, our hopes of a decent second-half rebound in activity – particularly in trade and capex (capital expenditure) – are fading, and global growth is on track to come in a little below trend for the year as a whole.
Recession risks are certainly higher than they were at the start of the year, as a cursory glance at the inverted US yield curve will suggest. But with labour markets robust and household balance sheets strong – on the basis of economic data, at least – risk of contraction over the near term is relatively contained. Further out, however, risks may be more negatively skewed.
The trade dispute is the most eye-catching of these risks and would pose a clear threat to the global economic outlook were it to escalate. The risk of a negative growth shock is among the reasons for the Federal Reserve’s (Fed’s) increasingly dovish tone for US rates. A less well telegraphed but equally valid reason for the Fed’s renewed dovishness is the weakness of inflation data this year. Certainly, the shift in rate expectations has been profound, and markets are now pricing the fastest pace of rate cuts in more than 30 years, absenting the global financial crisis. This is all the more notable given that just six months ago the market was still pricing rate hikes, and the Fed’s dovish reset coincided with a US first quarter GDP print that was the strongest in four years.
While it is clear that the outlook for policy has eased meaningfully, rates themselves have not actually moved yet. In our view, the market might be overstating the pace of rate cuts. If inflation remains muted, there is clearly capacity for a couple of “insurance” cuts, but the notion that the Fed may cut aggressively in the absence of a further downgrade to the growth outlook might be wide of the mark.
Either way, we do not see that easier policy is an unalloyed positive for risk assets; while it shrinks the denominator in present value calculations, it does little for the numerator – earnings – which remain hostage to sluggish levels of global industrial activity.
For now, the resilience of the equity market may well be emboldening the Trump administration to ratchet up trade rhetoric, but this is surely a drag on corporate confidence and earnings. Equity returns and bond yields are likely capped to the upside as a result, while to the downside easy policy, and the likelihood that trade rhetoric would soften if stocks fell sharply, provide a floor to equities.
Even if a deal on trade is forthcoming, it is unlikely to be comprehensive and even less likely to address some of the strategic differences between Washington and Beijing that have recently been laid bare.
Our asset allocation reflects this cautious tone. We keep our small underweight to stocks, supported by our quant models and reflecting the view that equities are near the upper end of their trading range. At the same time, we acknowledge that growth remains positive and policy easy, which together support our overweight to credit. Nevertheless, we are mindful that as the cycle matures the liquidity risk in credit may eventually overwhelm the attractive level of carry.
The drop in bond yields over the second quarter prompts a downgrade on duration from overweight to neutral. With just under a quarter of global government bonds yielding less than zero, we believe that, absenting a further downgrade to global growth, yields are at the lower end of their fair value range.
Regionally, we still favour the US in both equities and bonds but note that it is US large-cap stocks specifically where we are moderately upbeat on earnings. Europe remains a less favoured region, and our outlook on emerging market assets is cooling again as trade uncertainty creates a persistent headwind for growth in those economies.
Overall, this reflects a guarded macro outlook, increased tail risks and a scarcity of compelling relative value opportunities, barring our preference for US assets. Over the next few months, it is likely that the pendulum swings between hopes of growth rebounding and rates falling, and fears of intensified trade tension. As this unfolds, opportunities will present themselves, but with geopolitics driving the macro agenda, allocation may be as much about timing as it is about fundamentals.
John Bilton is head of global multi-asset strategy at JP Morgan Asset Management. The views expressed above are his own and should not be taken as investment advice.
Donald Maxwell-Scott of Rowan Dartington says every single person in the UK would have had to have eaten at least 15 of the meat-free treats since January to justify the uplift in the baker’s share price.
Anyone struggling to understand why growth investing’s supremacy over its value counterpart cannot last forever should look at the hype surrounding the launch of Greggs’ vegan sausage roll, according to Rowan Dartington’s Donald Maxwell-Scott.
Data from FE Analytics shows the MSCI AC World Growth index has made 283.75 per cent over the past decade compared with 194.08 per cent from MSCI AC World Value; however, value investing tends to significantly outperform over the extreme long term and many analysts believe it is just a matter of time before there is a mean reversion.
Performance of indices over 10yrs
Source: FE Analytics
Maxwell-Scott (pictured), a technical investment manager at Rowan Dartington, is one of these. He said a deteriorating economic outlook could mark the start of a return to value investing.
“Bond yields have fallen with the one exception of Italian bonds. The change in interest rate policy by the US has caused yields to come in across all fixed interest classes,” the manager explained.
“Greece is trading at 2.8 per cent, down from 3.6 per cent and now only marginally ahead of Italy. Mounting debt and fractured politics are causing concern. Falling yields suggest the global economic outlook is deteriorating, and with talk of the US Federal Reserve cutting rates, and mutterings about a potential need for more quantitative easing (QE), it all points towards a difficult economic period approaching.”
