A study by Vanguard explains the other measures that investors should consider when seeking out a passive fund provider.
Although the popularity of passive strategies in recent years has been fuelled by their relatively low costs, asset manager Vanguard believes investors should take other features into consideration when buying an index tracker.
Retail sales of tracker funds have continued to grow in recent years and 2019 looks to be a bumper year with 11 months of data for the Investment Association showing net retail sales of £16.2bn.
As inflows continue to find their way into the strategies, funds under management have reached 17.6 per cent of the UK retail industry total (as of November 2019).
Source: Investment Association
However, with greater passive flows there has come greater competition on costs between product providers.
This has driven down costs to a point where there are just a few basis points between providers.
“Expense ratio differences that have a material impact on a fund’s relative performance at 50, 20 or even 10 basis points verge on irrelevance at one-to-two basis points,” Vanguard said.
“At these levels, performance – and due diligence – depends on less visible and more complex elements of fund management.”
As such, the real savings achieved by switching to lowest cost product have been minimised or eliminated.
Instead, investors should take into account expenses and organisational incentives, portfolio management capabilities, securities lending, pricing strategies and scale “in more equal weights than in the past”.
Below, Vanguard highlights what – other than costs – investors should consider when choosing a passive strategy.
One of the things that investors should consider when choosing a passive provider is aligned incentives and how that might affect an investor’s returns.
As the costs of a fund are deducted from its net asset value and detract from performance, investors should seek out asset managers with disciplined expense management.
“Understanding a manager’s track record aids investors in determining how that manager will treat clients over time, such as the likelihood that costs will remain flat or decrease rather than potentially fluctuate over time when selective price competition is a business strategy rather than a core philosophy,” the asset manager said.
Secondly, the ownership structure of an asset manager can also help avoid conflicts of interests, Vanguard noted.
“The owners of publicly-traded or privately-owned firms may have competing interests with those of their fund investors,” the firm said.
“Mutually-owned, or similarly structured, asset managers, on the other hand, can offer better alignment with investors' objectives.”
Portfolio management capabilities
While some might consider index-tracking to be relatively straightforward, the passive giant argued that it is in fact more complex than many appreciate.
In judging a passive asset manager’s capabilities, investors should look at excess return and tracking error as measures worth considering.
Excess return – which measures the extent to which an index fund has out-or underperformed its benchmark – should usually be negative for tracker strategies.
However, some managers can seek positive numbers that offset costs by taking advantage of corporate actions such as mergers & acquisitions that change the composition of a benchmark.
Tracking error – which measures the consistency of a tracker fund’s return relative to its benchmark – can serve as an indication of the risk present in a manager’s process.
Both should be viewed together to determine how skilfully a fund is being managed.
As the above chart shows, while Fund A shows a higher average excess return than Fund B, its tracking error is significantly higher. This could result in different outcomes for different investors.
The loaning of portfolio securities to other financial institutions – such as hedge funds – can result in additional revenues for passive managers.
However, investors need to consider whether they are being adequately compensated for the risk being taken.
“Asset managers can differ significantly in terms of how much their securities lending revenues they return to investors and how much they retain as profit,” the firm noted.
“The percentage of gross revenue returned back to the shareholders from a securities lending programme may range anywhere from over 95 per cent to as little as 35 per cent, and thus it is important to understand what, if any, portion of revenue is retained by the asset manager when considering the quality of, and incentives behind, a securities lending programme.”
In addition, investors need to understand an asset manager’s lending philosophy.
A value lender will lend small amounts of hard-to-borrow securities where demand is high, as are fees. A volume lender will attempt to maximise a larger part of their portfolio, thereby increasing risks of a borrower default or collateral reinvestment.
Finally, while economies of scale can be achieved in passive asset management, it is becoming increasingly difficult to achieve.
As such, the size of an asset manager can determine a range of other issues, according to Vanguard.
Scale can determine how high or low trading costs will be, offering the opportunity for cross-trading within a range eliminating brokerage commissions or by aggregating large orders at lower commission.
The size of a passive asset manager can also open up greater opportunities in securities lending with a broader range to lend and ability to fill large orders.
Insight Investment’s head of investment specialists April LaRusse explains how fiscal policy should be brought back into markets.
After a slowdown in global growth last year and few levers left for central banks to pull to stimulate the economy, Insight Investment’s April LaRusse says that it might now be time for fiscal policy to be reintroduced to markets.
The Federal Reserve’s three rate cuts last year marked a return to the ultra-low rate environment of the post-crisis era following a brief flirtation with normalisation.
However, with rates already at low rates there is little room for central banks to cut further.
As such, Insight head of investment specialists LaRusse said that while the rates are likely to remain “nice and low” in 2020, fiscal policy may start to become a more important driver of growth.
“When we look back at 2019, we see the restarting of QE, and the reversing of interest rate hikes,” said LaRusse (pictured). “But an acknowledgement of that thing called fiscal policy probably needs to be utilised again.”
While support for fiscal policy has grown more recently as more populist politicians have sought to increase spending, LaRusse said it has been used sparingly due to concerns over levels of debt.
In addition, the public don’t seem to have the confidence in politicians to execute a policy, said the fixed income specialist, while governments themselves have also wanted to keep central banks and their monetary policies as a scapegoat for low growth.
“I think there's been this almost fear of trusting fiscal policy because fiscal policy is about politicians,” she said.
Distrust of politicians was seen last year – a period of intense political uncertainty.
“They’re the ones making the budget and making the changes and how much is spent and how much is taxed and how high they will allow a government debt to rise to,” LaRusse explained.
“It's almost like those decisions are just too hard and they would rather the central bank just cut interest rates because that's nice and easy and will solve the problem.
“It’s as if ‘we don't have to do anything because the central bank's going to fix it.’ “
She added: “The problem is when interest rates get so low, that another cut just doesn't help.”
But this has to change, according to LaRusse.
“If you have your foot on the brake by having tight fiscal policy – i.e. not spending a lot and keeping taxes pretty high – and you also have your foot on the gas with low interest rates, the economy doesn't move forward very fast,” she explained.
“If you take your foot off the brake you might actually see more sustained growth.”
Fiscal policy was a theme of the UK general election, as the Conservative party’s Boris Johnson pledged more money on things like the NHS and police service.
This would make sense, said LaRusse, but the UK is one place where a rate cut can be pencilled in because of the weakness of the economy and uncertainty surrounding Brexit.
Fiscal policy is likely to be deployed in Europe and has already been utilised in the US in the form of president Donald Trump’s tax cuts shortly after election.
The scope for monetary policy has also become more limited recently with the advent of negative rates, as government bond investors now face the prospect of a “guaranteed loss”.
As such, there could be a migration of investors into riskier assets for positive yields.
“Ultimately for those of us who need to save money for our futures, the point of investing is to earn some money,” said the Insight fixed income specialist.
“So, you're forced – even if you don't want to – to take more risk because what are you going to do when they offer negative return?”
As such, the lower rates for longer has created an “accidental problem,” LaRusse explained.
“They [central banks] wanted to cut interest rates to stimulate growth and wanted to encourage companies to borrow money, [so] they make it nice and cheap,” she said.
“They wanted to improve the healthiness of the banking sector. There were all these really great reasons for doing this.
“But you don't really want to do it for too long because it can cause all sorts of unintended damage to other parts of the economies and to savers.
She added: “The idea of wanting to use some other policy tool like good old-fashioned fiscal policy now is probably quite sensible because really what you’d quite like to do is get interest rates just back to something vaguely positive.
“It doesn’t have to be a big positive number, but it would make more sense.”
“So, you know, be careful about encouraging that sort of level of behaviour for too long at an extreme level. But, you know, hey, I'm not running the world,” LaRusse concluded.
After a 10-year bull run, Trustnet finds that more than 30 funds have made bottom-decile returns and volatility over the past decade.
The last decade saw stocks and bonds tear ahead in a strong bull market but several funds have handed their investors some disappointing returns with relatively high risk, research by Trustnet shows.
In an article yesterday, we highlighted the funds that combined top-decile total returns and annualised volatility over the 10 years to the end of 2019, with names such as Liontrust UK Smaller Companies, TB Evenlode Income and BNY Mellon Global Income appearing on the 17-strong list.
Here, Trustnet reveals the funds that have done the opposite: made bottom-decile returns for their investors while being among the most volatile members of their sector.
Of the 1,465 funds that have a long-enough track record and reside in a sector where decile rankings are appropriate, 32 are in the bottom 10 per cent of their peers on both metrics – close to double the number producing the highest returns and lowest volatility.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The chart above shows the returns of the fund that turned in the worst performance: Schroder ISF Global Energy, which made a 51.99 per cent loss over the period under consideration, with volatility of 25.20 per cent. Not only is this the lowest total return from the 32 funds highlighted by this study, but the fund also has the highest annualised volatility.
The £227.2m fund has a bias towards oil stocks and will hold stocks from the smaller cap space of the sector, which means it can be more volatile than the wider market. A look at its annual calendar returns highlights how much of a rollercoaster ride the fund has given its investors: for example, it lost 34 per cent in 2015 before making 64.71 per cent the following year.
Schroder ISF Global Energy has made negative returns in seven of the past 10 full calendar year – reflecting the challenging conditions that have faced energy stocks following the end of the ‘commodity super-cycle’ – including a 4.68 per cent fall last year.
“Despite the very strong performance in December, the full year 2019 has proved to be a year of ‘the perfect storm’ for energy equities,” manager Mark Lacey said recently.
“This negative performance and sentiment has been considerably more pronounced in the global exploration & production and global oilfield services sectors, where investors have literally dumped the equities as ESG [environmental, social & governance] concerns, focused on fossil fuel production and long-term sustainability of their business models has come in to question.”
Source: FE Analytics
The table above shows all 32 funds that were bottom decile for both returns and volatility between 1 January 2010 and 31 December 2019, ranked in order of their 10-year returns. There are a number of energy portfolios on the list, which is in keeping with trends seen in the wider market.
Over the 10 years to the end of 2019, the MSCI AC World index made a 183.01 per cent total return (in sterling terms) but the MSCI AC World Energy index was the worst performing sub-sector with a gain of just 37.78 per cent. MSCI AC World Information Technology, in contrast, was up 395.12 per cent.
Adrian Lowcock, head of personal investing at Willis Owen, said: “Energy and mining stocks all struggled as global growth slowed, recession never seemed far away and China struggled to transition from a global exporter to a domestic consumer.”
There’s also a number of funds that focus on emerging markets to be found on the list and one notable entrant is Templeton Global Emerging Markets. Franklin Templeton has a strong emerging markets franchise but this small fund had been a persistent underperformer, even when its stablemates were doing well.
