The coronavirus pandemic has brought trends that were five to 10 years away forward, making it more important than ever that investors start to rebuild portfolios, according to BlackRock.

Jean Boivin (pictured), head of the BlackRock Investment Institute – which carries out research to help the asset management house's clients and fund managers – said Covid-19 has warranted a complete reassessment of its outlook for markets and the global economy.

He said: “We used to worry and frame things – up until this year – around where we were in the business cycle and how late we were in the cycle. This is not the story anymore.

“Much of our focus is – and understandably so – is on what the evolution of the virus will be and how activity will be restarted. This is the main driver of markets and will continue to be.”

Indeed, the coronavirus is likely to have both a near-term impact on the structure of the investment environment as well as longer-term implications for investor outcomes, said Boivin.

“That will require a deeper rethink of how we build portfolios,” he said. “And the time to do that, in our view, is now.

“The future is running at us. The shock is accelerating the trends that were already in place, it’s pushing us closer to structural limits that we were seeing on the horizon, maybe over the next five to 10 years. But, in fact, it’s pushing us towards those much more quickly.”

These ‘limits’ are structural trends that were already reshaping the investment environment and outcomes, comprising inequality, globalisation, macroeconomic policy and sustainability.

Rising inequality was an outcome of the global financial crisis and the policy response has been behind the rise of populism in recent years. Globalisation, meanwhile, has increasingly come under attack with the global market becoming increasingly fragmented.

The macroeconomic policy toolkit will need significant innovation to deal with the next economic crisis, added Boivin, while sustainability is a burgeoning trend but one that will become increasingly important.

As such, investors need to begin reviewing their strategic asset allocations to make sure their portfolios are resilient enough to withstand or take advantage of these “supercharged” trends.

And there are three investment themes that BlackRock will be focusing on for the remainder of the year: ‘activity restart’, ‘policy revolution’ and ‘real resilience’.

On ‘activity restart’, head of macro research Elga Bartsch (pictured) highlighted the real impact of the coronavirus on the economy.

“We need to be clear: this is not a recession and what we’re going to see is not a recovery, it’s a restart,” she said. “It’s a restart after a major exogenous shock akin to a natural disaster.

“So, the first message for investors is that standard business cycle analysis and data are not really relevant here. What matters more is the cumulative size of the shock to the economy.”

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In normal conditions, Bartsch said, BlackRock strategists would be looking at business data and news flow to assess the extent of a downturn. However, the Covid-19 crisis has been “very visible” and as such the extent of the damage can be calibrated very quickly.

While the near-term contraction in growth has been one of the sharpest and deepest on record, the policy response has – so far – prevented it from becoming a full-blown financial crisis.

As such, current forecasts suggest a cumulative loss in GDP “that is only a fraction of that of the global financial crisis”, said Bartsch, and BlackRock has positioned itself as “moderately pro-risk” expressed in an overweight to credit.

The second trend – ‘policy revolution’ – highlights the huge amount of support that was needed to prevent the “devastating and deflationary impact of the virus shock”.

“What we have seen in terms of speed and size [of the policy response] goes well beyond all the stimulus we had seen over several years during the global financial crisis,” said Bartsch.

“What is even more important is the close coordination of monetary and fiscal policy and that was really predicated on the need to put money directly into the hands of private households and into the hands of companies.

“And that policy response was really good news in the near term because it was helpful in preventing some of the permanent scars you would have seen in if this escalated into a full-blown financial crisis.”

But while has been positive for risk assets, it has had an impact on government bonds – where BlackRock is now underweight – as yields have fallen.

There is also the potential for inflation, prompting the asset manager to move overweight to inflation-linked sovereign bonds, particularly as central banks become more tolerant during in the long-term due to huge government borrowing.

Finally, ‘real resilience’ concerns the supercharged trends the asset manager had already highlighted coming into the crisis.

These trends, said BlackRock global chief investment strategist Mike Pyle (pictured), have changed the nature of portfolio diversification, making it less an asset allocation decision and more about geographies and sectors.

“When we think about what it means to build portfolios that have resilience in the face of those real transformations [in the market],” he said.

“There is a tremendous amount of room to think about building portfolios through sustainable and ESG [environmental, social & governance] exposures that are much more resilient to the world that is coming into being.

“Secondly, around deglobalisation, increasingly across a range of dimension, the country is going to be a fundamental unit of analysis. That’s true because the country level is where policy takes place about economic policy and of course we’re seeing on the health side through public health policies as well.”

He finished: “So what we mean by real resilience is that the kind of traditional financial concept gives way – due to the changing nature of government bonds – [to] building resilience that’s mindful and alert to the underlying transformations of play in the global economy.”