QE is normally positive for growth investing, but with such measures having already been in place for a prolonged period, Maxwell-Scott pointed out further loosening would simply represent a tampering with the status quo.
The manager added that if he is correct about an economic downturn, then there is an argument for value investing – a strategy where stocks appear to trade for less than their intrinsic value, with the investor believing markets are inefficient rather than all the information being priced in.
He pointed to Greggs the baker to illustrate why.
“At the start of the year, Greggs was trading at £12.66 per share, but now the current market price is £22.60,” said Maxwell-Scott.
“This represents an increase of 77 per cent in its share price. If you multiply the difference between the two share prices (£9.94) by the number of shares Greggs has in issue, then they have added £1,005,530,400 – over £1bn of value.”
Performance of stock year-to-date
Source: FE Analytics
Equity analyst notes on Greggs suggest this is down to the vegan sausage roll the baker introduced in January, which is why Maxwell-Scott highlighted the difference in share price between the start of the year and today.
However, given that Greggs sells its sausage rolls for £1 each, this would mean it would had to have sold one billion of these to justify the increase in the share price.
“Assuming a UK population of 66 million, then it would mean each of us scoffing just over 15 vegan sausage rolls each,” the manager continued. “This doesn’t even assume the costs of producing and selling the vegan sausage roll.
“Of course, the above is a rather crude way of looking at it and there are other variables. But we believe it does illustrate that markets are not always as efficient as people think and that value is still out there.
“Indeed, Greggs could very well still be undervalued, even given the remarkable increase in its share price. There is certainly a danger that too many fund managers are on a one-way momentum growth train.”
The manager said that while investments in growth stocks such as the major tech names are all the rage at the moment, a return to fundamentals would likely take place if we were to enter a period of economic decline – which would inevitability lead to a correction in this area of the market.
He added recent falls in companies such as Facebook indicate that we may have already reached this point.
Value stocks, on the other hand, are often better protected in the event of turbulent markets, as they don’t sit on lofty valuations, so there is limited downside.
“What we might find is that after 10 years of growth being the more rewarding strategy, which is understandable given the high levels of QE, investor disappointment when expectations don’t meet valuations is severely punished,” Maxwell-Scott continued.
“However, while we believe a shift is underway, it might be some time before it materialises. We believe that certainty over Brexit will help the move to value investing – the stocks that have been out of favour. The hope is that we will get some clarity on Brexit when the next Tory leader is announced.”
Not everyone is convinced that value investing will overtake growth, however. In a recent article on FE Trustnet, James Anderson, manager of the Scottish Mortgage Investment Trust, said the investment world changed the day Microsoft listed as its performance since then has contradicted Benjamin Graham’s criticism of growth stocks.
Meanwhile, Anderson’s colleague at Baillie Gifford, Kirsty Gibson, said that we are currently seeing a convergence of multiple forces that will lead to a prolonged period of disruption, which value investing is failing to account for.
Allocators hike cash and move to lowest equity allocations in 10 years in bid to seek protection from trade wars and recession, the latest Bank of America Global Fund Manager Survey reveals.
Portfolio managers have moved to their most bearish positioning since the global financial crisis against a backdrop of deteriorating relations between the US and China and fears of a recession, according to the highly regarded Bank of America Global Fund Manager Survey.
Concerns over a trade war have soared month-on-month with 56 per cent of managers surveyed naming it as the top tail risk to the market, up 19 percentage points from last month. Trade war has topped the list of tail risks in 14 of the past 16 months.
Meanwhile, growth forecasts have slumped with a net 50 per cent of respondents expecting the global economy to weaken over the next year, consistent with 2000-2001 and 2008-2009 recession levels. In addition, a record 87 per cent of respondents now believe the economy in late-cycle.
As such, fund managers moved to highly bearish positions within their portfolios.
Average cash balances among survey respondents soared from 4.6 per cent in each of the past three months to 5.6 per cent in July, the biggest jump in cash since the debt ceiling crisis of 2011, when US legislators raised objections over the automatic increase in borrowing levels.
Source: BofA Merrill Lynch Global Fund Manager Survey
Allocations to global equities slumped by 32 percentage points to a net 21 per cent underweight – the lowest allocation since March 2009.
Bond allocations soared by 12 percentage points to a net 22 per cent underweight, which the bank said was the highest level since September 2011. Meanwhile, allocations to real estate rose to a 10 per cent overweight position, a three-year high.
The bank said fund managers’ asset allocations – moving away equities and towards bonds – now implies recessionary conditions, with the equity-bond allocation spread now down to 1 per cent, the tightest level since May 2009.
In addition, the survey – which was conducted between 7 and 13 June with 179 fund managers overseeing $528bn in assets taking part – found that portfolios have rotated from cyclical plays such as banks and technology into defensive areas like consumer staples and utilities.
