The manager says investors should look at which businesses the government helps to grow in the crisis and which ones it decides have no future.
The economic fallout from the coronavirus crisis could be every bit as bad as the early years of the 1980s, according to Simon Edelsten, manager of the Mid Wynd International Investment Trust.
However, Edelsten pointed out that despite his “dark memories” of this period, it was actually a great time for investors to get into the market.
Performance of index in 1980s
Source: FE Analytics
The UK unemployment rate stood at 4.5 per cent – or 1.5 million – in the three months to August, according to data from the Office for National Statistics. Yet there are fears this figure will rise as coronavirus cases begin to climb again and the prospect of another nation-wide lockdown becomes more likely.
Edelsten said that when he and his team are faced with challenges, they often resort to looking back at the lessons from history, meaning the recession of the early 1980s “when you had businesses closing and unemployment rising every week”.
“When Margaret Thatcher came to power in 1979, after the ‘winter of discontent’ when rubbish was pilling up, people thought things couldn’t get worse,” he began.
“But her policies to try to control inflation meant that interest rates were kept very high. And although the public had been shocked when unemployment in the UK went through 1 million in Ted Heath’s day back in 1972 to 1973, when Mrs Thatcher came to power, it had already got to 1 million.
“It then went through 1.5 million, through 2, and ended peaking at 3.25 million, putting enormous pressure on her and leading to doubts about whether her economic policy was wise.”
Edelsten noted that Thatcher’s government is still remembered for denying struggling businesses subsidies and aid packages, even if this meant they had to lay off large numbers of employees. As a result, large sections of the British manufacturing industry, particularly in the West Midlands, went under and never recovered.
Yet the manager said this doesn’t tell the whole story.
“First, a number of businesses were getting government help,” he explained. “Notably the Nissan plant – which is still said to be one of the most efficient in the world – was opened in Sunderland in 1984. Just after that, a large number of people who had worked in the shipbuilding industry on the Tyne went to work in laser manufacturing and started that highly competitive part of British manufacturing. So the green shoots of that new wave were there.”
Edelsten said this was also the start of the UK’s ‘knowledge economy’, adding that while the Conservative government of the time was associated with allowing industries to fail, “one extraordinary story from this time” was that it backed the nascent computer industry.
For example, Margaret Thatcher appointed Kenneth Baker as the UK’s first Minister of Information Technology in 1981 and authorised subsidies for British computer manufacturing, including the unfairly maligned Sinclair brand.
“You may all remember because he [Clive Sinclair] bizarrely thought that at some point people would be driving electric cars – a little ahead of his time, it has to be said, and his car was not quite like the ones that we drive today,” Edelsten continued.
“But at one point in 1983, the ZX81 Sinclair was the biggest selling home computer in the world, certainly by number. The government also pushed the BBC to design its own computer, and to run a set of shows to educate people on how to programme one, so the BBC Micro was born.
“The BBC Micro was built by Acorn Computers in Cambridge, so perhaps that government subsidy might have been the seed of many very successful computer businesses around there, not least ARM Holdings which has just been sold by SoftBank for $40bn.”
He added: “So even in an economic crash, it’s always worth keeping an eye out for the green shoots of the next cycle: which businesses the government helps to grow and which businesses the government decides there’s no future in.”
Edelsten said two growth themes that have come to the fore in the crisis and are likely to run for many years are sustainability – with renewable energy likely to be a major beneficiary of government spending to support the recovery – and working from home.
However, he prefers to pick up stocks slightly outside of the spotlight, so rather than investing directly in wind or solar farms, he is playing the theme of sustainability through efficient air conditioning companies such as Trane in the US and Daikin in Japan, both of which have done well recently.
“We were keeping an eye on them because more energy-efficient buildings were identified already as being something that the world needed to move towards,” he said.
“Then along comes the pandemic. Now if you’re in a tower block, you also need to clean and change your air much more frequently, so demand for advanced air conditioning has gone through the roof.”
And with some work-from-home stocks looking “faddish”, Edelsten said he is investing in a parallel theme of more efficient offices.
“We’re looking at other things which we think are going to be permanent sources of change, such as companies that might benefit from allowing us to do more of our interactions with the government online and helping them stop relying so much on paperwork,” he said.
“It may surprise you, the UK is quite well ahead today. Other countries are a long way behind, with people spending a lot of time queuing up at town halls filling in forms, sending off paper documents, faxing things and using old fashioned signatures. And none of that seems viable really.
“There’s a lot of work to be done and it’s important to keep looking forward.”
Data from FE Analytics shows Mid Wynd International has made 169.22 per cent Edelsten became manager in May 2015, compared with gains of 109.31 per cent from the IT Global sector and 105.95 per cent from the MSCI AC World index.
Performance of fund vs sector and index under manager
Source: FE Analytics
The trust is on a premium of 2.34 per cent compared with 2.95 and 2.32 per cent from its one- and three-year averages. It has ongoing charges of 0.66 per cent. It is not currently geared.
River & Mercantile's James Sym explains how the euro has effectively been "relaunched" by agreeing closer-than-ever ties between member states and why this should be great for European assets.
The cycle that has just ended undoubtedly belonged to the US equity investor. The nature of the policy response to various crises over the last five years led to a preference amongst investors for exactly the type of large growth stocks (chiefly the FAANGs) that the US economic and political system was so adroit at nurturing this last decade.
In Europe, it has been a much more difficult story. The financial crisis laid bare the structural imbalances of the euro and the policy response of the last cycle was disjointed. With a critically lower weighting to secure global growth stocks, and domestics suffering in the face of these headwinds, European equities materially lagged and became an ‘easy’ underweight for asset allocators.
But could this dynamic be changing? Will this underweight remain quite so easy?
The policy response to the crisis is an absolutely seminal moment for Europe. There is the usual alphabet soup of measures but in summary, Europe’s prospects for cohesion have been materially improved. 20 years after the launch of the euro we finally have common debt issuance and fiscal transfers between north and south, and a much bigger role for fiscal policy rather than sole reliance on ineffective monetary policy with ever more negative rates.
Allied to this, we are seeing early signs of a regime change in markets, which suggest that the ‘easy’ underweight to European equities might not be so fruitful in this next cycle.
There are two reasons why this new blend of policy mix is a game-changer for Europe, with serious investment implications. Firstly, when governments are half of your economy, as they are in many European countries, the propensity of those governments to spend is critical to the state of the business cycle. Looking out to 2024 the aggregate fiscal deficits will be worth at least an incremental 25 per cent of GDP, perhaps more.
For politicians wishing to be re-elected, while interest rates stay low, fiscal spend will likely stay high, setting up a potentially lose-lose scenario for growth stocks, to the detriment of the US and the relative benefit of Europe.
Secondly, this is the first time Europe has explicitly mutualised sovereign debt. Not only that, but the small print says this common debt will be repaid by the European Commission, rather than individual member states, not until 2058 and that the proceeds are being disproportionally allocated to the periphery.
That “Europe will be forged in crises”, as Jean Monnet’s vision for the EU stated, never looked more true.
Importantly, we have already had a dry run for this kind of synchronised and converging reduction in the cost of capital - the launch of the euro itself in 2002 - an uncommonly prosperous time for European assets.
This policy change is no less than a mini relaunch of the euro. This time, given where starting valuations are - banks start by trading on half book value, for example - then it almost goes without saying that relative value abounds in European equities and any positive catalyst should be felt by investors.
Another feature of a post-Covid world is that, in many ways, the rest of the globe is finally coming Europe’s way; a stark example being the changing fortunes of companies whose activities are enabling energy transition (EU good, US weak) over big tech (US good, EU weak) and who are finally attracting serious attention from regulators. Given the disproportionate weights on the different indices, rotation away from big tech would hurt the US more. There is a logical equivalence to selling, say, a FAANG stock and buying Europe.
The battle-scarred advisor will have heard the story of the European opportunity before but will also have seen a number of false starts and so leaving aside the fact that Europe has grasped the twin challenges of Brexit and Covid with surprising cohesion, perhaps walking in the shoes of the advisor in the ‘first’ European business cycle in 1716 is helpful - France had struggled for years in the aftermath of the profligacy of Louis XIV of Versailles fame, the economy was stagnant and the national debt crippling. However, unconventional policy action devised by the Mario Draghi of his day, John Law, led to a booming economy within 4 years and fantastic share price performance.
It all ended badly, of course, with the monopolistic Mississippi company being rendered worthless, thus setting up the next business cycle…
The serious point, of course, is that the policy response to the end of business cycles tends to set up rather different winning themes for the next. Being contrarian is most profitable at turning points.
All these ideas have serious investment implications for this coming cycle, just as the insight that we were in a lower-for-longer world would have had in 2008. It is easy to forget now but that was an incredibly uncertain time and it produced a very different looking cycle than the one that went before. Global markets could be going through a similar period of discovery. And for the European investor, chances are that might be no bad thing… beware of the ‘easy’ underweight.
James Sym is manager of the ES R&M European fund. The views expressed above are his own and should not be taken as investment advice.
During a watershed year for sustainable investing, asset manager Robeco has decided to strip investments in the worst fossil fuels from all its funds.
Robeco has extended its commitment to sustainable investing by excluding investments in thermal coal, oil sands and Artic drilling, arguing that they have by far the worst impact on the environment.
The fund house has a longstanding commitment to ESG (environmental, social and governance) and sustainable investment.
In its Sustainability Policy, the firm declared: “We see sustainability as a long-term force for change in markets, countries and companies.
“We are convinced that considering ESG factors results in better informed investment decisions and therefore leads to better results for our clients. […] By exercising our voting rights and engaging with the companies in which we invest we aim to have a positive impact on both our investment results and on society.”
The firm already has investment exclusions on several areas of the market. These areas are controversial behaviour, companies in severe breach of the United Nations Global Compact (UNGC) and Development (OECD) Guidelines for Multinational Enterprises, those involved in the production of palm oil and controversial products, including the production and manufacturing of weapons, tobacco and fossil fuels.
Carola van Lamoen, Robeco’s head of active ownership and the head of the sustainable investing centre, said the latest exclusions deal with the “worst of the worst”: carbon emitters.
Van Lamoen said that Robeco wants to support progress towards a low carbon economy, seeking alignment with the Paris Climate Agreement. This is an agreement between the UN members to take a global response to climate change and keep the global temperature rise this century below 2C.
Part of this process, van Lamoen said, includes supporting an economic shift away from fossil fuels.
“What we’ve done is we’ve focused on the worst of the worst,” she said. “So we’re excluding thermal coal, oil sands and Arctic drilling. We focus on those fossil fuel activities which have the most severe and negative impacts on worldwide carbon emissions.”
Companies which derive more than 25 per cent of their revenue from thermal coal or oil sands, or more than 10 per cent from Arctic drilling, will be barred from Robeco’s investment portfolios.
Thermal coal is the highest carbon-emitting source of energy in the global fuel mix. Meanwhile, oil sands are among the most carbon-intensive means of crude oil production and Arctic drilling poses higher risks of spills compared to conventional oil and gas exploration, as well as having potentially irreversible impacts on the Arctic ecosystem.
These exclusions apply to all of Robeco’s mutual funds including sub-advised funds, but not to client-specific funds and mandates.
But why engage with companies involved in these practices at all? Why not put the threshold down to 0 per cent?
