Trustnet takes a closer look at the IA Targeted Absolute Return sector to find out if the strategies managed to live up to their names in 2019.
After a disappointing 2018, the IA Targeted Absolute Return sector saw a vast improvement in performance last year with almost nine out of 10 strategies in positive territory.
Absolute return strategies have come in for much criticism in recent years as investors have increasingly questioned their mediocre performance against a backdrop of rising markets.
This has translated into outflows more recently with £4.5bn being pulled out of the sector during the first 11 months of the year, according to the Investment Association.
But last year the sector seemed to live up to its name as its average member made a gain of 4.38 per cent. However, it should be noted that the sector is home to a broad range of strategies, making such broad analysis challenging.
More detailed research by Trustnet found 86 per cent of the IA Targeted Absolute Return sector’s constituents made a return above zero in 2019, with just 17 of its 120 members posting a loss.
This marked a sharp turnaround from 2018, when just 16 per cent of total funds made a positive return.
As the below table shows, the percentage of the peer group recording positive returns last year was in line with 2017 and previous calendar years. These figures include funds from the sector that have since closed or been merged away, to avoid survivorship bias.
Source: FE Analytics
So, what made 2018 such a difficult year for absolute return strategies?
Adrian Lowcock, head of personal investing at Willis Owen, said that 2017 and 2019 were “very different markets” and, as such, he found it interesting to note that performance levels were similar.
However, Lowcock (pictured) noted that performance was about more than just the strong performance of equity markets last year, given the broad range of strategies that call the sector home.
Instead, returns often reflect the managers’ ability to successfully forecast geopolitical events and economic growth and how they impact asset classes, the fund picker said.
“It is naturally easier to make money if asset classes are rising but that might disguise risks that the sector is taking and doesn’t show whether they are delivering the protection, which is a very significant part of the proposition,” he explained.
“The geopolitical situation in 2018 was very difficult to predict, events such as Brexit were high-risk binary situations. Likewise, investors were still trying to understand Donald Trump and trying to predict his next tweet was even riskier.
“In such situations, it was hard to make big calls.”
Tom Sparke, investment manager at GDIM Discretionary Fund Managers, said that his first instinct when considering the research was to look at the impact of equity beta on performance.
Sparke explained: “2017 and 2019 were excellent years for equity markets so it follows that a correlation with equity markets may be a factor.
“The overall IA Targeted Absolute Return sector has a correlation with stock markets – using the MSCI AC World index - of 0.67 and only 16 of the 100 funds with a three-year track record in the sector have a negative correlation to stocks.”
Correlation chart of funds relative to MSCI AC World over 3yrs
Source: FE Analytics
He added: “Many of the absolute return funds toward the highest end of this scale are unashamedly equity-based. Therefore, as equity markets fell at the end of 2018, many of these funds moved down with them instead of protecting capital in these times.”
Sparke (pictured) highlighted funds such as Threadneedle Dynamic Real Return and Smith & Williamson Defensive Growth and Brooks Macdonald Defensive Capital that had high correlations to the MSCI AC World index.
With a score of 1 signifying that a fund has moved completely in line with the index, the Threadneedle fund had a figure of 0.91, while both the Smith & Williamson and Brooks Macdonald both had correlation figures above 0.8. (A correlation of -1 suggests that fund and index have moved completely in opposition to each other.)
Despite the seemingly high correlation with equity markets, Willis Owen’s Lowcock said there are still some strategies worthy of investors’ consideration in the sector.
The first he highlighted was the £6.4bn BNY Mellon Real Return fund managed by Aron Pataki, Suzanne Hutchins and Andy Warwick. Its first priority is capital protection and returns of 4 per cent above per annum over the long term.
“The team runs an unconstrained and flexible approach which initially uses Newton's thematic research to identify opportunities,” said Lowcock. “The fund invests in two parts: a core element which invests in shares and bonds with a long-term perspective and low turnover.
“Around the core they invest in cash, government bonds and derivatives in order to reduce risk. The underlying portfolio is composed of traditional shares, albeit with significant flexibility in asset allocation.”
Performance of fund vs benchmark over 3yrs
Source: FE Analytics
Over three years to 21 January, the fund has made a total return of 16.66 per cent compared with a 14.36 per cent gain for its LIBOR GBP 1m +4 per cent benchmark. It has an ongoing charges figure (OCF) of 0.8 per cent.
“They aim to add value through long-term fundamental research and via shorter-term trading opportunities,” said the Willis Owen fund picker.
“They take long positions in firms that can deliver earnings growth in excess of market expectations over the medium and long term while shorting stocks where earnings are priced in or where the terminal value is impaired.
“The approach is implemented within a set of risk limits that provide the managers with significant flexibility.
Janus Henderson UK Absolute Return has made a total return of 5.86 per cent over the past three years and has an OCF of 1.05 per cent.
AVI’s Joe Bauernfreund says shareholder returns used to come well down the list of priorities for companies in Japan – which is evident from the widespread use of “poison pills”.
Japan has a “poison pill” problem – but addressing this issue could create another tailwind for a region that has been neglected by investors for far too long.
This is according to Joe Bauernfreund (pictured), manager of the AVI Japan Opportunity Trust. AVI as a group is interested in cheap, overlooked and inefficient areas of the market and Japan has long ticked all of these boxes.
However, the manager said it was the implementation of Shinzo Abe’s Abenomics programme, and specifically the third arrow, which focuses on corporate reform, that convinced the group to open the AVI Japan Opportunity Trust.
“The mechanism through which Abe deals with corporate reform is the corporate governance & stewardship code which was implemented four or five years ago,” said Bauernfreund.
“It specifically targets the idle cash sitting on companies' balance sheets, encouraging them to do something productive with it or return it to shareholders so that they can spend it and drive the animal spirits in the economy that way.
“Finally, it appeared to us that not only did you have a cheap market, but you had a catalyst in place to try and unlock that.”
Bauernfreund said an important aspect of the code is that it encourages foreign and domestic shareholders to engage proactively with companies to encourage them to implement among other things, a stronger focus on shareholder returns.
While it may sound strange that investors would need to ask directors to focus on shareholder returns, the manager said that this used to come well down the list of priorities in Japan.
“The objective of most companies in Japan was to build up a cash pile for a rainy day, so they never had to go through that existential crisis that they endured in 1989 to 1990 when that bubble burst,” he continued.
“It was also to employ as many people as possible and keep them in employment and pay them a pension when they retired.
“And it was to make a positive contribution to society so, as a nation, they could be proud of what they achieved. Shareholders came very last in that pecking order and Abenomics is about changing that.”
Bauernfreund said Japan has already made enormous progress, with return on equity ticking up, the majority of companies hiring independent directors and share buybacks doubling from 2018 – which was itself a record year.
However, he said there is still plenty more to be done before companies in Japan reach the standards of their peers in the west, with the manager pointing to portfolio holding Fujitec as an example.
Fujitec is one of the world’s top-10 elevator manufacturers, selling to customers in Japan, China, south-east Asia, North America and Europe. Bauernfreund said the most appealing aspect of Fujitech’s business is the maintenance contracts that it receives after the installation of an elevator. These last for decades, producing steady, recurring profit.
The company has been the third biggest contributor to AVI Japan Opportunity’s performance since the trust’s launch and is expected to deliver 15 per cent profit growth for the year ahead.
Yet while its peers trade on EV/EBIT (enterprise value-to earnings before interest and tax) multiples of 20x, Fujitec is on just 8x.
“But if you look at its balance sheet, the reason becomes clear,” said Bauernfreund.
“One third of Fujitec’s balance sheet is allocated to low-yielding cash and investment securities, which account for 46 per cent of Fujitec’s market cap. These contribute little to profits and are valued at a heavy discount by the market.
“That creates this sort of impediment to full value realisation.”
However, Bauernfreund said there is “another sting in the tail” when it comes to the low valuation, which brings him on to the subject of the poison pill.
“Ten or 15 years ago, an American investor had a stake in Fujitec and wanted to take it over, so the company, like many Japanese companies, put in place a ‘poison pill’,” he explained.
“The poison pill essentially prevents anybody who is unwanted from making a bid for a company at risk of being diluted down to zero.
Bauernfreund said that poison pills have come under attack under the new era of more stringent corporate governance, with many companies eliminating them. However, Fujitec managed to win support from the majority of shareholders to keep it in place.
“Our angle with Fujitec is that you have a very high-quality business that is very undervalued because of its balance sheet, and because of the poison pill,” the manager continued.
“We are working with the managers in a constructive way to try and get the share price up to fully reflect the value – they fully appreciate that the company is undervalued.
“They don't want to be taken over by a foreign entity, they would rather not be taken over by a Japanese entity either.
“But they recognise that within the next couple of years, when the vote comes up again from shareholders, they are likely to come under increased pressure to eliminate the poison pill.
“So they have a job to do.”
Data from FE Analytics shows AVI Japan Opportunity has made 14.78 per cent since launch in October 2018, compared with gains of 11.73 per cent from its IT Japanese Smaller Companies sector.
Performance of trust vs sector since launch
Source: FE Analytics
The trust is trading at a premium of 3.56 per cent to net asset value (NAV) compared with 2.89 per cent from its one-year average.
It is 10 per cent geared and its management fee is 1.0 per cent of either the market cap or NAV, whichever one is lowest.
David Absolon, investment director at Heartwood Investment Management, considers how the power of central bank stimulus in stimulating the economy might be waning.
Central banks have tremendous influence over financial markets. To understand this, we need to understand not only what central banks are, but also their designated role in the economy.
What do central banks do?