“Fund manager survey investors have not been this bearish since the global financial crisis, with pessimism driven by trade war and recession concerns” said Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch.
The survey further noted that the investors have moved into assets that outperform when interest rates and earnings both fall while going more underweight those that are positively corelated to rising growth and inflation.
Indeed, around of one-third of respondents to the survey expect short-term interest rates to fall over the next 12 months. Nevertheless, managers have a low strike price for the Federal Reserve to cut rates – despite recent speculation of more imminent action – at a weighted average level of 2,430 compared with current levels of around 2,900.
On a corporate level, fund managers have also taken a more pessimistic outlook on profit expectations with a net 41 per cent of investors saying they expect earnings per share to deteriorate in the next year, a 40-percentage point decline and the second biggest one-month collapse in the 23-year history of the survey
Fears also remain among respondents about corporate indebtedness with 42 per cent claiming companies remain overleveraged.
Source: BofA Merrill Lynch Global Fund Manager Survey
As such, allocators have rotated from cyclical plays such as banks and technology into defensive areas, including consumer staples and utilities.
Allocations to global banks fell 20 percentage points to a net 13 per cent underweight in July, the biggest underweight to the sector since February 2016.
Conversely, exposure to utilities stocks soared by 13 percentage points month-on-month to a net 14 per cent underweight, a three-year high. Consumer staples also benefited from a move to a more bearish stance as allocations rose to their highest levels since May 2013 at a net 5 per cent overweight.
The most popular sector with investors is healthcare, which rose for the first time in four months to a 23 per cent overweight, making it the consensus overweight.
On a regional level, investors have moved away from eurozone equites falling by 17 percentage points to an 8 per cent underweight. This just below the seven-year low of an 11 per cent underweight recorded in January 2019.
While fund managers have become more bearish they remain positive on the US equity market, where allocations inched up to a 5 per cent overweight and made it the second most popular region among investors.
The most preferred region for equities was global emerging markets, which despite a 13 percentage point month-on-month fall remains the consensus overweight among allocators at 21 per cent.
Source: BofA Merrill Lynch Global Fund Manager Survey
The UK remains the consensus underweight among fund managers. Although there was a slight month-on-month improvement, it is a 24 per cent underweight among asset allocators as Brexit remains unresolved and the Conservative party appoints a new leader.
While the UK remains the most underweighted regions, among European fund manager respondents Italy remains the most disliked region with a net 42 per cent saying they would underweight the country over the next 12 months, a sharp deterioration in sentiment since May.
The Threadneedle UK Equity Income manager believes that conditions now look similar to the tech bubble of 1999.
A rotation out of growth stocks and into more value names appears to be overdue, according Columbia Threadneedle’s Richard Colwell, although it is far from clear when this will take place.
One of the defining features of the bull market that has been in play since the end of the global financial crisis is the outperformance of the growth and quality investment styles. As the chart below shows, value investing has significantly lagged these kinds of stocks.
To recap, growth stocks have revenues and earnings that are expected to increase at a faster rate than the average company; quality stocks are those with consistent profitability, market-leading positions and low debt; and value stocks tend to trade at a lower price relative to fundamentals such as dividends, earnings and sales.
Performance of growth, quality and value investing over 10yrs
Source: FE Analytics
Columbia Threadneedle Investments head of UK equities Richard Colwell believes the strong outperformance of quality-growth over value cannot continue over the long term, as the “extreme positioning” in defensive growth is making a “sharp rotation” possible.
Colwell – who manages strategies such as the £4bn Threadneedle UK Equity Income and £340.5m Threadneedle UK Equity Alpha Income funds – argued that current market conditions are starting to look reminiscent of 1999/2000 as investors hunt out ‘new economy’ stocks.
“‘Party like it’s 1999’, ‘Let’s all meet up in the year 2000’, ‘Back to the future’… there are no shortage of cultural touchstones we can reach for as we consider current equity markets,” he said.
“Since the jitters of late 2018 we have seen a resurgence in demand for defensive growth. In the US this has principally meant 'Big Tech', but in the UK we have seen mega-cap commodity stocks take their place at the top of investors’ buy lists and dominate market leadership.”
The left-hand chart below shows that high yielding stocks across Europe and the UK (which the manager is using a proxy for the ‘old economy’) have only been cheaper once during the past 30 years. He noted that one occasion was in 1999/2000, which resonates s given the parallels with that period being seen today.
Meanwhile, the chart on the right suggests that the ‘new economy’ – represented by the profitability of new IPOs in the US – is currently seeing the same levels of optimism that it did some two decades ago. It shows that a high proportion of stock market floats are not profitable.
“At the turn of the century the global market’s appetite for growth also saw investors draw a line between stocks which represented the ex-growth, tepid ‘old economy’ and the dynamic, disruptive ‘new economy’ led by stocks predominantly belonging to the TMT [telecommunications, media and technology] sectors,” the Threadneedle UK Equity Income manager said.