Van Lamoen said sustainability is not something that can be achieved overnight as it is a “transition” for companies to move from being high carbon emitters to more sustainable businesses.
Engaging with companies during that transition is a huge part of the management’s process, van Lamoen said, and the companies in that stage still present investment opportunities.
“Within the engagement we’re focusing on lowering the carbon footprint of companies and also making high carbon companies transition-proof. And we will keep that focus to decarbonise,” she said.
But there are limits as to which companies can be reasonably engaged with to make lower carbon changes, van Lamoen said. Ultimately companies above these 25 per cent and 10 per cent thresholds are beyond the reasonable point of becoming sustainable.
She said: “The companies which are proposed for exclusion are now far away from a reasonable rate of transition and basically we concentrate our efforts where sectors and companies can make a meaningful change.”
One of these sectors is the automotive industry, an area where van Lamoen said “a multi-decade transformational change has begun”.
“What we see is that ultimately manufacturers are starting to transition to electric cars and place more emphasis on renewable transport systems. If you compare this approach in the automotive industry to a couple of years ago, this is a massive change,” the Robeco head of active ownership explained.
“We started that engagement [with nine car companies] in 2017 and at that time achieving zero emission transport was not even being considered by any major car manufacturer. But now three years later the world is thinking [about it] and there is an industry acknowledgment of achieving zero emission transport.”
This, van Lamoen said, is an example of an industry where there are substantial efforts being made to lower carbon emissions.
“We do this for a reason and it’s part of our entire sustainable investing approach. Being a sustainable investor not only means you exclude it means that you integrate ESG, you vote, you engage,” van Lamoen concluded.
“And for those companies which are the worst of the worst you also exclude.”
October’s edition of Trustnet Magazine asks if property can bounce back from its slump and advises how to get your finances in order of you lose your job.
The latest issue of Trustnet Magazine, out today, focuses on the continuing fallout from the coronavirus crisis. With a significant proportion of businesses realising their employees can quite easily work from home as a result of the economic lockdown, Pádraig Floyd asks if commercial property is the latest sector to be disrupted by technology.
Meanwhile, Rebecca Jones asks the experts for the best way to invest any money you had previously written off on a rail season ticket and Anthony Luzio finds out how to get your finances in order if you are worried about losing your job in the current economic climate.
This month’s sector focus falls on IA North American Smaller Companies, which Adam Lewis discovers is the best sector for anyone who wants to maximise their exposure to the US economy.
In the regular columns, John Blowers reveals what action you can take to counter some of the biggest failings of the pensions industry, CFP SDL Free Spirit’s Andrew Vaughan names three companies that focus on re-investing cash flow into their business to deliver compound growth, and Nexus IFA’s Kerry Nelson reveals which fund she is using for protection in case the market has underestimated the threat of inflation.
As always, Trustnet Magazine is free – you do not even have to enter any details. Simply click here to start reading, then click the arrow pointing down on the right-hand side of the screen if you want to download the PDF.
AJ Bell’s Laith Khalaf explains how UK smaller companies have historically found a way to deliver long-term returns even during difficult periods for the wider market.
While the dual impact of Brexit and a new wave of Covid-19 cases has made the UK market seem unappealing to some investors, there is one part of the market that has delivered attractive returns over the long term.
Laith Khalaf, financial analyst at AJ Bell, said the UK small-cap space offers greater opportunities than its larger peers.
“Smaller companies have the potential to deliver higher returns over the long term than their large-cap cousins,” said Khalaf. “They have greater scope to both grow their earnings and to become more widely recognised by equity analysts and professional investors which serves to boost share prices.”
Performance of FTSE Small Cap vs FTSE 100 over 20yrs
Source: FE Analytics
As the above chart, shows, over the last 20 years the FTSE Small Cap index has returned 172.03 per cent, compared with 93.91 per cent for the FTSE 100.
Brexit and Covid-19 uncertainty mean it can be tempting for investors to try and find a sense of stability in the larger names, but the analyst said historically, the opposite is true.
“No one has a crystal ball which will tell us how markets perform from here, or indeed when would be the best time to invest,” said Khalaf. “However, we can look at historical returns to provide some context, in particular how UK smaller companies fared during the financial crisis.”
Performance of FTSE indices & sector since 2007
Source: FE Analytics
The analyst said if you had invested in June 2007, near the top of the market, the average open-ended smaller companies fund would have turned £1,000 invested into £2,418 today. That compares to £1,510 from the FTSE 100.
“You would have had to have the mettle to watch your investment halve before recovering,” he said. “But smaller companies did recover, strongly.
“Even if your timing is lousy, if you take a long term view and are willing to ride out turbulence, smaller companies can deliver strong returns, given time.”
Below, Khalaf highlights four fund picks for investors looking to invest in UK smaller companies.
Standard Life UK Smaller Companies Trust
Nimmo has run the trust since 1997 and invests in a concentrated portfolio of around 50 stocks and makes use of the asset managers’ quantitative screening tool Matrix.
“The propriety screening tool looks across the whole investment universe to provide ideas for research, based on growth, momentum, quality and valuation metrics,” said Khalaf.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Standard Life UK Smaller Companies Trust has made a total return of 21.97 per cent over three years compared with a 4.49 per cent loss for the average IT UK Smaller Companies peer and 6.39 per cent loss for the Numis Smaller Companies plus AIM benchmark.
The trust is 2 per cent geared, has a yield of 1.6 per cent and ongoing charges of 0.88 per cent. It is currently trading at a 7.2 per cent discount to net asset value (NAV).
Tellworth UK Smaller Companies
The pair recently had to pull the launch of a ‘Best of British’ investment trust, but Khalaf said investors can still access a smaller companies-focused open-ended fund which they have been running since November 2018.
The AJ Bell analyst said while the track record is “too short to be meaningful’, Marriage has a long track record of investing in the small-cap space.
Khalaf said the fund invests in companies with strong franchises and pricing power, as well as companies which the team believe are going though change and which has left them attractively valued.
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
Since launch, the Tellworth UK Smaller Companies fund has returned 2.53 per cent, in comparison to the Numis Smaller Companies plus AIM benchmark which returned 2.88 per cent and the IA UK Smaller Companies sector returning 3.28 per cent. The ongoing charges figure (OCF) is 1.32 per cent.
CFP SDL UK Buffettology/CFP SDL Free Spirit
Finally, Khalaf highlighted two open-ended strategies from boutique asset manager Sanford DeLand Asset Management which have significant exposure to the small-cap space.
The latter is more small-cap orientated than UK Buffettology – with approximately 70 per cent in smaller companies compared to 47 per cent – although both sit in the IA UK All Companies sector.
While the two funds have holdings in common, Vaughan has reduced the number of cross-holdings with Buffettology from around one-third of the portfolio to approximately 18 per cent.
Due to the size of UK Buffettology, it understandably has found it increasingly difficult to take stakes in very small companies.
“That makes Free Spirit a very attractive proposition for people who’ve done well out of Buffettology,” said Vaughan.
“One of the reasons that Buffettology’s performed so well is it was identifying small- or mid-caps seven or eight years ago and holding them and getting multi-bag investment returns out of them.”
Performance of funds vs sector over 3yrs
Source: FE Analytics
While the IA UK All Companies sector made a loss of 8.06 per cent, the CFP SDL Free Spirit fund made a total return of 37.60 per cent over three years while the CFP SDL UK Buffettology fund made 26.34 per cent.
Free Spirit has an OCF of 1.27 per compared to 1.19 per cent for UK Buffettology.
Carl Harald Janson of the International Biotechnology Trust says there will still be plenty of work to be done once a vaccine receives approval.
The world will not return to its pre-coronavirus normal until next summer, according to SV Health Investors’ Carl Harald Janson – and this is assuming a vaccine receives approval before the end of the year.
Janson (pictured), who manages the International Biotechnology Trust, said that there is currently an “arms race” taking place between biotech and pharmaceutical companies, with 37 vaccine candidates in human trials and 91 in pre-clinical development, as at the start of September.
And he noted that the industry is pulling out all the stops to ensure that once a vaccine receives approval, it can be quickly rolled out on a massive scale.
“Usually when you develop vaccines or drugs, you develop the production side in parallel, but you wouldn’t necessarily scale up,” he explained. “But this time it seems that the industry has actually scaled up already and has done this very much at its own risk: if the drug doesn’t work, some losses can be taken.
“But on the other hand, if there is a win, then very quickly there will be a certain number of vaccine doses available relatively quickly. There are already many public declarations about how many units Astra and Pfizer can produce. I think the numbers are in the hundred millions.”
There was good news on Friday when Pfizer said it is likely to submit its Covid-19 vaccine to the Food and Drug Administration (FDA) for emergency authorisation in November. The company has already begun manufacturing the vaccine so it can be rolled out as soon it is given the green light. Ben Osborn, the boss of Pfizer in the UK, said 100 million doses could be made available by the end of the year, of which 40 million – enough for 20 million patients – would end up in the UK.
However, Andrew Pollard, director of the Oxford Vaccine Group backed by AstraZeneca, predicted the first vaccine wouldn’t be ready until the beginning of next year, and it wouldn’t be until next summer that life would go back to normal.
Janson had more sympathy with Pollard’s point of view, predicting it would take three months for the vaccine to be produced in significant numbers and noting there would still be plenty of work to do at that point.
“Say 1 April, you probably have a high number of doses,” he continued. “It takes a little while to get all these doses distributed to the doctors, nurses and hospitals. That doesn’t happen in one day, but I think it should happen in a relatively short period of time, let’s say one to three months.
“And although it is free to be vaccinated, it is not mandatory, so some people might choose not to accede to take the vaccine immediately. So there’s going to be a vaccination curve where you get 10, 20, 30, 40 or 50 per cent of the population vaccinated.
“At the middle of next year, maybe everyone that should be vaccinated will have been.”
Again though, the story doesn’t end there. Janson pointed out that once someone has been vaccinated, it usually takes 21 days before the relevant antibodies have developed and they are fully protected.
Fortunately, however, he said that the changing of the seasons should offer some respite.
“At this point, you also hit the summer,” he explained. “This is a good thing: as we saw this year, there was a reduction in the number of patients that had Covid in summer. Now it’s back up again because it’s autumn.
“If you have the same kind of fluctuation, with cases down in the summer and more people getting vaccinated, maybe by next autumn there are not going to be more new cases.
“This is a personal guess and is not necessarily the view of the International Biotechnology Trust, per se. But my view is that maybe towards next summer is when we can go back to normal.”
Data from FE Analytics shows International Biotechnology Trust has made 261.59 per cent since Janson joined in September 2013, compared with 195.65 per cent from its IT Biotechnology & Healthcare sector and 169.42 per cent from the NASDAQ Biotechnology index.
Performance of trust vs sector and index under manager
Source: FE Analytics
It is trading at a premium to net asset value (NAV) of 2.1 per cent, compared with discounts of 2.96 and 1.76 per cent from its one- and three-year averages. It has ongoing charges of 1.3 per cent, which includes a performance fee, and is not currently geared.
The Fidelity Special Situations manager concedes that value investing is going through a tough time but argues plenty of opportunities can be found.
The UK stock market currently has more investment opportunities than during the peak of the global financial crisis thanks the unique circumstances created by the coronavirus pandemic, according to Fidelity International’s Alex Wright.