‘This too shall pass’ is a phrase Orbis Investments’ Alec Cutler first heard whilst studying at business school, quickly teaching him about the good and bad weeks investor have in markets.

Repeated by a colleague some years later, Cutler said it taught him that “everything is temporary”, a fact he has held onto during the past few months as Covid-19 upended normality and caused a sharp market moves.

“We should always resist the urge to think that whatever it is today is what it’s always going to be,” the manager said.

“And I feel kind of at a crossroads from a market standpoint, where people are convinced that interest rates are going to stay low forever, that government bond yields are going to stay low forever and that the FAANGs are never going to get knocked off the block.

“And the world changes and that’s what makes it super exciting. Now flash forward and think about Covid and this too shall pass.”

This idea that nothing in markets will remain stagnant and trends will shift needs to be re-remembered, according to Cutler, especially when it comes to the US.

“The US equity market has been the place to be for the past 10 years. It’s been an absolute freight train,” the Orbis manager said, especially during the Covid-19 crisis as investors piled into the growth FAANG stocks [Facebook, Apple, Amazon, Netflix, Google-parent Alphabet].

 

Source: Orbis Investments

The FAANGs now make up over 20 per cent of the S&P 500 index, according to Orbis.

In the same way that the FAANGs dominate the US index, the US in turn dominates the global market too, with the country accounting for 48 per cent of the global market today, according Cutler.

However, he noted that the US’ share of global GDP declined in recent decades – falling from 28 per cent in 2000 to 24 per cent today.

 

Source: Orbis Investments

“The US level of production and global output has dropped since 2000 while its percentage of the world’s equities has only risen,” he said.

While the dominance of US and growth equities has been the ‘norm’ for some time, so has the unpopularity of UK equities. Cutler described the UK as “the most hated market in the world”.

“It’s the second most hated theme to energy and you can imagine how hated energy is. But they’re not that far apart,” he added.

But, the manager firmly believes that just as Covid-19 will pass so too will the popularity of the US and the unpopularity of the UK.

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Such dominance has happened before but with a different market. Back in the early 1990s, prior to the Japan asset price bubble burst and consequential recession, Japan was 40 per cent of the world index and only 10 per cent of GDP, Cutler said.

“This is when the Japanese were going to continue to dominate the world because they were such wizards at manufacturing. But you don’t hear about that much anymore now,” the manager (pictured) said.

“At that time in the 90s Japan was the be-all and end-all and no one could see any possibility to reason or how that could change. Just as they are today with the US,” he said.

And this view is reflected in Cutler’s £41.7m Orbis Global Balanced fund, which is run with a contrarian approach. While it does invest in the US, it has a strong position in the UK with holdings such as Bank of Ireland, AIB, Balfour Beatty, Domino’s, Drax and Headlam.

Cutler has a 20 per cent allocation to the US in the fund but he prefers Chinese internet companies over the popular US options because of three things.

One is valuation because they’re much cheaper, according to Cutler, while the second reason is “technological leadership”.

“Everyone thinks and assumes with a Western superiority complex that Google, Facebook, Microsoft have superior technologies to the Chinese equivalents but that is not true anymore. Tencent and Alibaba are now leading the way,” Cutler said.

And thirdly, unlike the US government, the Chinese authorities will support the big names as they develop a monopolies, making them more dominant.

Cutler concluded: “Think long term, don’t overreact and keep in mind that this too shall pass.”

Orbis Global Balanced has made a total return of 42.44 per cent over the past five years, outperforming the IA Mixed Investment 40-85% Shares sector but underperforming against the MSCI World index.

 

Source: FE Analytics

The fund has no up-front charges but does have a performance fee of 50 per cent of the outperformance of the fund over the MSCI World benchmark.

Financial markets in the first half of 2020 have experienced extraordinary volatility due to the coronavirus pandemic and widespread economic lockdowns.

In March, global equities crashed and lost about three years’ worth of gains in a few weeks but have since made them back over the span of a few months.

High returns usually coincide with high volatility and, as such, the five highest returning members of the IA Global sector – Baillie Gifford Long Term Global Growth Investment, Baillie Gifford Global Discovery, Baillie Gifford Positive Change, Baillie Gifford Global Stewardship and Aubrey Global Conviction – are all in the eighth, ninth or 10^th decile for volatility.

However, this is not always the case and a select number of funds have managed to combine some of the sector’s highest returns with the lowest volatility over the turbulent six months that have marked 2020 so far.

In this research, Trustnet has looked for IA Global funds that were in the top quintile for both high returns and low volatility during the opening six months of 2020.

