Market Outlook Autumn 2013
“Courage is resistance to fear, mastery of fear, not absence of fear.” - Mark Twain
INTRODUCTION
There is no doubt that fear has been a big driver of markets over the last 5 years, in fact so much so that analysts have found a way to measure how much fear exists at any one time. The Volatility Index or VIX is seen as an accurate barometer for market sentiment. When investors are feeling nervous about the stocks they invest in they often take out insurance to protect against the downside and when increasing amounts of this type of activity take place, you can observe according spikes in the VIX. The graph below shows what has happened to the VIX over the last 5 years. We can observe the peak in the index when Lehman Brothers went bust in October 2008 due to the sub-prime mortgage crisis. There was a further jump in the index when the the Dow Jones index to drop by 9% in a session only to swiftly recover when investors realised that a computer glitch was to blame. VIX sentiment gradually calmed until June 2011 when the eurozone crisis emerged and the future of the euro looked in doubt leading to another spike in the index. Further eurozone worries and the ability of economies such as Italy and Spain to cope with their debt caused a further peak in late July 2012. Shortly after this Mario Draghi made his “whatever it takes” speech and fear in the markets has gradually
been evaporating ever since with the index dropping to new lows. This means that, from a general perspective, investors are
annum can be earned by investing in a balanced portfolio of funds.
been at any point over the last 5 years. What this tells us is that we are in a very
deposit rates is the main reason that current stock market values can be, and are likely to
crisis. Market fear has subsided following a year of double digit returns from stock markets and there is a general air of optimism about the future. Whilst this is all very positive, those with a more pessimistic approach may say that, lack of fear or not, markets are overvalued and that a crash is just around the corner. Whether or not you agree with this sentiment very much depends upon your view of what ‘over-valued’ means. Value is relative and the key to appreciating this is in understanding how the relative returns of various investments interact with each no risk to capital, I wouldn’t have to try too of potential investors a mile down the road money. Unfortunately, rates at this level are not available at the moment, but they were not so very long ago. Five years ago you could easily take out a societies. Today those institutions aren’t 1%. In this low interest rate environment, but they are available if you know where to look. Dividend yields of around 4% per
collect dividend income, but they also have the potential for capital growth as share prices tend to rise over time. It’s not just cash deposits that have been under pressure recently, some market analysts believe that a “great rotation” is under way. This term is used to describe a potentially huge transfer of money out underlying returns that have been driving this theme. Back in September 2012 the yield that you could achieve by buying a 10 at 3% per annum, investors buying Gilts at this price were guaranteed to lose 1.5% each year. Obviously it doesn’t make sense to hold an investment that is certain to lose money so why were investors willing to do it? The answer is fear that other investments and so large numbers of investors were buying Gilts, pushing prices up and yields down. Over the last year, there is again evidence of investors reducing fear as Gilt prices have been falling and yields are rising. At the time of writing, the yield on the 10 year Gilt has risen to 2.5% per annum. at present suggesting that Gilts are not an attractive long term investment and this is to be the preferred investment destination.
VOLATILITY INDEX (VIX) 2008 - 2013 Lehmans collapse 2010 Flash Crash
Eurozone currency crisis Eurozone debt crisis
03/01/08
2009
2010
2011
2012
2013 Source: Yahoo Finance
FIXED INTEREST
We have reduced our allocation to Fixed Interest by around half. This wasn’t an easy decision to make on the basis that aside from cash, there are few asset classes which remain uncorrelated, but we believe now is the right time to start to trim back and it may not be the last time we do this. Bond markets have become increasingly jittery. The long-term fallout from Quantitative Easing is still unknown and whilst the irony is that the most popular assets to own continue to be Gilts and US Treasuries; corporate bonds look increasingly vulnerable. During the period since our last report, Emerging Market Debt was worst hit. The
rotation” tide turns. We are not yet seeing space of a few days driven solely by the impact of a strengthening US Dollar versus local currency debt. Much of this revision has since washed through and funds have recovered somewhat. We feel this downturn has been driven by a lack of understanding of the asset class rather than it being the most risky to own. In our view emerging market debt is the cornerstone of our
do this. exposed to Western debt and has some so we are maintaining this holding. We have sold out of more traditional corporate bond funds such as M&G Optimal Income and Royal London Corporate Bond. These funds have greater exposure to Gilts and high grade credit, which in our view
PROPERTY
Property has been the main benefactor of our interest exposure. For a long time we have held property solely in our super cautious portfolio strategies; but we have reached the time when we feel that there is scope for the sector in the longer term. We have decided not to increase our weightings to the F&C UK Property fund based largely on the size of our potential allocation versus the size of the fund. When researching property funds we are cognisant of some key factors: how large is the fund and therefore how much exposure are we likely to have within it once we invest; what into which geographic markets and sectors is the fund investing. We have taken an allocation to the Standard Life Select Property and the L&G UK Property funds. The former is in many ways the epitome of the type of property exposure we seek. It is a combination of bricks & mortar holdings with some Real the majority is in bricks & mortar. The fund invests globally. The fund has core holdings in Australian and Eastern European commercial property. The theory behind the latter being improved economic conditions leading to an increase in manufacturing. The Australian economy has tightened over recent times and this has led to an increased focus on capital values rising whilst investors seek yield from the property sector ahead of others. The fund continues to make purchases in areas such as Perth, Australia where supply is constrained.