While all parts of the global stock market tanked at the start of the 2020 coronavirus crisis, the UK has been among the slowest to recover after taking one of the biggest economic hits. Added to this are the continued complications surrounding Brexit.
This means that the FTSE All Share is sitting on a loss of 18.77 per cent over 2020 so far – significantly below other major indices’ returns for the same period (in sterling terms).
Performance of stocks over 2020
Source: FE Analytics, as at 16 Oct 2020
FE fundinfo Alpha Manager Wright, who runs the £2bn Fidelity Special Situations fund and £525m Fidelity Special Values investment trust, said: “The current market focus has been extraordinarily narrow, leaving large swathes of the UK equity market overlooked and unloved.
“Investors seem to have lost sight of valuations and are focusing on those stocks they think might become long-term winners. The companies currently favoured are typically capital-light and expected to generate high returns - notably, this extends beyond virus beneficiaries.”
This has proved to be a challenging environment for contrarian value investors such as Wright. Fidelity Special Situations, for example, is in the bottom quartile of the IA UK All Companies sector this year after falling 25.5 per cent.
The unique nature of the coronavirus crisis means that even shares in “steady” companies with visible and relatively safe earnings are struggling, the manager said.
He highlighted holdings such as Sanofi, which has strong diabetes, cardiovascular and oncology franchises and a credible Covid-19 vaccine under development, and Imperial Brands with its a core cash-generative business and a loyal customer base as examples of such companies that are being overlooked by investors.
“On the positive side, the current market is resulting in very cheap valuations and the most opportunities I can remember since 2008. We are not having to compromise on quality and are even able to buy companies that are seeing earnings upgrades but remain very cheap compared to the broader market,” Wright continued.
“The result is a portfolio of companies with more resilient earnings, better returns on capital and less debt but on considerably more attractive valuations than the broader market.”
Although value has underperformed growth for much of the past decade, this hasn’t always been the case. Indeed, the value style rallied harder than growth in the first year after the global financial crisis, as shown in the below chart.
Performance of global equities between Mar 2009 and Mar 2010
Source: FE Analytics
At the moment, however, value remains firmly out of favour as investors concentrate on growth stocks that look more attractive in a low interest rate, low growth environment.
Wright has been using this as an opportunity to add to holdings in his portfolios and highlighted life insurers with strong positions in pensions and retirement income as a preferred area.
He argued that the life insurance sector offers investors an attractive combination of cheap valuations, strong demand/supply fundamentals and growing earnings. Recent financial results from life insurers has demonstrated their resilience.
“Aviva is a good example of the value currently on offer and is one of our largest holdings,” the Fidelity Special Situations added.
“It trades on five times 2021 earnings, despite reporting strong first half results that underlined its resilience during the Covid-19 crisis. The insurer has recently appointed an impressive new chief executive and is implementing far-reaching strategic changes aimed at refocusing on its core businesses.”
There are several other areas of the UK market where valuations are “extremely attractive” and positive change is being seen, but many investors are staying away from them, Wright said. This is particularly the case when it comes to UK smaller companies and forms with a domestic focus.
On the other hand, there are pockets of UK stocks that continue to look unattractive no matter how cheap they are.
Wright is significantly underweight oil companies and banks. He noted that UK oil majors Royal Dutch Shell and BP are embarking on a long, complex and high-risk transitions towards a more diverse energy mix, which will likely put pressure on future cash flows, while the banks will continue to suffer from low (or even negative) interest rates and potentially deteriorating credit demand.
Looking forward, the coronavirus pandemic is an obvious source of near-term uncertainty and normal activity will not be fully resumed until an effective vaccine is developed. In addition, those investing in the UK have the complicating factor of Brexit and what the country’s eventually relationship with the EU will look like.
“Improved clarity on these matters may well be the catalyst for investors to broaden their investment horizons beyond the narrow range of secular growth stocks currently in favour,” the manager finished. “The recent period has been painful for value investors, but we believe it sets up a very attractive opportunity set and very good upside potential from here.”
Performance of fund vs sector and index under Wright
Source: FE Analytics, as at 16 Oct 2020
Wright has managed Fidelity Special Situations since January 2014, over which time it has generated a total return of 15.32 per cent. While this puts it in the third quartile of the IA UK All Companies sector and is behind the benchmark, it’s worth noting that the fund was ahead of both until the coronavirus pandemic struck.
The manager has a longer track record on Fidelity Special Values, which he has worked on since September 2012. Since then, the investment trust has made a 105.39 per cent total return – beating its average IT UK All Companies peer (up 72.46 per cent) and FTSE All Share benchmark (up 49.89 per cent) by a wide margin.
Fidelity Special Situations has an ongoing charges figure (OCF) of 0.91 per cent. Fidelity Special Values has ongoing charges of 0.97 per cent, is trading on a 7.84 per cent discount to net asset value and yields 3.17 per cent.
Ed Smith, head of asset allocation research at Rathbones, considers whether equities can continue to rise as the economy recovers from the impact of the Covid-19 pandemic.
Global earnings expectations seem unreasonably high for 2021, despite the distinct possibility of continued economic weakness into next year. The most optimistic forecasts for global economic growth would still put the world’s GDP about 3-4 per cent below pre-pandemic levels.
That would be on the more severe side of a ‘normal’ recession — one that isn’t precipitated by a financial crisis — and akin to the downturn of the early 1990s. This macroeconomic picture is greatly at odds with expectations for listed companies’ earnings, what’s called microeconomics in the trade. According to consensus estimates, profits are set to soar next year, partly due to the extremely depressed levels seen this year.
The initial economic recovery has been much better than people had expected when we were in the midst of the second-quarter lows. The Citi Economic Surprise index is a measure of how actual economic data readings match up with analysts’ expectations. As you can see from figure 1, US data has posted the greatest run of positive surprises on record — by quite some margin. And the picture is the same in the UK and Europe.
Riskier assets, such as stocks and corporate bonds, tend to move with macroeconomic surprises, so this no doubt helped spur stocks higher over the summer. Yet these surprises tend to mean revert — forecasts catch up with reality as expectations are revised — and this alone could remove a short-term driver of returns. On top of that, there is huge scope for economic data to disappoint in the months ahead. Leading economic indicators already suggest the stellar run for stocks may soon moderate as support programmes roll off and confidence slides.
If analysts’ earnings forecasts come to fruition, next year’s profits will be higher than they were in 2019 for every sector of stocks bar finance and real estate. We are sceptical that earnings can recover so far so quickly, especially in some of the more beaten-up areas of the market (figure 2). It is hugely uncertain how this unprecedented recession will play out, increasing the risks to profits, in our view.
Running out of steam
There are already some signs that the initial recovery may be running out of steam, especially in Europe. In July, retail sales growth contracted in many developed and emerging markets. Global surveys of business confidence confirm a slower pace of improvement and in many economies, manufacturing barometers have fallen back to levels that suggest output is falling again, even though industrial production is still more than 10 per cent below pre-Covid levels. Ordinarily, these manufacturing surveys would send persistently positive signals for many months after their recessionary lows. Meanwhile, household confidence — even in the US where the recovery has been relatively strong — has barely budged from April lows. Among those with lower incomes cohorts, the mood reached new lows in August. This isn’t quite enough data to firmly conclude a change in trend, but it’s enough to make us cautious.
Unemployment continues to be the biggest risk, in our view. This figure holds the key to recoveries because it colours the mood of the whole economy. When unemployment is high, people are wary of spending in case they get the chop next. They put off big purchases, like upgrading the fridge or the home it goes in, and worry about spending on the little stuff, like going to the cinema or buying fancier food for dinner. All of those individual decisions add up to less business for companies, which then cut projects and jobs to protect profits. That works in reverse, too. When unemployment starts to fall it kickstarts a wave of spending and demand for goods and services that drives economic growth, encourages businesses to expand and reinforces the confidence of households.
UK unemployment has remained artificially low because of the furlough scheme. US unemployment gives a clearer picture, however. The jobless rate fell quickly from a peak rate of 14.7 per cent in April to 8.4 per cent in August. Excluding those labelling themselves ‘temporarily unemployed’, however, unemployment is still creeping up. If a large chunk of these people end up unemployed for more than six months, then history suggests they may find it difficult to ever find a new job, which would be a headwind to the ongoing recovery. This isn’t solely a low-wage phenomenon either: unemployment in finance and IT is still roughly as high as during the global financial crisis.
Historically, stock markets recover from recessions when unemployment is still high. That’s because markets anticipate the green shoots that are about to break surface and — crucially — they assume that unemployment will start to fall in a linear and consistent manner, as it invariably has in the past. But it is conceivable that unemployment may get stuck this time or start to increase again in the fourth quarter as temporarily laid off or furloughed staff end up not getting re-employed.
Risk of a second wave
Markets have proved relatively resilient in the face of a severe ‘second wave’ of Covid-19. That’s because the rate of hospitalisation and, particularly, deaths have remained lower than during the initial outbreaks. Better treatment and a younger age profile of cases have allowed governments to refrain from redeploying the most stringent lockdown measures.
Whether this can continue into the winter is unclear, however. The highly contagious virus is stubbornly difficult to contain, so is likely to dampen economic activity — and therefore employment prospects — for some time yet, even though there really is a long way to go to get back to where the world was at the turn of 2020. It seems most likely that governments will persevere with a sort of ‘whack-a-mole’ approach of localised restrictions, rather than resort to second nationwide lockdowns. If we’re correct, that means the chance of another Jules Verne-like plunge in global GDP is remote.
We believe the situation warrants a bias towards ‘growth’ businesses, which are less reliant on improving GDP for their profits, and ‘quality’ companies, whose earnings vary less than the average from one year to the next. These companies won’t benefit as much from a surprise improvement in the global economy, yet they should be more resilient to disappointments. They also tend to hold less debt relative to their profits, which insulates them from increasing bankruptcies and the rise in borrowing costs that usually accompanies them.
But what if it all goes horribly right?
The truly unimaginable scale of public sector support has kept unemployment and business defaults from ever getting near the horrendous expectations of analysts when lockdowns first loomed. Financial stresses were contained, leaving borrowing rates and bankruptcies nowhere near where they were in the last crisis.
It may just be that we’re being way too cautious. It may turn out that the astronomic injections of cash by central banks, the sacks of loans, guarantees and waived and deferred taxes will help businesses and households power out of this downturn like never before. As we’ve said many times, this situation and the responses to it are unprecedented. No one knows for sure how this will play out over the coming months and years.
Companies have been given tax breaks and wage subsidies and essentially free money to stay afloat. Many American households were given more cash during pandemic-induced unemployment than when they were employed and people weren’t allowed to evict tenants. Essentially, in many countries, all the bad stuff and panicking wasn’t allowed to happen.
With the Fed’s recent adoption of a more flexible inflation targeting framework and the continued ultra-dovish stance of other major central banks, there could be yet more monetary policy stimulus coming down the pipe. Contrary to what you may assume, the Fed’s Congress-approved business support packages have hardly been touched, so there’s plenty of help out there. The amount of policy space available should be supportive of the equity markets even if the economic environment deteriorated again.
Ed Smith is head of asset allocation research at Rathbones. The views expressed above are his own and should not be taken as investment advice.
Schroders’ Sarah Liu says that while the rest of the world battles with rising cases of Covid-19, China is returning to normal levels of activity.
Western nations are bracing themselves for a difficult winter period as the coronavirus pandemic will coincide with seasonal flu threatening the burden on healthcare and increasing the level of restrictions.