The table below are the 16 funds ranked by their first-half returns, filtered for those which delivered first quintile returns and first quintile (or lower) volatility. Where available, the five-year return is also shown.

Source: FE Analytics

The Fundsmith Equity fund, run by FE fundinfo Alpha Manager Terry Smith, made the list with H1 returns of 7.46 per cent and annualised volatility of 25.96 per cent.

Despite being at the lower end of the list for H1 performance, it has the highest five-year return of 147.58 per cent thanks its quality-growth approach. It is also the largest fund in the table with £20.2bn under management.

However, several of Fundsmith Equity’s peers have delivered higher returns with lower volatility over this period.

Of the 345 funds in the sector, three delivered first decile returns while also ranking first decile for low volatility.

H1 2020 performance of top decile funds vs sector

Source: FE Analytics

The £159m New Capital Global Equity Conviction fund is the first of these three. The fund looks for 40 to 50 high-quality stocks globally, finding stocks that trade on a cheaper valuation than they believe it deserves, but also where the company’s growth potential is higher than consensus estimates.

It returned 17.5 per cent in H1 and has almost half of the portfolio allocated to US equities, with top three holdings that include Microsoft, S&P Global and Mastercard. However, the fund’s next biggest weighting is in Chinese equities, where it has a 16.2 per cent exposure, including a large position in Chinese e-commerce giant Alibaba.

Next is the £266.3m Morgan Stanley Emerging Leaders Equity fund which returned 13.52 per cent in H1, also ranked highly. It has a focus on global quality companies, but has a heavier weighting to companies within China and India.

It has a 29.2 per cent weighting to Chinese equities, and a 21.29 per cent weighting to Indian equities. It has two of its largest holdings in Chinese tech giants Alibaba and Tencent, and a large position in India’s Kotak Mahindra Bank.

It comes as little surprise that one of the top-performing global funds during a pandemic is one that invests into healthcare and medical-related companies.

The £363.9m Schroder Global Healthcare fund, which returned 12.51 per cent, is the only healthcare-focused fund in the list and the final strategy to appear in the top decile for returns and volatility.

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There are several other funds worth noting also.

At the top of the list for total returns is the AMP Capital Global Companies fund. It invests in a concentrated portfolio of 25 to 35 global companies but is not widely available for sale to investors in the UK.

Like Fundsmith Equity, several funds that appear on the list have a quality-growth approach – which has not only thrived over the past decade but continued to outperform during the coronavirus crisis.

The £731.4m Comgest Growth World fund is one. It has the third highest five-year return, delivering 110.18 per cent, and the lowest volatility of the all funds in the table.

The fund has a higher weighting to the consumer products, healthcare, and technology sectors, compared to its peers, and has only a 38 per cent weighting into North America compared to the peer average of 50.41 per cent.

The £321.2m Trojan Global Equity fund is another notable fund on the list. Like all of the Troy Asset Management’s strategies, it is run with capital preservation at the heart of its process, as well as a preference for quality-growth stocks.

The reason for placing an emphasis on volatility is because it essentially measures the risk an investor takes in the search for return. The volatility can show how stable a fund returns’ are, allowing investors to get a better gauge of risk-adjusted returns.

If a fund is fluctuating with highly volatile returns, performance is likely to be higher, but on the flipside of that, the risk of loss is also higher.

Lower volatility of returns gives an investor smoother and more predictable returns, and can also speak to the consistency of returns.

While a lot of funds delivered exceptional returns during the first half of the year, what makes the funds in the table unique are the top-ranked performance combined with low volatility during one of the most volatile periods of recent financial history.

There have been just two points in the past 15 years when Asian equities have been cheaper than current levels – which suggests the region could be about to embark on a period of powerful performance.

This is according to Ian Hargreaves, who runs the Invesco Asia Trust. The manager said that not only is Asia cheap on a historical basis, with its price-to-book (P/B) ratio of 1.6x one standard deviation beneath its average, it is also cheap on a relative basis, comparing favourably with 2.2x from the rest of the world and 3.4x with the S&P 500.

Source: Invesco

Yet while he believes such low starting valuations bode well for an investor buying in at this point, he warned they need to be selective if they want to tap into the recovery.

“There are two big things going on in markets,” said Hargreaves. “One is the coronavirus, the other is the divergence between value and growth. It is important to note that the divergence had been going on for quite a while before the coronavirus and when it struck, it just accelerated.

“We thought that when the market hit the trough at the end of March, it was too cheap overall. Now it has bounced back 25 to 30 per cent, we wouldn't really say that.