Old economy versus new economy
Source: Columbia Threadneedle Investments, Factset/Morgan Stanley, MSCI Europe, 30 April 2019. Numis Securities, Topdown Charts, Jay R Ritter
“This year, just as back then, a dovish pivot from the Federal Reserve following successive hikes sent a signal to markets that low rates and cheap borrowing could be here to stay.
“And while the music’s still playing most people take the view that, in the words of another Prince, this time former Citigroup CEO Charles ‘Chuck’ Prince, ‘you’ve got to get up and dance’ – that’s even if more than four of every five companies coming to market is loss-making?”
But determining exactly how close the markets are to this music stopping is a “contentious subject”, Colwell added. Some believe that another rate cut by the Federal Reserve will extend the bull market, similar to how its dovish response to the Long-Term Capital Management collapse and the Asia crisis of 1998 led to another leg of growth.
“In assessing the present day, we believe we could be an hour closer to midnight than many would like to believe,” the manager added.
“An accommodative Fed may have kept the party going in 1999 but sowed the seeds for a painful hangover in 2000 with ‘old economy’ stocks benefitting from a dramatic rotation out of tech and growth.”
He pointed out that the S&P 500’s growth versus value premium surpassed its 2000-peak in April this year, while the ‘Buffett indicator’ (a measure of total US market cap as a percentage of US GDP) has approaching levels last seen 19-20 years ago. “We would argue these are two more indications that the elastic has become very stretched,” he added.
“In this we are not seeking to call the end of the current cycle, rather we hope this adds some context to our caution on the sustainability of the current consensus positioning. Could we be due a downturn reminiscent of the early 2000s where the US economic recession was relatively mild, but equity market rotation out of the ‘growth’ basket was violent?” Colwell said.
“We think the proliferation of passive and exchange-traded fund money in the market these days will only amplify the severity of any such event, given the ‘valve-like’ quality of passive fund positioning (money rushes in at speed … but try rushing out!). In the meantime, some naysayers are folding as the pressure of taking the opposing side intensifies up to the point of reversal – voluntarily or otherwise.”
When it comes to the UK stock market, money has flowed out over recent on the back of the uncertainty created by Brexit, even among the companies with high overseas earnings – which Colwell described as being “highly disproportionate to reality”.
Overall, the valuation of the UK market relative to the MSCI World index shows the country has not be as cheap for 30 years and has only been cheaper once over the past 40 years.
“This is an important area of value and has created opportunities for active managers – as has the blanket derating of ‘old economy’ stocks thought to be doomed to declining growth, or worse, by ‘new economy’ disruptors. We acknowledge that some of these companies have big structural issues, but should they really be priced for extinction?” the Threadneedle UK Equity Income manager said.
“In our view the answer is not black & white, but in fact grey. Instead, we would ask whether the market has punished a share price without giving due consideration to the resilience of the business or its ability to adapt.
“With the elastic once again becoming very stretched we think that, just as in the early 2000s, a marked rotation from growth into value is overdue. Our aim is not to predict the timing or the indeed the trigger, but to ensure our portfolios are best prepared to weather the turbulence and seize the opportunities when that moment arrives.”
Performance of fund vs sector and index under Colwell
Source: FE Analytics
Colwell has managed the Threadneedle UK Equity Income fund since September 2010, over which time it has generated a top-decile 135.49 per cent total return. This ranks the fund sixth out of 63 peers in the IA UK Equity Income sector.
The fund has an ongoing charges figure (OCF) of 0.83 per cent and is yielding 4.3 per cent.
Fixed income manager David Roberts explains why now may not be the best time to buy UK government bonds given the uncertain outlook.
It would take a brave person to back gilts in the current environment given the lack of clarity over who the next prime minister, chancellor and Bank of England governor will be, according to Liontrust Asset Management’s David Roberts.
While the governing Conservative party might have now abandoned its austerity drive – in place since the global financial crisis – there remains a significant public deficit.
Yet, gilts have continued to enjoy their status as a risk-free asset despite the economic uncertainty caused by Brexit and the polarised political environment, according to Liontrust Strategic Bond manager Roberts.
“As taxpayers, we should all be happy that the international community that life funds and pension funds regard the gilt market as a risk-free asset because that allows the government to fund schools, hospitals, etc on rates that are, for the investor, irrational,” said the manager.
“It’s good for the taxpayer who is effectively part of those who are borrowing money [because] if the government couldn’t fund the economy at such a low yield, then taxes would have to go up.
General government debt (Total, per cent of GDP, 2008-2018)
“It is in all their interests that gilt yields are still low to allow the government to service that debt because some of us are, unfortunately, not old enough to remember the 1970s and the last time the International Monetary Fund was knocking on the door. That is not a good situation to be in.”
Another challenge facing gilts is the uncertain political backdrop.