Central banks are national organisations in charge of conducting monetary policy (the regulation of interest rates and the money in circulation), such as the Bank of England, the European Central Bank, and the US Federal Reserve. As theoretically independent bodies, they are also responsible for regulating the nation’s banking system and providing other financial services.
The common goal of all central banks is to foster economic stability within their own region. As part of this aim, most central banks aim to keep domestic inflation at low but positive levels – usually around 2 per cent over the medium term. This should keep consumer prices under control while also encouraging gently rising wages (themselves usually a sign of a high employment levels). However, some central banks have other specific mandates too. For example, the US Federal Reserve has a dual mandate of 2 per cent inflation alongside low unemployment, as part of wider curator’s role within the economy.
How do central banks impact the economy?
Central banks impact the economy when they take action to control levels of liquidity (in effect, the total amount of money) in the financial system.
In doing so, they have a number of levers to pull. The most publicly visible is the setting of interest rates, providing a guide for other financial institutions’ rates when issuing loans, mortgages and bonds. If inflation looks too high, the central bank can raise interest rates, slowing spending and growth rates; if inflation looks too low, the central bank can lower interest rates to incentivise spending and stimulate the economy.
What influence do they have over investment markets?
In the wake of the financial crisis in 2008, central banks worked hard to boost the beleaguered global economy. This meant slashing interest rates (in some cases to negative levels and record lows) in an attempt to bring down the cost of capital in the global economy, making it cheap to borrow and spend, and aiming to give a shot in the arm to production and employment.
Central banks also pulled a second lever, embarking on massive asset purchase programmes known as quantitative easing (QE). This involved buying large amounts of ‘safe haven’ assets like government (and later corporate) bonds, lowering the yields on these assets and pushing investors into more adventurous areas of the market in search of returns. Some of these quantitative easing schemes have simply been replaced by new ones upon expiry, as in Europe, leading to a ballooning total amount of assets held by central banks since the financial crisis. At the end of 2000 (some years before the crisis), the largest three central banks in the world combined owned around $1.3trn of publicly-traded assets. Today, this figure is closer to $13trn.
How has this altered the investment landscape?
Since the financial crisis, central banks have become one of the largest institutional holders of public market assets. This means that they have more capacity to impact market prices than ever before, leaving other investors somewhat at the mercy of their policies.
Interest rate cuts across the developed world have also led to an unprecedented spate of negative-yielding debt, with global levels skyrocketing from $6trn in October 2018 to peak at a record-breaking $17trn over the summer. Given that this means lenders (i.e. bond market investors) are effectively paying borrowers (governments and businesses) for the privilege of giving out their capital, if these bonds are held to maturity, this is a truly staggering place in which to find ourselves.
There is also some evidence to suggest that central bank activity over the past decade has led to unintended societal consequences: post-2008 policies may have disproportionately benefited the wealthy, in turn fuelling a rise in populist voting patterns. This has led to extremist political agendas finding their way into mainstream economic discourse, including a growing wave of protectionist policies on the right, as well as drives for (re)nationalisation of private assets on the left.
Can central banks maintain their power?
Central bank policymakers (particularly in Europe) are increasingly calling on governments to enter the fray and begin spending to aid economic growth. If this materialises in earnest – particularly from economic powerhouses like China and Germany – it would almost certainly mean a boost for investment market sentiment.
In the meantime, global growth is slowing, and with already record-low interest rates, central banks have limited traditional weaponry left in their arsenals. Their potential to adapt should not be underestimated, and governments may yet step up. However, given the sheer volume of assets purchased in recent years, investment markets are understandably questioning just how much firepower the central banks have left in this already very long period of economic expansion, and how effective they can be in tackling the next crisis. Only time will tell.
David Absolon is investment director at Heartwood Investment Management. The views expressed above are his own and should not be taken as investment advice.
The JPM Global Macro Opportunities fund has started looking at the impact that government and corporate responses to climate change is having in the market.
The surging attention on the global climate crisis and how the world needs to address this with urgency is creating a powerful investment theme, according to the team behind the £1.4bn JPM Global Macro Opportunities fund.
Last year was one when climate change was brought into sharp focus, with Swedish environmental activist Greta Thunberg becoming a household name, protests from the likes of Extinct Rebellion garnering much attention and the media covering the issue in depth.
This came against a backdrop where the real effects of climate change were all too easy to see around us. The World Meteorological Organization has confirmed that 2019 was the second hottest year on record after 2016, exacerbating problems such as wildfires and extreme storms.
These factors mean that an investment theme has emerging in how the world’s governments, companies and individuals respond to the challenges of climate change, said JPM Global Macro Opportunities manager Shrenick Shah.
Source: JP Morgan Asset Management, NASA Goddard Institute for Space Studies
The fund’s approach seeks to identify market mis-pricing of macroeconomic trends, with themes such as ‘widespread technology adoption’, ‘maturing US cycle’, ‘emerging market convergence’, ‘China in transition’ and ‘Japan beyond Abenomics’ currently being at play in the portfolio.
At the start of 2020, one new theme – ‘climate change response’ – was added. As well as JPM Global Macro Opportunities, it can also now be found in the other multi-asset mandates run by Shah and his team.
“The evidence is clear that global temperatures are rising and we can see that, as we stand today, average global temperatures are roughly one degree above the mid-20th century average,” the head of JP Morgan’s macro strategies team explained. “The evidence is also clear that this acceleration in temperature is due to greenhouse gases coming from human activity.”
The Paris Agreement, which was adopted by 187 members of the United Nations Framework Convention on Climate Change, aims to strengthen the global response to the threat of climate change by keeping a global temperature rise this century “well below” two degrees Celsius above pre-industrial levels. It also encourages countries to even further limit the temperature increase to 1.5 degrees Celsius.
The only significant emitters which are not parties to the Paris Agreement are Iran and Turkey, although the US is scheduled to pull out if Donald Trump wins the 2020 presidential election.
But Shah said the Paris Agreement’s aim to make governments responsible for taking action to addresses the impact of increased levels of greenhouse gases will have far-reaching effects.
“While progress has been slow, what’s increasingly drawing our attention is that the rate of response from governments – in particular through legislation – is accelerating quite quickly,” the JPM Global Macro Opportunities manager said.
Source: JP Morgan Asset Management, UN Principles for Responsible Investing
“When you overlay that with last year being a year clearly where public awareness with regards to climate change increased dramatically, the confluence of those two factors is going to accelerate quite quickly the rules and regulations, in particular in Europe, surrounding climate change.”
The FE fundinfo Alpha Manager highlighted the UK government’s pledge last year to bring all greenhouse gas emissions to net zero by 2050, making it the first major economy in the world to pass laws to end its contribution to global warming. He expects other governments to follow, which would create opportunities for investors.
“It’s clear that businesses, in light of the new legislation and developing attitudes, are going to have to shift their strategies somewhat,” he said. “In some sectors, business strategies are going to have to change quite significantly.”
A good example would be power generation as this sector is a major contributor to greenhouse gas emissions and legislation coming into force will push companies in the space to think about new ways of generating electricity.
This was seen recently in Germany, where the government and regional leaders last week agreed to phase out coal-fired power stations by 2038. The country already has over 250,000 people working in renewable energy, significantly more than are in its coal industry.
Shah said: “The companies that are ahead in this transition, the companies that are investing in renewables in the power generation sector, are already getting rewarded by markets.
“This is an important point: financial markets have a tendency to bring forward very quickly into the prices of securities actions that are going to be undertaken in the next five to 10 years. As we see an increased focus on these actions, price moves that are in response to climate change responses from the various agents are going to take place in financial markets sooner rather than later – and this is exactly where we see opportunities.”
There are other areas of opportunity within JPM Global Macro Opportunities’ ‘climate change response’ theme, with a notable one being consumer staples.
Consumer preferences appear to be changing to have a greater focus on sustainability, such as avoiding single-use plastics, and companies that are able to shift their product mix to reflect this are likely to be “winners in their space”. The manager highlighted Nestlé, which is a holding of the fund, as a consumer staples name that is doing this.
In addition, the fund is looking for opportunities to short the losers under its ‘climate change response’ team. An area of focus here is energy stocks, which are also seeing their cost of capital increase as banks and capital markets become less willing to fund oil and other ‘dirty fuel’ projects.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Shah has managed JPM Global Macro Opportunities since its launch in February 2013. Over that time, it has generated a total return of 54.90 against 17.17 per cent from its average IA Targeted Absolute Return peer. However, it has also been significantly more volatile than the sector owing to its ambitious return target.
The team at FE Investment said: “Although the fund has a higher objective than its absolute return peers (cash plus 7 per cent), we believe the team has the capacity to reach it. There is a strong focus on risk management as JP Morgan is one of the leading experts in this field, so we believe investors benefit from advanced risk management strategies.”
JPM Global Macro Opportunities has an ongoing charges figure (OCF) of 0.66 per cent.
With some investors getting jittery about market in 2020, Aberdeen Standard’s Gerry Fowler considers whether now is a good time to hold cash.
With a great deal of geopolitical uncertainty and some market headwinds still unresolved, it might be tempting for some investors to take some risk off the table and hold cash instead.
Aberdeen Standard Investments’ Gerry Fowler said 2019 was a more positive year for markets than initially anticipated with the Q4 rally coming after months of macropolitical uncertainty that created a drag on markets.
But there are still potential issues in the year ahead.
Looking at developed market bonds, Fowler said it’s hard to find any that give a yield above 2 per cent. Meanwhile, equity valuations are “as high as they’ve ever been since the 2000 bubble”.