but returns have been benign at best this year. We retain the Jupiter Strategic Bond fund alongside the Rathbone Ethical Bond fund, because we feel the managers have a better spread of assets and have proven over the years that they can be nimble in terms of where they invest and when. More
On the REIT side of things, markets are more volatile as they remain highly correlated to the US’ decisions on Quantitative Easing. REIT market, but similarly Japan’s sudden dips and rises in the Japanese REIT market, property bubble. The L&G fund is more focused on the UK bricks & mortar property market, but we favour this fund over others due to its ability hope not to see a return to the days of property markets drying up, but we have to class and therefore funds which seek to maintain some REIT or cash like exposure are preferable to those which are purely bricks & mortar. We have looked at many such bricks & mortar funds and they talk a good story in terms of high rental yields and pick ups in activity, but when it comes to analysing the statistics, the growth attained is, more often than not, diminished hugely by the transaction costs associated with running property funds. That is in essence why we have been so cautious on property to date. It is not good that an asset class sounds great when the in an environment where we are likely to see Central Banks cutting back on QE exposure to an asset class, which should
That is not to say that we underestimate M&G, as we maintain holdings in some of interest funds, but we are mindful that a rapid rate and we fear it is only a matter of time before Optimal Income becomes closed to new investors.
UK EQUITIES
The funds listed have performed exactly as we would have anticipated.
returns on a consistent basis. One of the
The Invesco Perpetual High Income fund is the least startling, but even so the manager of this fund is extremely pleased that it is now performing strongly in both bull and bear markets. The prospects for the fund are as compelling as they ever have been with genuine belief that the pharmaceuticals sector in particular will start to generate strong returns over the coming years. The fund is heavily exposed to companies such as GlaxoSmithKline and there would appear to be an impending point when the return on drug patents shifts from being an all or nothing exercise to lower scale, but more
Recovery fund, which at the time of writing was up by around 28% in 2013 alone. We have decided to top up our allocation to this fund and the Unicorn UK Income fund. We are mindful of not being seen to chase returns, but these funds are some of the most exciting in our portfolios because their stock ideas still seem to have a long way to run. The Schroder Recovery fund has seen a couple of boosts over the past few months as banking stocks such as Lloyds have started to gather pace ahead of a much anticipated return to the dividend register. There has been a shift in sentiment towards the banks, amongst institutional investors anyway, but the Recovery fund
gain by being early to the party. The Unicorn UK Income fund is the spicier of the two UK Smaller Companies funds with Harry Nimmo behaving as per usual on a steady dividends are factored in, but the fund selects from slightly smaller companies and so when success stories come through, the fund has an injection of growth ahead of its Alpha fund is one of the more interesting picks. This would be regarded as one of the more punchy funds in the Threadneedle UK not have to be boring. Their historic yield of around 3.6% isn’t the highest in the sector, but it consistently boosts positive capital returns.
TOTAL RETURN BID-BID LINE CHART (FROM 10 SEP 2008 TO 02 SEP 2013) FROM UK RETAIL UT AND OEICS UNIVERSE. REBASED IN POUNDS STERLING. 35%
A
30%
B 25% C D 20%
E
15% F 10%
5%
0%
January 2013
February
March
April
May
June
July
August
C - Stan Life Inv - UK Smaller Companies Ret in
Source: Financial Express 2013
EUROPEAN EQUITIES
We have maintained our current European allocation with the Threadneedle European Select and SVM All Europe SRI funds. Both have returned over 19% year to date. There are some funds in the sector, which have been phenomenal. The Invesco Perpetual European Income fund has been
one of those returning over 28% over the same time period. Such a return across every fund would be fantastic, however, our decision to retain Threadneedle over Invesco highlights our approach to fund selection. Invesco have backed southern could be regarded as higher risk for higher return. We believe that Europe is on the mend, but although Invesco can claim that their enthusiasm has been backed up by performance, the selection of Invesco seemed a risk too far at our current juncture in the European story.