While Brexit remains the most significant challenge for the UK economy, the resignation of prime minister Theresa May has led to a leadership contest and it remains as-yet unknown who will replace her and who the next chancellor of the exchequer will be.
In addition, Bank of England governor Mark Carney is due to step down early in 2020 – having delayed his exit twice already due to Brexit.
“Obviously, it is possible we could end up in a general election before either an incoming prime minister or chancellor have really had the ability to make their mark other than with respect to Brexit,” said Roberts.
However, the Liontrust Strategic Bond fund manager said while much of the government’s attention has been focused on Brexit over the past three years, everything else has been put on hold.
“People tend to forget there’s a whole economic situation that most people are more interested in and required to be sorted out irrespective of the political mess that is the in-fighting in Westminster,” said Roberts.
“Irrespective of whether one is a Brexiteer or a Remainer, I think we have to recognise that that we are at risk of throwing the proverbial economic baby out with the Brexit bathwater one way or another.
“We just moved away from a focus on broad economic and political issues to one very narrow theme, albeit an important one.”
Yet, May’s European Parliament elections signalled that support for a hard Brexit remains strong, which could stoke inflation and would not necessarily be good for interest rates.
Likewise, the populist leftist parties running on anti-austerity tickets and supportive of deficit expansion strategies which could lead to higher gilt yields.
“You know, there’s a kind of natural bias to believe that a right-leaning party should be quite good for the national accounts of a country and, by extension, the government bond market,” he said.
“But at the moment it’s quite nice to just see the matter whether it's left or right, you’re probably stuffed either way if you buy gilts.”
He added: “It’s nice from our perspective because we can choose to avoid them but perhaps not so nice from the perspective of the average man or woman in the street.”
As such, the manager said the Liontrust Strategic Bond fund has no exposure to the UK gilt market.
“The reason we have zero exposure to gilts is because, to be perfectly honest, I have no idea where guilds are going in the short term,” he explained. “There is no way I can justify taking a risk for clients in something I do not understand in the medium to longer term.”
Unless the Bank of England begins engaging in quantitative easing again, it’s very difficult to see an outcome that is positive for gilts, the Liontrust manager said.
“For fund managers, or as in most walks of life, if outcomes are uncertain then we’re best avoiding them,” he added. “That’s exactly how we view the UK bond market at the moment. You could make a lot of money you could lose your shirt.”
Roberts joined Liontrust in January 2018 from Kames Capital along with Phil Milburn. They were further was joined by Baillie Gifford’s Donald Phillips, who had previously worked with the pair at Kames.
The Liontrust Strategic Bond fund was launched in May 2018 with the aim of maximising total returns over a long-term period of at least five years through income and capital growth.
Performance of fund vs sector since launch
Source: FE Analytics
Since launch, the Liontrust Strategic Bond fund has made a total return of 4.74 per cent against a 3.96 per cent gain for the average IA Sterling Strategic Bond peer.
The fund has an ongoing charges figure (OCF) of 0.70 per cent and a yield of 2.03 per cent.
Renewable energy may soon put downward, not upward, pressure on energy prices, prompting a much faster move away from fossil fuels.
Subsidies to promote renewable energy are felt most acutely by the poorest in society, so the narrative goes. This is a very backward-looking view, largely based on assumptions that no longer stand up to scrutiny.
In the coming decade, we expect a wave of cheap renewable energy to put downward, not upward, pressure on energy prices This in turn will make electric vehicles (EVs) a more affordable option than their polluting combustion engine counterparts.
The common political narrative that a major initiative to tackle climate change is a liberal luxury is likely to be transformed. It will be replaced by a symbiotic set of social and economic policies that will accelerate the transformation away from fossil fuels.
Renewables are now "in the money", yet attitudes remain outdated. Yes, the 30% of power production in Europe that comes from renewables was only achieved with significant taxpayer subsidies. These initially raised energy bills for consumers. However, as the charts below illustrate, a powerful combination of technological development and manufacturing scale advances has brought unsubsidised wind and solar power costs to below the average wholesale power price across the European continent.
Projected falls in the cost of solar energy
The same applies in the US and many other parts of the world. In fact, last year James Robo, of Next Era Energy, the largest developer of renewables in the US, predicted that by the early 2020s the total cost of building new wind and solar plants will be below even the variable costs required to operate an existing coal or generating facility, at which point it makes no economic sense to even operate such facilities.
This all means that from now on as we add more renewables to the energy generation mix, they will begin to exert a deflationary force on overall power prices. More of the electricity consumed by the grid will come from lower cost renewable sources, squeezing out the higher cost fossil fuel generation from the system.
As power prices fall, so will the cost of EVs. Battery costs are declining rapidly, and cheap power will further support the total cost of ownership for EVs to decline below their combustion engine equivalents within a few years.