“After a dramatic slowdown in global growth in 2019, we don’t hold out much hope that stronger growth will save the day.
“Perhaps it’s no surprise then, that investors are worried about their money this year and have been piling into money market funds,” he added, noting recent investor surveys by Bank of America Merrill Lynch showing increased cash holdings.
Inflows into money market funds from 1990 to now
Nevertheless, the multi-asset strategist noted that over the past 40 years “there have been only five calendar years when holding cash has been better than investing in either bonds or equities”, for US investors at least.
And 2019 was not a year where it was better for investors to hold cash, said the multi-asset strategist – given the “robust” performance from equities and bonds.
Whilst cash definitely has a role in investors’ portfolios, Fowler said that there are four reasons why they might actually be making a mistake by piling into cash now.
Real interest rates are negative
Interest rates were a major story in 2019, with the US Federal Reserve reversing its programme of policy tightening and interest rate hikes amid investor growing anxiety. The Fed made three rate cuts during the course of last year but wasn’t the only institution to act.
However, positive real interest rates have been important for holders of cash in each of the five years when they beat bonds and equities.
“In 2019, global central banks collectively made 80 interest rate cuts and pumped over $400bn into the world’s financial system reducing cash returns to negligible, sub-inflation levels across developed markets,” Fowler said.
“With such an abundance of cheap money sloshing around, we don’t expect real interest rates to be positive in any major economy in 2020.”
Indicating that the conditions are not right for cash to beat out bonds and equities again.
There’s always a good investment somewhere
Fowler said his historical analysis of cash versus bonds and equities only relates to US assets, suggesting that investors might be able to put their cash to good use elsewhere around the world rather than sitting in the bank earning only low levels of income.
“For example, emerging market bonds currently provide a yield of around 5 per cent,” he said. “Yields on comparable developed market government bonds are much lower: under 2 per cent in the US, around 0.5 per cent in the UK and negative in many European countries.”
“Emerging market debt is one of several strategies we like that potentially offers an attractive trade-off between risk and return.”
If nothing’s going up, go short
For investors that are worried that assets are about to lose value, there is a simple solution: go short.
Just as it’s now easier for investors to access different markets they can also access alternative investment processes “able to deliver positive returns irrespective of whether markets are rising or falling”.
“To achieve this, so-called ‘absolute return’ funds manage investment risks more precisely and use all investment tools and techniques available,” he said.
“This includes taking short positions that make money when an asset price falls.”
However, it is worth noting that absolute returns do still carry a range of risks and are not a guaranteed investment option as their name is sometimes mistaken for.
Put your cash to work
While holding cash may feel secure, the multi-asset strategist said, “in reality it comes with three insidious effects”.
“It is eroded by inflation, which, despite currently being low, soon adds up,” he said. “There is the opportunity cost of the returns that you might have had, if you had been invested. Most significantly, there is a timing risk when you do decide to put the money to work.”
Fowler concluded: “As others put their cash to work before you, they drive up asset prices, making your decision to invest more risky – there is a cost to being last.
“As we enter a year when real interest rates are negative, cash may soon become a hot potato.”
With valuations at extreme levels, Sue Noffke and Andy Brough explain how they’re looking at the UK stock market heading into 2020.
A group of shares can rise simply because investors view them more favourably, without any corresponding change in near-term prospects. Collectively, investors ascribe a higher value to the group.
The chart illustrates how UK growth stocks are being ascribed a high value relative to value stocks. It compares the price-to-earnings ratio (a commonly-used valuation metric) of these two groups. On this basis, growth stocks are being valued almost twice as highly as value stocks, which is significantly above the average valuation premium shown by the green line.
However, these distortions will not last forever. If monetary policy has indeed been stretched to its limits, then fiscal policy and economic restructuring will likely be turned to in order to lift economic activity.
Financial markets may see this as a trigger for rising inflation and higher interest rates. This would likely be supportive to the outperformance of lowly-valued value stocks over their growth counterparts.
Bias towards more lowly-valued stocks
A resolution of the Brexit stalemate may also be positive for UK value stocks. These include domestic banks, property companies, housebuilders, consumer discretionary areas (general retailers and leisure companies), food retailers, media agencies and utilities.
Accordingly, we have a slight bias towards more lowly-valued stocks at the moment, where we can still find equities that are not priced for perfection.
It is not certain that the UK general election on 12 December will help break the Brexit stalemate. But in any event, as a stock picker I embrace mispriced opportunities which arise during such periods of uncertainty (for details, see Why as an investor I’m looking through Brexit fears).
Private equity (PE) and PE-backed buyers are finding a disproportionate amount of opportunities in the UK. There has also been an ongoing stream of bids from overseas businesses for UK-quoted companies. For a detailed explanation of these trends see: Who’s buying UK shares and what does it tell us?).
At a time when the majority of the market is uninterested in UK equities, we share the opinion of these other large and experienced long-term investors and recognise the valuation opportunities.
Andy Brough, Head of Pan-European Small and Mid Cap Team:
UK small and mid-cap (SMID) shares have outperformed other areas of the stock market over the long term. We expect this trend to continue.
The recent pick-up in UK mergers and acquisitions (M&A, the buying, selling or combining of companies) is particularly focussed on SMID companies. In the past they have attracted a relatively greater part of the M&A pie, a trend that shows little signs of changing (see chart below).
In a rapidly-evolving world, SMID companies are generally better able to capitalise on new opportunities as they tend to be more dynamic, and have a smaller base than their large counterparts have from which to achieve growth. M&A activity helps make room for the next tranche of exciting small company shares to emerge.
This dynamism is perhaps best underlined by the ever-changing constituent list of the FTSE 250, which we refer to internally as the “Heineken index” given its potential to “refresh” a portfolio in a way large cap companies struggle to do.
Overlooked and misunderstood
Often referred to as the market’s “second tier”, the FTSE 250 is the next most established group of shares quoted on the London Stock Exchange outside of the FTSE 100. It has returned 520% over the past 20 years versus 136% from the FTSE 100 (total returns 31/10/1999 – 31/10/2019, source: Thomson Reuters Datastream).
The FTSE Small Cap index, home to some of the smallest companies, has returned an equivalent 253%.
The pick-up in M&A this year is also telling on another level. A number of SMID companies on the receiving end of bids have been domestically focussed. These include UK pub operators Greene King and EI Group plus smaller peer Fuller Smith & Turner, which sold its brewery (of London Pride acclaim) to Asahi of Japan.
Other examples include Dairy Crest (snapped up by a Canadian peer), Telford Homes (bought by American real estate firm CBRE) and Hull broadband provider KCOM, acquired by Australian investment business Macquarie.
This suggests that the value which can be found in spurned UK domestic quoted stocks relative to an equity market which has reached historic highs has not gone unnoticed by all market participants.
Resilient UK economy
October’s “Brexit bounce” gave a taste of what might happen should sentiment improve – the share price recoveries of investment trusts invested in UK SMID companies were particularly pronounced. Such trusts tend to have a greater exposure to UK domestically focussed shares than their large cap equivalents do.
During periods of market stress, sentiment towards UK domestically focussed shares is prone to becoming excessively negative. This happened last winter (for details see Death of the High Street? Why we’re still backing UK retail). Backers of shares such as petcare specialist Pets At Home, homewares retailer Dunelm and athleisure leader JD Sports (since promoted to the FTSE 100) have done well in 2019.
We take comfort that the UK economy is not in dire shape. Recently released data from the Office for National Statistics show that growth in household spend (three quarters of all spending in the economy) has continued in 2019. It would also appear to us this growth is reasonably sustainable, underpinned by a strong jobs market, real wage growth and lower taxes.
You can read and watch more from our 2020 outlook series here
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Trustnet discovers which managers have responsibility for the most open-ended funds and investments trusts.
Close to 30 fund managers are currently working on 10 or more different portfolios, research by Trustnet shows, with one running 23 funds at the moment.
According our data, there are just over 3,500 named individuals and teams working across 4,539 strategies in the Investment Association and Association of Investment Companies universes. But, obviously, there’s more to it than each fund having 1.3 managers running its money.
In this article, we reveal the individual managers who have their names attached to the most funds and trusts today. Of course, that’s not to say that this is a problem in any way – as some of the names on the list have generated strong returns for their investors over the years.
After teams were excluded, the individual fund manager working on the most portfolios is Ian Aylward, who is the head of manager and fund selection at Barclays Wealth and Investment Management.
Aylward is a named manager on 23 funds, serving as sole manager on three of them and lead manager on the other 20. He runs a team of 12 fund selectors that cover long-only equity, fixed income and liquid alternatives managers; this team runs a number of multi-asset and single-asset multi-manager portfolios for Barclays, as well as overseeing mandates with more than 70 third-party groups.
Performance of Aylward vs peer group composite since joining Barclays
Source: FE Analytics
The 23 funds that Aylward works on are found in many sectors, ranging from the multi-asset peer groups to IA UK All Companies to IA Global Bonds. Our data shows there is close to £4bn run across these portfolios, with the largest being the £539.4m Barclays GlobalAccess Global High Yield Bond fund.
Since Aylward was appointed to the funds in December 2016, four of the 23 funds have made top-quartile returns including the £445.5m Barclays GlobalAccess UK Opportunities fund.
Another four are in the second quartile while eight are in the third and six are in the bottom. The remaining fund is in the IA Property Other sector, where quartile rankings are not appropriate.
However, the funds have climbed up the rankings over more recent time frames with seven of them making first-quartile returns over one year and another nine sitting in the second quartile.