It was in the bottom decile of the IA Global Emerging Markets sector in 2010, 2011, 2012, 2013, 2014 and 2015 but has moved up the rankings under manager Chetan Sehgal (who took over in 2017) and was top-decile in 2019 with a 21.18 per cent total return. That said, its weak run in the first six years of the past decade mean it was in the bottom decile for the full period despite its stronger latter years.
Performance of Templeton Global Emerging Markets by calendar year
Source: FE Analytics
While the funds mentioned so far are relatively small in size, some larger portfolios are present on the list of volatile underperformers.
The biggest name on there is Templeton Asian Growth, with assets under management of £2.4bn – making it the fifth largest member of the IA Asia Pacific Excluding Japan sector.
Seven funds in the IA Japan sector have managed to beat the Topix in at least seven of the past 10 calendar years, with two of them managing it in eight.
Legg Mason IF Japan Equity and T. Rowe Price Japanese Equity are the most consistent IA Japan funds of the past decade, beating the Topix, the most common benchmark in the sector, in eight of the past 10 calendar years.
Of the 53 funds with a track record of at least a decade, another five managed to beat the index in seven of the past 10 calendar years.
Performance of funds vs sector and index
Source: FE Analytics
While many of the funds that top the tables in this series tend to eke out small but consistent returns above those of their peers and benchmark, Legg Mason IF Japan Equity has taken a different route. Its gains of 701.17 per cent over the 10-year period in question are not only the highest in its sector – more than 450 percentage points above the fund in second place – they also make it the best-performing fund in the entire IA universe over this time.
Manager Hideo Shiozumi focuses on companies that can benefit from what he calls “a changing Japan” – an aging population, changing consumer lifestyles and “internet empowerment”.
As a result, he has a high exposure to medical & nursing care services, outsourcing businesses and e-commerce.
Dzmitry Lipski, investment analyst at interactive investor, is a fan of the fund, saying: “This is an adventurous option, with a bias towards small and medium sized companies focusing on profitable niches. The manager has a buy-and-hold, high conviction strategy that we rate highly. The fund could also be seen as a play on healthcare, since it has around 26 per cent exposure.”
Aside from beating the Topix in eight of the past 10 calendar years, it has beaten the IA Japan sector in nine of the past 10 years and the IA Japanese Smaller Companies sector in seven of these.
Legg Mason IF Japan Equity is not perfect, however. Its concentrated nature – close to 60 per cent of its assets are invested in its top-10 holdings – and focus on the lower end of the market cap spectrum means it can be highly volatile. It lost more than 80 per cent of its value between 2006 and 2008, for example, which the manager blamed on indiscriminate selling of small and mid caps, as well as blow-ups in some of the property companies he held.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
It is £1bn in size and has ongoing charges of 1.02 per cent.
Next up is T. Rowe Price Japanese Equity, managed by Archibald Ciganer, who aims to invest where growth is underpriced. Two-thirds of the portfolio is invested in stocks that have a secular tailwind, with competitive advantages stemming from brands, technology and industry positioning. The remaining third is invested in companies that are undergoing transformation, either through restructuring or a strategy change.
The FE Investments team said much of the fund’s success can be attributed to the manager.
“The fund leverages Ciganer’s local knowledge as he manages the portfolio from Tokyo,” it explained.
“When Ciganer took over as portfolio manager in 2013, he increased the portfolio’s exposure to growth companies, reduced the number of stocks and increased exposure to smaller companies.
“This has been positive as the fund’s alpha generation relative to the benchmark has improved considerably. The fund would be best suited to a portfolio with a long-term investment horizon as well as one that can tolerate medium to high volatility levels.”
In a recent note to investors, Ciganer claimed that improving productivity is key to addressing Japan’s long-term demographic issues, but fortunately the country is rising to the challenge.
“Efforts to boost productivity are being driven by both the public and private sectors in Japan,” he said.
“On the public side, a focus on broad structural reform is creating a more flexible and dynamic working environment, with increased workplace participation a key objective.
“Meanwhile, the private sector also understands the need to boost productivity in order to stay globally competitive. Companies are investing in new technology and systems with the aim of encouraging smarter, more efficient work practices.”
Data from FE Analytics shows T. Rowe Price Japanese Equity made 188.76 per cent over the 10-year period in question, compared with gains of 147.37 per cent from its Topix benchmark and 141.23 per cent from its sector.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
It is £190m in size and has ongoing charges of 0.91 per cent.
The funds that beat the Topix in seven of the past 10 calendar years are LF Morant Wright Nippon Yield, Baillie Gifford Japanese, AXA Framlington Japan, Lindsell Train Japanese Equity and Barings Japan Growth Trust.
FE fundinfo Alpha Manager Nick Train highlights the stocks that made a difference in his Finsbury Growth & Income Trust last year.
Investors should be wary of “gloomy headlines” when trying to forecast stock market returns, according to top-performing manager Nick Train, who believes that markets could continue to outperform in 2020.
Train said he was delighted with the performance of his £1.9bn Finsbury Growth & Income Trust last year, particularly “given how much worry the year 2019 gave investors”.
Last year the trust made a 21.82 per cent total return, compared with a 19.17 per cent gain for the FTSE All Share benchmark.
Performance of trust vs sector & benchmark in 2019
Source: FE Analytics
“It is an important lesson for us all that despite trade wars, Brexit and political uncertainty, the UK stock market and indeed many global stock markets did very well,” he explained. “Gloomy headlines are often the worst indicators for future stock market returns.”
Train said that while the firm has developed a reputation for investing in “so-called ‘defensive’ companies”, it had other major holdings that were not defensive at all.
“These are still businesses with brands or franchises of great durability and value, but where profits are more volatile than for, say, a soap manufacturer,” said Train.
“And it was these holdings, by and large, that produced the best returns in 2019.”
The manager said there were six large positions in the concentrated portfolio that were up by 28 per cent or more, including: London Stock Exchange, Daily Mail & General Trust, asset manager Schroders, US-listed confectionery company Mondelez, fashion house Burberry and accountancy software company Sage.
The biggest riser was London Stock Exchange Group, which was up by more than 90 per cent last year after an ultimately unsuccessful bid from the Hong Kong Exchange drove up the share price.
Performance of UK winners in 2019
Source: FE Analytics
Elsewhere, Daily Mail & General Trust benefited from the streamlining of its digital portfolio, which “had the effect of releasing cash value for investors, but also revealing how much future value could still be realised”.
Schroders was rewarded for its decision to invest in to its private wealth business in 2019, the value of which should become more apparent in the years ahead.
Burberry was boosted by the success of its fashion reboot which moved the brand “even more upmarket”, said Train, while the steady business performance of Cadbury-owner Mondelez surprised pessimists.
Finally, Sage reached an important milestone of £1bn annual recurring revenues, having persuaded customers to sign up to subscription software services.
“These reliable cash flows and Sage’s high profit margins allow the company to invest in improved services and we hope that this will drive more growth,” he added.
Despite some strong individual returns in the portfolio, however, there were also “two shockers” last year: soft drinks company AG Barr and educational publisher Pearson.
Performance of “two shockers” in 2019
Source: FE Analytics
The first – AG Barr – was down by 25 per cent, although Train said the problems were likely temporary and a reaction to “several years of wonderful gains”.
For Pearson, which made a loss of 30 per cent, this year will be an important one when investors should really be able to judge whether the multi-year investments in digitising its intellectual property will pay off.
Looking ahead, Train said there were some positive signs for further global growth.
The first was that last year was the second biggest on record for global merger & acquisition activity, at $5.5trn.
“In a year marked by so much macro-economic angst, it was encouraging to see corporations around the world looking to get deals done in order to take advantage of the obvious opportunities for profitable growth offered by technology change and the continuing opening up of emerging markets,” he explained. “We expect 2020 will be another big year for corporate activity and that this will be supportive for stock markets.”
Secondly, Train noted that companies are becoming more profitable as they become more efficient.
“As we get cleverer and more productive, there is more wealth to go around,” he added. “The long-term correlation of this trajectory to rising stock markets is clear and as good a reason as any to be optimistic about 2020 and beyond.”
Since Train took over management of the trust in December 2000, it has made a total return of 629.93 per cent against a gain of just 169.98 per cent for the FTSE All Share and a 225.87 per cent return for the average IT UK Equity Income peer.
Performance of trust vs sector & benchmark under Train
Source: FE Analytics
Finsbury Growth & Income trades at a discount of 2.4 per cent to net asset value (NAV), is 1 per cent geared, has a yield of 1.9 per cent and ongoing charges of 0.66 per cent.
Fidelity International investment director Medha Samant explains why a trust that uses a value process to invest in emerging markets finds more opportunities in India than market giant China.
India is currently the best place for finding opportunities in the Asian market, more so than China, according to the team behind the £307.6m Fidelity Asian Values trust, which has a 7 per cent overweight position in the country.
Over the past few years India has been less-favoured market among the Asian mix.
The MSCI India index has underperformed the MSCI Emerging Markets index over the past year and is lagging the MSCI China over one, three, five and 10 years.
MSCI India versus MSCI Emerging Markets over the past year
Source: FE Analytics
Added to that, the International Monetary Fund (IMF) cut its economic growth forecast for India last October.
But despite this Fidelity International’s Medha Samant maintains the Indian market is one of the best places to find opportunities, so long as you look for “the organised players in an unorganised market”.
An example of that is Power Grid Corp of India, which is the portfolio’s biggest holding at 3.70 per cent. Fidelity Asian Values currently has 23.9 per cent of its portfolio in Indian stocks, compared with 21.6 per cent in China.
Samant explained that with the Indian government currently focused on infrastructure it is paving the way for power companies to develop; a long-term theme since power will always be in demand.
Samant said that as the Indian government is trying to provide stimulus there and with the government opening up the power sector, Power Grid Corp is an example of someone who stands in a very good position to gain contracts in the future.
The Indian government has been putting efforts into boosting its economy as the Indian prime minister Narendra Modi, who came into office in 2004, significantly eased the way businesses can operate.
“There are different ways to play Asia,” Samant said, adding that you don’t just have to invest in the region’s bigger names like Alibaba, Tencent, or Samsung for growth.
Indian based holdings in the fund include non-banking financial company Shriram Transport Finance and IT company Redington India.
“We prefer these single, mono lines of businesses,” Samant said. “The businesses we own are basically good businesses run by good people available at good prices.”
Indeed, this allocation to India and finding the companies able to take advantage of the stable trends within the country has helped provide top-quartile returns in Fidelity Asian Values over a five-year period; a considerable outperformance for a trust running an out-of-favour value style.