China on the other hand have lifted restrictions as a result of successful track & trace system, boosting the consumer sector in allowing shops and restaurants to stay open.
Sarah Liu, head of China A-shares research at Schroders, said investment and export areas have so far led the recovery, but this is now being joined by the consumer sector.
Private consumption currently accounts for 39 per cent of gross domestic product (GDP) in China, a relatively low figure when compared to 68 per cent for the US and 54 per cent for the eurozone.
“Despite the setback this year, we expect this figure to rise further as the transition from an investment-led to consumption-driven economic growth model continues,” said Liu.
The International Monetary Fund (IMF) is projecting China’s economy to expand by 1.9 per cent in 2020, putting it on track to be the only major world economy to grow this pandemic-hit year.
By contrast, the US economy is expected to shrink by 4.3 per cent, while the eurozone is forecast to contract by 8.3 per cent, the IMF said in its latest update this month.
E-commerce is expanding and accelerating
Like the rest of the world, the rate in which e-commerce has accelerated since March has been one of the key themes of the pandemic.
In China, the largest beneficiaries have been the segments which were previously unpenetrated by online sales, according to Liu.
This has opened up markets where consumers were previously unaccustomed to buying products online, such as the delivery of fresh foods and groceries and the purchases of larger home appliances.
In education too, almost all of Chinese students made the switch to online learning during the year, increasing the penetration rate to over 90 per cent in the first half of the year.
“This was an area which parents and students were particularly reluctant to switch from offline in the past,” she said.
Dominance of market leading companies
The Schroders head of China research outlined that industry leading consumer companies are considerably increasing market share.
“The largest players have greater economies of scale, are growing faster and are able to cut prices in order to consolidate the market,” she said.
The growth of e-commerce has had the added benefit of providing consumers with better information availability and therefore better price awareness.
Liu gives the example of Midea, the world’s largest home appliance manufacturer, who cut prices of air conditioning units to the lowest point in a decade this year.
Higher levels of research & development (R&D) budgets allow for investment in new technology which accelerates the level of automation and enables costs to be cut that way.
Overseas consumption is returning to China
Chinese citizens are estimated to account for over a third of global luxury goods spending, yet only a “small fraction of this spending has historically been in China,” said Liu.
This is changing, however, and government measures have begun to encourage domestic spending to support its duty-free industry.
Cuts to value added tax (VAT) and lifting the duty quota cap have allowed for major domestic groups to benefit this year.
“The impact of the pandemic has been to fan this trend,” she said. “With international tourism constrained by lockdowns and quarantines, there has been a recovery in domestic tourism, which should continue to benefit after the pandemic abates.”
The split between luxury and mass market
China’s burgeoning middle class has increased average incomes and the preference for luxury goods and services.
This was apparent between 2008-2018 when average selling prices showed consistent increases.
“But this trend is not as uniform as it once was,” she added. “In fact, the reverse is true over the past few years for some segments. What we see today is consumer behaviour becoming somewhat polarised.”
Liu stated that luxury brands have seen strong growth in demand while mass market consumers have become more value conscious, exacerbated by the financial pressures of the pandemic.
“While companies offering value for money, or those with a strong luxury brand are performing well, it’s the brands in the middle who face the greatest pressure,” she noted.
Online integration of resources
Many of these companies in the consumer space are looking to integrate their online and offline businesses.
According to Liu, the aim is to share their stock, marketing campaigns and customers, which will improve supply chain efficiency by keeping stock closer to the end customer and reduce shipping costs.
This is also extended to the sales side, which has seen investment in supply chain and inventory management systems.
For example, ANTA Sports recently announced the acquisition of 30 per cent of its distributors.
Liu said that in the near term the focus on Covid-19 will still impact China’s global economic activity, but the consumer sector will become an increasingly important component of the economy.
Analysts at Stifel argue that investing actively as opposed to passively has proven to be better in Japan and compare three Japanese investment trusts.
The argument for investing in Japan using investment trusts rather than a passive solution is strong, according to analysts at Stifel, who have highlighted the strong outperformance of several funds they cover.
Stifel analysts highlighted three investment trusts that have outperformed the Topix benchmark over one-, three- and five-year periods.
“The trusts have been able to do this by using cheap leverage and strong stock selection,” they said. “This has more than compensated for them having higher fees.”
The analysts said this illustrated the trusts’ growth-focused approach, which has been ”very much in vogue for some time” and explains why the strategies have performed strongly.
Each of the three trusts follow growth-focused investment philosophies, with between 51 and 57 per cent of their portfolios invested in information & communications, electronics and services. These sector weightings represent significant overweights relative to the benchmark, where the Topix has a 31 per cent allocation.
The analysts also noted that all of the fund managers actively try to get exposure to the structural growth of the internet and factory automation, with between 40 and 50 per cent of their portfolios invested into these themes.
Fidelity Japan Trust
The first trust highlighted by the Stifel analysts was the £370m Fidelity Japan Trust managed by Nicholas Price, who has been running the fund since 2015.
This is the only trust the analysts rate as positive and is the best performing fund over five years.
The cheapest of the three, the Stifel analysts believe it has the greatest potential to re-rate.
They said Price finds many of the most interesting opportunities in the mid-to-small cap space – where almost half of the 101 names in the portfolio come from –and has a more active trading approach selling when an investment approaches its target price.
The Stifel analysts noted that the manager had “demonstrated his confidence in the market opportunity” after seeking and being granted permission by the trust board to increase leverage to 25 per cent, to take advantage of the Covid-19 market sell-off.
While this level of leverage was significantly higher than normal, the analysts admitted, it “reflected the manager’s conviction”. On average, the leverage of the trust during Nicholas Price's tenure has been 17 per cent, according to the analysts.
As at 15 October 2020, the trust is trading at a 8.5 per cent discount to net asset value (NAV).
But Stifel believe there is room for further narrowing of the discount given the turnaround in performance since Price was appointed lead manager five years ago.
In sterling terms, the trust has returned 165.19 per cent over the last five years, compared to 87.33 per cent from the average peer in the sector and 59.81 per cent from the Topix benchmark.
Performance of trust vs sector & benchmark over 5yrs
Source: FE Analytics
The trust has ongoing charges of 0.97 per cent and is 23 per cent geared, according to the Association of Investment Companies (AIC).
JP Morgan Japanese Investment Trust
The second trust is was the £1.3bn JP Morgan Japanese Investment Trust, managed by Nicholas Weindling – who has been running the fund since 2007 – and Miyako Urabe, who joined in 2019.
Despite delivering strong performance, the analysts said the trust was expensive relative to its own history and therefore gave it a neutral rating.
The fund has a buy & hold approach and is the only trust of the three with a large-cap and mega-cap portfolio overweight with 80 per cent of the portfolio invested there.
The analysts said this may have aided the strategy’s strong performance in recent years, given that the Topix returned an additional 12 per cent over the last three years, compared to the Russell Nomura Small Cap index which has advanced by 5 per cent, in sterling terms.
Despite the use of leverage and strong performance over the last few years, the analysts cautioned that the trust’s discount of 8.4 per cent to NAV as at 15 October 2020, was at the top of its three-year discount range, and ‘well above’ its 12-month average discount of 11 per cent.
In sterling terms, JP Morgan Japanese Investment Trust has returned 159.15 per cent over the last five years, compared to 87.33 per cent from the average peer in its sector and 59.81 per cent from the Topix benchmark.
Performance of trust vs sector & benchmark over 5yrs
Source: FE Analytics
The trust has ongoing charges of 0.69 per cent and is 15 per cent geared, according to the AIC.
Baillie Gifford Japan Trust
The last trust covered by the analysts was the £1bn Baillie Gifford Japan Trust run by Matthew Brett and Praveen Kumar, who have both been running the fund since 2018.
Given that the trust is the weakest performer of the three but also the most expensive on a premium basis in the sector, the analysts have it on a neutral rating. The trust was trading at a 1 per cent discount to NAV as at 15 October 2020.
The trust runs a relatively concentrated overall portfolio, with 67 holdings, and has a significant exposure to the mid- and small-cap space, constituting around 55 per cent of its portfolio.
The analysts highlighted that the Baillie Gifford Japan team have significantly reduced their net leverage to 3 per cent, compared with 12 per cent at the end of March. This was due to the “reduced economic visibility and in order to have dry powder available should significant buying opportunities emerge”, they said.
Historically, Baillie Gifford Japan Trust used to trade with leverage of around 15 per cent, however since Brett was appointed lead manager in 2018, this level has moderated to around 11 per cent, the analysts noted.
They also pointed to the trust’s history of trading at a premium to NAV due to it being the strongest performing fund in the sector. However, over the last five years its performance relative to its peers had “deteriorated”, the analysts cautioned.
“This combined with the funds' expensive valuation has meant that investor demand has moderated resulting in the derating,” they finished.
In sterling terms, the trust has returned 118.75 per cent over the last five years, compared to 87.33 per cent from the average peer in its sector and 59.81 per cent from the Topix benchmark.
Performance of trust vs sector & benchmark over 5yrs
Source: FE Analytics
The trust has ongoing charges of 0.7 per cent and is 3 per cent geared, according to the AIC.
Trustnet asks four fund pickers which funds they recommend holding alongside growth giant Scottish Mortgage Investment Trust.
Scottish Mortgage is the world’s largest investment trust and this, combined some spectacular returns, means it is a mainstay of many investors’ portfolios. But which funds can be used to complement this popular strategy?
The £16bn Scottish Mortgage trust is currently the top performing trust of the IT Global sector across all time frames, making the peer group’s highest total returns over one, three, five, 10, 15 and 20 years as well as over shorter periods.
Over the past 15 years – which includes the global financial crisis and the coronavirus pandemic - the trust has made more than 1,500 per cent – compared with a gain of ‘just’ 275 per cent from its average peer.
Performance of Scottish Mortgage versus sector over 15yrs
Source: FE Analytics
Managed by James Anderson and deputy manager Tom Slater, Scottish Mortgage follows the growth investing style and has a preference of innovative businesses that are disrupting their industries, especially in the tech space.
The high-conviction strategy that invests in well-run businesses for the long term (at least five years) and its top holdings include Amazon, Alibaba, Tencent, Tesla, Spotify and Netflix.
With many investors holding, or at the very least aware of, Scottish Mortgage trust, below are four names to help fill in the gaps alongside it.
Schroder Global Recovery
Running a value style process with a major underweight to US technology, Schroder Global Recovery is completely polarised to Scottish Mortgage. This is exactly what makes it a complementary holding, according to AJ Bell’s Ryan Hughes.
“With Scottish Mortgage having a clear focus on growth investing, the obvious point to look for a complementary holding is with a value manager,” he said. “Value investing is horribly out of fashion at the moment and as a result there are fewer managers pursuing this approach where once it was the predominant style.”
Hughes said that Schroder Global Recovery’s correlation to Scottish Mortgage is just 0.46 since it launched just under five years ago, which highlights how the two are invested in very different areas.
“While performance has clearly been painful, it would certainly bring diversification to any portfolio with Scottish Mortgage but will give some protection should the market pivot towards value investing,” he added.
As Hughes pointed out, value investing has struggled since the 2008-9 financial crash, as the persistently low interest rate environment has favoured growth stocks.