Source: FE Analytics
The above table shows all 27 fund managers that are named as working on an Investment Association and Association of Investment Companies portfolio, either as a lead manager, co-manager or deputy manager.
In second place is Kieran Doyle, who is a senior portfolio manager at BlackRock and works in the asset management house’s institutional index equity team.
Doyle works on 21 index trackers in the two investment universes covered by this research, with these funds running more than £70bn between them. The largest is the £11bn iShares UK Equity Index (UK) tracker, while another four funds run more than £5bn each.
In addition, the manager is named on another 13 funds that are domiciled in Dublin or Luxembourg and are listed in the offshore fund sectors.
Quilter Investors’ Paul Craig appears in third place with 18 funds with his name against them, including the £3.3bn Quilter Investors Cirilium Balanced Portfolio and £3.1bn Quilter Investors Cirilium Moderate Portfolio.
There are also some very well-known names on the above list, including Aberdeen Standard Investments’ Bambos Hambi – who runs the MyFolio fund ranges.
These fund-of-fund offerings have a strong following thanks to healthy risk-adjusted returns over the years, with the largest being the £3.8bn ASI MyFolio Managed III fund. Hambi runs more than £15bn across 15 funds, all of which reside in the IA Volatility Managed sector.
Performance of Hambi and Onuekwusi over 5yrs
Source: FE Analytics
Justin Onuekwusi, head of retail multi-asset funds at Legal & General Investment Management, is another popular investor and runs 16 portfolios with combined assets of £7.7bn.
These multi-asset funds are built from range of LGIM’s index trackers and have also generated strong returns in recent years.
Trustnet’s research also found that 2,191 managers are named on just one fund or trust, while 748 work on two. Some 271 work on three portfolios and 123 split their time between four.
The managing director said while Smith and Train are fantastic managers, “they’re not the only people in the world who have suddenly worked out how markets work”.
Investors should be careful not to assume Terry Smith and Nick Train have “cracked” markets, according to Charlie Parker, managing director of Albemarle Street Partners, who warns their habit of consistent outperformance is soon likely to be tested.
Smith and Train have been among the most consistent high achievers of the past decade – Train’s LF Lindsell Train UK Equity fund has beaten the IA UK All Companies sector average in every one of the past 11 years, while Smith’s Fundsmith Equity fund has outperformed its IA Global peer group in every full calendar year since inception in November 2010.
Performance of funds vs sectors since Nov 2010
Source: FE Analytics
However, while Parker (pictured) has exposure to both managers in his client portfolios, he has recently begun to trim his exposure to their funds in anticipation of a value revival.
“Every academic study shows quality adds value over the long term. I’m not arguing against that,” he explained.
“It’s just about whether it’s the only show in town. And at the moment when you go to IFAs, almost everything they own is quality growth, which removes a lot of earnings risk from those portfolios.
“But earnings risk isn’t the only thing that matters, price risk also matters, and a hell of a lot at that.
“All we are doing is saying have a bit of balance in your portfolios. We are not knocking Terry Smith or Nick Train or anyone else – they are fantastic managers – but they’re not the only people in the world who have suddenly worked out how markets work.”
Parker is not concerned about the liquidity in the portfolios run by Train or Smith and said it is unlikely they will make the same mistakes as Neil Woodford. Instead, he is more worried about the impact of a rise in long bond yields, pointing out the performance of these managers has correlated closely with the price of the instruments. He also pointed out that they are unlikely to change their process to accommodate a change in the backdrop.
“They won’t think like this at all,” he continued. “They will say, ‘just look at our companies and the strength of our companies’ and say everything else is noise. That’s fine. That’s how they think, that’s their process. Fund managers have got to have a framework for how they operate.
“But when I look at it, I can see the correlation. I can see the bond yields moving up, so I just want to provide some balance in portfolios.
“We’ll have to wait and see what the weather does. Nick Train is quite honest, he says, ‘yeah, it won’t carry on like this, but I still think it’s worth sticking with it’, which is not an unreasonable argument at all.”
Parker is playing the value theme through the Schroder Recovery, Jupiter UK Special Situations and Man GLG UK Income funds. While the disconnect between growth and value is wider in regions such as Europe, the managing director said a UK slant helps to dampen the risk in this trade due to the tailwind from greater political certainty – important because “value has been a graveyard of champions over the last five years”.
Performance of funds vs index over 3yrs
Source: FE Analytics
In a recent article published on Trustnet, the managers of the Scottish Mortgage Investment Trust rubbished the idea of a mean reversion from growth to value, with Tom Slater referring to disruption as “a more enduring and powerful force than people believe”.
Meanwhile, his co-manager James Anderson warned many of the companies and sectors investors are backing to benefit from a ‘value’ resurgence are more likely to be “physically destroyed”.
Parker said he has some sympathy with this view, pointing out that one of the biggest drawbacks of value investing in the investment environment of the past decade has been that it fails to account for the exponential growth in the take-up of new technology.
However, he said the problem now is that while quality growth and tech stocks have continued to get more expensive, every sector containing any value has been labelled “redundant”.
“A good starting off point for that analysis is the banks,” he continued. “If you’re saying that value will be disrupted out of all existence, you’re also saying you’re going to bet against Société Générale to maintain its foothold in French banking at a time where it’s got enough cash to buy pretty much any disruptive technology out there.
“This is the problem – I think every company has the opportunity to not be disrupted out of existence when it has cash.”
Mark Nash, head of fixed income at Merian Global investors, considers global markets in 2020 and the potential risks to the asset manager's outlook.
Our base case for 2020 is unchanged, looking for a global reflation dynamic to take hold that the bond markets are not positioned for. However, there are clear risks to this view and as ever, timing will be very important. We believe the current set up is the growth ‘trough’ in another mini-cycle that has been repeated multiple times since the 2008 crisis. The cause of these cycle downturns is always different but the response the same. This time, the trade war has been the primary cause and the response – monetary easing and fiscal spending – the same.
However, unlike 2012 (European crisis) and 2016 (emerging market credit crunch), the upswing will certainly prove less strong and thus likely be prone to bouts of disappointment in growth outcomes. The reason for this is this time round China is not engaging in the fiscal and monetary support anywhere close to the levels we have seen previously, undermining the ferocity of the recovery. Its focus is clear – to continue on the deleveraging path they have had since 2018 to promote financial stability above all else. The trade war was likely seen as good cover to blame outside sources for the pain of this necessary adjustment to support the switch from an investment lead to consumer growth economy. This has been occurring as China also slows structurally as GDP growth falls on the back of labour force saturation and the natural productivity growth slowdown that comes at its current stage of development.
This presents a problem for the reflation view that relies on China growth remaining supported and a buoyant Chinese currency. If Chinese growth issues – geopolitics or otherwise – worsen, the resulting response from the authorities will be to intervene in the currency or keep domestic rates high. This essentially represents management of its pegged exchange rate with the US dollar and will cause a tightening in domestic financial conditions. Exchange rates are generally allowed to float to rebalance economies externally as fundamentals change. So, if exchange rates are pegged and external rebalance is not allowed to occur, the economy will devalue internally via a fall in wages and prices. This will be a difficult political outcome for president Xi as the income hit will be extreme. A depreciated Chinese yuan is the more likely outcome and with it, China’s weak growth problems become a problem for the rest of the world. The US put yuan stability on the table during the phase one trade negotiations, which would have been a tough pill for the Chinese leadership to swallow given their fear of suffering a similar fate to Japan after the Plaza Accord. The bottom line here was continued disagreement between the US and China – which seemed highly likely – would surely precipitate yuan weakness.
If this had occurred, the Federal Reserve (Fed) would also have played its part, as the refusal to engage in more of an easing cycle (and not just insurance cuts) is propping up the dollar and preventing flows into emerging markets. If China’s economy weakens further and the Fed don’t react, then the resultant fall in the yuan would cause mass risk aversion in US markets (similar to the devaluation scare in 2016) until the Fed cut and get rates and the dollar down.
The Fed continues to not recognise the dangers of a strong dollar and their role in preventing tight dollar conditions globally. Shrinking central bank US dollar reserves (due to currencies being propped up) and the inability of emerging markets to ease sufficiently is keeping monetary conditions too tight and inhibiting the recovery.
Fed ‘QE-lite’ is a stopgap measure to support domestic funding but until funding conditions ease (through a lower federal funds rate and weaker dollar) the market will remain hooked on more and more Federal buying. Further spikes in US financing conditions will not only damage the US economy but also global financing conditions.
We remain cautious until there are clear signs Chinese growth is bottoming and/or the Fed makes further rate cuts and this logjam is broken and reflation can have a chance. Until there is resolution, bond yields will struggle to rise as global dollar liquidity continues to tighten. As growth remains lacklustre, there is a clear danger for risk assets unless this dynamic changes. We fear the Fed needs US equity market pain before they act – tightening global conditions almost guarantee that. Once we have more clarity and something gives, we will look to add reflation positions back to sizable risk levels. Until then, caution is warranted in global markets into 2020.
Mark Nash is head of fixed income at Merian Global Investors. The views expressed above are his own and should not be taken as investment advice.
The lack of correlation between different emerging market economies is something that investors should consider when making an allocation, according to Kepler Trust Intelligence’s Callum Stokeld.
Investors need to stop treating emerging markets as one ‘blob’ and consider making more single-country allocations if they want diversification and returns, according to Kepler Trust Intelligence’s Callum Stokeld has warned.
The broad range of emerging markets to invest in has grown in the past few decades as developing countries have lowered barriers to entry and allowed foreign money to come flooding in.