On its Chinese underweight, Samant explained that just because its allocation is below the market average does not mean that Fidelity Asian Values manager Nitin Bajaj cannot find opportunities there.
Like India, Samant said it’s about finding those companies working within a consistent trend in what is another volatile market.
The macroeconomic issues with China have been ongoing with the latest noise around its trade war with the US suggesting that a potential peace treaty may be on the horizon in 2020.
One part of the noise and confusion created by the trade war has consequentially been the realignment of trade routes.
Bangladesh has become the preferred alternative for European firms and Vietnam the new manufacturing path for the US.
But Samant explained that rather than trying to negotiate these new trade routes and the alliances still being established, one of the key areas of focus was “China for China” – essentially the domestic companies focusing on delivering Chinese growth.
Within China, Bajaj is looking to find those companies who are tapping into trends stable enough that they are unaffected by the trade war. Companies such as Xingda International Holdings, which produces the steel rods used in the manufacturing of car tyres.
Performance of Xingda International Holdings since December 2006
Source: Google Finance
The rise of the middle class in China has meant that more people are able to buy cars for the first time – something which has greatly helped to boost the car manufacturing industry.
That, along with the need for China to adopt more alternate power sources to help tackle its air pollution issues, means it is also becoming a hub for electronic cars with supercar giant Tesla hosting one of its headquarters there.
“The trade war, or whatever you might call it, is not going to impact this,” Samant said.
Along with this new social class is the desire for a better quality of life, mirrored by wage increases. But it’s not just a better quality of home life that is rising but quality of health, bringing about a rise in running in China.
“It’s a no brainer,” Samant said. “We bought a Chinese sportswear brand and the primary focus is on running. So again, it's not a complicated business, it’s a mono line. It’s the market leader in offering running apparel and shoes in the top tier, tier-two, tier-three, tier-four cities.”
This again is something unlikely to be impacted by the trade war. “People are going to be running,” Samant said, “It’s a trend that’s only going to be improving in China. It's not exporting. It's China for China.
“So you can't say, you know, just because our country allocation is underweight, we're not finding many companies to invest.”
Fidelity Asian Values runs a bottom-up value style approach, a method that has been decidedly out of favour over the past decade when growth has significantly outperformed.
But this has not appeared to hinder the fund’s performance as it has produced a top quartile return over the past five years, making 77.93 per cent over that time frame and outperforming both the MSCI AC Asia ex Japan index (58.01 per cent) and its average IT Asia Pacific Smaller Companies peer (22.36 per cent).
Performance of trust vs sector & benchmark over 5yrs
Source: FE Analytics
The five FE fundinfo Crown-rated trust has a yield of 2.17 per cent and ongoing charges of 0.99 per cent. The fund is currently trading at a premium to net asset value (NAV) of 0.8 per cent and is 12 per cent geared.
Trustnet looks over the past decade to discover which funds sit in the top decile of their sector for both total returns and annualised volatility.
Well-known names such as Liontrust Special Situations, BNY Mellon Global Income and Threadneedle European Select are among the handful of funds that have managed to balance some of the highest returns of the past decade with some of the least volatile rides.
The last 10 years have, on the whole, been very profitable for investors as the worst of the global financial crisis was over by the time 2010 arrived and a decade of ultra-loose monetary policy supported a strong bull market.
As we saw in a previous article, the highest total return between 1 January 2010 and 31 December 2019 came from Legg Mason IF Japan Equity. This fund made 701.17 per cent over the 2010s – but with bottom-decile annualised volatility of 21.67 per cent.
Likewise, another seven of the 20 funds that made the best returns of the last decade were at the bottom of their respective sectors for volatility – names such as Merian UK Smaller Companies Focus, Baillie Gifford Japanese Smaller Companies and T. Rowe Price US Large Cap Growth Equity – demonstrating that investors were rewarded for risk over the long run.
However, in this research we looked for the Investment Association funds that are in the top decile for both total returns and annualised volatility over the last 10 years, meaning they combined strong returns with less risk than their peers.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
Out of 1,465 funds that have a long-enough track record and reside in a sector where decile rankings are appropriate, just 17 managed to combine top-decile returns with volatility. The performance of the fund that made the highest return is shown in the chart above.
Liontrust UK Smaller Companies is headed up by the FE fundinfo Alpha Manager duo of Anthony Cross and Julian Fosh alongside Victoria Stevens and Matthew Tonge. It made a 418.88 per cent total return between 1 January 2010 and 31 December 2019 while its annualised volatility was 10.75 per cent.
The £1.1bn portfolio is managed using Liontrust’s Economic Advantage process, which looks for companies with a durable competitive edge that comes from intangible assets such as intellectual property, strong distribution channels and significant recurring business. Top holdings include market researcher YouGov, cloud communication provider Gamma Communications and bill payment firm PayPoint.
Square Mile Investment Consulting & Research, which gives Liontrust UK Smaller Companies an ‘AA’ rating, said: “The investment process applied is considered, well defined and steers the fund’s management team towards relatively steady businesses that it believes have a competitive edge and are gradually growing and generating high levels of cash.
“The emphasis here is very much on a firm’s intangible strengths, which by their very nature are difficult to assess using more traditional analytical techniques and therefore are often overlooked by many market participants.”
Source: FE Analytics
As the table above shows, LF Gresham House UK Micro Cap is the fund that made the second highest return out of those shortlisted by our research. The £191.8m fund is run using valuation techniques that lead manager Ken Wotton developed in the private equity industry, which he combines with an emphasis on protecting capital and achieving long-term growth.
Analysts at FE Investments, who have the fund on their Approved List, like LF Gresham House UK Micro Cap’s “thorough research process” and highlighted the strong stock selection that Wotton has shown while running the fund.
“The fund’s specific approach has resulted in a fund that has protected particularly well when markets are under pressure,” they added.
“It is also one of few UK small-cap funds to deliver positive returns in every calendar year since inception including particularly difficult periods such as 2014 and 2018. Stockpicking has largely driven performance with 2015, 2017 and 2018 being years of notable outperformance due to good stock selection.”
Michael Faherty and Marco Lo Blanco’s £1bn Seilern World Growth fund appears in third place. The process behind this fund seeks out “exceptional businesses” that have superior growth prospects, sustainable competitive advantages, high returns on invested capital and low or no net debt.
A rigid vetting process means that only around 70 of the world’s listed equities make it onto Seilern Investment Management’s investment universe, leading the firm’s funds to run high-conviction portfolios with low turnover. Seilern World Growth’s top holdings at present include Google parent Alphabet, Estée Lauder and Mastercard.
Of the 17 funds that combined top-decile total returns and annualised volatility over the 2010s, the portfolio that did so with the lowest volatility is TB Evenlode Income. It made a 246.74 per cent return in the last decade, with volatility of 9.31 per cent.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The fund, which is head up by FE fundinfo Alpha Manager Hugh Yarrow with Ben Peters as deputy, has a quality-growth bias and prefers companies that hold a large market share or competitive edge while consistently generating high levels of recurring cashflows.
“The fund has an excellent track record, beating its FTSE All Share benchmark every year since inception,” analysts at FE Investments said. “The fund has protected well in down or flat markets – it outperformed in 2011 and 2018 when equity markets sold off.”
With assets of £3.7bn, TB Evenlode Income is one of the larger funds in the IA UK All Companies sector but there are some other giants on our list of those that have made top-decile returns with low volatility in the 2010s.
The biggest of the 17 funds is BNY Mellon Global Income, which is headed by Nick Clay. It is joined on the list by the £5.6bn Liontrust Special Situations fund, the £1.7bn Threadneedle European Select fund, the £1.7bn TM CRUX European Special Situations fund and the £1.5bn Schroder Asian Income fund.
Tomorrow, a Trustnet article will reveal the funds that posted some of their sectors’ lowest returns and highest volatility over the past decade.
Darius McDermott, managing director of FundCalibre and Chelsea Financial Services, explains why now might be a good time for investors to think about making an allocations to European equities.
It has not been smooth sailing for those investing in Europe in the past decade. It’s a market that has been riddled with challenges, such as the sovereign debt crisis and, more recently, trade wars, Brexit and the rise of populism.
It’s been a decade where negative headlines have dominated - but could the start of a new one see a change in fortunes for the region?
The start of 2019 saw the outlook for Europe go from bad to worse, as disappointingly weak economic indicators kept rolling in. Italy was in recession, while Germany was flirting with the possibility of following, as vehicle emission tests – introduced following the Volkswagen scandal – and a fall in car sales in China acted as a drag on industrial output.
It was, therefore, a pleasant surprise to see the MSCI Europe return almost 20 per cent in the last calendar year, as the region showed resilience in the wake of uncertainty. However, uncertainty has dominated sentiment, with all three European equity sectors seeing net outflows totalling almost £4bn between January and November 2019, according to figures from the Investment Association. Europe also saw net equity outflows of £1.3bn in 2018.
Changes occurring and improving fundamentals
The European Central Bank (ECB) has followed the dovish tone of others in 2019 by making moves to inject growth into Europe. These moves have come in the shape of cutting its deposit rate to -0.5 per cent in September 2019, while also bringing back quantitative easing.
We’ve also seen a change at the top of the ECB, with Mario Draghi’s tenure coming to an end in October, and former International Monetary Fund chief Christine Lagarde taking over at the helm. A recent note I read from Lazard indicates change may be on the agenda, with Lagarde likely to move away from solely relying on monetary policy, by encouraging eurozone governments to boost spending.
While it is far from being solved, there is also something of a respite from the overhanging threat of geopolitical uncertainty in Europe. We’ve seen a General Election in the UK , which finally gives Boris Johnson and the government the mandate to agree a Brexit deal – hopefully minimising the threat of a no-deal scenario on markets, while the phase-one agreement between the US and China has also been beneficial. Both situations can still turn sour, but for now - no news is good news.
Importantly for Europe, the underlying fundamentals look reasonably attractive. Unemployment levels in the EU stood at 6.3 per cent in November 2019, the lowest level since January 2000, according to Eurostat. Tighter labour markets are also slowly translating into higher wage growth. This, coupled with eurozone banks easing credit standards and inviting more lending, has indicated a better economic outlook than perhaps many of the headlines would indicate. As is often the case with Europe, this optimism needs to be tempered, and in this case, it is by high debt to GDP levels in the likes of France, Belgium, Italy and Spain.
Could there be an argument that we are actually in a sweet spot given that there is wage growth, low unemployment and money supply, while inflation is not at worrying levels?
Cutting through the noise to find opportunities
In addition to the underlying data not being reflected in the top-line negativity, I feel there are two additional drivers long-term investors should look to consider when investing in Europe. The first is: it is home to a number of leading global companies and, therefore, is not solely dependent on the continent, with approximately 40 per cent of revenues coming from overseas.