As with so much related to climate change, the importance of this shift is being underestimated by financial markets: investors appear reluctant to forecast a future in which renewables and energy storage come to dominate power markets.
In recent years it has been a very powerful and well used argument for entrenched industry and various politicians to argue that tackling climate change is socially regressive. Yet instead of being a liberal-inspired tax on the poor (who spend a greater portion of their income on heating and energy), renewable energy is now making electrical power and electric mobility more affordable, a fact that is likely to be increasingly recognised by politicians across the political spectrum.
It will also be increasingly apparent that those arguing against such action are largely driven by vested interests to protect profit pools or existing assets, to the overall detriment of consumers and taxpayers.
However, it remains the case that renewable power will only tackle part of the sources of greenhouse gas emissions that need to be eliminated by 2050. At the moment, industries such as cement, aerospace and livestock farming have no viable technological solution for eliminating the gross emissions from their operations. In other industries, such as chemicals and many consumer products, the solutions are available but will be expensive and inflationary to implement.
“If we all worked on the assumption that what is accepted as true is really true, there would be little hope of advance”, Orville Wright, American Inventor
Despite Orville Wright’s prescient awareness to challenge assumptions, even he couldn’t get over his own deeply ingrained assumptions about what will and won’t be possible in the future when he said that “No flying machine will ever fly from New York to Paris”.
With renewable energy we now have a clear view of what is possible in the next decade – cleaner power and lower transport prices that will be increasingly socially progressive. We now need to hope and believe that technology will help us with the other solutions needed to fully achieve a zero emission economy. Is this any less achievable than flying uninterrupted to Paris from New York seemed to Orville Wright in 1909?
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Scott Berg, portfolio manager of the T. Rowe Price Global Growth Equity fund, discusses the long-term factors we believe will continue to drive the technology sector.
A little more than a decade ago, the investment universe of the technology sector was composed primarily of personal computers and software companies. However, this has changed dramatically in a relatively short space of time and has generated enormous value creation.
As large-scale investors, we must grapple with this extremely dynamic industry and also scrutinise lofty valuations in some areas. This is why our annual trip to Silicon Valley – where we meet with top executives of the leading tech firms – is hugely valuable for deepening insights into our investments in the sector.
A chief objective of these trips is to identify the long-term secular forces at work. These need to be distinguished from the short-term cyclical swings that may lead to profits or losses in a given quarter but tell us little about a company’s potential to generate long term wealth for shareholders. Among the long-term factors we believe will continue to drive the sector are the expansion of media platforms, the rise of artificial intelligence and the increasing potential of the cloud.
The growth of media platforms
When we met with Facebook – including three of the divisional executives and Sheryl Sandberg – much of the discussion was around regulation and putting controls in place. We were able to gain more appreciation for the process, in terms of internal operations and how it is interacting with external constituents to get where it needs to be. Clearly, it needs to address these issues, but we feel it understood and was actively tackling these issues.
Outside of this, we felt encouraged. There is a significant amount of work going on behind the scenes with more monetisation of activities. Listening to the Instagram executive on Insta video, IGTV, monetising the ephemeral nature of Instagram Stories, as well as the associated personalisation, gave us a much better sense of what is possible down the track. A meeting with the head of advertising also suggested Stories could be a game changer. Top-line growth was not likely to slow and there is a chance we may even be talking about acceleration in a year or so.
Another key highlight was the technology led rise in the scale and scope of the leading companies, allowing them to expand across industries and national borders. Netflix is a great example. It has become the largest video company in history – largely because its reach is unconstrained by infrastructure. This provides a key advantage over other firms that need to lay cables or set up broadcast towers. International expansion has allowed Netflix to spread the cost of high quality programming among a global subscriber base.
Rise of machine learning and AI
Machine learning and AI are the key themes for the next decade and beyond, with platform companies are the best placed to benefit. However, this may be an area of ongoing conflict between the US and China, as the countries race for global leadership.
Analysing customer preferences is an example of innovation reshaping the economy. AI relies on powerful computing resources, which are now available to many firms through cloud computing services such as Alicloud, AWS and Azure. But providing computers with the information needed to make decisions and perform tasks without human intervention – the branch of AI known as machine learning – also requires vast amounts of data. This is one reason the biggest tech companies and internet platforms are taking the lead in developing machine learning-based artificial intelligence (AI).
A theoretical topic for years, we are now starting to see real fundamental impact on company business models from AI use cases. Workday is a cloud-based provider of HR software. Unlike the static software competitors install on a company’s servers, Workday’s product is constantly learning and its experience with millions of employee records means it can now predict which workers are in danger of growing dissatisfied. In our meeting, we had a real sense of the strength and durability of its cash flow. It was also apparent how powerful its analytics capabilities had become and the improved value-add to the customer.