The increased weighting of Chinese stocks in emerging market benchmarks and the inclusion of Saudi Arabia have been met with greater flows to those countries.
Nevertheless, some investors still prefer their exposure to these economies to be more broad-based, with some £27.2bn invested in the IA Global Emerging Markets sector.
However, investors should be wary of treating emerging markets as a broad geographical allocation.
“It is something of a truism to say that emerging markets are not a homogenous blob, but a range of highly differentiated economies and stock markets,” said Kepler analyst Stokeld.
“Yet as investors, we often categorise them as one and the same, especially from an asset allocation and risk management perspective.”
He added: “Increasingly, divergences can be seen in how these markets correlate to one another as they mature.”
The Kepler analyst said while Asia-Pacific and global emerging market strategies are typically merged into broad asset classes, single market exposure to underlying market may give more effective diversification.
The make-up of emerging markets benchmarks has changed considerably over the past decade. However, the data below shows how the largest constituents in the MSCI Emerging Markets benchmark are not as correlated to the index as some may thing.
Rolling monthly 3yr r-squared of indices relative to MSCI Emerging Markets over 5yrs
Source: FE Analytics
Using the r-squared ratio – a measure of how closely correlated two indices are – Kepler found that indices “have exhibited a general trend of declining correlations” over the past decade with the exception of China, which has seen its increase significantly over the period.
“Apart from China, all the major emerging markets – including Hong Kong – show a clear decline in their r-squared to the wider benchmark,” said Stokeld. “However, this still tells us little of the dynamics which drive these different markets, or how they correlate to wider global equity markets.
“Clearly each country has very different listed equity markets, composed of very different industries. Sector exposure can therefore be regarded as a driver of relative performance in different macro environments.”
As the below chart shows, there are substantial differences in sector allocations at a country level in the MSCI Emerging Markets index.
The analyst said that while industry factors may help drive shorter-term performance, internal drivers will become increasingly important “as economies develop, real wages rise and populations age”.
“Different countries and regions will be inevitably and increasingly subject to internal drivers of returns,” he said.
Below, Stokeld takes a closer look at several emerging market countries and regions to determine what is driving returns.
China, which has the highest correlation to movements in the emerging markets index, is not as correlated to movements to its peers in the BRIC club (Brazil, Russia, India & China), says Stokeld.
The analyst said the Chinese market has a greater correlation with Korean and Taiwanese markets, which are more export orientated and “are often perceived as being tied to global trade volumes”.
Rolling monthly 3yr r-squared of indices relative to MSCI China over 5yrs
Source: FE Analytics
Chinese authorities’ capital controls also restrict the ability of domestic savers to allocate overseas, he said, and therefore have a very strong domestic bias.
“In recent years, this has facilitated rallies in asset markets as and when the authorities make credit more readily available, but it has been noted that these often tend to vary between different assets at different times,” he added.
“Accordingly, Chinese markets have frequently been driven by changes in domestic monetary conditions, and microeconomic policy decisions affecting the relative desirability of shares compared to property.”
Another BRIC member, India has “unsurprisingly, consistently low” correlations to other emerging market given the importance of domestic drivers – such as demographics and savings.
“Indeed, investors’ primary concern in recent years has been the varying expectations of the Modi government’s success – and to what degree – in reducing the role of the state in the economy and pursuing more free-market economic policies,” said Stokeld,
“Similarly, domestic inflation expectations often impact the relative attractiveness of bonds to equities, particularly to domestic investors.”
Latin American markets, said the Kepler analyst, are dominated by the Brazilian and Mexican markets, which represent around 63 per cent and 20 per cent of the regional benchmark respectively.
“The drivers of Brazilian markets have become increasingly internal in recent years, though political noise around potential tariffs has seen the Mexican market diverge from this pattern,” he said.
“As with India, investor sentiment in Brazil has mainly centred on perceived political developments. After enduring the worst recorded recession in Brazilian history in the early 2010s, investor confidence has tentatively started to return.”
Like the Latin American market, Eastern Europe is dominated by one big player: Russia.
“The declining correlation of eastern Europe to wider emerging markets comes against a backdrop of ratcheting geopolitical tensions between Russia and the west,” said Stokeld.
“Over the past 10 years, the Russian economy has experienced significant internal turbulence, including sharp interest rate rises to stem capital outflows following the imposition of sanctions.”
Rolling monthly 3yr r-squared of indices relative to MSCI Russia over 5yrs
Source: FE Analytics
The Kepler analyst added: “It is debatable whether, following these events, Russia will start to align more closely again with the global economy and global markets.”
With the FTSE 100 index having significantly underperformed its international peers until recently, Trustnet asks whether have UK stocks are still priced too cheaply?
UK stocks are currently being valued and viewed as if they were an emerging market rather than as one of the bigger and more developed markets, but could things now be about to change following the Conservative general election victory?
Kleinwort Hambros chief investment officer Mouhammed Choukeir said that until recently the UK market has been treated like an emerging market in terms of its pricing and investor outlook.
“If you think of investing in emerging markets, it’s typically investing in countries that have big geopolitical uncertainty,” Choukeir said. “It's typically investing in countries that have high risk premium.
“You think of emerging markets you think of places that are largely unloved or people are fearful of them. People don't want to be investing there because it just feels too risky.”
However, if you take those three dynamics – geopolitical uncertainty, low valuations and unloved sentiment – said Choukeir, a picture of the UK begins to emerge.
The UK has been an in-and-out of favour with investors since the 2016 EU referendum where the unexpected ‘Leave’ result caused some investors to eschew the UK market.
The uncertainty that has persisted around Brexit has been enough to keep many international investors away.
Performance of the FTSE 100 versus S&P 500 since the 2016 Referendum
Source: FE Analytics
Whilst the UK could be seen by some as an emerging market on some measures, investors do not have to worry about some of the structural weaknesses of a real emerging market.
Instead, investors get the upside of what is essentially an emerging market trade, said Choukeir, but with the structural elements of a developed market such as rule of law and strong corporate governance.
“The UK market is one of our favourite themes for this year, specifically the mid-caps within the UK, partly for those reasons,” he said. “You get an unloved asset that has a lot of uncertainty but with attractive valuations.
“So that's really, the way to think about investing in emerging markets is if you're getting the valuations right then you're getting compensated for the risk and the UK presents that value right now in the global space.”
Harrison (pictured) said: “From a financial point of view it hurt over the last summer having a big UK overweight.
“Compared to some of the other global managers, I was a lot more overweight [domestic stocks] and they just had nothing in the UK.”
Almost doubling his UK exposure from 6 per cent to 11 per cent in August. Harrison said he moved overweight at a time when “everyone had thrown the towel in, and I just thought ‘it’s too cheap’.”
This UK overweight and US exposure helped drive the fund’s performance last year, said Harrison, as it went from being a third quartile performer to one in the top quartile.
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
“I hear other global managers saying ‘I wouldn’t touch the UK’,” added Harrison. “But we just saw that the value was there and I still think that the value is there.
“I think that this year the UK could be really interesting.”
Indeed, the tide of anti-UK sentiment may now be about to change in the wake of the “Boris Bounce” according to Rob Morgan, pensions & investment analyst at Charles Stanley.
The Conservative party landslide victory in the 2019 general election removed the risk of a less market-friendly, Jeremy Corbyn-led government while also providing some clarification over Brexit, according to Morgan.
But whilst there is still the risk that “tariffs and trade friction could still be damaging, it does mean there is the potential for uncertainty to lift further and boost the market, which remains good value on a variety of measures,” Morgan added.
“For instance, the dividend yield gap between the FTSE 100 and 10-year gilts has never been wider. UK equities are also trading at a generous valuation discount to their global equivalents – notably Europe and the US,” he said.
“Sterling has recovered some lost ground, it remains cheap on a trade-weighted basis and this is likely to be a draw for overseas investors – and for M&A.”
He added: “A combination of an uptick in business activity and the government’s sizable spending plans could support a reacceleration of growth this year and provide reason for sentiment to improve.”
One fund that Morgan said could benefit from this is the “lesser-known” GVQ UK Focus fund, a £238.1m private equity-style strategy overseen by FE fundinfo Alpha Manager Jamie Seaton and deputy manager Oliver Bazin.
Investing in up to 35 small- and medium-sized UK businesses Morgan said that the fund has a low turnover of holdings, is focused on buying high-quality companies with high and sustainable cash flows.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Over the past three years, the fund has underperformed both the FTSE All Share benchmark (up 46.45 per cent) and the IA UK All Companies peer group (46.64 per cent) with a total return of 41.97 per cent. The fund has a yield of 2.41 per cent and an ongoing charges figure (OCF) of 0.98 per cent.
With 2018 and 2019 giving UK investors some differing conditions to navigate, Trustnet finds out which funds remained in the top quartile for both years.
A handful of funds in the three main UK sectors were able to generate top-quartile returns in both 2018 and 2019 – with many of the peer group’s biggest names failing to do so.
Last year, the FTSE All Share made a total return of 19.17 per cent – aided by the December general election and easing concerns around global growth. This sits in stark contrast to the 9.47 per cent loss that hit in 2018.
But which funds were able to make the highest returns of the IA UK All Companies, IA UK Equity Income and IA UK Smaller Companies sectors during both of these different years?
Of the 96 funds that were in the top quartile of the UK equity sectors during 2018, just 13 of these maintained that ranking in 2019. The performance of the fund that made the highest total return over both years can be seen below.