Growth versus value over 10yrs
Source: FE Analytics
But this is where the strength of the Schroder management team comes into its own, according to GDIM investment manager Tom Sparke, who also picked the Schroder Global Recovery fund.
He said: “One of the most prominent value teams in the market today is that of Schroders, whose Recovery funds have an embedded process of picking companies that are on low valuations but with good turnaround prospects.
“The experienced Global Recovery fund team share the longer-term view of the Baillie Gifford team but run a more diverse portfolio of assets within which you would not find any common holdings with Scottish Mortgage investment trust.”
Over the past three years, Schroder Global Recovery has underperformed against its MSCI World benchmark and IA Global peer group, having lost 13.14 per cent.
Performance of fund versus sector and index over 3yrs
Source: FE Analytics
It has an ongoing charges figure (OCF) of 0.94 per cent.
Ninety-One Global Special Situations
Sticking with the theme of holding an utterly polarised style fund, FundCalibre’s Juliet Schooling Latter recommended the £137m Ninety-One Global Special Situations fund.
“It is chock- full of value stocks – companies that are cheap and out of favour,” she said.
“It has a bank, builders’ merchant and airline in the top 10, so it’s quite risky and has suffered in a growth environment. But if we do get a snap back in value – or the news is ‘less bad’ – it could do very well.”
The fund has made a loss of 23.20 per cent over the past three years, an underperformance compared to its IA Global peer group (up 28.32 per cent) and MSCI ACWI index (up 28.03 per cent).
Performance of fund versus sector and index over 3yrs
Source: FE Analytics
Ninety-One Global Special Situations has an OCF of 0.88 per cent.
JOHCM Global Opportunities
“Alternatively, JOHCM Global Opportunities is perhaps a more cautious option,” Schooling-Latter continued.
“It buys quality companies but has a strong valuation discipline so will have a different portfolio make up to Scottish Mortgage.”
FE fundinfo Alpha Managers Ben Leyland and Robert Lancastle aim to identify long-term trends and themes and then buy undervalued, high quality companies which benefit from these trends and themes for the £402.6m portfolio.
Schooling-Latter said: “The managers very much believes that the price you pay for a company means something in the long term.”
The managers are also happy to hold a large portion of cash in the fund during periods of market uncertainty of “when there simply aren’t any opportunities in the market”, she added.
This ability to hold high levels of cash worked well for the fund during the March-April crisis period. “When the cash position was high and the manager was able to redeploy that money into new, better value, stock ideas,” Schooling-Latter said.
Performance of fund versus sector and index over 3yrs
Source: FE Analytics
JOHCM Global Opportunities has an OCF of 0.85 per cent.
The final pick is the £5.2bn Trojan fund, chosen by Adrian Lowcock, head of personal investing at Willis Owen.
The fund is run by FE fundinfo Alpha Manager Sebastian Lyon and co-manager Charlotte Yonge. Like all of the funds managed by Troy Asset Management, Trojan places capital preservation at its core; it does this by building a portfolio based on quality blue-chips, index-linked bonds, gold and cash.
Lowcock said: “Lyon’s philosophy is to avoid destructive falls in value which makes it easier to then grow returns over the longer term.”
According to Lowcock, this is achieved by considering the risks of an investment from business models, high debt, valuations and corporate governance.
Lowcock said that recently the fund has moved away from its historically UK-focused tilt to now having a “greater US bias”.
The five FE fundinfo Crown rated fund has outperformed both the IA Flexible Investment sector and UK Retail Price index over the past three years, with a total return of 16.82 per cent.
Performance of fund versus sector and index over 3yrs
Source: FE Analytics
Trojan has an OCF of 1.02 per cent.
With the news that Man GLG managers Stephen Harker and Neil Edwards will be retiring next year, Trustnet assess fund pickers’ reactions to the announcement.
This week, Man GLG announced that both Harker and Edwards would be retiring after almost 20 years at the firm.
Both Harker and Edwards have been co-managers of the £1.1bn Man GLG Japan CoreAlpha fund since 2006, while they also co-manage the offshore version of the strategy.
Management of the Man GLG Japan CoreAlpha fund will be handed over to Jeff Atherton, who has been a co-manager on the fund since 2011.
When longstanding managers leave or retire from their funds, it can unsettle investors. This is due to concerns that the process will change or shifts in the equilibrium of the fund’s management could impact on performance, posing the question of whether they should stick with the new management or not.
But Darius McDermott, managing director of Chelsea Financial Services, said that this retirement news should not concern investors in the Man GLG fund.
He said: “Both managers are in the mid-60s so the announcement is perhaps no surprise although may well have been brought forward due to recent working from home practices and a general taking stock of our futures.
“Jeff Atherton, who is also a co-manager, will take on the lead role, supported by a very strong team that has been boosted in the past few years.”
McDermott added: “Whilst the team is losing a huge amount of experience, nothing will change day to day and the team-based process and philosophy will remain.
“Jeff is well known to the market and there will be a very orderly and unrushed handover. I think this is good succession planning and should not be of concern to investors.”
Under the managers’ tenure the Man GLG Japan CoreAlpha fund has outperformed both its sector and index with a total return of 103.22 per cent. This compares with the TSE TOPIX index’s 92.37 per cent rise and the IA Japan sector’s 83.79 per cent return.
Performance of the fund versus sector in index under Harker and Edwards tenure
Source: FE Analytics
That said, the fund is currently in the bottom-up quartile of the IA Japan sector over one, three and five years. Over this last time frame, it has underperformed its average peer by more than 30 percentage points.
Willis Owen head of personal investing Adrian Lowcock described Harker as a “contrarian investor” and noted that the fund is run with a value approach, which has struggled over recent years and has been outpaced by the growth style.
Lowcock said Harker (pictured) believes company valuations revert to a long-term average in price, meaning that he will look for businesses which are unloved by the market compared with its competitors. Harker uses price to book ratio and P/E ratios to assess a company’s value.
This “real value bias” will remain in the fund’s process once he retires, Lowcock said.
“Under Stephen Harker, Man GLG's Japan CoreAlpha team have built one of the leading, and longest running, franchises in the fund management industry, but importantly they have instilled a true team ethos in what they do, and in Jeff Atherton and the other members of the team they have real long-term experience,” he said.
"Stephen is the face of the strategy, and is synonymous with Japanese equity investing, with his focus on long-term reversion to the mean, and a real value bias, instilled in everything the team do. That philosophy won't leave with Stephen and Neil's exits, and because of this, investors don't need to rush to make a rash decision here.”
Lowcock added: "Despite periods of underperformance, the strategy boasts an impressive long-term track record and there's no reason to think that can't continue after Stephen's exit next year."
Rathbones’ Alex Moore explains what has been driving gilt funds' performance this year and what role they can play in your portfolio.
Although they’re not the most exciting strategies on the market, gilt funds have demonstrated what they can add to an investor’s portfolio during the pandemic, according to Rathbones’ Alex Moore.
Over the past year, the returns of the gilt sectors have swung out to extremes: sometimes among the best performers, other times sitting at the foot of the performance table.
Performance of gilt fund sectors over 1yr
Source: FE Analytics
However, while the low-rate environment – and further cuts as part of the Bank of England’s coordinated response to the pandemic – has put further pressure on yields, they have continued to be utilised by investors.
Over the past 12 months, the IA UK Gilt sector has seen bursts of inflow activity.
The strategies saw increased interest in the run-up to last December’s general election between a Jeremy Corbyn-led Labour Party and Boris Johnson’s Conservatives and earlier this year as talks between the UK and EU faltered in February/March.
The onset of the pandemic, the imposing of lockdown conditions and the stimulus-fuelled rally of Q2 saw outflows for the sector as investors looked to redeem from more liquid holdings.
Nevertheless, the increase in the number of Covid-19 cases and the lack of progress on a post-Brexit trade deal has seen some inflows return to the sector more recently
Source: Investment Association
Meanwhile, the inflationary impact of the government’s UK economic response has seen net inflows for the IA UK Index Linked Gilts sector over the past five months.
Yet, the strategies have performed their role in investors’ portfolios perfectly, according to Rathbones’ head of collectives research Moore.
“The interesting thing about gilt funds – and gilts generally – even though returns were low they demonstrated brilliantly how holding them can really improve portfolio diversification,” he said.
“People understand the return profile of gilts quite clearly: you can see how they’re priced and you can see what their coupon is.
“But in times of economic stress, with the flight to safety in a low-yielding environment, gilt funds have been able to return to a client’s portfolio.”
However, as the Covid-19 pandemic and the search for a vaccine continues, the UK economy remains frail and the Bank of England has been unable to raise rates.
Further pressure on the economy from the protracted and fractious trade negotiations with the EU has led the Bank to investigate the possibility of negative rates.
As such, it’s become a more taxing environment for gilt funds, said Moore (pictured).
“Whereas people have been using gilts as a means of supplementing income, now that is proving difficult,” he said. “If you’re looking for a cash proxy even short-duration Treasuries are yielding between 0.1 and 0.5 per cent and that is extremely low.”
Despite a more challenging outlook for UK gilts, however, managers do have other means at their disposal to add value, Moore noted.
“As with every fund there is the ability to go off benchmark,” he said. “Whether it be investment grade credit funds buying high yield or UK equity income funds having the ability to go overseas, gilt funds [also] have an allocation they can use to supplement returns.
“Common off-benchmark positions have historically been index-linked bonds. They can have relationships with gilts and being able to understand those dynamics is important.
“Some gilt funds also like to buy overseas sovereign bonds of comparable credit quality.”
He continued: “You’re obviously paying a fee to utilise their [the fund manager’s] skill and utilise their ability to analyse markets but they do have means of finding incremental returns on top of gilts.”
One of the biggest challenges for UK government paper at the moment, however, is the increasing correlation between gilts – and other areas of fixed income – with equities, said Moore.
“Those longer-term defensive qualities and liquidity qualities we’ve seen with gilts is – at the margin – deteriorating,” he explained. “It doesn’t always happen for very long, it happens in short bursts.”
Moore finished: “In a time like this when corporate bonds and high yield were extremely illiquid, those markets that you can transition and position in and out of effectively can make very efficient tactical asset allocation calls.
“So, [gilts] can still serve a purpose, but it’s important to understand at the moment given how low rates and yields are and how much return they have had this year, the challenge for active managers in gilt funds has got a bit trickier.”
Argonaut Capital Partners’ Barry Norris explains why he is short vaccine companies in his top-performing absolute return fund.
The idea of investors holding out for a ‘silver bullet’ vaccine is misguided, according to Argonaut Capital Partners absolute return manager Barry Norris.
The FE fundinfo Alpha Manager has shorted vaccine companies, as he believes they will have little pricing power and will lose out to the first mover advantage.
While the IA Absolute Return sector has struggled this year – its average member is up just 0.03 per cent – Norris’ FP Argonaut Absolute Return fund has risen more than 30 per cent. The manager credits this to the fund’s low correlation strategy, as oppose to the low volatility tactics of other funds in the sector.
With the introduction of new restrictions in the UK, governments are giving increasing weight to the importance of a vaccine.
“One of the most dangerous ideas is that we can lock down the economy and behave in an exceptional risk averse way because there is a silver bullet vaccine,” he said.
“There’s a lot of misinformation and misconceptions about Covid and this is now the biggest one of those.”
He explained that investors and analysts who talk about different stocks plays dependent on the emergence of vaccine aren’t taking into the account the nature of the solution.