The importance of the cloud
In nearly every meeting, companies talked about the importance of the cloud. In recent years, we have seen a transformation in the way businesses collect and deploy information. Key to recent changes have been constantly updated cloud-based software systems, which allow companies to integrate information in new ways. While the impact of this change is perhaps most visible to consumers in the rise of online retailing, it is also touching other industries. We may even be on the cusp of financial companies moving data into the cloud.
Salesforce.com is at the leading edge of this transformation. Salesforce’s customer relationship management system, offered by subscription over the internet, allows companies to not only maintain records on current customers, but also to identify new prospects. Data then flows into revenue forecasts, inventory management and other parts of the enterprise.
Scott Berg is portfolio manager of the T. Rowe Price Global Growth Equity fund. The views expressed above are his own and should not be taken as investment advice.
Investor expectations of Fed rate cuts might be off the mark, according to two market experts, as the Federal Reserve prepares to meet later this week.
While the pausing of the Federal Reserve’s rate-hiking programme earlier this year gave hope to markets of further easing, expectations of an imminent rate cut could be wide of the mark, according to market experts.
The US central bank’s rate-hiking programme last year – which aimed to ‘normalise’ interest rates after years of loose policy – contributed to a difficult 2018 for markets, in which the S&P 500 recorded its first annual loss since the global financial crisis.
However, the decision to halt the programme earlier this year amid weaker economic data sparked a rally in markets and made the prospect of rate cuts to support the economy more likely.
While the re-opening of the US-China trade issue stymied that progress, more positive noises from the Fed have sparked a further rally in recent days.
However, investors may have gotten ahead of themselves, according to George Lagarias (pictured), chief economist at Mazars.
“Following remarks from [Fed chair] Jay Powell in early June that the Fed would support growth, and given evidence of slowing economic activity in the US, investors assumed that the Fed would completely reverse its previously hawkish strategy and start cutting rates,” he explained. “And, as always, when the Fed is dovish, traders are happy to buy opportunities at market dips. Therein lies the risk.”
He said markets now expect three rate cuts until the end of the year, meaning cuts in all meetings after September, although that is unlikely.
“While the bond futures markets, from where those odds are derived, are hardly representative of the whole market, it is still indicative that maybe investor expectations have overshot reality,” he said.
For three rates cut to happen until December, he argued, the economy would have to be in freefall.
“Currently this is not the case,” he said.
Indeed, Lagarias doesn’t see signs of recession that would justify a triple rate cut for the rest of this year.
“Manufacturing has somewhat slowed down, but employment is still very high, wage growth decent, consumption is hanging on, consumers and businesses are optimistic, and the Fed is now projecting a 2 per cent annualised growth rate for Q2, 0.5 per cent higher than two weeks ago,” he explained.
He advised caution in the weeks to come, given “the possibility of even the slightest word [of the Fed] being misinterpreted”.
Indeed, Lagarias said chair Jerome Powell will have to balance a more dovish message with bringing rate expectations back to reality, without hurting growth or market exuberance at the next meeting of the Federal Open Market Committee (FOMC) on 19 June
Sandra Holdsworth, head of rates at Kames Capital, said markets are likely to keep speculating for a bit longer about the Fed’s stance on rates although there is little need for rates to be either higher or lower than at present.
She said that data showed that while the US economy was expanding at a slower pace than 2018 it is performing better than the Fed had forecasted for this year.
“The infamous ‘dot’ plot which shows how the committee members see interest rates evolving over the next few years will, in all likelihood, continue to show an upward path in rates into 2020, completely at odds with market pricing,” Holdsworth said.
Federal Open Market Committee ‘dot plot’
Source: Federal Reserve
“Expectations are building in the bond markets that the US Federal Reserve is about to embark on an easing cycle starting in July, and market pricing suggests that rates will be 0.75 per cent lower by year-end from current levels,” Holdsworth noted.
“The validity of the dot plot has to be questioned in an easing cycle as the FOMC does not pre-plan rate cuts, they usually are reactive to events, crises or recession.”
She added: “The FOMC also forecasts a long run rate, which is currently at 2.75 per cent, and again looks vastly different from bond market pricing.”
Kames Capital’s Holdsworth said that rates are expected to be around 2.15 per cent in 10, 20 and 30 years’ time, which illustrate how far the bond market has ‘front run’ Fed policy expectations.
As such, Holdsworth (pictured) considered the implications of a potential move towards easier monetary policy for markets.
“Firstly, and probably most importantly, by signalling it will ease, the implication would be that we have seen the top of the interest rate cycle,” she said. “That should surely mean the long-term rate must be lowered substantially, closer perhaps to the average rate of the last 10 years which is a mere 0.5 per cent.”
She explained: “This is a bit extreme as it does include the immediate post-crisis period, but even over the last five years it is still less than 1 per cent.”
However, such a move would put the rate over 100 basis points lower than that implied by the market and 175 basis points from the FOMC estimate.