Performance of fund vs sector and index over 2018 and 2019
Source: FE Analytics
The £143.2m Premier UK Growth fund made 29.89 per cent across 2018 and 2019, putting it in first place in the IA UK All Companies sector and ahead of the FTSE All Share by a significant margin. This cumulative return was the result of a 6.84 per cent loss in 2018 (when the market was down 9.47 per cent) and a gain of 39.42 per cent last year.
The fund, which has been run by Benji Dawes and Jon Hudson since the end of 2017, has been relatively strong over much of the past two years but rallied hard in the final quarter of 2019 – as the chart below shows – after the Conservatives’ general election victory boosted sentiment towards the UK stock market.
At the start of 2019, the managers said: “We are told regularly by the media that the UK economy is in dire straits as a result of the political shenanigans in Westminster. Foreign investors have shunned the UK stock market over the past twelve months. As a result the valuations of UK companies are at low levels compared to historic levels.
“It is typically periods of increased uncertainty and naysaying that excess returns are made by those investors willing to look beyond the newspaper headlines. We have already seen some UK companies acquired by foreign companies so far this year.
“We are equity investors with a long-term horizon and a bottom-up focus. It is our strong conviction that the Premier UK Growth fund owns a collection of high-quality companies with the opportunity to exploit large addressable markets. We are not short-term traders. Therefore, whilst we remain extremely optimistic about the future of our companies over the long term, we will not spend time guessing which direction markets will move in the very short term.”
Because of this view, the fund went into 2019’s final quarter with an overweight to UK small- and mid-caps, which had been underperformed amidst Brexit uncertainty but went on to rally stronger when December’s election handed prime minister Boris Johnson a strong majority.
Source: FE Analytics
This trend can also be seen in the some of the other funds that top the above list, such as VT Teviot UK Smaller Companies, ASI UK Mid Cap Equity, Gresham House UK Multi Cap Income and TM Cavendish AIM.
Andrew Bamford and Barney Randle’s £67.1m VT Teviot UK Smaller Companies fund made 28.73 per cent over 2018 and 2019 – which are its first two full calendar years of track record.
The fund’s strong returns have come after a period when the three areas that it focuses on - UK equities, smaller companies and value stocks – have struggled to make progress. Simon Evan-Cook, who owns VT Teviot UK Smaller Companies in his Premier Multi-Asset Global Growth fund, said it is one of his favourite funds at the moment.
“Since launch, the fund has done extremely well and this has been a period when small-cap value really hasn’t done particularly well,” the multi-manager recently told Trustnet.
“This situation has started to change so it will be interesting to see what this fund can do with the wind at its back, rather than in its face. If you get reflation and expansion, then companies that are priced well lowly can re-rate quite significantly with only a little improvement in the outlook.”
Performance of fund vs sector and index over 2018 and 2019
Source: FE Analytics
Many of the 13 funds that made it onto this research’s shortlist are some of the smallest members of their peer groups. Nine of them have assets under management of less than £200m, with the smallest being the £6.9m CFP SDL Free Spirit fund.
The largest on the list, however, is the £1bn Royal London Sustainable Leaders Trust. Oversee by FE fundinfo Alpha Manager Mike Fox, the fund concentrates on companies with strong environmental, social and governance (ESG) qualities, the potential for growth and a relatively undervaluation by the market.
Analysts with FE Investments said: “Fox is a very experienced manager and his track record highlights the benefits of his style – despite several periods of outperformance of cyclical sectors and natural resources companies, the fund continues to beat its peers and the wider market over the long term.”
The other larger funds on the above list of outperformers in 2018 and 2019 are Peter Michaelis and Neil Brown’s £615.2m Liontrust UK Ethical fund and Gerard Callahan’s £541.5m Baillie Gifford UK Equity Alpha fund.
Martin Currie’s Mark Whitehead is investing in a company that aims to reduce the amount of methane produced by farm animals.
Fund managers are often accused by investors of generating “hot air” when talking up their track record or the prospects for their fund and asset class.
However, Mark Whitehead, manager of the Securities Trust of Scotland, is hoping to reduce it – through investing in a company that aims to cut methane emissions.
Securities Trust of Scotland targets an income that rises above inflation every year to maintain investors’ spending power.
Source: Securities Trust of Scotland
To achieve this, Whitehead’s team applies a nine-step checklist to gauge the sustainability of every potential holding’s dividend, which has led him towards stocks hoping to make a positive impact on the environment.
“There’s a lot being taught at the moment about health and wellness and how much environmental damage we’re doing because we’re eating more and more animal protein, particularly in Asia,” he said.
“There is this surge in middle class incomes and in China alone, the amount of people that are now able to eat meat and can afford white goods – the numbers are pretty mind boggling.
“There’s no doubt that it’s pretty bad for the environment, it is very high in terms of water intensity and animal husbandry produces about 14 per cent of global emissions.”
This is one of the reasons why Whitehead (pictured) decided to invest in DSM Nutritional Products, a company he said should benefit from the trend towards eating more plant-based protein due to its production of vitamins that go into these products.
However, the manager said that what excites him most about the company is its “Clean Cow” project.
“This is basically a food additive that it is trying in New Zealand that goes into concentrates that you feed cattle and pigs,” he explained. “It thinks this additive will reduce methane production by up to 30 or 40 per cent per cow and pig, which is obviously significant as methane is a great driver of carbon emissions.
“That could be a very big total addressable market which it is innovatively producing for itself. But that’s just one part of the business: the planet and sustainability are absolutely at the forefront of how it runs. It is able to think about the planet first and then obviously produce pretty strong profit growth from a lot of the other stuff it is doing.
“It’s a really fascinating company, it has produced really strong dividend growth for us, and was one of the better performers in the portfolio last year. We really believe that structurally it is going to win out.”
This is not the only company in Whitehead’s portfolio that represents a play on the theme of sustainability. However, while DSM aims to reduce the amount of methane produced by cows and pigs, another one of his holdings is attempting to help the environment by making even more smells.
“International Flavors & Fragrances is a US company which, as the name would suggest, is innovating in using botanicals and this type of thing to try and drive different flavours and fragrances in plant-based protein,” he continued.
“There’s a lot of innovation going into plants and making sure that they taste good, because obviously, a lot of them don’t.”
Whitehead said the business is performing an important role in the uptake of non-meat protein, as despite consumers’ willingness to swap meat for a substitute, in the past they have been left disappointed with the alternatives available. However, he said International Flavors & Fragrances is helping to change this, particularly in the ready meal market.
“If you eat a ready meal, a lot of them when they are sitting on the supermarket shelves taste pretty bloody revolting,” he explained. “International Flavors & Fragrances uses enzymes and molecules which start to react when the temperature gets to a certain level when you put a ready meal into the microwave, which releases the taste and smell.
“There’s a lot of innovation and again, we think that’s a real long-term structural trend: we need to be eating more plants, and it is able to make them a lot more palatable for us through its business model.”
Data from FE Analytics shows Securities Trust of Scotland has made 78.79 per cent since Whitehead took over in May 2016, compared with gains of 73.65 per cent from the MSCI AC World index and 63.95 per cent from its IT Global Equity Income sector.
Performance of trust vs sector and index under manager tenure
Source: FE Analytics
The trust is trading on a premium of 1.54 per cent to net asset value (NAV) compared with average discounts of 3.81 and 5.63 per cent over the past one and three years.
It has ongoing charges of 0.9 per cent, is yielding 2.96 per cent and is 8 per cent geared.
Julian Chillingworth, chief investment officer at Rathrbones, explains why labels such as 'growth' and 'value' can be deceptive and investors need to look beyond them to sift the winners from the losers.
The value train has been touring the world over the past few months, with investors hanging off the sides in their eagerness to get on board. In this case we think it’s best to resist the fear of missing out and remain contentedly on the platform.
The S&P 500 Value index returned more than 11 per cent over the three months to November’s end — well ahead of the 6 per cent of its ‘growth’ sister index. There will be periods when the share prices of these sorts of businesses, which do better when economic activity picks up, will outperform, but we feel like they will be few and fleeting. For investors who resisted the urge to chase them, this has certainly paid off in the past. In the three years to 30 November, US ‘growth’ companies made 65 per cent, outstripping ‘value’ ones by 27 percentage points (see figure 1 below).
In a world of limited economic growth — a situation we believe will endure — it seems misguided to rely on accelerating economies to increase the overall pool of earnings. And, therefore, it seems misguided to buy ‘value’ companies that need reaccelerating growth to really outperform. Instead, we believe it’s prudent to stick with ‘growth’ companies that are doing business better than their rivals and taking in more earnings at the expense of competitors who just can’t keep up.
Sealing the deal
The recent rotation into value came after investors got excited about the chances of a ‘phase one’ trade agreement between the US and China, combined with some extremely early signs of a potential worldwide bottoming in manufacturing surveys. Both China and America flagged the high likelihood of sealing the deal before the end of the year, but then US president Donald Trump took to Twitter and the deal’s timeline dissolved. Similarly, you would need a magnifying glass to spot some of the upticks in economic data that got many investors excited.
Unfortunately, the more reliable economic indicators are sending only the most tentative of signals. Our own global leading economic indicator (LEI) troughed three months ago, but you can barely see the uptick on the chart (see figure 2 below) Both the six-monthly and annual trend rates are still firmly negative, and they have a more stable relationship with the performance of cyclical sectors than defensive ones. Other off-the-shelf indicators, such as the Organisation for Economic Co-operation and Development's (OECD) composite leading indicator for 23 nations, have yet to find a floor. Many of the indicators that are turning up are in some of the weakest parts of the world — Europe, notably. The Ifo index of German business confidence rose again in November, but it’s still consistent with GDP contraction in the fourth quarter, which we believe is unsupportive of a rally in cyclical shares.