“The question is, will the vaccine stop you being infected, or will it just lessen the symptoms?” he asked.
“Given that over 90 per cent of infections are asymptomatic already, if the vaccine doesn’t stop you getting the infection but just stops symptoms, how will that stop the spread of the disease?”
Norris explained that because trials are only taking place in healthy adults, the people that are most at risk are left out of trials as they’re less likely to generate an immune response.
“My contention is if its 50/50 in the healthy adult population, with lower efficacy in people at risk from Covid, then why is it being styled as this silver bullet to cure Covid? It doesn’t make sense,” he said.
“The only way it could make sense if it’s some sort of psychological placebo to get governments out of the deep lockdown holes of their own making.”
With this in mind, Norris has taken short positions on several companies in the sector who he feels are trading at overinflated values.
“We’ve avoided the blue chip companies as it doesn’t really move the needle for them,” he explained.
“This idea of a vaccine as being the only solution has obviously helped pump up these stocks. But you look at some of the companies developing vaccines and they’re just not credible.”
“Maderna have never ever come up with a vaccine or drug that has been approved,” he continued.
“CureVac have a market cap of $10bn and this is a company that doesn’t have any sales. Considering too the company had an initial public offering (IPO) in July, and in June had a pre-IPO fundraising which valued it at $1.5bn.”
Norris explained that vaccine companies make up about 7 or 8 per cent of the net asset value (NAV) of his fund and around roughly 15 per cent of its short book.
“We closed our short in BioNTech because if any vaccine is going to be approved before Christmas it will likely be the BioNTech/Pfizer vaccine,” he added.
He explained that while there is considerable amount of first mover advantage, there is little for the majority.
“As a group, if one of them gets lucky, then the other lot will go down so you hedge yourself by being short all of them,” he said.
The pricing power of similar vaccines would be hard to gauge and Norris sees no advantage to that.
“My contention would be, even if we got to a situation where the marginal efficacy vaccines were approved, there’s so many that could do that, there are no differentials between them,” the manager said.
He also believes the overinflated valuations is especially prevalent in the small-cap space: “Their share price has gone up a hundredfold because they’ve had a press release mentioning a Covid vaccine, irrespective of whether they’ve got an ability to do so.”
Amidst the backdrop of shorting those stocks, FP Argonaut Absolute Return has enjoyed strong returns year-to-date. While the market had one of the sharpest contractions in history in March, the fund enjoyed its best ever month, returning 15 per cent.
Performance of fund vs sector YTD
Source: FE Analytics
He explained that the absolute return funds that have struggled so far this year have been those focused on low volatility.
“We’ve always marketed it as a low correlation fund,” he said.
“Low volatility means the returns will be modest and fees will be a high proportion of the targeted returns and what we saw in March when the market was down, all the low volatility funds lost money.”
Norris outlined that a low correlation strategy offers diversification in the sense that success and failures come at different times to the market’s successes and failures.
“Most people will own passive and long only funds,” he said. “This is an industry where 99 per cent of equity returns come at the same time.”
He explained that investors are primarily focused on volatility alone as a diversifier, which is not what the FP Argonaut Absolute Return fund offers.
“If my fund only delivers returns at the same time as the market delivers returns then there’s no unique selling point,” he said. “If my returns come at different times then I’ve got a USP and a valuable diversifier.
“If you genuinely are uncorrelated, you don’t want low volatility, because low volatility would mean lower returns.”
He concluded: “Why have a lower uncorrelated return when you have a higher uncorrelated return?”
Performance of fund vs sector since launch
Source: FE Analytics
Since launch in February 2009, FP Argonaut Absolute Return has made a total return of 146.59 per cent. It has an ongoing charges figure (OCF) of 2.67 per cent
Jamie Ross of the Henderson Euro Trust says that because the advantages of a dominant online platform are so obvious, you need to invest in them when “the economics are horrible”.
Many fund managers refuse to invest in businesses that aren’t making any money, and on the face of it, this certainly seems like a sensible idea.
Berkshire Hathaway chairman Warren Buffett once summed up his strategy as: “Rule No 1: Never lose money. Rule No 2: Never forget rule No 1.” It goes without saying that it is easier to avoid a permanent loss from your investments if the underlying business is turning a healthy profit.
However, many of the fund managers that have performed the best over the past decade have done so by recognising the growth of the internet and its associated technologies has turned much of conventional investment orthodoxy on its head.
And Jamie Ross, manager of the Henderson Euro Trust, said that nowhere is this truer than in online platforms.
An example of one of these businesses is Delivery Hero, a takeaway food app that offers obvious benefits to its customers.
“If you go back 10 years ago, you'd probably wander around and pick up some dog-eared bit of paper from the drawer and try and make out the number on it, before phoning up and ordering your chow mein,” said Ross.
“These days a lot of that business is moving to far more convenient app-based transactions where you can have a quick scout around which takeaway restaurants look attractive on whatever night you happen to be ordering. They've already got your details, your address, so it just takes a couple of clicks.”
Ross owns Delivery Hero in his portfolio, along with other platform businesses such as Scout24, “the German equivalent of Rightmove”, and Swiss online pharmacy Zur Rose.
And the manager said that while these platforms make life easier for customers, they provide even greater benefits for investors, which helps to explain why these companies account for three of the top-10 biggest contributors to performance in the past financial year.
“Linking this theme is a really key point about platform businesses that comes to the root of why we like them,” he continued.
“If you think about a platform business and what it does, the first point to make is it doesn't produce anything itself. This is not a manufacturer of products: it sits in between the manufacturer or the merchant of the products and the consumer and it just links them up. So it tends to be capital light.”
However, Ross said the real beauty of platforms – and it doesn’t matter what market they are in – is that they get exponentially more powerful as they grow.
“If you run a platform and you have 100 merchants and 100 consumers, if one extra consumer joins, then all of the merchants theoretically are marginally better off because their audience has increased by 1 per cent,” he added.
“When those merchants benefit, that attracts new merchants to the platform: because those 100 merchants are now doing 1 per cent better, this will probably cause another merchant to join. And you can see that that would have a positive impact on the consumer side of things. So you get this virtuous circle, where anytime anyone joins the platform, its adds utility to every user.
“That means scale brings scale, and scale brings success to these businesses.”
Yet because the attributes of these businesses are so obvious when they reach a significant size, they are often priced at excessive valuations. Not only does this put them out of reach of value managers focusing on traditional metrics such as P/E ratios, it also means the best time for growth managers to invest has long passed.
As a result, Ross said it is better to take a step back, look at the life cycle of these types of businesses, weigh up the potential of those in their early stages and invest before their advantages are apparent to the rest of the market.
In most cases, this means investing before they have started to make any money.
“This is where the beauty of heavy amounts of analysis comes in,” he explained. “If we think about these platform businesses when they launch, the economics are horrible.
“Delivery Hero has generated no cash over the last three or four years. This business is loss-making, so taking it at face value, what's the attraction in that? Who wants to own a multi-billion [pound] loss-making business? But the fact is that to set up and build the power of a dominant platform in a particular market, you have to spend a lot reinvesting the proceeds back into growing a better business that serves the customer and the merchant better.
“Often as an active manager when you find these loss-making or low-profitability businesses, most people will turn their nose up and say, ‘it trades on a P/E of 200x, I'm not interested’. But maybe what they don't fully look into is these businesses are dramatically under-earning because of the investments they are making.
“‘What does that business look like in five years’ time’ is the kind of analysis we've been doing on these.”
Ross said reinvesting to attract customers at an early stage is a particularly important part of platforms’ business models, because local dominance matters – most customers will only have one takeaway app on their smartphone, for example, and will tend to go for the one where choice is greatest.
In this way, he said that Delivery Hero looks well set for the future, as the dominant player in 38 of the 40 markets it operates in.
“This is a very difficult game to be a number two or number three player,” he added.
In a previous Trustnet article, Ross said the board of the Henderson Euro Trust had abandoned its dividend target as it would allow him to avoid mature, cash-rich industries in long-term decline and focus instead on those that are on the way up.
“When we talked about industries of the past and industries of the future, I think you can clearly see which of those two categories platform businesses fall into,” he finished.
Data from FE Analytics shows Henderson Euro Trust has made 16.8 per cent since Ross joined in August 2018, compared with gains of 4.8 per cent from the IT Europe sector and 2.91 per cent from the FTSE World Europe ex UK index.
Performance of trust vs sector and index under manager
Source: FE Analytics
The trust is on a discount of 10.92 per cent compared with 10.95 and 8.7 per cent from its one- and three-year averages. It has an ongoing charges figure of 0.81 per cent and is 2 per cent geared.
Investors can still rely on a blend of carefully selected UK equities for a regular income and good capital growth, according to Schroders’ Sue Noffke.
I have experienced several market corrections in my three-decade investment career and the one we endured early in 2020 was one of the most challenging yet. During the peak uncertainty in March my advice to investors was clear: try your very best to resist knee jerk reactions. We take a long-term view on investing and this didn’t change during Covid-19. Six months later, I can report on early evidence to show that this mind-set is paying off again.
The easing of lockdown measures (in late spring/early summer here in Europe) has been followed by a good recovery in global economic activity. Worryingly, however, we’ve also seen a pick-up in infection rates in a number of territories necessitating the re-imposition of some restrictions.
Despite the ongoing uncertainty, many companies are getting back on track, looking to the future and feeling sufficiently confident to give some guidance on their likely financial performance for the rest of 2020. Where appropriate, a number of companies have also resumed the payment of dividends they deferred in the spring.
Other positive evidence for UK companies includes the unveiling of new investment plans and some sensible mergers and acquisition (M&A) proposals. What we’ve found is that the strongest companies are well-placed to consolidate their positions following the crisis. Incidentally, it is good to see the resumption of bid interest in UK equities from overseas buyers as global deal making begins its road to recovery.
When reflecting on a tumultuous spring and summer, I would highlight the following seven reasons for optimism around UK quoted companies and their dividends.
1. The instances of positive news have been obscured by a focus on high profile dividend cuts
That 2020 will be a bad year for dividends is not in debate, however some pretty dire scenarios for dividend cuts have been tempered since the early spring. Forecasts in April/May that global dividends might fall by up to a third versus 2019 levels have since been significantly pared back.
Those who have taken a measured and long-term investment view during this crisis have already, quite literally, reaped the dividends as they’ve correctly judged which payments were less vulnerable than the market had feared.
To pick out just one example, the decision by Tesco to pay a materially higher final dividend this year is worth exploring.
Clearly the company has benefited from its essential retailer status. However, there has been much hard work behind the scenes over the past few years under the (now outgoing) CEO Dave Lewis. This has helped to rebuild customer loyalty and drive volume growth. Additionally, the agreement in March to sell Tesco’s Asia division for a good price has done much to strengthen the company’s financial position, or balance sheet.
Other resilient business, such as GlaxoSmithKline and defence group BAE Systems (see below) have also continued to pay dividends. Headlines such as “Shell Cuts Dividend for First Time Since World War Two” have helped put cuts front of mind, while the payment of a record $3.7bn final ordinary dividend by Rio Tinto passed by without comment. Meanwhile, “Now BT takes the axe to its dividend: Shareholders will get no annual payout for first time since 1984 privatisation” may have given the impression of endless cuts.