We have retained the Standard Life being. This fund is being challenged by the Blackrock Continental European Income fund. The Blackrock fund has been running for a couple of years and is starting to pick up pace, whereas the Standard Life fund follows their house approach of being less nimble. This latter approach should work well if markets do wobble a bit over the next few months whereas the Blackrock fund is less well tested in such conditions. For this reason we shall keep faith with Standard Life for now, but keep the funds under review.
US EQUITIES
We have switched the whole North American allocation into the Threadneedle American Extended Alpha fund, by selling out of the AXA Framlington American Growth fund. We have been gradually reducing our exposure to the AXA fund in favour of the Threadneedle version. North America is leading the global recovery and we believe
that their renewed verve for innovation and manufacturing will continue, however, there will be inevitable sensitivity to the strength of the US Dollar and a phased withdrawal of QE. We feel that the AXA fund may
statistic we look for when researching funds is the number of positive and negative periods a fund has experienced over a set amount of time. The Threadneedle fund has negative performance.
given the concentrated nature of the portfolio and the bias towards technology. Technology was one of the reasons we economic recovery will ironically adversely The Threadneedle fund has performed marginally better at reduced levels of volatility and will be better placed to make positive returns in falling and rising market conditions. Past performance may not be a guide to future performance, but a key
Our decision to opt for the Neptune US Income fund was validated by Aviva’s fund last week. They are planning on relaunching an alternative fund, but they were concerned that they had taken in its newfound level.
ASIA
We have sold our allocation in the Baring Korea fund. We cannot explain that decision without reference to Japan. We have not entered the Japanese market, but Japan’s resurgence has negatively impacted Korea. Japanese exports have become more competitive as a result of Abe’s version of Quantitative Easing, which has directly hurt Korea. Korea has traditionally relied upon exports of electronic goods and automobiles. The likes of Samsung have become major players in mobile technology, but Korea has too few stocks like this at the moment that can compete with cheaper Japanese goods. We are not convinced that the Japanese revival are waves of goodwill in the air, Korea will face serious headwinds in the short term. We have maintained our exposure to the Newton Asian Income and Neptune Greater China Income funds. China has been an underperforming element in portfolios. There are two schools of thought in this regard with one camp believing that the and the other believing that the Chinese authorities are allowing the economy to slow down ahead of fundamental economic changes. Neptune are in the latter camp. The fund itself has been weak in terms of capital returns, but has been bolstered by a dividend yield above 4%. Prospects for China look uncertain for the remainder of 2013, but ignoring the immediate noise, there are still opportunities in the energy, IT and infrastructure sectors where domestic demand for the likes of cheap laptops shows little signs of abating.
growth opportunities in Asia away from China. The manager is keen on healthcare on the basis that populations are ageing and the opportunity to enter nascent markets in that sector is huge. In terms of regions, the Philippines are one of the preferred areas. The manager sees Filipinos with international experience returning to the region, thus improving productivity and the remains the core holding as valuations look attractive and dividend yields are competitively high.
There has been encouraging news in respect of the Schroder Small Cap Discovery fund as this fund has started to be discovered by a wider audience. We have supported the early gains in the markets. We see no reason to change our approach to this fund, but additional investors coming into the fund call in being early to the party.
GLOBAL EQUITIES
The only change we have holdings is to reduce the First State Global Listed Infrastructure fund in a couple of the income strategies. on marginally reduced dividends across the globe. The fund remains central to the rest of our portfolios. We have increased
Income and the Artemis Global Income funds instead on the basis that they can hunt in similar markets for slightly higher dividend yields. The Standard Life Global Smaller Companies and Artemis Global Income funds remain our preferred choices in the global sector. We have considered alternatives to the Standard Life version, but these have tended to be pseudo-American funds rather than a broader spectrum and so in direct comparison they may seem better on a short time horizon, the more global reach of the Standard Life fund meets our objective for global and emerging market
small cap exposure better at present. Jacob de Tusch-Lec gave a fair synopsis of global markets when we met him in June and he was extremely nervous about a possible tipping point in global outlook. He had made a conscious decision to reduce his REIT exposure and remained committed to more of his boring stocks such as Danish insurers and telecoms. This attitude was encouraging because it would be easy for him to become complacent given the returns he has achieved, but he is being sensible. He had the courage of his convictions to return to Europe early, but he also seems convinced of when he needs to cut back and watch the dust settle. This perspicacity should bode well for investors.