Of course, we hope that the economic indicators have found their bottom, and that the uptick observable in many will develop into trends that can be followed. But a market strategy based on hope over fundamentals is a gamble.
When the pace of economic growth began to slow early in 2019 and the outlook became gloomier, we felt that it made sense for investors to start shifting their equity investments away from cyclical sectors and towards defensive ones. And that was the case even though we didn’t think a recession was necessarily likely to ensue. A difficulty we noted at the time was a lot of defensive shares looked a bit expensive, so you can see why investors might be clamouring for cheaper value stocks at the first signs of a recovery. However, our analysis found that in most cases, regardless of the initial relative valuation, defensive sectors tend to outperform during a slowdown. The risk of a global or US recession — and therefore a sustained slump in markets — is relatively low, but the cycle is just as likely to continue to slow as it is to accelerate. That means remaining invested but with a defensive bias.
Looking for value
As long-term investors, we’re always looking for companies with the cash flows to invest in themselves and stay ahead of the opposition, regardless of the economic cycle. We won’t limit our search to companies that have a ‘growth’ label, or avoid others because they are labelled ‘value’. We look for businesses that have strong, reliable earnings that make it easier for them to adapt to an ever-changing world. According to a recent study by academics from the Stern School of Business and University of Calgary, the average large North American ‘growth’ company (top 30 per cent by market capitalisation) spends $1bn a year on research and development alone.
Many value companies simply may not have the spare cash to make the crucial investments in branding, research and development, automation, data analytics and bolt-on acquisitions that will help them tomorrow. In many cases, they have to use the cash to repay lenders or support short-term dividend policies to keep shareholders happy. The more uncertain the future for businesses, the more hefty the premium would-be investors are likely to demand for putting up their cash, so higher capital costs could make it uneconomic for ‘value’ companies to reinvest in themselves.
The North American study, which investigates the reason for the underperformance of value over the past few decades, made some interesting findings about the few ‘value’ companies that have managed to buck the value slump and turn themselves around. They had decent business models and lots of free cash flows to start with, which allowed them to borrow to invest heavily in plant and research and buy back shares, which reduces costly equity capital and frees up future cash flow even further. So, for a value company to do well, it must make radical investments in itself, probably financed by lots of debt, to catch up and become a ‘growth’ company. There are many risks there: over-leverage, poor execution and also the simple fact that a great escape plan could bankrupt a business if recession arrives too soon.
Over recent months, European stocks have staged a recovery as investors have looked to the region as a key value opportunity, seeing it as the final frontier of a 10-year economic cycle. But apart from a few great businesses that tend to be multinational and insulated from the most damning of Europe’s structural issues, we think Europe is likely to remain mired in low growth.
Rocket fuel for the 21st century
What about investment in the intangible assets that are the rocket fuel of the 21st century economy? By one estimate, northern European countries — the powerhouse of the eurozone — invest just $100bn to $200bn each per year. That compares with about $2trn of intangible investment in the US and $700bn in China. The US has been home to scores of world-beating companies of the kind that just don’t exist anywhere else. It seems reinvestment may be the ticket. There are relatively cheap companies out there that are not poor quality, just as there will be companies with a ‘growth’ label that are loss-making. But many value companies tend to be cheap for a reason, either because they are very cyclical, their earnings are hard to forecast, or they’re in sectors — like retail, old media, banks and energy companies — that are facing big structural challenges like disruptive technology, changes in consumer behaviour or climate change.
We believe that in the longer-term, growth is very likely to outperform value for the reasons we have discussed, but in the nearer term we recognise that macroeconomic conditions appear to turning more positive, and therefore one might look slightly more favourably on quality value names.
Julian Chillingworth is chief investment officer at Rathbones. The views expressed above are his own and should not be taken as investment advice.
FundCalibre research director Juliet Schooling Latter highlights a handful of recently launched funds and those with new managers worth considering.
When a fund has just launched or comes under new management it can often be difficult for investors to be persuaded to buy into it and often err on the side of caution.
However, with new products regularly coming to market and natural turnover in the industry resulting in frequent manager changes.
Below, FundCalibre’s research director, Juliet Schooling Latter (pictured) highlights five funds who have come under new management or that are recently launched but worth keeping an eye on.
Zehrid Osmani – Legg Mason IF Martin Currie European Unconstrained
The first fund highlighted by Schooling Latter is Legg Mason IF Martin Currie European Unconstrained managed by Zehrid Osmani who joined the Martin Currie in 2018 from BlackRock.
At BlackRock, Osmani, ran three funds including the BlackRock SF European Opportunities Extension fund, which had a similar approach to his new fund.
The £30.3m fund has a focused, high conviction portfolio of quality growth European equities with no constraints, all of which are an appealing element, according to Schooling Latter.
The FundCalibre research director also noted that Osmani really focuses on a long-term investment outlook, something she said is important “to avoid short-term noise” and is “refreshing at a time when many investors are becoming increasingly short term”.
Performance of fund vs sector under Osmani
Source: FE Analytics
Since taking over the Legg Mason IF Martin Currie European Unconstrained fund it has made a return of 37.05 per cent; outperforming the IA Europe excluding the UK peer group (19.81 per cent).
The fund has an ongoing charges figure (OCF) of 1.05 per cent.
Jochen Breuer – Fidelity Asian Dividend
While Breuer has a dividend focus, said Schooling Latter, he doesn’t only look for yield – offering some capital and dividend growth – although it is 30-40 per cent higher than the wider market.
“He likes to invest in high quality franchises, with good balance sheets, good levels of cash and strong management teams who understand capital allocation,” she said.
“While the portfolio favours high quality companies, Breuer will not invest in them at any price so the fund has a value tilt. “
Performance of fund vs sector & benchmark under Breuer
Source: FE Analytics
Breuer has managed to outperform both the IA Asia Pacific Excluding Japan index (35.38 per cent) and the MSCI AC Asia Pacific ex Japan High Dividend Yield sector (26.52 per cent) with a 44.20 per cent total return.
The five FE fundinfo Crown rated fund has a yield of 3.44 per cent and an OCF of 0.75 per cent.
Edmund Harriss and Mark Hammonds – Guinness Emerging Markets Equity Income
The $1.9m Guinness Emerging Markets Equity Income fund has been managed by Edmund Harriss and Mark Hammonds since launch in December 2016.
FundCalibre’s Schooling Latter said the pair follow “a tried and tested process, which has proved successful with their Asian and global equity income funds”.
“The managers do not look for income until the latter stages of their process,” she said. “This ensures they don’t miss out on good companies just because they are paying a smaller dividend.
“They have a one in-one-out approach, and the final 36 stocks in the portfolio are equally weighted.”
Since launch, the Guinness Emerging Markets Equity Income fund has underperformed both its MSCI Emerging Markets benchmark (37.03 per cent) and the IA Global Emerging Markets peer group (34.75 per cent) with a total return of 32.78 per cent.
It has a yield of 2.98 per cent and an OCF of 0.99 per cent.
Kunjal Gala – Hermes Global Emerging Markets SMID Equity
With veteran emerging markets investor Gary Greenberg announcing his intention to retire retirement in June 2022, colleague Kunjal Gala has been named as co-manager as part of succession planning on Greenberg’s portfolios, including the $180.6m Hermes Global Emerging Markets SMID Equity fund.
Gala has already worked alongside Greenberg on the larger $5.8bn Hermes Global Emerging Markets fund since 2016.
“Gala takes the wider macroeconomic picture into account when thinking about overall country weightings, and looks for undervalued quality companies - or as he describes it: ‘great companies at good prices, or good companies at great prices’,” said Schooling Latter. “Or as Kunjal said ‘great companies at good prices, or good companies at great prices’.”
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
The Hermes Global Emerging Markets SMID Equity fund was launched in September 2018 and since then has made a return of 23.05 per cent, outperforming both the IA Global Emerging Markets sector (20.09 per cent) and the MSCI Emerging Markets SMID Cap index (13.64 per cent).
The fund has an OCF of 1.20 per cent.
Mike Scott – Man GLG High Yield Opportunities
The final fund on the list is the £31.8m Man GLG High Yield Opportunities fund overseen by Mike Scott. Scott previously managed a similar strategy at asset manager Schroders – Schroder High Yield Opportunities – which he left to join Man GLG towards the end of 2018.
Schooling Latter said while Scott’s new strategy follows a similar proves, he now has the flexibility to short bonds although that does not make it an absolute return fund.
She said Scott also has an unconstrained approach investing globally, albeit with an emphasis on the UK, North America and Europe.
Performance of fund vs sector since launch
Source: FE Analytics
Since launch, the Man GLG High Yield Opportunities fund has made a 9.40 per cent total return, outperforming against the average IA Sterling High Yield peer, which made 5.56 per cent over the same time frame.
The fund has a yield of 9.54 per cent and an OCF of 0.75 per cent.
The latest edition of Trustnet Magazine looks at the grim reality of retirement with an insufficient pension pot.
We are regularly reminded that we are not saving enough for our old age, which is why this month’s edition of Trustnet Magazine examines what retirement actually looks like if you haven’t paid enough into your pension. Hannah Smith’s cover story uses the example of Sarah, a 58-year-old mother of three, who always had good intentions when it came to saving for retirement, but who found life always got in the way. It is not all doom and gloom though, as Laura Miller finds out there is an easy – and free – fix for NEST savers to boost the value of their pension. Staying on this theme, Pádraig Floyd finds out that what are regularly cited as the main weaknesses of pensions could actually be their biggest strengths, while John Blowers reveals how to set up your SIPP.