“But what we would say is the opportunities in investing in Asia are now more about this big discrepancy between value and growth, rather than opportunities to just simply ride the wave of the market going up.”

Of course, many managers warned at the start of the year that the growth versus value dispersion had reached such an extreme, a reversion was inevitable – yet in the end, the opposite was true.

Hargreaves admitted it was possible the divergence could go even further, but said in such a scenario he could bring the value/growth split in his portfolio up to 60:40 from its current 50:50 level.

While the manager does not believe the growth names in his portfolio are expensive, any movement far above what he regards as fair value would see him trim these positions in anticipation of a catalyst to spark a value revival.

“So what's the catalyst for a value rotation? It’s the other way around to the way we think, as we are bottom-up: we see where the value is in the market and buy accordingly, then think about top-down,” he added.

“Obviously there are plenty of arguments, such as inflation kicking in. But when we look back at previous changes of leadership, I think sometimes you can point to valuation being the catalyst and I think we're approaching that point.”

While Hargreaves is not a value manager, his process involves investing in companies that he believes are worth considerably more than their valuation suggests.

He said this is possible because a company’s share price is typically more volatile than the fair value of the underlying business. Company fundamentals continuously move and because the market has a tendency to extrapolate both positive and negative shifts into the future, it is possible to gain an edge when it overreaches itself.

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“There are a few key elements of the process,” he explained. “Firstly, we often look in unloved parts of the market for new ideas. We then bring our team skill and experience to bear to really get to grips with the fundamentals of the companies we're looking at and to develop an understanding of where we believe the market might be wrong in how it's valuing the business.

“This requires an ability to think long term and often necessitates the courage to move against mainstream thinking.”

One example of this process in action was the investment in Mediatek, a Taiwanese designer of silicon chips that power consumer electronics products such as flat-screen televisions, smartphones and voice assistant devices such as Amazon Echo.

Hargreaves said the company has a strong record of growth and profitability, generating positive free cash flow in every one of the last 20 years. However, when he started to look at it in January 2017, it had fallen on hard times and its share price was about 50 per cent below its all-time high.

“The problem was that it underestimated how quickly the market in China would transition from 3G smartphones to 4G and its 4G product just wasn't mature at the time, which led to low selling prices,” the manager continued.

“Along with high manufacturing costs, this resulted in a double hit to its margins and profits.

“What got us interested initially in January 2017 was that pretty much 50 per cent of the market cap was backed by cash on the balance sheet and investments it had.

“Even excluding that cash, the company was trading on a low-teens multiple but on earnings that were on margins 50 per cent below historical levels. A low multiple of trough earnings, in essence.”

Hargreaves said that, along with his knowledge of the company’s track record, talks with Mediatek’s management convinced him this was primarily a timing issue that would be addressed by new product launches later in 2017, rather than a fundamental problem with the company's technology.

However, because sell-side analysts were focused more on weak sales in the first half of the year, he was able to invest in the knowledge that the new products would allow gross margins to recover to more normal levels, driving “a leveraged improvement in profit”.

“The downside support from the cash balance and the low multiples strengthened our belief in the significant undervaluation, but what was really important here was our focus on the medium term rather than the short-term weakness in earnings,” he continued.

“If you fast-forward to today, you can see the share price did recover: the 4G chips led to an improvement in margins. More recently, the share price has had another leg-up and that has been driven by a re-rating as it became clear that Mediatek is also well placed in 5G and can benefit from the problems that Huawei is currently experiencing.

“But in our view, it's beginning to approach fair value and so our shareholding has been coming down. This is a very typical pattern that you see in our investments: there's an inverse relationship between the share price and our shareholding.”

Data from FE Analytics shows the Invesco Asia Trust has made 109.82 per cent since Hargreaves took charge in February 2011, compared with 107.16 per cent from its IT Asia Pacific sector and 89.07 per cent from the MSCI AC Asia ex Japan index.

Performance of trust vs sector and index under manager

 

Source: FE Analytics

The trust is on a discount of 12.68 per cent, compared with 11.4 and 11.44 per cent from its one- and three-year averages.

It is 4 per cent geared and has ongoing charges of 1.02 per cent.

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One of the things we’ve looked to do since the launch of our own fund of fund range in 2017, is to find new ideas and sources of growth and income returns. This drive has seen us find numerous opportunities within specialist investment trusts.

Crucially, these trusts have allowed us to diversify our portfolios and reduce the risks from the wider global economy. In a world of low-interest rates, they have also delivered reliable yields at a time when investors have been crying out for them, with the noise getting louder in recent months.