The Kames head of rates said it would be “simply too big a statement to make at this current juncture when US economy is performing well, employment is still rising and financial conditions are easing”.
“Should they do so, however, yields across the whole of the fixed income universe have a long way to fall,” she said.
“A change in stance like this may well also be positive for riskier assets as the move is perceived as less of a response to concerns but more a ‘recalibration’ of Fed thinking about what the ‘neutral’ rate for the economy is,” she added.
“On an international comparison, US interest rates are far higher than in Europe and Japan as president Donald Trump is so fond of pointing out.”
Holdsworth concluded: “The FOMC have surprised us a couple of times this year. We should remain alert to more surprises, they could be even more meaningful than what we have seen already.”
Research from the Association of Investment Companies also shows that two peer groups have an average yield of more than 8 per cent.
There were 15 investment trust sectors where the average yield was 3 per cent or more at the end of May 2019, according to research by the Association of Investment Companies (AIC), while two peer groups had a yield in excess of 8 per cent.
The research, which follows the AIC’s sector review that took effect on 28 May 2019, shows that the highest yields tend to be on offer in alternative sectors such as those focusing on debt, although more mainstream areas like UK equity income are also represented.
Annabel Brodie-Smith, communications director of the AIC, said: “There is an array of choice for income-seeking investors who are considering investment companies.
Source: Association of Investment Companies
“Clearly substantial yields are available from sectors investing in alternative assets such as specialist debt, leasing, property and infrastructure. That said, there are four equity sectors amongst the highest-yielding and several have delivered healthy levels of dividend growth over five years.
“It’s important income investors realise that higher yields can come with higher risks and investors need to do their investment research thoroughly. If investors have any doubts as to whether investment companies are suitable for them, they should speak to a financial adviser.”
The table above shows that the IT Debt – Structured Finance sector with the highest dividend yield, standing at 9.19 per cent at the end of May 2019.
As its name suggests, trusts in this peer group focuses on investment opportunities in structured finance, or a complex form of financing using instruments such as collateralised load obligations (CLOs), syndicated loans and mortgage-backed securities.
There are nine trusts in the sector and the highest yield at the moment is from Fair Oaks Income, at 13.4 per cent. This trust concentrates on US and European CLOs or other structures that provide exposure to portfolios consisting primarily of US and European floating-rate senior secured loans.
Fair Oaks Income has made the peer group’s highest total return over three and five years; over five years, it’s up 43.66 per cent – compared with a 1.13 per cent gain from its average peer.
The trust is trading on a discount to net asset value (NAV) of 1.5 per cent. An initial investment of £10,000 made five years ago has led to dividend payouts of £9,266 since.
Performance of trust vs sector over 5yrs
Source: FE Analytics
Other high-yielding members of the IT Debt – Structured Finance sector include Blackstone/GSO Loan Financing (12.2 per cent on its ordinary shares, 13.4 per cent on its C shares), Chenavari Toro Income (10.4 per cent) and Carador Income (10.3 per cent).
The IT Leasing sector comes next in the AIC’s research, with an average yield of 8.27 per cent. This is a specialist sector that invests in assets to be leased, such as aircraft, ships and manufacturing equipment.
Both are also trading on premiums to NAV – 11.9 per cent in the case of Doric Nimrod Air Two, 32.3 per cent for the other trust – while their respective five-year total returns stand at 16.6 per cent and 18.5 per cent. An initial investment of £10,000 made five years ago in Doric Nimrod Air Two has created £3,774 in dividends.
Like many members of the sector, they have high gearing – 127 per cent for Doric Nimrod Air Two and 169 per cent for Doric Nimrod Air Three. The highest gearing of the sector, however, is Amedeo Air Four Plus at 515 per cent.
The table above shows how investors seeking out the highest yields have to look towards alternative sectors, with IT Property – Debt, IT Debt – Direct Lending, IT Commodities & Natural Resources and IT Renewable Energy Infrastructure all being at the top of the table.
That said, the popular IT UK Equity Income sector has made it onto the list thanks to its average yield of 3.97 per cent.
The peer group’s average yield has been pushed up by the 22.6 per cent form British & American. Its portfolio is built around other investment trusts and other leading UK- and US-quoted companies.
It is trading on a 23 per cent premium to NAV but has made a loss of 38.4 per cent in total return terms over the past three years. An initial investment of £10,000 resulted in income payouts of £4,604; it has also increased its dividend for the past 24 years.
Despite British & American skewing the sector’s average yield, every other IT UK Equity Income trust aside from Finsbury Growth & Income is yielding more than 3 per cent; Finsbury Growth & Income yields 1.7 per cent.
High yields can be found among the likes of The Investment Company (6.4 per cent), BMO UK High Income (5.6 per cent), Merchants (5.3 per cent), Chelverton UK Dividend (5.2 per cent) and Aberdeen Standard Equity Income (5 per cent).