Secondly, European stocks are still undervalued compared with many other parts of the globe, particularly the US. This is a trend which has remained consistent since the global financial crisis of 2008 (the eurozone crisis of 2010-12 resulted in a delayed recovery in the region). According to FactSet, the MSCI EMU index (European Economic and Monetary Union) is on a 17.5x price-to-earnings ratio compared to 19.1x for the S&P 500.
There are clear value opportunities. Indeed, the divergence between quality/growth and value has surpassed levels seen during the TMT (technology, media & telecommunications) crisis and the global financial crisis. An article by Invesco head of European equities Jeffery Taylor highlights this point by stating there are plenty of examples of outperformance being driven by “re-rating rather than fundamentals alone.
Markets began shifting towards value in Europe in the last quarter of 2019, but the big question is, can this turnaround be sustained? Schroder European Alpha Income fund manager James Sym believes the shift has been positioning-led and that a regime change in markets and shift in mindset from policymakers could mean the shift to value lasts.
Sym says it is a classic business cycle call to buy economically sensitive stocks when the purchasing managers’ index (PMIs) are low amid a pessimistic consensus. He cites oil & gas and banks as two sectors which look particularly compelling, adding the latter does not need to see bond yields rise too much for a change in sentiment. However, he does believe some highly valued areas of the market, such as technology also offer opportunities.
In summary, I would not be foolhardy enough to tell you we’ve seen the low point in Europe, as history has taught us to expect the unexpected. What I would say is we support the view that it is undervalued and currently have a 20 per cent allocation to the region in our managed funds. Importantly, it seems the market may be starting to see the opportunity as well, with Morgan Stanley’s chief European economist Graham Secker saying they have just started to see some inflow back into the region after “85 weeks of consecutive outflows totalling $150m”. As a sector, it’s a classic example of one investors will have to be patient with, and take the rough with the smooth.
Sym’s Schroder European Alpha Income fund is one to consider for those looking to tap into Europe. His pragmatic style means he is not wedded to a particular investment approach. The 30-50 stock portfolio favours stock ideas which have a lot of potential to do well, but are less likely to fall on hard times.
Another to consider is the RWC Continental European Equity fund, managed by Graham Clapp. This fund is also style agonistic and is designed to find companies where financial performance will be better than the market expects. The average stock size is usually around 3 per cent, which prevents any one stock from dominating the portfolio. It also has a high active share.
Another with a value discipline is the Marlborough European Multi-Cap Income fund. Managers David Walton and Will Searle offer access to much smaller companies than many of their peers. These businesses are often overlooked and hence have the potential to outperform. This can carry extra risk, but the managers look to diversify in terms of sector and country.
Darius McDermott is managing director of FundCalibre and Chelsea Financial Services. The views expressed above are his own and should not be taken as investment advice.
Royal London Asset Management senior economist Melanie Baker highlights six issues that could limit growth during 2020.
Global growth is likely to be “unspectacular” this year, according to Royal London Asset Management’s Melanie Baker, who warns that six worries are preventing the global economy it from taking off.
The most likely scenario for the global economy this year, said the Royal London senior economist, is that growth stabilises at around 3 per cent and a recession is avoided.
“Although it should pick up, global growth is likely to be unspectacular as we continue to work through this mini-cycle,” said Baker (pictured). “Uncertainty looks set to linger, fiscal policy is becoming less supportive in the US and stimulus continues to underwhelm in China.
“Meanwhile, financial conditions look vulnerable to tightening if inflation shows more signs of life.”
As such, there are six worries that Baker and the multi-asset team at Royal London believe investors should be thinking about.
The first worry centres on the uncertainty surrounding trade relations and the damage to business sentiment and global growth over the past 18 months by tariff threats and actions.
“When businesses are more uncertain about the outlook, including the policy backdrop, companies can hold back on making big decisions,” she said.
Uncertain around economic policy and its impact on business sentiment rose through much of 2019, said Baker, as the below chart suggests.
“Recent uncertainties businesses face don’t just relate to familiar factors like end-demand, but have extended to whether they will even be permitted to deliver a particular product or service to an end customer at all,” said the RLAM economist.
Politics and upending policy norms
Something else that investors will have to get used to is the new trend of more populist politics that would have been unthinkable “10 or 20 years” ago.
“For some, previously unorthodox policies and political uncertainty seen in multiple economies reflect part of a populist undercurrent in politics and lingering issues around inequality and social mobility,” Baker said.
Beyond the trade situation with the US, China continues to face a number of economic challenges with recent slowing in the world’s second largest economy and concerns over its demographics.
In addition, it faces concerns about the level of corporate debt in the system.
“The stock of corporate debt remains high as a percentage of GDP and troubles appear to be persisting in the banking sector including through a build-up of bad debts,” said Baker.
“That authorities are keen to avoid stimulating a credit-fuelled upturn is therefore positive for medium-term growth sustainability, but there are risks in the disruption of credit flows for the short-term outlook.”
Labour market slowdown
After several years with unusually strong employment figures, growth has started to slow in the eurozone, layoffs have risen in the UK and indicators suggest unemployment rates in the US and Japan are higher.
“Any significant downturn in the labour market would threaten the relative resilience of the consumer,” the RLAM economist explained. “In the US, UK, Japan and the euro area, consumer spending has been an important driver of growth in 2019.”
The return of inflation
“Recent events in the Middle East are a reminder that oil prices and general geopolitical tension are always something of an underlying risk for forecasts,” said Baker, highlighting the US-Iran standoff since the start of the year.
Yet, she said, inflation could become a “more general and sustained theme” if growth is stronger than expected over the year with the labour markets still looking “relatively tight” in a number of major economies.
“An ‘inflation scare’ isn’t our central case, but would be a threat to benign financial conditions,” Baker added.
Debt as an accelerant in a downturn
Finally, Baker said there are good reasons to worry about the role that large corporate debt piles and future bad debt may play in any potential downturn, particularly given the very high levels of debt in the US and China, the world’s two largest economies.
“As growth slows and profitability is eroded, problems re-paying debt and rolling over debt could emerge in some sectors,” she explained “These could morph into broader financial stability problems through effects on markets and financial institutions.”
Taken together, Baker is anticipating more subdued global growth this year as markets show signs of bottoming out and central banks and governments continue to provide stimulus.
“The global economy has slowed, not contracted,” she explained. “Growth rates have slowed so much so fast that a strong bounce-back would any way look the most likely outcome.”
Baker added: “Developments since early October have been positive for the outlook, helped by some improvement in US-China trade relations.
“Somewhat better than expected GDP growth outturns in Q3, the fading of immediate ‘no deal’ Brexit risk and more fiscal stimulus also justify upward revisions to our GDP growth forecasts.”
The economist said it five things would make the firm more confident that global growth will pick up in 2020 : more stimulus, particularly fiscal, materialising; a ’phase one’ US-China trade deal being signed; the US not immediately replacing China with Europe as a target for tariffs; whether the elimination of ‘no deal’ Brexit will make European companies more optimistic; and time passing with no sharp deterioration in labour market data.
River & Mercantile fund manager Will Lough explains how the most obvious UK companies might not be the best bets for investors in 2020.
Some of the most-loved pockets of the stock market are at a risk of de-rating in 2020, even though investors continue to buy into them, according to River & Mercantile’s William Lough (pictured).
After several years as the most out-of-favour asset class following the Brexit referendum, sentiment towards UK equities has started to shift back making relatively cheap companies look more appealing.
However, Lough – manager of the £73.2m ES R&M UK Dynamic Equity fund – said that investors need to be more careful.
“The risk in the UK market, I would argue is more towards businesses which are in the quality phase of the cycle and have been able to compound growth at relatively attractive rates,” he said.
“But the multiples that people are putting on those profits are very high and perhaps people have forgotten that in the end markets for these stocks are cyclical.
“So that is stuff which is a bit more cyclical than people expect and has been lumped into the quality-growth and basically given any multiple because they think that it will always grow.”
The fund manager said two stock examples of these risk companies are FTSE 100 technology company Halma.
Lough said Halma was a “phenomenal businesses” but had hit its “blue sky valuations,” his term for holdings where “more things could go wrong for the enterprise than could go right at that point”.
The manager said Halma is currently delivering high single-digit organic sales growth, but in order to justify the current share price they have to keep up high levels of return “without any blips” for a decade.
Halma stock price over the last 5yrs
Source: FE Analytics
High valuations for tech names have been a prevalent story in the US market where the S&P 500 has been driven in recent years by just a handful of companies. While not much of this “hyper growth” has been seen in the UK – where there are considerably fewer large tech companies - mispricing risks have occurred.
“What I’m trying to do is find companies that actually have robust franchises, where they’re not overearning versus the cycle, and they’re not at peak returns in the cycle,” he said.
“Buying peak returns and peak valuations is something that has shown up in a cycle over the past and is not historically a very good strategy.”
However, this does not give a good overall picture of the UK stock market, Lough said, and he is – in fact – very optimistic about the opportunities to be had.
“There are so many more positives than negatives for the UK equity market as we sit today,” the ES R&M UK Dynamic Equity manager said. “It’s a broad market, in terms of the types of opportunities
“It’s a market which has very strong rule of law, so it’s an attractive jurisdiction for investors even after Brexit which investors need to remember.”
The Conservative party’s landslide victory in the December general election gave greater clarity for international investors about the path of Brexit and saw the left-wing Labour party swept away, boosting sentiment.
“The UK has just faced three years of quite a lot of uncertainty and whatever anyone thinks about Boris Johnson, he’s just won a very sizable majority,” said Lough. “The sort of majority that is pretty rare in developed economies.”
Performance of FTSE 100 and IA All UK Companies sector over 1yr
Source: FE Analytics
Although a predominantly bottom-up investor, Lough believes an improved UK outlook has provided a platform for pockets of opportunity to come through as both investors and consumers who have been holding back their cash and spending will now put that to work in a more stable market.
“You have these catalysts for better performance, with an improving economic backdrop and a starting valuation which is very attractive across the board and in relative terms,” he said.
Looking at stock-specific opportunities, Lough highlighted supermarket giant Tesco whose “arrogance” at taking their position in the market for granted caused a decline and he bought them during their “positive growth” rebound.
Typically classifying stocks into four categories - Growth, Quality, Recovery and Asset-Backed – Lough said he considered Tesco a ‘recovery’ stock transitioning to a ‘quality’ one and is the second largest holding in the portfolio.
Another example of a stock going through a “growth positive trend” is west London property investment and development company Capital & Counties, a recovery or asset-backed holding.
Lough said the firm’s disposal of its Earls Court interest for £425m had been a positive catalyst that has allowed it to move on and refocus on its “high quality” Covent Garden site.