Areas we’ve looked at include the likes of investment trusts investing in renewable energies, such as wind farms or solar panels, which have been taking advantage of government subsidies and the drive towards a carbon-neutral economy.

 

Challenges during the sell-off – but also big opportunities

In the recent sell-off, the level of volatility of these trusts rose markedly. There were days when the market was down 4-5 per cent and they were down 10 per cent – effectively indicating that they were geared to the market. Some of the sell-off was not even to with the trusts themselves, but because people were ruthlessly selling the UK mid-cap index, where a number of these specialist vehicles reside.

We still believe there are big gains to be made from investing in these trusts and the past few months, while tumultuous – have reinforced our views. Why should an investment trust that trades based on whether the wind blows or not – or indeed whether the sun shines or not – go down by 40 per cent in three or four weeks? It shouldn’t, but it did.

And this led to some stark opportunities: we ended up cutting positions in some holdings we really like, in favour of trusts that were on significant discounts – some had fallen 50 per cent with no rationale whatsoever.

And we’re not alone. Other providers have also been using investment trusts to bolster returns. Below are four multi-asset examples.

 

TB Wise Multi-Asset Growth

Managed by Tony Yarrow and Vincent Ropers, TB Wise Multi-Asset Growth invests in around 30-60 underlying funds and investment trusts, with a preference for out-of-favour areas. The managers take high conviction positions, while turnover in the fund tends to be low. The fund uses a number of investment trusts such as the Ecofin Global Utilities & Infrastructure Trust.

 

VT Seneca Diversified Income

This Liverpool-based asset house adopts a strong, value-based approach to multi-asset investing. The four-strong investment team behind VT Seneca Diversified Income execute their ideas via a mix of funds and direct securities. Using both alternative and traditional asset classes enables the team to achieve true diversification, while also delivering a monthly income. The team also uses a number of investment trusts in areas like infrastructure and debt.

 

Premier Multi-Asset Monthly Income

Premier Multi-Asset Monthly Income is designed to produce a high and sustainable income and has risk management at its core. Manager David Hambidge aims to generate equity-like returns, with less volatility via a multi-asset, multi-manager portfolio. The portfolio, which has a historical yield of 5.8 per cent (as at 30 April), has typically had exposure to a number of specialist investment trusts in the likes of the property, healthcare and lending sectors.

 

Brooks Macdonald Defensive Capital

Managed by Niall O’Connor, Brooks Macdonald Defensive Capitalholds a number of instruments, such as convertible bonds, preference shares, structured notes, bond and loan assets, and discounted assets. It aims to deliver positive absolute returns over rolling three-year periods, in a range of market conditions. The fund also has access to specialist investment trusts, such as Hipgnosis Songs (which gives exposure to songs and associated musical intellectual property rights) and Greencoat UK Wind.

 

Darius McDermott is managing director of FundCalibre and Chelsea Financial Services. The views expressed above are his own and should not be taken as investment advice.

The economic disruption caused by the coronavirus pandemic has been dubbed the “The Great Lockdown” by market commentators and the International Monetary Fund (IMF).

Investors are still trying to assess how much of the damage is temporary and how much is permanent, however the IMF has said it is likely to cause the worst economic downturn since the 1929 Great Depression.

In late February, before lockdown, financial markets crashed in an unprecedented wave of selling that caused most asset classes worldwide to fall, followed by an equally unprecedented rapid bull market.

One hundred days have passed since the lockdown in the UK began on 23 March, and Trustnet has looked at 25 of the highest returning funds since this period began. Where available, the five-year return for each fund was also included.

 

Source: FE Analytics

Gold and precious metal funds accounted for 10 of the top-25 in the list.

The top performing fund in the list was the £23.2m MFM Junior Gold fund which has more than doubled since lockdown began, returning 114.54 per cent.

Two of the largest gold funds also made the list, with the £1.4bn BlackRock Gold & General fund run by Evy Hambro and FE fundinfo Alpha Manager Tom Holl coming in seventh.

The £1.32bn LF Ruffer Gold fund came in 15th, but has delivered a 268 per cent five-year return, the highest of all the gold-focused funds.

Investor appetite for gold this year has been largely driven by the central bank measures and fiscal spending around the world to fight the pandemic’s economic fallout.

The precious metal is favoured amongst investors for its hedging properties in the event of market downturns, and as a store of value if government spending causes currency debasement and runaway inflation.

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Gold – as represented by the Bloomberg Gold Sub index below – has rallied 15.79 per cent year-to-date, in US dollar terms. However, investing in gold mining companies which produce and sell gold for profit are considered a more leveraged bet on the gold price, and as the below chart shows the FTSE Gold Mines index – a benchmark of mining companies deriving most of their revenues from mined gold – is up by 28.93 per cent so far this year.