With Covid-19 far from over, from an investment perspective it’s worth remembering the natural tendency in us all to sometimes focus on the negatives, to the exclusion of all else. In our opinion, the resilience of the strongest companies with the strongest balance sheets will increasingly come into focus with time and the benefit of hindsight.
2. The timing of the first wave of the pandemic contributed to the gloomy prognosis
We’ve not had a global pandemic in more than 100 years, so you can understand why many company boards were initially very protective of their balance sheets – BAE, for instance, initially deferred its final dividend for 2019 which it subsequently paid on 14 September, to those who had held the shares prior to the ex-dividend date of 6 August.
The timing of the pandemic contributed to the level of cautiousness. When in early March the World Health Organization declared a global pandemic, a large proportion of companies had already declared their final dividends for 2019. We were approaching the AGM season with late March and April dividend payment dates looming – there was not an awful lot of time for boards to consider the merits, or otherwise, of revising dividend recommendations to shareholders.
Using our own experience, we supported boards taking a measured approach, where appropriate – in the case of personal and commercial insurance provider Direct Line, for instance, this contributed to the board’s decision to keep the final dividend payment under review, rather than cancel it.
3. Companies and shareholders have worked together well
We initiated a position in Direct Line in May 2020 at a very attractive valuation. The company published a reassuring set of interim results in August, revealing that it had not been adversely affected by Covid-19. As a consequence, not only was the board able to confidently declare an interim dividend of 7.4p a share (2.8 per cent ahead of last year’s interim payment) but it also proposed a special catch-up payment, to fully cover the stalled 2019 final – a positive contribution for all shareholders in the company at that time.
These payments reflect the strength of Direct Line’s balance sheet, not least because the company has been able to return cash and comfortably meet ‘capital adequacy’ rules. Capital adequacy rules stipulate the amount of additional funds insurance companies should hold on their balance sheets. These funds are to shield the companies, their policyholders and other financial counterparties in the event of a deep recession or economic dislocation, such as that caused by Covid-19.
4. Governments and central banks have taken lessons from the past
Some pretty catastrophic scenarios were being envisaged in March. Remember, efforts to contain the virus had hit economic activity indiscriminately, everywhere, all at the same time. There was a real fear that many companies would fail.
This was also reflected in very bleak sentiment towards the life insurance companies, to take another example. In order to cover future payments to their policyholders (liabilities), life insurers hold corporate bonds for which the risk is that companies default.
The dire conditions for companies seemed certain at the time to have consequences for insurers’ capital adequacy. In addition, there were fears that the fall in government bond yields following the crisis might have a negative impact as lower rates increase the valuations of insurers’ liabilities, as well as the valuations of the corporate bond assets backing them.
However, governments and central banks took lessons from the past and were, thankfully, quick to offer significant support for individuals, economies and the financial system – the benefits of these actions have been clearly reflected in narrowing credit spreads.
The credit spread is the margin that a company issuing a bond has to pay an investor in excess of government yields and is a measure of how risky the market perceives the borrower to be. The chart below tracks credit spreads for the ‘high yield’, or riskier corporate bonds and lower risk ‘investment grade’ corporate bonds.
5. Markets have rewarded stockpickers
The share price of insurer M&G fell more than 40 per cent in March, which seemed to us an excessively large fall. There are many valuation metrics and many ways in which these metrics can be compared (whether on a relative or absolute basis) in order to judge if a company is mispriced. When a prospective investment, however, offers a dividend yield of 16 per cent (as did M&G at its share price lows) we’re firmly in the realm of absolute value which, ordinarily, one might think too good to be true.
We took a view that the circumstances were extraordinary and that dividends would, in fact, be paid this year, and be sustainable in future years. There were a number of technical factors which meant sellers of the shares were out in force at the time. Meanwhile, gating of the group’s property funds (a temporary measure to limit redemptions in a fund during difficult times, especially one with illiquid assets) and redemptions from a high-profile product hit sentiment more than the economic impact might have warranted.
We decided to initiate a position after combining these observations with our fundamental analysis. This analysis indicated that the cash generated by M&G’s legacy annuity business would largely cover dividend payments. In our opinion, the company was able to make these payments and satisfy capital adequacy rules. In late May, the company confirmed an inaugural final dividend of 11.92p a share, and a “special demerger dividend” of 3.85p following its successful separation from Asian-focused insurer Prudential in late 2019.
Prudential and Legal & General have also paid in full their final dividends declared prior to the crisis, although it should be noted that Prudential’s final payment for 2019 was rebased lower to reflect the demerger of M&G. All of these positives were less visible at the time than was the negative of Aviva withdrawing in early April its recommendation to pay a final dividend for 2019.
6. Many more individual mispriced opportunities remain for both income and capital growth
The recovery in M&G underlines how mispriced opportunities can offer both good income and capital growth prospects. With Brexit in the background - and Covid-19 creating ongoing challenges for the domestic UK economy - sentiment towards UK equities remains poor. Global investors are not, however, discriminating between internationally focused companies and the domestically focused ones which we believe face a more uncertain outlook.
Of all the regions, we are perhaps most optimistic about the growth outlook for Asia where many countries have previous experience of virus containment, better contact tracing programmes and younger, healthier populations. Once it has demerged the US business, Prudential, for example, will be squarely focused on the expanding Asian middle class which is driving spending on healthcare and pension products, opportunities not properly reflected in the valuation in our view.
The UK equity market’s overlooked status has also created a relative valuation opportunity in a specialist distributor of plumbing and heating products, Ferguson. The company operates almost exclusively in North America but trades on a lower price-to-earnings multiple versus its US peers. In this context, news earlier this year that it will seek approval for an additional listing in the US in 2021 made perfect sense.
7. Investors who are able to be patient should benefit the most
Sometimes it takes external events to wake investors up to a mispriced opportunity. We’ve seen this with security company G4S which, earlier this month, rejected a bid approach from private equity backed and Montreal headquartered peer Garda World. Prior to the bid, and before Covid-19, we pushed for the sale (in preference to a demerger) of G4S’s cash solutions business, culminating in Brinks purchasing it for £660m in February. As a result of a strengthened balance sheet, simplified structure, emerging markets’ exposure and investment in new technologies, G4S’s long-term prospects look good. In time we expect it to return to paying a dividend at an attractive level.
As a holder of 10 per cent of G4S shares, we believe that the bid proposed by Garda World and BC Partners materially undervalues G4S and its prospects. However, we are open to a deal at a fair price that more accurately reflects peer multiples, synergies and other strategic benefits that an acquirer will gain from.
More broadly, it is encouraging at an overall level to see the resumption of interest in UK equities by large and experienced long-term investors.
William Hill is another company where we’re willing to be patient investors. The gaming group is in a good competitive position to expand in the US – paying a dividend now could well curtail its ability to maximise these opportunities.
These situations are very different to those in the oil and telecoms sectors, for instance, where the crisis has exposed pre-existing weaknesses. Despite the initially positive market response to BP cutting its dividend, the company’s transition from fossil fuels to clean energy will take time and the lower oil price environment is compounding the uncertainties which face it.Sue Noffke is manager of the Schroder Income Growth investment trust. The views expressed above are her own and should not be taken as investment advice.
The parameters for all of the Investment Association’s fund sectors have been relaxed in the wake of Covid-19, the trade body has confirmed, although managers have to prove strategies have been impacted by the coronavirus pandemic.
The Investment Association – the asset manager trade body – has confirmed to Trustnet that it has relaxed the parameters for membership of all its sectors, which could allow some managers to go beyond previous limits on things such as overseas exposure and asset class allocations for a limited time.
The decision to allow fund managers to go beyond the sector parameters as a response to the Covid-19 pandemic could potentially make comparison for funds more challenging.
Each sector under the IA’s supervision has a clear definition, setting out the criteria a fund must fulfil for membership. Classification into sectors allows investors and advisers to compare similar funds and strategies.
The trade body announced in April this year that the yield requirements for the IA UK Equity Income and IA Global Equity Income sectors would be relaxed, as companies began to cut dividends in the face of lockdown conditions.
The IA told Trustnet that the decision to focus on the two equity income sectors was taken as these were the two most likely to be affected by the pandemic.
At the same time the equity income press release was distributed, however, the IA provided additional guidance to members that it would be willing to extend such flexibility to funds in all the sectors.
The trade body noted that such flexibility is not being extended to funds automatically and that there must be evidence to suggest the manager was unable to meet the sector’s requirements due to Covid-19.
The system is overseen by the trade body’s Sectors Committee, while an independent monitoring company checks funds monthly to ensure they comply with the sector definition. Usually, if the fund is non-compliant with the sector definition, the committee can remove the fund from the sector.
Under current guidance, however, when a fund fails to meet the sector requirements the IA will enter into dialogue with the asset manager.
If the circumstances of its non-compliance with the sector come as a result of Covid-19 and require a longer-than-typical period to come back into alignment, the IA will allow up to six months for it to become compliant again.
Since being released in April, the guidance was reviewed in September by the Sectors Committee – made up of IA members, IA staff and third-party data companies – and will be reviewed again in January.
“The point of this is to give fund managers some flexibility so that they can avoid taking investment decisions purely in order to stay compliant with the sector requirements in the short term, given everything that is happening with Covid,” the trade body noted. “The fund manager’s focus should be on the best interests of their investors in the long term.”
The change in guidance for the IA’s sectors has not been as widely publicised as those for its two equity income sectors and there are some concerns that investors may not be aware of the change.
Adrian Lowcock (pictured), head of personal investing at investment platform Willis Owen, said while the suspension of parameters in the equity income sectors made sense, given the economic backdrop, there was less of a case for other sectors.
He said: “The issue for investors is that the whole point of these categories is that investors know what they’re buying and know what the rules and limits are on what they’re buying.
“As soon as you remove those rules and limits, it naturally weakens the strength of them. When they did it for the income space it made sense because it was an exceptional circumstance. But doing it for the other spaces? Does it really matter?
"What’s more important the category or whether a fund flips into another [category] for a period?”
While the changes are unlikely to impact on performance or comparison with the peer group, investors should be keeping an eye on the allocations within the funds they own or are researching.
Lowock continued: “While these IA sectors are useful as categories, they’re not an alternative to doing your own research because its important to oversee what’s going on in the fund that you’re buying and not trust somebody else to tell you.”
Darius McDermott, managing director at Chelsea Financial Services and a member of the IA’s Sectors Committee, said the change to the equity income sectors was a sensible decision and that there should be some flexibility on a short-term basis when funds don’t comply with sector criteria.
He said: “This was not just a crisis, this was a crisis that led to dividend cuts on equities where there is a sector requirement. So, I think the relaxation of that rule was appropriate.
“I think there’s always been flexibility on a short-term basis but the IA sectors are there for a reason which is allowing IFAs, investment managers and the public to make some form of sensible comparison against each other.”
However, McDermott said where managers have taken outsized allocations beyond there sector parameters there would need to be some reassessment of whether they remain in the peer group.
“People should have some flexibility in the short term, but in the long term [for example] if you want to be a UK fund you need to have 80 per cent in the UK; if you haven’t then you shouldn’t be in that sector,” he finished.
As the ‘electrification’ of the global economy continues, renewable energy assets could be a call option on electricity prices, according to Premier Miton Investors' James Smith.
Last year, the UK became the first major economy to pass a commitment to net zero emissions into law, kickstarting its transition to a greener economy.