“When you’re looking at something like the UK opportunity [set], if there was one defining feature that I’d be looking for in investments it’s companies that have been able to use the difficulties of the last three years to cement and strength and their market position,” he said. “And that is a classic feature of the best cyclical franchises.
“Within the UK specifically it is the case that even after a kind of a relatively decent bounce in share prices in the last quarter of last year I think there is there is plenty of opportunity today in UK domestically facing companies.”
Performance of fund vs sector & benchmark under Lough
Source: FE Analytics
Since being appointed lead portfolio manager of the fund in April 2018, ES R&M UK Dynamic Equity fund has made a 14.35 per cent gain compared with a 16 per cent return for the average IA UK All Companies peer and a 16.02 percent return for the MSCI United Kingdom IMI benchmark.
The fund has an ongoing charges figure (OCF) of 0.93 per cent and a yield of 2.60 per cent.
The Baillie Gifford manager says that in every area of the world, it will soon be cheaper to build renewable energy farms and the associated storage than to carry on operating oil or gas facilities.
Oil & gas stocks could be worthless in as little as five years, according to James Anderson, manager of the Scottish Mortgage Investment Trust, who warns many of the industries and companies that investors are backing to benefit from a ‘value’ resurgence are more likely to be “physically destroyed”.
In a recent presentation, BMO investment manager Scott Spencer noted that Baillie Gifford – which runs Scottish Mortgage – has been the dominant fund house over the past decade, with its bias to the growth style of investing pushing it to the top of the charts in a variety of sectors.
However, he then pointed out that “the fund everyone was buying 10 years ago” – M&G Recovery – has been the worst performer in the IA UK All Companies sector in the past decade, returning 49.31 per cent.
Spencer said that just as M&G Recovery’s once successful strategy eventually fell out of favour, so Baillie Gifford’s growth bias is now due a fallow period, which is why his team has switched to a value bias across its multi-manager range.
Anderson’s co-manager Tom Slater argued this idea of mean reversion relies on a mis-reading of why growth investing has done so well.
“If you connect 5 billion people to a global network, if you see the innovation that is driving that and the new business models that have been putting a real squeeze on existing industries,” he said, “I think this is a far more enduring and powerful force than people believe.”
“Growth really comes from one of two sources: either an increase in demand or an increase in supply. But actually, the trend we have been seeing is that supply has been more effectively able to meet consumer demand as a result of innovation.
“It’s not the swings between growth and value that we’ve seen in the past economic cycle. It’s driven by an underlying trend which is likely to continue for some time.”
Anderson said he is far more dogmatic than his co-manager in his belief of growth’s supremacy as an investment style, claiming that rather than coming to the end of a successful run, “I don’t I think we have seen anything yet”.
For example, he noted that while value has underperformed over the past decade, it has not done too badly in absolute terms. However, he warned this could be as good as it gets for this strategy, saying: “It seems to me that there is every prospect over the next 10 years that many of the companies that people are looking to for this much-vaunted mean reversion are going to be physically destroyed.”
Performance of indices over 10yrs
Source: FE Analytics
Anderson said this statement does not just apply to the obvious areas such as retail, but also sectors that many professional investors regard as defensive, such as oil & gas. And, despite efforts by environmentalists to put pressure on fossil fuel producers through protests and divestment campaigns, the manager said the biggest threat to the sector is cold, hard capitalism.
“The whole nexus of solar and wind power, batteries, battery storage, everything we see both in relationships with companies and from academics, is that there is going to be a continued, almost inevitable – with a 90 per cent+ probability level – 15 to 25 per cent decline every single year in these prices,” he explained.
“Now that means that within the next five years, just about everywhere in the world, for every single different energy source, it will be cheaper to build solar or wind plus storage than to just carry on operating even gas facilities, let alone oil.”
Anderson pointed out that by this point, taking this trend to its natural conclusion, energy will become so cheap it is effectively free.
“That means that you will have a complete set of stranded assets in many of these areas that people believe are going to revert to being ‘value’,” he added, “and the prices of the shares will fall in absolute terms rather than just underperforming. So I think it’s going to get more dramatic.”
In light of this view, it is unsurprising that Anderson counts automotive and energy company Tesla as one of the largest stocks in his portfolio.
What may raise eyebrows, however, is the identity of another one of his top-10 holdings, luxury sports car manufacturer Ferrari. Despite this company’s historic relationship with the internal combustion engine and fossil fuels, Anderson said discussions with its management team suggest it has come to the same conclusion as he has about the future of energy.
“One of the most interesting parts for me has been seeing how the great rivals of these [disruptive] companies are trying to evolve,” he added.
“We continue to be very grateful to the extent to which the people at Ferrari and particularly John Elkann [chairman of Ferrari and Fiat Chrysler Automobiles] talk us through an awful lot of things. And one of the resonant points from my perspective is that he is absolutely upfront in saying, the brand, the luxury, the demand does not protect Ferrari in the long run.
“Unless you can be at the cutting edge of transport engineering, it won’t last. And that cutting edge is now electric. So, I think that we are seeing whole sets of industries being transformed.”
Data from FE Analytics shows Scottish Mortgage has made 531.9 per cent over the past decade, compared with gains of 198.75 per cent from its IT Global sector and 187.07 per cent from its FTSE All World benchmark.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
It is trading at a premium of 2.37 per cent to net asset value (NAV) higher than the one- and three-year averages of 0.83 and 1.77 per cent, according to data from the Association of Investment Companies (AIC).
The trust is 8 per cent geared and has ongoing charges of 0.37 per cent.
Trustnet finds out how the best- and worst-performing strategies of 2018 got on during 2019 in what was a very different year for markets.
To say that the performance of markets last year was an improvement on 2018 would be a huge understatement.
As the Federal Reserve looked set to continue tightening policy, reducing liquidity, and the relationship between the US and China deteriorated, it was difficult to see much cause for optimism early in 2019.
Nevertheless, a reversal by the US central bank and the prospect of a US-China trade deal helped boost sentiment. UK investors also benefited as the December general election returned a large majority for the ruling Conservative party and provided greater certainty for the domestic economy.
After a loss of 3.79 per cent in sterling terms for the MSCI AC World index in 2018, the index rallied by 21.71 per cent last year.
Given the change in market conditions, Trustnet revisited the best & worst performing strategies of 2018 to find out how they got on in 2019.
As the chart below shows, most of the top-performing strategies of 2018 made positive returns again in 2019, with many showing a marked improvement on the previous year’s showing.
Source: FE Analytics
However, there were three funds from the top-20 in 2018 that made a loss last year: Wellington Global Total Return, Wellington World Bond and Vanguard Japan Government Bond Index.
Having made a total return of 11.33 per cent during 2018, Wellington Global Total Return made a loss of 1.34 per cent last year.
The $161m absolute return fund is managed by Wellington’s global bond team. It invests in a portfolio of fixed income assets, seeking absoluter returns above its cash benchmark over the medium-to-long term.
Its sister fund – Wellington World Bond – made a smaller loss of 0.12 per cent during 2019 after a double-digit gain of 10.74 per cent during the previous year.
Meanwhile Vanguard Japan Government Bond fell by 1.17 per cent last year.
However, the best performer of 2018 – Polar Capital Healthcare Opportunities – also delivered a strong performance last year, making a total return of 14.35 per cent.
The $1.5bn, four FE fundinfo Crown-rated strategy is overseen by Gareth Powell. It topped the performance tables in 2018 with a return of 15.51 per cent.
However, it wasn’t the biggest gain recorded by a 2018 top-20 performer.
That went to five Crown-rated Brown Advisory US Equity Growth, which made a 34.72 per cent return last year. The $1.1bn US equity fund, managed by Kenneth Stuzin, invests in mid- to large-cap companies with strong & sustainable revenues, cash flow and earnings growth. It had made a return of 11.34 per cent during the more challenging conditions of 2018.
Sister strategy Brown Advisory US Sustainable Growth also delivered a strong 30.47 per cent gain last year, after making a return of 11.4 per cent in 2018.
Given the strength of the rally last year which lifted almost all assets, it’s little surprise that almost all of the worst-performing funds of 2018 delivered a positive total return during 2019.
Just two funds of 2018’s worst-performing strategies made a loss again last year, against a vastly improved economic picture and more positive sentiment in most markets.
Source: FE Analytics
Invesco Korean Equity was the worst performer of the bottom-20 funds from 2018, making a 5.24 per cent loss in 2019 (it was down by 23.41 per cent in 2018).
The Korean equity market has been affected by slowing Chinese growth and trade tensions with Japan, as well as some negative implications from government policy, Invesco noted.
The only other fund from 2018’s bottom-20 to record a loss last year was the L&G UK Alpha Trust, which – after a 22.05 per cent loss in 2018 – was down by 2.74 per cent in 2019.
This small- and mid-cap fund was taken over by Rod Oscroft at the start of 2018 following the departure of former manager Richard Penny to CRUX Asset Management.
The worst performer of 2018 – ES Gold and Precious Metals – returned a respectable 13.07 per cent gain in 2019 following a 28.86 per cent loss during the previous year.
It benefited from positive trends for gold prices which rose early in the year against an uncertain policy and geopolitical backdrop.
There were also some strong performances to be found among the bottom performers of 2018.
The best performing strategy was Allianz All China Equity fund, a $288.5m vehicle overseen by Anthony Wong and Sunny Chung. Having made a loss of 21.87 per cent in 2018, the Chinese equity fund recorded an impressive 41.85 per cent gain last year.
Another Chinese equity strategy – GAM Star China Equity – also rebounded strongly after a loss of 23.90 per cent in 2018, making a gain of 32.83 per cent last year.
European equities appeared to have turned a corner in the fourth quarter, rising to heights not seen in years. Aviva Investors' Edward Kevis considers whether the rally still has room to run in 2020?
As we entered 2019, European stocks had not been so out of favour since the sovereign debt crisis at the start of the decade. Having shed 10 per cent in 2018, the MSCI Europe index is currently trading at about 15x earnings, compared to 17x earnings for the MSCI World index based on earnings expectations for 2019.
With the benefit of hindsight, one could argue European stocks had become so cheap a recovery was inevitable. In the three months ending 31 October, the MSCI Europe rose 2.59 per cent, outperforming the 2.19 per cent return for the MSCI USA, in local currency terms.
The question is whether the rally – at least for the broader market - will run out of steam this year, especially as key political risks such as Brexit, the US-China trade spat and higher US tariffs on European goods remain unsolved.
Below are three things that European equity investors should watch in 2020.