Performance of indices year-to-date (USD)

Source: FE Analytics

Seven of the top-25 funds in the list were US equity-focused funds.

Many US technology companies have seen the adoption of their products or services accelerated by the lockdown and coronavirus pandemic.

The top performing US funds have been those which are overweight the technology companies seen to be benefiting from the growing adoption of e-commerce and cloud software.

In third place was the £4bn Baillie Gifford American fund, which delivered a 70.75 per cent return over the period and 294.67 per cent over five years, the highest of the top-25 with a long-enough track record. The fund’s top three holdings include e-commerce providers Shopify and Amazon, as well as electric vehicle and clean energy company Tesla. It is co-managed by Tom Slater, who also co-manages the Scottish Mortgage Investment Trust.

Lower down in eighth place was the £3.2bn Morgan Stanley US Growth fund, which returned 64.88 per cent over the period. Its top three holdings include Amazon and Shopify, as well as Okta, a cloud-based identity management software company.

The accelerated adoption of technology has also driven the performance of the £168m LF Miton US Smaller Companies fund, which is heavily invested into smaller US tech companies. Two of its top holdings include Everbridge, a company that sells communications services for notifications of emergencies, and Teladoc, a telemedicine and virtual healthcare company.

Of the five UK funds that made the top-25, two were UK smaller companies funds.

The £5.9m MFM Techinvest Special Situations fund, which also focuses on growth technology businesses, returned 68.92 per cent over the period.

The £53.8m LF Miton UK Smaller Companies fund run by Gervais Williams, has also made a strong comeback since the beginning of lockdown, returning 59.34 per cent over the period. The fund’s largest holding is in Avacta, a Cambridge-based biotherapeutics and reagents firm which is currently developing a potential Covid-19 therapy.

The other two UK funds that made the list were FTSE 250-focused funds, one being the £2.8bn Merian UK Mid Cap fund run by FE fundinfo Alpha Manager Richard Watts, which has over 12 per cent invested in online retailer Boohoo Group.

Some of the poorest performers since lockdown began were property strategies, many of which have been gated due to their lack of liquidity and to halt outflows, withthe £411m Aviva Inv UK Property and the £343m LF Canlife UK Property ACS funds standing out.

The post-coronavirus world could see the return of a “proper” corporate bond market, according to BMO Global Asset Management’s Kelly Prior, following a decade of “distortion” by central banks.

In a previous Trustnet article, BMO co-head of multi-manager Rob Burdett argued that events such as the coronavirus crisis often lead to “some form of regime change” that can have an impact on economic conditions, politics, fund management styles, consumer attitudes or corporate behaviours.

Kelly Prior, a member of BMO’s multi-manager people team, believes that one area where this regime change will be seen is the corporate bond market.

As central banks lowered interest rates in response to 2008’s global financial crisis, business took advantage of this by raising money in the bond market to fund aggressive balance sheet management, such as carrying out share buy-backs.

Data from the Securities Industry and Financial Markets Association shows the US corporate bond market was $5.3trn in size in 2008 but had grown to $9.6trn by the end of 2019.

US outstanding fixed income

 

Source: Securities Industry and Financial Markets Association

However, this period has also seen an increase in the number of businesses that are unable to service their debt, or so-called 'zombie companies'. Prior said that 4 per cent of US companies were ‘zombies’ in 2007-8 but this is now “terrifyingly” closer to 20 per cent.

“It just shows you the sort of the things that have actually been happening through this distorted period we've been through this for the last 10 or 12 years. And now this is going to come home to roost,” she said.

“Everybody has sort of forgotten about the structure of how companies and how they are actually run. Equity is worth nothing if you can't service your debt.”

Corporate bonds were hit hard by the coronavirus sell-off in the first quarter of 2020. In March, the iBoxx Sterling Corporate index lost 7.52 per cent – beating the 10.89 per cent drop in global equities (represented by the MSCI AC World index) but far behind the rally in safe havens like government bonds and gold.

Performance of indices in Mar 2020

 

Source: FE Analytics

“Now things are really going to change because if you've chosen to have more debt, you're likely to be charged more for that because ultimately you're going to be a risky company,” Prior added.

“There are many facets to this but essentially companies now are going to be run more for the benefit of bond holders than equity holders. There is going to be this want to be able to service your debt.”

The BMO multi-manager added that the distortion of the past decade means many investors have forgotten that companies which show capital discipline and make prudent use of the money they’ve borrowed should be rewarded for this over the longer term.