The commitment requires the UK to bring all greenhouse gas emissions to net zero by 2050. But in order to do that, electricity must play a much bigger part of the overall energy mix than it has in the past.
James Smith, manager of the £57m Premier Miton Global Infrastructure Trust, said this “electrification” of the economy could put some upward pressure on electricity prices in the future.
Over the last decade, electricity prices have had quite a bumpy ride downwards.
The average monthly cost of electricity per megawatt-hour has gone from around £40 in 2010 to £28 as of June 2020.
Price of electricity in the UK over the last 10yrs
Smith said this decrease is down to the huge gains in electricity efficiency over the past 10 years, which has resulted in less electricity being consumed.
This has even been seen among everyday household items such as lighting and washing machines, the manager noted.
He said: “If you replace an old bulb with an LED bulb, it’s using 80 per cent less power, and your new washing machine compared to one that is 10 years old is like 50 per cent more efficient.
“Every year in Europe for the past seven or eight years, power demand has been coming down by 2 or 3 per cent quite consistently.
“At some point that is going to stop, and we get into this realm of what we call ‘electrification’.”
Electrification is going to be accelerated by the net zero pledge, as well as by things such as the UK government’s indication that it will ban the new installation of gas boilers from 2025, which would mean that electricity heating will be required instead.
Combined with things such as the rise of electric-powered vehicles, Smith anticipates there could be increased demand for electricity by roughly 15 per cent.
He explained: “If you look at where electricity is coming from, we’re to close down most of our nuclear plants over the next seven to eight years, all the coal is pretty much coming out of the system, and a lot of gas plants are loss-making, so you can expect that to come off the system as well.
“Now it’s going to be replaced by renewables and that’s fine, but renewables are intermittent for the most part.
“You can’t call on them to run, it’s what we call ‘non-dispatchable’. So, electricity is going to be more volatile and electricity prices may start to go back up.”
Smith continued: “If an investor owns a portfolio of renewable UK assets whilst electricity prices start to go up and not down due to any increase in cost, it goes straight down to the bottom line.
“If you are an electricity bull, this is a way to play it. Buying renewable energy assets are a good option on that.”
However, the price of electricity in the future is a very complicated equation, which Smith admitted, is problematic to forecast.
“Very few people have an opinion one way or another,” he said. “If you said to the average man on the street, ‘what do you think is going to happen to electricity prices in the next 10 years?’ You’d just get a blank look.”
This is one reason why Alex Araujo, manager of the £294m M&G Global Listed Infrastructure fund, prefers not to not take on what he calls ‘wholesale electricity price risk’ in his portfolio because ‘it is very difficult to call’.
He explained: “We’ve got a tension in the electricity market at a very high level.
“We have the transition towards renewables and the cost of the generation of renewable energy coming down rapidly thanks to efficiency improvements and cost reductions in the supply chain.
“The other side of the story is that we do have a lift in demand in certain areas that we didn’t have before, such as electric vehicle charging for example.
“As we move towards the electrification of heat in households which is not currently the practice, you could see some demand increase.”
He added that in Europe, an important component of the electricity price is the carbon price – the mandated price of carbon – and that price of carbon is only going up.
Despite these factors, Araujo anticipates that ultimately cost efficiencies will win over the long term and electricity prices will come down.
He said: “That doesn’t suggest that we should use more of it, but that is my expectation over time. But in the near term there is that tension.”
And, Premier Miton’s Smith said that for investors who do think a lot about gold and commodity prices, “electricity prices could be an interesting thing to think about”.
We asked Stuart Podmore, our resident behavioural finance expert, what the results of the Schroders Global Investor Study tell us about the reasons behind our investment choices.
Over 80% of investors over the age of 51 said they would not pick higher returns over investing in what they believe in. That compares to 75% for millennials.
So, are millennials less moralistic?
Stuart Podmore: "I don’t think so. I think this actually points to millennial pragmatism.
"There was a happiness study undertaken by Blanchflower and Oswald in 2017, refreshed in 2019, which looked at more than one million people across 51 different countries and examined their level of happiness. The results showed that we’re most happy at age 16 and happiness deteriorates until the age of 48 when we reach a “pit of despair”, after which we become happier through to 90 years old (if we live that long!). A lot of this may be to do with the financial security that is often achieved in one’s later years.
"I think the millennial pragmatism suggested by the study points to the idea that they’re on the downward slope of happiness. Millennials are getting older and they’re feeling the financial burdens and pressures of life – stretching to buy a home, educate children, look after ailing parents, while also putting enough aside to provide for retirement.
"With these greater and broader responsibilities, millennials have to be more pragmatic about their money and perhaps they’re therefore more willing to compromise on their values. Maybe people are more likely to stick to their principles a little later in life when they’ve earned a bit more wealth or are in a more comfortable financial position.
"It could also be that millennials realise that returns are going to become increasingly difficult to come by (as we point out in our Inescapable truths for the decade ahead)."
The study also found that the sustainability issue investors were most concerned about was how companies impact communities and society. Environmental issues and the treatment of staff ranked close behind.
What do you make of this?
Stuart Podmore: "Think back to the early stages of the pandemic when companies’ behaviour towards customers, staff and suppliers came under very close scrutiny. This demonstrated to me the key desire we all share for fairness, one of the broad emotional and expressive needs we have when investing.
"When we believe something is unfair, we experience an intense emotional response and this works in tandem with staying true to our values.
"I see this survey result as endorsement that investors recognise sustainability is not just about climate change or electric vehicles, but about all aspects of a company’s behaviour and how it conducts its business in the long term.
"And in the future, there might be two corollaries from this. First, that our social need for cooperation will be critical for future engagement and change. Second, that investors will altruistically punish those companies that don’t play their part, by deploying their capital elsewhere."
It’s encouraging to note that a significant number of investors don’t think they have to sacrifice returns for their beliefs. The study shows that 42% of investors are attracted to sustainable investing because they believe it can offer higher returns.
What does this tell us?
Stuart Podmore: "It would appear that investors are realising that certain values, needs and wants are achieved in the context of sustainable investments, with a long term perspective. That clients’ wealth objectives can coexist with other needs is a welcome revelation for some, and an area where behaviourally literate advisers can make a tangible difference for clients."
About the Schroders Global Investor Study:
Schroders commissioned Raconteur to conduct an independent online study of 23,450 people in 32 locations around the world between 30 April and 15 June 2020. This research defines “people” as those who will be investing at least €10,000 (or the equivalent) in the next 12 months and who have made changes to their investments within the last 10 years.
This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.
The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.
Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.
Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.
The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.
Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.
The S&P 500 has had one of the best post-crisis rallies of any global market. But has too much too soon made US large-caps a risker investment?
The S&P 500 is one of the few indices that have already managed rebound from the coronavirus crash and exceed their pre-coronavirus levels this year, but has this made it a riskier part of the market?
Year-to-date, the S&P 500 index, which is home of the US large- and mega-cap stocks, has made a total return of 12.04 per cent. As shown in the chart below, very few indices have achieved this level of recovery.
Indices’ performance YTD
Source: FE Analytics
In the space of eight months, the S&P 500 has gone through its shortest bear market in history – dropping from 3,386 points on 19 February to 2,237.4 points on 23 March – before exceeding its pre-coronavirus high by August on the back of massive amounts of fiscal and monetary stimulus.
Yesterday, the S&P 500 closed at 3511.93 points, still ahead of its pre-coronavirus high.
This rally has been largely driven by growth/tech stocks. Companies such as Microsoft, Apple, Amazon and Facebook have thrived in the low interest rate environment, while lockdown restrictions increased demand on tech to carry out working from home and socialising.
But this rapid rally has compounded worries that US stocks’ valuations are too stretched and that the index has become immensely concentrated. A significant share of the S&P 500’s returns are down to just a few tech giants.
The Russell 2000 index – the US small-cap market – has rallied following the initial coronavirus sell-off. But year-to-date the index has made a total return of just 0.85 per cent.
Performance of Russell 2000 index and S&P 500 YTD
Source: FE Analytics
Although small-caps have historically been the riskier asset class compared to large-caps, could the S&P 500 rally’s be a case of too much too soon and could small-caps now be a less risky option?
Brachle, whose runs a bottom-up, quality focused process on the trust, said: “For existing small-cap investors or potential small-cap investors, that’s one of the most exciting things for small-caps in particular.
“If we look at the valuation of small-caps today versus large caps, it’s actually the lowest in two decades. Historically when small-caps are this cheap versus large-caps, they’ve outperformed large-caps by a single digit per cent annually over the next decade.”
The manager added: “Obviously we wouldn’t say that valuation is a catalyst. But it certainly matters when thinking about long-term returns. So you know, that is certainly one of the more exciting things in our view about the small-cap space.”
Brachle pointed out that the major rally seen in the S&P 500 is partially a product of the highly volatile macroeconomic environment this year.
He said: “I would bring it back to the macro environment that we’ve been in and what that has meant for some of the performance.
“Obviously, Covid-19 hit and the US economy ground to a halt for a certain period of time, and then the Fed acted very quickly to lower interest rates. And when you think about that type of environment, people are going to go towards what they perceive to be safer and that’s larger-cap companies over smaller-cap companies, which tend to be a little bit more macro sensitive.”
A similar pattern also played out in the small-cap space, Brachle said, where investors flocked to the more expensive but high returning tech and healthcare stocks during the crisis.
“Both during the sell-off end of February to the end of March and the subsequent rally, tech and healthcare are the only two sectors– and I’m talking small cap here that outperformed the market both on the way down and on the way up,” Brachle said.
Performance of small-cap healthcare and technology sectors versus the index YTD
Source: FE Analytics
This, the manager said, reflects that in volatile periods investors want to go where they are certain of top-line growth for safety.
But although these two sectors have held up well during the crisis, Brachle pointed out that they are two areas the JP Morgan US Smaller Companies trust has been historically underweight in.
Looking at the trust’s latest sector weighting compared to the Russell 2000 benchmark, the trust is underweight healthcare by 6.7 per cent and tech by 1.1 per cent.
But this hasn’t made it underperform over the long term.
Over the past five years, the $223.5m JP Morgan US Smaller Companies trust has made a total return of 76.22 per cent, outperforming both the sector and index.
Performance of trust vs sector & index over 5yrs
Source: FE Analytics
Being able to move away from the benchmark but still outperform is partly what makes being a small-cap manager so exciting, according to Brachle.
He said: “One of the things which excites me personally as a small-cap investor is that it’s a more inefficient market [compared] to large caps.
“It gives managers like ourselves, with a really defined investment process, the opportunity to apply that to a broad universe of stocks and really put together a portfolio that we feel is far better and far higher quality than the overall benchmark.”
Ultimately, the small-cap space creates more room for managers to flex their managerial muscles and implement their process, which Brachle agreed with.
“I think that we’ve certainly found that to be true for our investment process,” he said.
This is something which isn’t as easily done in the highly scrutinised and efficient large-cap space he added.
“If there’s fewer people paying attention to these companies then it gives us more opportunity to apply our investment process to identify good long-term winners. I don’t know how many analysts Apple has covering it right now, for example but it must be dozens and you don’t usually find that in a small-cap space.”
JP Morgan US Smaller Companies is currently trading at a 9.2 per cent discount to net asset value (NAV) – as at 14 October – is 5 per cent geared, has a dividend yield of 0.8 per cent and an ongoing charges of 1.23 per cent.