1. Macro risks remain, but should become less uncertain
Compared to the US and other benchmarks, European stock indices are generally more dependent on the global trade environment. This has put a drag on the region for several years, but a reversal appears to be happening. A combination of more optimism around US-China trade talks and an extension to Brexit negotiations helped attract inflows back into the asset class, especially in the fourth quarter. Weak economic data also meant continued monetary policy support from the European Central Bank (ECB).
While the macro environment could worsen in 2020, the US elections should provide an economic incentive for Donald Trump to progress trade talks. Since the end of the First World War, incumbents have all been re-elected when the economy is strong. In contrast, almost all – including George HW Bush, Jimmy Carter and Gerald Ford – who faced a recession in the two years before the elections subsequently lost the race. Progress in trade negotiations with China should therefore become a higher priority for Trump as the election approaches. However, he also needs to appeal to his core constituents by being ‘tough on China’. This may result in market volatility during the on-again, off-again talks, but likely tip the balance towards a trade deal.
2. The valuation gap may close between top and bottom sectors
Although the European equity index is trading slightly above its long-run average of price to expected earnings, there is still a lot of dispersion between sectors. Higher-beta cyclical stocks that are more exposed to economic conditions have generally fared worse than the more defensive, lower beta companies. The automotive industry, for example, trades at about nine times earnings compared to utilities, which trades at about 16x earnings based on 2019 estimates.
This gap may narrow in the coming year. Most of the bad news appear to be priced in, with upside potential if macro conditions stabilise or improve. Underperforming sectors, such as auto, banks and energy, may have the potential for earnings upgrades relative to higher-value sectors such as consumer staples, utilities, and food and beverage. In addition to a healthier macro-environment, expectations for more stable or even higher earnings could boost stocks in these sectors.
3. Stock selection remains critical
As we head in 2020, the combination of macroeconomic uncertainty and high dispersion of valuation multiples between sectors should – in theory – again make for a stock picker’s market within Europe. Rather than positioning portfolios in anticipation of macro developments, investors will likely be better served by picking stocks they believe to be undervalued. And mispriced stocks can be found in any sector.
Within the auto sector, for example, global trade tensions and structural changes in the industry have lowered valuation multiples. A small number of companies have met these challenges by strengthening their balance sheets – cutting costs, reducing inventories and improving cash flows – giving them more of a financial cushion in uncertain times. In the long term, however, the ability to take advantage of industry trends such as the transition to autonomous and electric vehicles will also determine a company’s prospects.
There may even be opportunities in sectors facing major headwinds. Healthcare, for example, may become more volatile if it plays a central role in either parties’ US election campaigns. A key point of contention between frontrunners in the US election is drug pricing. Therefore, companies that benefit from solid fundamentals and attractive valuations but lower drug pricing risks could outperform.
Edward Kevis is a European equities portfolio manager at Aviva Investors. The views expressed above are his own and should not be taken as investment advice.
PIMCO’s Joachim Fels and Andrew Balls highlight the key macroeconomic themes that they expect to impact markets in 2020.
Despite a relatively strong to last year for markets and a broadly positive outlook for 2020, there are still several key macroeconomic themes that investors should be aware of, according to asset manager PIMCO’s Joachim Fels and Andrew Balls.
Fels – a global economic adviser – and Balls – chief investment officer for global fixed income – have identified seven macro themes that everybody should be paying attention to in 2020.
1. ‘Time to recession’ has increased
Recession risks that were heightened during the middle part of the year have receded in recent months, said Balls and Fels, as a result of greater monetary easing, a trade truce between the US and China, better prospects of an orderly Brexit and a rebound in economic data.
“As a consequence, we are now more confident in our baseline forecast that the current window of weakness for global growth will give way to a moderate recovery during 2020,” they said.
“With fiscal and monetary policy now working in the same direction –further easing – in almost all major economies, the outlook for a sustained economic expansion over our cyclical horizon has improved.”
2. But ‘loss given recession’ has likely increased, too
Further easing is likely to have increased the loss in the event of a recession too, said Balls and Fels.
“Whenever the next economic downturn or major risk market drawdown hits, policy makers will have even less policy capacity to manoeuvre, thus limiting their ability to fight future recessionary forces,” the PIMCO pair explained.
As such, while ‘time to recession’ has increased, so too has ‘loss given recession’.
3. Potential cracks in the corporate credit cycle
Caution towards corporate credit market stems from concerns about the riskier segments, which could be vulnerable to any economic slowdown.
“Private credit, leveraged lending, and high yield debt have been concentrated in businesses that are highly cyclical and have riskier credit profiles,” they noted. “Moreover, despite solid bank equity positions, post-crisis regulation creates incentives for banks to ration credit when heading into a downturn.
“With speculative grade lending currently around 35 per cent of GDP, stress across these sectors would be more than enough to contribute to recession.”
4. Home sweet home
The housing market should be an area of strength for the US economy in 2020 and beyond, argued Balls and Fels, as the decline in mortgage rates has brought affordability levels back to November 2016 levels and excess homes built pre-crisis have been absorbed.
“We are now entering a period of overall scarcity across the US,” they noted. “Housing vacancy and inventories are at their lowest levels since 2000, while household formations are once again picking up, arguing for an increase in investment needed to grow the housing stock.”
5. The world leads, the US lags
Balls and Fels are anticipating that global growth will likely trough and rebound earlier than US growth this year, as has been seen in previous cycles.
“US growth momentum may lag global growth momentum at least for some time during the first half of 2020,” they said, highlighting a rebound in global manufacturing data and a slowdown in US economic growth ahead of the presidential elections.
6. Inflation: The devil they prefer
Although the PIMCO strategists are forecasting benign inflation for advanced economies, medium-term upside risks should outweigh downside risks “especially given how little inflation is priced into markets”.
Labour markets have continued tightening and wage pressures – although moderate – have started to pick up.
“If unemployment falls further as economic growth recovers this year, wage pressures are likely to intensify over time, and firms will find it easier to pass on cost increases as demand improves,” they said.
“After many years of missing their inflation targets on the downside, virtually all major central banks seem to prefer inflation – the devil they know – over deflation – the devil they don’t know.”
They added: “Against this backdrop, and despite the expected global growth recovery this year, we see the major central banks largely on hold this year and expect the bar for tighter policy to be generally higher than the bar for further easing.”
7. Dealing with disruption
Despite the expectations of a pick-up in global growth and supportive monetary and fiscal policy, there potential for “significant bouts of volatility caused by geopolitics and national politics around the world”.
Relations between the US and China are likely to remain fragile, while the US presidential election will also be worth keeping an eye on, said Balls and Fels.
Recent protests against the political establishments in several emerging market economies have added to the potential for further volatility.
As such, investors may have ‘deal with disruption’ and make sure they are positioned accordingly.
“While the baseline outlook for 2020 looks positive, we also recognise risk premia has been compressed by central bank action, leaving little cushion in the event of disruption,” they said.
“We see a range of political and geopolitical risks in addition to the potential for macro surprises, central bank exhaustion, and rising volatility.”
Balls and Fels added: “As well as a close focus on liquidity management, careful scaling of investment positions, and caution on generic credit, we will look to have somewhat lower weight on top-down macro trades, to keep powder dry and potentially of on the offensive in a more difficult investment environment.”
BMO Global Asset Management’s multi-managers say although quality-growth managers could be on their way out active managers overall could be about to become more popular again.
This could be the year that the active fund manager will be “born again”, according to the BMO Asset Management multi-manager team, who believe there could be a shift away from passives.
Last year, the asset management industry saw a significant amount of fund flows again moving out of actively managed strategies into passive holdings, putting even more pressure on active managers to prove their worth.
It’s the continuation of the trend that has seen investors put billions into cheaper passive strategies as markets have marched higher and active managers have lagged.
This can be best seen below in the example of the S&P 500 which has traditionally been very difficult for fund managers to outperform given how efficient and well researched the market is.
Performance of IA North America sector vs S&P 500 over 10yrs
Source: FE Analytics
However, Gary Potter (pictured), joint head of the multi-manager team at BMO Global Asset Management, said that the trend of constant passive inflows and is about to reverse in 2020.
“We do think after a long time – and we said this last year as well by the way, just to be clear – that we are going to see a renaissance for active managers,” he explained.
“The only game in town over the last five years has been passive. And that game looks to be, not over, but certainly the challenge will be on them to demonstrate [that they can deliver] if the earnings backdrop is difficult.
“But then good active managers should really earn their corner and be born again.”
Taking the UK as an example, Potter said that in 2019 the average IA UK All Companies fund was up by 22.44 per cent, but in the growth sub-sector – which has more passive than active funds – actively managed strategies beat the passive holdings by 3.3 per cent on average last year.
“On a time when everyone was chomping at the bit about low costs and [that] you must go passive because active can’t outperform, [you] ignore active managers at your peril,” said Potter.
“So, even if you want to buy a passive, we think there is a really strong chance that active managers really do come back into fashion in the next two or three years. And we’ve already started to see the impact that can have.
“And that’s just the average person,” the multi-manager added, “we’re not paid to find the average fund manager, we’re paid to find the better ones.”
Whilst Potter does strongly believe that investors will return to active strategies, he said quality-growth funds – some of the best performers of the past decade – could struggle this year, especially if value also makes a comeback, which he also believes could be on the cards.
“We certainly have been adding more value over the last year,” Potter said. “That was early. I don’t think it’s wrong, [but] I think it’s early.”
As growth stocks have become very expensive, Potter said any fiscal stimulus from central banks or the economic cycle continues to recover would benefit value stocks.
“We don’t think that history repeats, but it does rhyme,” the BMO multi-manager said. “And 2002 to 2007 value absolutely smashed growth.
“We’re not saying that’s going to be the same case this year, but there could be some sort of mean reversion going on. And we’ve started to see that.”
One example of this decline of the quality-growth style more recently, said Potter is Nick Train who’s £8.4bn Lindsell Train Global Equity fund has recently recorded bottom-quartile returns as value has found favour.
Performance of Lindsell Train Global Equity over several periods
Source: FE Analytics
Potter was keen to point out that this example was “nothing against Nick Train,” but noted that he had been through a bad period more recently.
Investors. he said, were buying “on the basis… that it can repeat its returns; but it’s not so likely”.
Like Lindsell Train Global Equity, the £19bn Fundsmith Equity overseen by Terry Smith has also enjoyed a decade of considerable outperformance making returns of 373.22 per cent over that time frame, a vast gap from its IA Global peer group (136.16 per cent).
But the quality-growth fund has also suffered a recent series of underperformance with fourth-quartile returns as well over the past six months.
“We don’t have a crystal ball,” said Potter. “We have no idea what’s going to happen with Donald Trump or the Middle East.