GLOBAL EMERGING MARKETS
We have switched into the Somerset Emerging Market Dividend Growth fund. This fund has been around for a while and we have been monitoring its progress, but until recently it has not been available to UK retail investors. The fund replaces the Newton version and had it been available earlier, it would have been our preferred investment house, who specialise in belies the fact that they manage billions of assets globally, but they prefer to focus on a niche market rather than try to be all things to all men. The manager is based in cash, he won’t necessarily rush to market and top up existing holdings as he is very reserved about where he invests. The fund is a Dividend Growth hybrid, which means that not all assets within the fund have to generate an income, but they do have to commit to growing their dividend yield year on year. The manager believes scope for increased dividend generating growth as well as dividends if they take a longer-term approach. In many respects, it UK Income fund. The fund has consistently means it is within the upper echelons
of the investment universe. The fund is intriguing as it invests in markets, which are traditionally not regarded as dividend hubs. The UAE, Chile and even Korea are good examples of this. We must make the point that we don’t select funds just because they are slightly contrarian, but there is merit in a sound argument, backed up by year on year evidence that the process works. What we particularly like about the manager is the engagement with investors. It can sometimes be a struggle to ascertain what exactly managers are thinking and doing, but Edward Lam who runs the fund, provides a balanced and thought provoking resume each month on the pluses and negatives for the fund together with his comment which has been and gone in recent days. We are maintaining faith in the Invesco Perpetual Emerging European fund. We recently met with the manager Liesbeth Rubenstein and she continues to be pragmatically optimistic on the future.
Turkish tensions were running high when we met her and it was interesting to hear how there is a disparity between what we observe on the news and the reality on the stock market. Yes, undoubtedly the region has struggled of late, but such uprisings are far more commonplace than we may realise and often have little impact on stock values. Economic news coming out of Russia continues to be on the favourable side, but the emerging world as a whole has been punished more than developed markets and invested during uncertain times.
GLOBAL EMERGING MARKETS (CONTINUED)
Neptune Latin America has been a disappointment. Considering 2012 was so strong, 2013 has thus far been extremely few months with a strengthening US Dollar causing local currency depreciation, and populist protests in the likes of Brazil. That being said, long-term prospects remain true. Mexico continues to see political reform passed and has seen global exporters to the US increase their presence in the country. The second half of 2013 should see Mexico start to recover in line with the recent announcement of a National Infrastructure Plan. Peru has had a terrible year on the stock market, but that basic statement dismisses the fact that 60% of Peru’s stock market comprises miners and actually the non-mining Peruvian holdings have fared relatively well. Emerging markets doomsayers continue to dominate headlines and each time
a semblance of good news develops, something negative arises to scupper it. We believe that there is a lack of understanding of the emerging world and it stems from unrealistic expectations. In the same way interest sector generating double-digit returns every year, the emerging world was supposed to shoot the lights out every year. That simply isn’t and won’t be the case, but what is true is that recovery in the emerging world has lagged the developed world only dream of. At the risk of turning chartist, the signs indicate that now is the wrong time to give up on the emerging world,
suggests we need to loosen the shackles on fear and return to fundamentals. Finally, whilst we strongly believe in the long term case for investment in emerging markets, we are also aware of the increasing attractiveness of the so called ‘Frontier Markets’. These countries include the likes of Vietnam, Kazakhstan, Armenia, Ghana and Oman that someday hope to grow into emerging markets. Frontier markets are interesting because historically they have tended be uncorrelated to both developed and these markets are not mainstream investment destinations, they are not as
to the G7 elite forever? Markets before the growth throughout the globe and although it can seem blinkered to review the world since September 2008, longer-term history
money out of EM, but that does not tend to happen in frontier. Clearly this is a sector to watch.
decided to stick with what we have for two reasons. Firstly, valuations have plummeted. There is no hiding from that and the headwinds of a strengthening US Dollar may not be good for gold. That said, gold is still an immensely powerful asset to own and if the world becomes a trickier place, gold and
some of our other fund managers would
COMMODITIES
We maintain our exposure to the Blackrock Gold & General fund. The various discussions we have had around this sector range from selling out of commodities completely, moving into a more generalist natural resources fund or even increasing allocation to take account of such wretched valuations. In the end we
CHANGES AT A GLANCE
doesn’t take much nervousness to see gold
stocks in their own portfolios, so we may not regret topping up our allocation. That is as positive as we can be on the subject, but putting things into perspective, it remains a small part of portfolios. Nevertheless it is a sector that we keep a close eye on, because it is the one area with the biggest capacity
liking. The other reason is that if gold does recover, one would hope that
have to be prepared to move one way or the other should the need arise.
Allocation Increased
No Change
Allocation Decreased
Fixed Interest Property Commodities
THE NEXT STEP
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