On the flipside, companies that are over-leveraged and have poor management should be made to pay for that, in a functioning corporate bond market.

“It's almost a proper market now. I think the corporate bond world is going to become, hopefully, a proper market. Good companies that are conservative are going to be OK but we are going to see defaults pick up. It might be painful, but that’s normal” she said.

“It’s going to change corporate behaviour for sure and that can only be a good thing.”

Against this backdrop and amid the improving yields on offer, Rob Burdett and Gary Potter’s team has been increasing the corporate bond exposure of its multi-manager funds.

At the end of March, the team started a position in Jonathan Golan’s £916.5m Schroder Sterling Corporate Bond fund. The fund is the eighth highest returner of the 99 funds in the IA Sterling Corporate Bond sector, as well as being a top-quartile performer over one, three and five years.

Prior said: “It's something that we've been watching for a while: just a lovely vanilla corporate bond fund. [Golan] was able to take advantage of this real shift in markets and buy some great credits. He really extended the spread duration of that product through that time. And has managed to lock in some fabulous credits.”

Performance of funds in 2020

 

Source: FE Analytics

The team also recently bought Chris Bowie’s £1.4bn TwentyFour Corporate Bond fund. It is fourth quartile in the IA Sterling Corporate Bond sector over three months but has beaten its average peer over three and five years.

“We've known Chris for a very long time; we used to own him when he was at Britannic [Asset Management],” Prior said. “He has a very intellectual way of thinking about risk and return. But again, nothing rock'n'roll. It's just looking at good quality credits and it paid for the risk that you're actually taking.”

The BMO multi-manager team also has a longstanding position in Janus Henderson Strategic Bond, which is managed by John Pattullo and Jenna Barnard. The £3bn fund has made a second-quartile 9.49 per cent total return over the past three months and is in the IA Sterling Strategic Bond sector’s first quartile over one, three and five years.

“It made a fabulous shift into US investment grade through this period and it benefited from taking advantage of the moves in terms of available credits,” Prior finished.

“This is a true strategic fund and it’s been interesting to see how they've adapted their strategy. They did incredibly well last year through their duration. This year, it's been about US investment grade. They are really shifting where they're taking their risk, which is exactly what you want to see.”

Why are we talking about negative interest rates in the UK?

The UK economy was growing at a relatively weak pace – then the coronavirus pandemic arrived, posing an enormous threat to the system. The Bank of England (BoE) wanted to keep money in the real economy and to kick-start spending. The intention is to get money flowing out of banks and into the economy in the form of loans and mortgages.

Quantitative Easing – the BoE buying government bonds and corporate bonds – is one way to do this and cutting interest rates is another. As interest rates are now only 0.10%, cutting much further would lead to negative interest rates.

If interest rates are cut so far that they fall below zero, the theory should still apply - negative rates should encourage borrowing and discourage deposits and savings. But, in practice, negative interest rates can result in some bizarre outcomes – for savers and mortgage holders.

Has this negative interest policy actually worked in other countries – has it boosted their economies and increased lending?

“The evidence from Europe does not really suggest that negative interest rates encouraged greater lending activity”, noted Azad Zangana, Senior European Economist and Strategist at Schroders. “In fact, lending was stagnant until the European Central Bank started its own funding for lending scheme”.

If banks are charged for holding cash reserves with the central bank, rather than being paid, then it eats into their profit margin and requires them to recoup the cost in some way.

In theory, banks should pass on the cost to savers by giving them a negative interest rate. In reality, where negative interest rates exist, banks have been reluctant to do this, choosing instead to either increase banking fees or charges. If they cannot do this, then some banks have simply reduced lending, which may be the worst possible outcome given the policy’s intention is to stimulate business activity. 

What about my mortgage? If I have a negative mortgage interest rate, would my bank actually pay me to borrow?

Yes. It sounds crazy, but it’s true. In this topsy-turvy scenario, the lender would actually pay the borrower. In some European countries, where central bank rates have been below zero for several years, mortgages at sub-zero rates – or “reverse-charging” – are no longer so unfamiliar. Put another way, if your mortgage comes with a negative interest rate, you’ll end up paying back less than you borrowed.

Where this happens, the bank doesn’t actually make monthly payments to the borrower. Instead, the bank reduces the outstanding capital, thereby accelerating how fast the borrowers reduce their debt. Clearly, where interest rates are negative, there is little incentive for the mortgage borrower to repay debt.

Why would a lender pay someone who is borrowing money from them?

Are you wondering, what does the lender get out of this arrangement? Well, in the world of negative interest rates, a negative return may still look attractive when compared to other returns the bank could receive on its capital. It also depends on other factors (rather than just the interest rate). This might include the security of the underlying asset (such as property) and the size of the “return” (loss).