“What we do is focus on primarily finding the gems – the really good active managers with smaller capacity and high-performance attributes that really do come through.
“And I think in 2020 we are quite optimistic as a team that some of those managers will actually do very well compared with their passive counterparts. We’ve got to find good active managers who demonstrate that they can do the job, it’s what we do.”
The BMO Multi-manager teams run two fund ranges: the Lifestyle range, with five “core” risk-targeted options; and, the Navigator range, made up of five risk-profiled funds.
The largest of the Navigator funds is the BMO MM Navigator Distribution fund – a £1.1bn globally diversified income fund.
Performance of fund vs sector over 3yrs
Source: FE Analytics
Over three years BMO MM Navigator Distribution has made a total return of 11.13 per cent compared with a 13.16 [per cent gain for the average IA Mixed Investment 20-60% Shares peer. The fund has a yield of 4.6 per cent and an ongoing charges figure (OCF) of 1.44 per cent.
Trustnet searches the IA Global sector for the funds that made the best returns in both the down year of 2018 and the market surge of 2019.
Close to 30 funds in the competitive IA Global sector managed to deliver top-quartile returns in both 2018 and 2019, despite the two years presenting investors with very different conditions to navigate.
Last year ended up being one of the strongest for investors in the past decade, with markets overcoming worries such as the US-China trade war, Brexit and slowing economic growth. The MSCI World index ended 2019 with a total return of 22.74 per cent (in sterling terms).
This was in stark contrast to the year before, when many of the same issues dragged on investor sentiment and the global equities index made a loss of 3.04 per cent.
Against this backdrop, Trustnet looked across the IA Global sector – which has attracted a swell of inflows in recent years – to see which funds turned in top-quartile returns over both 2018 and 2019.
Of the 76 funds that were in the peer group’s top quartile in 2018, 27 retained this position last year. They can be seen below, ranked in order of their cumulative return over both years.
Source: FE Analytics
The fund at the very top of the list – LF Blue Whale Growth – only launched in September 2017. It is run by Stephen Yiu of Blue Whale Capital, which was started by Hargreaves Lansdown co-founder Peter Hargreaves.
Yiu builds a concentrated portfolio of between 25 and 35 companies, with top holdings at present including Mastercard, Facebook and Boston Scientific. Close to half of the portfolio is in tech stocks while 70 per cent is in US names, both of which are areas of the market that have performed strongly in the recent past.
Between launch on 11 September 2017 and the end of 2019, LF Blue Whale Growth has made a total return of 42.61 per cent – ranking it second in the IA Global sector over this time frame. Only Baillie Gifford Positive Change made more, with a 43.14 per cent gain.
Performance of LF Blue Whale Growth vs sector and index over 2018 and 2019
Source: FE Analytics
Hargreaves, chairman of Blue Whale Capital, said: “At the outset we cautiously promoted our fund and our lofty objectives of delivering consistent outperformance alongside a globally diversified, concentrated portfolio of disruptive companies, emphasising how we would strive to be the number one fund.
“This certainly raised a few eyebrows; however, I am incredibly proud of my team topping the performance table and, in doing so, beating some of the most famous names in fund management.
“However, our work is not done as we wish to build on this level of performance for our investors. We see many reasons to be positive in 2020, but we keep a cautious eye on the global economy as we navigate possible pitfalls and take advantage of investment opportunities when they arise.”
In second place in terms of 2018 and 2019’s cumulative returns is Seilern World Growth. It is headed up by Michael Faherty and focuses on quality stocks with “proven track records, sound financials and predictability of future earnings growth”.
This is another portfolio with a bias to the US and tech stocks, counting the likes of Google-parent Alphabet, Mastercard and Nike among its largest holdings.
Seilern World Growth launched in December 2007 and has a strong long-term track record: it is currently in the IA Global sector’s top decile over one, three, five and 10 years.
In third place is a fund that takes a more specialised approach than the two mentioned above. As its name suggests, William Argent’s VT Gravis Clean Energy Income fund offers exposure to companies operating in the provision, storage, supply and consumption of clean energy.
Performance of Fundsmith Equity vs sector and index over 2018 and 2019
Source: FE Analytics
Some of the IA Global sector’s best-known names can also be found on the list of funds that were able to outperform in the very different years of 2018 and 2019.
With assets under management of £19.2bn, Fundsmith Equity is one of the largest funds in the industry today and has generated handsome returns since its launch in 2010.
Manager Terry Smith has a quality-growth bias with a big chunk of the portfolio invested in areas such as the US, consumer staples and technology – all of which have risen strongly for much of the past 10 years.
“However, Smith’s superior stock selection can’t be denied as this tends to be what keeps the fund supported during times when his style is more likely to be out of favour,” analysts with FE Investments said. “In relative terms, the fund remains impressive, only being challenged by a few other funds with similar investment strategies.”
Other funds that topped the IA Global sector in 2018 and 2019 while running more than £1bn include Morgan Stanley Global Opportunity, Wellington Global Quality Growth, Pictet Security, Baillie Gifford Long Term Global Growth Investment, Robeco Global Consumer Trends Equities and Rathbone Global Opportunities.
Hugh Grieves and Nick Ford of the LF Miton US Opportunities fund say “it’s no good making lots of money for people one year and taking it all back the next”.
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GVQ Investment Management’s Jeff Harris, co-manager of Strategic Equity Capital, explains why the outlook for the UK smaller companies beyond the FTSE 250 index look so attractive currently.
In our view, at this moment, the opportunity in UK small companies (those too small to be included in the FTSE 250) is excellent for a number of reasons.
First, historically, small companies have generated superior returns in the UK as one of the best performing asset classes according to data from the Investment Association. This is a function of their greater ability to grow (from a smaller base), being less well known and off the radar of many investors and not being as widely owned. However, over more recent years, the performance of UK small companies has been someway behind the larger end of the UK market. Perhaps unsurprising given the backdrop in the UK.
Despite the recent bounce in share prices post the general election, the FTSE Small Cap index (18.82 per cent) and the AIM All Share index (13.26 per cent) materially lagged the mid-cap FTSE 250 index (28.88 per cent) in 2019. We believe the more muted performance of genuinely small companies over recent times is for several reasons. Small companies are perceived to be higher risk and, with the well-discussed changes brought about by MiFID II, less well researched and more illiquid. Outflows in this sector have been vast (according to the Investment Association), further dampening small company valuations over recent months and years. Companies with a market capitalisation even sub-£1bn is a part of the market commanding ever less attention. This is further manifested in the small-cap discount to mid-cap. This has peaked to multi-year levels (see chart) and historically has been followed by a reversion. In our view, this provides a great opportunity for focused small-cap investors.
Second, small companies contain many attractive qualities long term investors should value. Far from being ‘high risk’, the lower end of the market is a fertile ground for quality companies. Companies with highly attractive characteristics such as strong cash flows (e.g. Alliance Pharma), repeatable revenues (e.g. Medica), limited exposure to economic cycles (e.g. XPS Pensions) and strong financial positions (e.g. Ergomed) abound. These qualities are a good basis for the delivery of strong long-term shareholder returns.
Third, history has shown that valuation anomalies rarely persist in the long term. The gap closes as companies re-rate on the public market, or, as is often the case, quality small companies get acquired. Private equity fundraising has hit record levels in recent years which is being and will continue to be put to use; ‘Private Equity races to spend $2.5trn cash pile’ was an article in the Financial Times this summer. The level of ‘dry powder’ is already two times the levels of 2006/07. Debt financing is generationally cheap with very low interest rates and is widely available to source for prospective acquirers. Furthermore, low starting valuations enhance prospective returns for financial buyers. Public to private activity has been evident in 2019 with a regular flow of deal announcements at the smaller end of the market. For example, in our portfolio, large holding IFG Group was taken private by Epiris Private Equity at a 46 per cent premium earlier this year. According to Preqin, the data provider, investors view small to mid-market buyout funds as presenting some of the best opportunities in private equity.
Whilst near-term investor focus is very much on attempting to catch those companies that will offer strong returns benefiting from the clarity provided by a recently elected Conservative majority government, UK small caps are well placed beyond this. It has become a more neglected part of the market owing to the diminution of broker and investor attention ensuing from MiFID II and the growing concerns over liquidity. It also remains mischaracterised. Whilst there will inevitably be some ‘riskier’ small companies, there are also many high-quality niche market leaders with valuable IP and attractive growth and cash flow characteristics. We believe the valuation discount applied to these high-quality smaller companies should not persist over time and if it continues, transactions will, as they have in the past, provide a good means to generate shareholder value.
We are often asked ‘how the portfolio is positioned’ or ‘how to navigate the prevailing (always uncertain) environment’. Our answer is consistent. Whilst always mindful of the economic environment and its impact on our investible universe of companies, our approach is grounded in a longstanding process. Invest in high quality covetable small companies trading at a discount to their fundamental value based on their ‘real world’ value, this being how private equity would value their cash flows. This provides a strong precedent for valuation and a good compass in all environments. We believe the prevailing environment provides real opportunity for small-cap investors.
Jeff Harris is co-manager of Strategic Equity Capital. The views expressed above are his own and should not be taken as investment advice.
Research house makes 14 additions to its model portfolio as 13 leave after reporting rise of 22 per cent in 2019.
Temple Bar, Fidelity Special Values, Templeton Emerging Markets and BlackRock World Mining are among several additions to the Winterflood Investment Trusts model portfolio, following a review at the start of 2020.
The firm saw 71 per cent of the total number of trusts outperform their relevant peer groups in 2019 in a strong year for the firm’s model portfolio, which rose by 22 per cent.
Source: Winterflood Investment Trusts
“2019 was a good year for investors in investment companies, with the sector benefiting from narrowing discounts and rising premiums,” Winterflood’s analysts noted.
“44 per cent of funds generated share price total returns of 20 per cent or more, while only 16 per cent saw negative returns.”
Nevertheless, Winterflood has made a number of changes to its model portfolio at the start of 2019, with 13 trusts making way for 14 additions.
There were several changes to the UK equity portion of the portfolio, with the first being the switching of Mark Barnett’s Perpetual Income and Growth for Alastair Mundy’s Temple Bar Investment Trust.
The firm highlighted the poor performance of Perpetual Income and Growth in recent years and the need for an extended period of outperformance before shares re-rate.
While the trust should benefit from a recovery in UK stocks, the firm said Temple Bar would offer exposure to UK domestic, value-orientated names.
Performance of trusts over 3yrs
Source: FE Analytics
Another change in the UK equity space involved swapping Aurora Investment Trust for Alex Wright’s Fidelity Special Values. Winterflood analysts noted the volatility of the former’s share price and stock-specific risk given the highly concentrated nature of its 15-strong portfolio.