In the magazine’s regular columns, Waverton’s Luke Hyde-Smith names the trust he is using to diversify away from equities and bonds, BMO Global Asset Management’s Jamie Jenkins picks three stocks set to benefit from the increased focus on sustainability and, finally, in this month’s sector focus, Anthony Luzio finds out why it is so important to take a global outlook when investing for income.
Following another strong year for Fundsmith Equity, its manager stressed how he is careful to avoid problems such as illiquidity and style drift that brought down Woodford Investment Management.
The collapse of Neil Woodford’s investment empire last year prompted increased scrutiny on issues such as illiquidity assets and style drift but Terry Smith has reassured investors that they do not need to worry about these with his own asset management house.
One of the biggest events of 2019 was the closing of Woodford Investment Management, which came in the wake of the suspension of its flagship LF Woodford Equity Income fund. The fund ran into problems after months of poor performance and heavy outflows highlighted its high weightings to illiquid unquoted stocks.
In the 10th annual letter of the Fundsmith Equity fund, the FE fundinfo Alpha Manager noted the strong performance of his own fund last year. Fundsmith Equity made its top-quartile total return in a row during 2019, outperforming the the MSCI World index in the process.
Smith (pictured) conceded that the £19.7bn fund had “a couple of poor months” in September and October, when a combination of the rally in the sterling and a ‘rotation’ from the quality-growth style that it follows into value stocks cost it around 6 percentage points of performance.
Performance of Fundsmith Equity vs sector and index over 2019
Source: FE Analytics
Many commentators have argued that value stocks are due to outperform the quality approach, given that the style has lagged for much of the post-crisis bull run, but the Fundsmith Equity manager pointed out that this argument has been made for several years – without any meaningful rotation actually taking place.
“If you read the breathless commentary on this in much of the press without knowing the actual performance of our fund you might be surprised to find that, notwithstanding these events, it ended the year up by 25.6 per cent which was our second best year since inception and outperformed the MSCI World index by 2.9 per cent,” he added.
While the manager spent the bulk of the letter – which can be found in full here – examining his investment strategy of ‘buying good companies’, ‘not overpaying’ and ‘doing nothing’, he also said it “seems impossible” to talk about 2019 without mentioning the demise of Woodford Investment Management.
The most obvious problem with LF Woodford Equity Income, Smith said, was that it was a daily-dealing open-ended fund with had a weighty allocation to illiquid holdings such as unquoted companies.
He also noted that Woodford is not the only one to have recently run into this problem, pointing to the current suspension of M&G Property as well as those property funds that were gated in 2016 after the Brexit referendum.
Performance of LF Woodford Equity Income vs index since launch
Source: FE Analytics
“Where does the Fundsmith Equity fund stand on this? We have always regarded liquidity as an important issue. As evidence of this, we have published a liquidity measure on our fund factsheet since 2012,” he continued.
“Equally we only invest in large companies. At 31 December 2019 the average market capitalisation of the companies in our fund was £114bn and we estimate we could liquidate 57 per cent of the fund in seven days.
“The reality is that the only type of fund which can guarantee 100 per cent liquidity on demand is a cash fund, and I presume that is not what you wish us to invest in. But I suspect you will find it hard to find more liquid equity funds than ours. It tells you much about its liquidity that some of the least liquid stocks we hold are the FTSE 100 companies, InterContinental Hotels, Intertek and Sage.”
In addition, Smith highlighted how much of the discussion around the Woodford incident has centred on the ‘star manager’ culture that exists in the asset management industry. While Smith doesn’t like that particular phrase, he does not believe this was at the root of the problem.
“I think this concern is focused on the wrong issue. I think it makes no more sense to avoid funds run by ‘star’ fund managers any more than it does to avoid supporting sporting teams because they have star players,” he said.
“The trouble arises not because teams have star players but if the star tries to play a different game to the one which delivered their stellar performance. Would Juventus do as well if Cristiano Ronaldo played as goalkeeper? How is Usain Bolt’s second career as a soccer player going?”
Instead, Smith believes the real problem is that when Neil Woodford started his own fund house, he radically changed the investment style that had served him so well over his three decades at Invesco Perpetual. While Woodford had started owning unquoted stocks while at Invesco Perpetual, this accelerated once he left to set up on his own.
Could this happen with the Fundsmith Equity fund? Its manager “thinks not”.
Performance of Fundsmith Equity vs sector and index since launch
Source: FE Analytics
“We have no desire to change our strategy. We are convinced that it can deliver superior returns over the long term. I would pose a different question which links the discussion of the Woodford affair with the earlier discussion of the ‘rotation’ from quality stocks into value stocks,” he said.
“If you expect such a ‘rotation’ to occur at some point and for value stocks to enjoy a period in the sun would you rather we tried to anticipate that and switched into a value investment approach of buying stocks based mainly or solely on the basis of their valuation or would you rather we stuck to our existing approach of buying and holding high quality businesses? I would suggest the latter approach might be better, and it is what we are doing. There will be no style drift at Fundsmith.”
Only four funds have managed to outperform the FTSE All Share index over each of the past five calendar years, research by Trustnet has found.
The UK equity market has endured a number of challenges in recent years as the prospect of Brexit become a reality and previously taken-for-granted assumptions about the economy were put into disarray.
The landslide general election victory by the Conservative party under Boris Johnson has, however, seen sentiment towards the UK improve with greater clarity around the direction of Brexit.
Nevertheless, it has been a difficult environment for UK equity managers to consistently outperform.
As such, Trustnet looked for IA UK All Companies and IA UK Equity Income funds that have managed to outperform the FTSE All Share – a common benchmark for UK equity strategies and investors – in each of the past five years.
There were just four, all from the IA UK All Companies and sector, beat the UK equity benchmark in each year since 2015: Allianz UK Opportunities, Liontrust UK Growth, MI Chelverton UK Equity Growth and TB Evenlode Income.
Below, Trustnet takes a closer look at each of the four funds.
Allianz UK Opportunities
The style-agnostic fund aims to beat the FTSE All Share over rolling three- and five-year periods by investing in concentrated portfolio of companies that are significantly undervalued relative to their assets or long-term earnings potential.
Writing last month, Tilletsaid the general election result was a “clear positive for the UK equity market” despite the fact that some extreme mis-pricings in the market had now been corrected.
“Valuations within the UK equity market remain attractive and we expect investor sentiment towards the UK to continue to improve during 2020 and beyond,” he said.
Performance of fund vs index in past 5yrs
Source: FE Analytics
Of the four funds, Allianz UK Opportunities was the best performer in 2016 – the year of the EU referendum – when it made a 20.29 per cent gain.
During the past five years to the end of 2019, the fund made a total return of 63.22 per cent compared with a gain of 43.84 per cent for the FTSE All Share index.
Under Tillet, the fund has returned 83.38 per cent to 31 December 2019 against the benchmark’s 59.67 per cent gain.
Liontrust UK Growth
The £444.9m Liontrust UK Growth fund also makes the list for UK equity funds consistently outperforming the FTSE All Share in each of the past five years.
Cross and Fosh employ their ‘Economic Advantage’ process to identify large- and mid-cap companies with durable competitive advantages allowing them to defy industry competition and sustain higher-than-average levels of profitability for longer than expected.
Performance of fund vs index in past 5yrs
Source: FE Analytics
Analysts at FE Investments said the managers’ focus on high quality companies protects the fund during weaker market conditions, while exposure small-caps has helped drive performance albeit increasing its sensitivity to the UK economy.
Over the five years to 31 December 2019, Liontrust UK Growth made a return of 66.51 per cent.
The fund had made a total return of 321.08 per cent under Cross and Fosh, compared with a gain of 214.25 per cent over the same period.
MI Chelverton UK Equity Growth
Focusing further down the market cap scale than many of their peers, Baker and Booth seek out companies that are highly cash generative giving them the ability to fund their own growth. Typically, holdings in the portfolio will have some form of competitive advantage that gives them high margins.
MI Chelverton UK Equity Growth was the strongest performer of the four strategies in three of the five calendar years under review and made a total return of 40.58 per cent last year alone.
Performance of fund vs index in past 5yrs
Source: FE Analytics
As such it was the strongest performing strategy of the four funds in the study, returning 157.7 per cent during the period under review. The next best performer, TB Evenlode Income, in comparison, made a gain of 82.36 per cent.
Baker joined Chelverton Asset Management from Rathbones in June 2014 and was appointed to the fund as manager in October 2014. He was joined by Booth in November 2017.
TB Evenlode Income
The final entrant on the list is the £3.7bn TB Evenlode Income fund and is the only equity income strategy to have outperformed the index in each of the past five years.
Managed by Alpha Manager Hugh Yarrow and Ben Peters, TB Evenlode Income is also the only fund of the four to deliver a positive return in each of the past five calendar years: its three peers in the study and the FTSE All Share all fell to a loss in 2018 while it was up by 0.39 per cent.
Performance of fund vs index in past 5yrs
Source: FE Analytics
Like the other funds in the study, the strategy is a concentrated portfolio – owning around 40 holdings – and has a quality bias albeit with a greater focus on income and dividend growth.
“The outlook for 2020 is, as normal, complex. Sentiment has improved materially towards the outlook for both the UK and global economy during 2019,” Yarrow and Peters wrote in their December factsheet.
“However, UK political uncertainties remain, global geopolitical risk is elevated, global deflationary pressures persist, and valuations are not as attractive as they were a year ago.”
TB Evenlode Income launched in October 2009 and has made a total return of 257.71 per cent gain since then.
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.