As such, the firm added Wright’s Fidelity Special Values, which follows a similar value/contrarian approach but is more diversified with 90 holdings and a greater exposure of mid- and small-caps.
In addition, Schroder UK Public Private Trust – formerly known as Woodford Patient Capital – exited the model portfolio following a tough year for the trust performance-wise and the replacement of veteran investor Neil Woodford as manager.
In the international equities space there were also a number of changes.
Although a strong performer, the firm opted to add Zehrid Osmani’s Martin Currie Global Portfolio to its list of trusts following a repositioning that sees the fund focus on undervalued growth stocks.
“Performance has been good and we could see the fund growing through issuance given its zero discount policy,” he said.
Instead, the firm is backing Henderson Euro Trust, which has performed well under new lead manager Jamie Ross who took over as sole manager n February 2019 following Tim Stevenson’s retirement – although Ross has worked on the trust since September 2018. In addition, it trades at a wider discount than the peer group.
Performance of Henderson EuroTrust under Ross
Source: FE Analytics
Another switch occurred in the North American part of the portfolio, as the firm replaced North American Income Trust for JPMorgan American, having been impressed by new managers Jonathan Simon and Tim Parton.
“In our opinion, the new approach represents a more actively managed strategy than was previously the case and allows the fund do benefit from the stockpicking abilities of two experienced managers, while essentially negating their style biases,” the Winterflood analysts noted.
Another change saw Baillie Gifford Japan enter the portfolio in place of JPMorgan Japanese, as the former trades at around net asset value (NAV) to offer an attractive entry point and boasts a strong track record.
Both Schroder Asian Total Return and BlackRock Frontiers were trading at premiums to NAV prompting the switches into Asia Dragon and TEMIT.
Specialist and alternative strategies
Among the specialist and alternative strategies part of the portfolio, Winterflood also made several changes.
“These funds are managed by the same well-resourced team but the latter offers a larger, more liquid vehicle, with a broadly comparable yield,” they noted.
It also added the Aberdeen Diversified Income & Growth trust – a multi-asset strategy with an absolute return objective – overseen by Mike Brooks and Tony Foster.
Finally, the firm added to its fixed income holdings in the portfolio with the addition of BioPharma Credit, which at 7.1 per cent offers an attractive yield and an entry point for investors with the trust trading at around NAV levels.
Discount/Premium of BioPharma Credit over 5yrs
Source: FE Analytics
“The fund has performed well since launch, generating an annualised NAV total return of 7.5 per cent,” Winterflood analysts noted. “This is below its medium-term target of 8-9 per cent but includes the initial investment period.”
Kleinwort Hambros’ Mouhammed Choukeir looks at events that the market doesn’t expect to happen but are entirely in the realms of possibility.
Brexit negotiations ending up a roaring success, Donald Trump losing November’s election and Russia flexing its geopolitical muscle more than anyone could expect are some of the events that are entirely possible but are being ignored by the market.
This the view of Mouhammed Choukeir, chief investment officer at Kleinwort Hambros, in his annual ‘Tails of the Unexpected’ report – which looks at each year’s unlikely, but feasible, events not priced by markets.
“Markets are exquisitely unpredictable and, each year, events – financial, economic, geopolitical or otherwise – occur which few see coming, but cause powerful ripples to the prices of securities,” he said. “Instead of consensus-tinged forecasting, we continue an annual tradition of exploring what unlikely but feasible events are not priced by markets in the year ahead.”
Below, Choukeir highlights five potential events, examining what the consensus view is not pricing in, the possible market reaction and how they relate to Kleinwort Hambros’ portfolio positioning.
Currency markets are pricing in another bumpy year of negotiations between the UK and the European Union, as shown by fizzling out of the post-election rally in sterling. The pound has fallen from the $1.35 it hit in the immediate reaction to the election, as the market realised that this is the start of the country’s negotiations with the EU, not the end, and that trade talks could potentially last for years.
However, Choukeir said: “The consensus may not be pricing in sheer exhaustion. Most minds are anchored by the recency bias of the last three years, where much ‘noise’ has been generated by missed deadlines and crossed ‘red lines’.
Performance of sterling vs US dollar since Brexit referendum
Source: FE Analytics
“However, following the original referendum, and now a general election, it is clear most British people want to leave. Most Europeans want this over with too, with little appetite for ‘punishing’ the UK at the cost of prolonging the morass.
“And while trade deals usually take longer, a negotiated settlement may be easier in this instance given near-identical starting positions on many rules and regulations. It also gives the UK the ability to cut taxes and regulatory red tape, actually breathing life into the idea of the ‘Singapore on the Thames’.”
Under this scenario, sterling could hit $1.75 and €1.55 as Brexit happens faster than the market expects, while domestically focused UK stocks such as mid-caps rally hard. But government bonds may sell off aggressively as investors dump safe-haven, low-yielding assets and invest in riskier ones.
In its strategies, Kleinwort Hambros has a net bias to risky assets and an overweight to UK equities. It has also hedged part of its US equity positions and all gold holdings against a rise in the value of sterling.
Although few commentators are expecting a recession in 2020, not many are forecasting an economic boom either and the consensus is for “yet another year of slow, meandering economic growth across the world”.
Kleinwort Hambros noted that this is largely down to depressed manufacturing output and poor capital expenditures by corporates unwilling to invest, especially while the US and China have a tense trade relationship.
“US and Chinese negotiators appear to have closed a ‘phase one’ trade deal. They are also strongly incentivised to complete ‘phase two’ given the US election year on one hand and a Chinese social contract predicated on growth on the other,” the firm said.
“Moreover, while economies will continue to receive powerful support from central banks, there also is evidence fiscal policymakers will be more active – this could prove a game-changer. Far from a recession, global economies may well re-enter expansion mode from the current ‘slowdown’ stage.”
If this is the case, global GDP could jump to around 5 per cent while risky assets such as equities and high yield debt would perform well. Kleinwort Hambros said it does own some defensive assets that would suffer in this scenario but does have a risk-on stance in general.
Private equity has enjoyed a strong run over the past decade, in terms of capital raised and deployed as well as the distributions back to investors. Total buyout value jumped 10 per cent at the end of 2018 to hit $582bn (including add-on deals) globally, marking the strongest five-year run in the industry’s history; many have expectations that private equity will deliver high double-digit returns.
“Low interest rates and steady GDP growth in the US and Europe have helped the industry, but the real juice in returns has come from selling assets acquired at cheap valuations in the years after the great financial crisis at much headier multiples now,” Choukeir said.
Performance of average private equity trust over 10yrs
Source: FE Analytics
“This thunderous recent performance has diverted waves of new liquidity towards the asset class: a decade ago, a $1bn fundraise would have been notable; today, some funds raise more than $100bn. Dry powder, or capital which is raised but not yet spent, is above a record high of $2trn. This has led to a transformed landscape: PE firms are forced to deploy ever more money not only at richer valuations, but also on increasingly speculative underlying investments. This is a dangerous convergence of factors.”
If there were a disorderly wind-down of some large private equity funds, Kleinwort Hambros believes the wider impact would be quite limited as the asset class does not pose the same systemic risk as mortgage-backed securities did in 2008. However, it could still create a risk-off environment that would see assets like high-yield bonds suffer, while a fall in private equity valuations could cause a knock-on drop in publicly traded companies.
Kleinwort Hambros thinks the coming decade will be more challenging than the past one for private equity returns, adding “2020 may well be the year the unravelling begins”. With this in mind, the investment house has no exposure to private equity in its flagship portfolios and “remains vigilant” about valuations in public equity markets.
If the bookies are to be believed, Donald Trump has just over a 50 per cent chance of winning this year’s presidential election. History suggests that prevailing economic conditions are the most important factor for an incumbent president seeking re-election and Trump has a lot in his favour in this regard: unemployment is at a record low, wages are rising briskly and the Federal Reserve says there is just a 25 per cent chance of a recession in 2020.
“Usually, established Western democracies see policies tilt between ‘centre-left’ and ‘centre-right’. This time may well be different, with a Democratic victory predicating a substantial leftward lurch in public policy and thus a big increase in current taxes,” Choukeir added.
“Remember, president Trump slashed corporate taxes dramatically in 2017; a return to even the pre-Trump status quo will cause post-tax corporate earnings to contract.”
If the Democrats were to win the election, then there would be substantial rise in corporate taxes no matter who their candidate is – which would cause a contraction in US corporate earnings and lead to a sell-off for US equities, with the strong chance of this spreading to global markets. Investors would likely rotate into government bonds, causing their yields to fall.
Kleinwort Hambros noted that government bonds offer poor value in absolute terms at present, although it regards them as essential in helping to risks from equities and other risk-assets in multi-asset portfolios. However, in a global sell-off the firm would look to reallocate back into equities “when valuations are cheap, momentum turns positive and sentiment is still oversold”.
The consensus view is that 2020 will be another year of range-bound oil prices. Choukeir pointed out that even the assassination of Iranian general Qasem Soleimani in early-January only caused an increase of around 5 per cent in the oil price.
“When it comes to oil prices, many focus on the Middle East. However, Russia may actually be the swing factor,” the chief investment officer said.
“In the last decade, Russia has unshackled itself from its post-Cold War funk and reasserted itself on the global stage in a major way: Ukraine’s annexation; critical backing for the Syrian and Iranian regimes which has tilted the balance of power in the Middle East; US general election interference in 2016; alleged assassination attempts of former spies, including in the UK; huge African investments, and thus influence.
“Much of this would have been unthinkable in 2010. At the start of 2020, a strategic attack on a missile bunker in the Baltics or similar is also unthinkable, but that is why it’s not priced in. The risk is also heightened as the US president will be under huge pressure in an election year to ‘rectify the sins’ of Russian interference in 2016.”
Price of Brent crude over 10yrs in US dollars
Source: FE Analytics
Kleinwort Hambros said the potential market reaction of Russia and Nato looking like they are the brink of an armed conflict could be significant, given that Russia produced about 11.4 million barrels of oil per day in 2019, accounting for 11 per cent of world output. Any threat to this could cause oil to shoot to $150 a barrel, creating a spike in headline inflation.
Meanwhile, equities would sell-off but any safe-haven rally in bonds would be crushed by soaring inflation. Gold, however, “would go through the roof”.
Choukeir concluded: “We have all been dulled by the constant cacophony of geopolitics. Indeed, there is much evidence that it tends to be a red herring in terms of risk allocations and thus best ignored for asset allocation purposes.
“However, it certainly impacts certain markets, such as commodities, if they’re directly in the line of fire (pun intended). We have a large allocation to gold particularly to help insulate portfolios somewhat in the event of such ‘black swan’ events.”