In this sense a mortgage is just like a government bond producing a negative yield. In 2019, for example, a Danish bank offered a ten-year mortgage at –0.5%. Compared to other potential returns it could get on its cash, it must have viewed this as an attractive opportunity.

Could UK mortgage rates really go negative?

It seems highly unlikely. After the 2008-2009 financial crisis, some UK “tracker” mortgages – the interest rate the borrower pays for the loan rises and falls in line with the Bank of England’s rate – did indeed come close to zero. The BoE rate fell by 90%, going from 5% to 0.5% in under a year. UK banks learned from that experience.

Most tracker mortgage contracts currently in force have a mechanism in place which prevents them from dropping below a stated positive interest rate, irrespective of whether or not the BoE cuts its rate. In any case, a high proportion of UK mortgages are on fixed rates, so BoE rate reductions would not apply to those borrowers’ loans.

If I am a UK saver, would I have to pay my bank to look after my money?

Negative interest rates penalise consumers and businesses for keeping savings in their bank accounts, as their value would decrease over time. To avoid charges, some households could even decide to withdraw savings from banks and instead invest in a home safe. Not only is this a security risk, but the withdrawal of assets from financial institutions reduces liquidity and the ability of banks to lend.

Banks would not pay out anything to consumers, who receive zero on their savings, but in the main, investors do not have to pay the banks to hold onto the money for them. Negative interest rates have actually already been put in place in the eurozone, Japan, Switzerland, Sweden and Denmark. And that is what has happened to consumers and businesses in those countries.

However, savers in Germany are among those experiencing negative rates on deposits but, so far, the majority of those affected are institutions or individual savers with large sums such as €100,000 or more. What savers have to pay for the bank to actually hold their money is sometimes called “depositary charges”. Only recently have smaller German savers been hit by such charges.

What could happen to bond markets if the UK has negative interest rates?

An interest rate cut into negative territory could boost UK bond markets. This is because when yields fall, bond prices actually rise. However, lower yields also decrease any future income that would accrue to bond holders.

Growing expectations for interest rate cuts have already sent UK yields on government bonds below zero for the first time last month. For example, the yield on the two-year UK government bond (gilt) was -0.03%, meaning investors were willing to accept a nominal loss if they held the bond to maturity. This means they were effectively paying the UK government to hold their money.

What could be the impact on stock markets?

Lower interest rates could be positive for the UK stock market because they increase the value of future earnings that companies make that would eventually be paid out to shareholders. Companies’ earnings become more valuable in a low interest rate environment. When this happens, share prices tend to appreciate in value.

What could the BoE do instead of moving to negative interest rates?

Azad Zangana said: “Although we do not expect to see negative interest rates in the UK, if this did actually happen, it could have a number of far-reaching consequences for consumers, businesses and banks as well as the economy. We actually doubt the BoE will cut interest rates below zero. Instead, further expansions in QE are possible, with the BoE continuing to indicate that interest rates will remain on hold for some time.”

In terms of what could happen next, to support the economy, the BoE could continue to buy more bonds. This can lower borrowing costs and encourage lending without moving the base rate into negative territory.

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An election can be lost in the televised debates and unfavourable media coverage during the course of a campaign. However, this is not a normal year and not a normal campaign.

Politically and socially, the US is in distress and president Donald Trump’s approval ratings are at a low point due to his handling of Covid-19 and nationwide protests over the killing of George Floyd.

Estimated electoral college votes

 

Source: The Economist

As of 1 July, data from The Economist predicts the likelihood of a Biden victory at 89 per cent, winning 343 electoral college votes, more than the 270 needed to take the presidency.

However, it’s likely that markets and businesses would prefer a victory for pro-business incumbent than his Democrat rival Joe Biden.

The issue of the US-China trade war also looms, while the possibility of rising infections in the winter months could cause further uncertainty.

Below, Trustnet talks to five market experts on their views and where this election may be won and lost.

 

Jason Hollands, Tilney Investment Management Services

While the election is important, said Jason Hollands, managing directorof Tilney Investment Management Services, the fiscal stimulus packages in the US show that its deeply divided politics can come together, offering hope for more cohesive relationships in the future.

“The US Congress has repeatedly managed to reach bipartisan agreements on fiscal stimulus measures and notably, at greater speed than the EU has,” he said. “The Fed have been swift in responding to the crisis through an unlimited commitment to purchase assets and supply copious amounts of liquidity.”

Trump’s poll ratings leave little to be desired, but the trade tensions with China offer a chance to show strength in the face of growing expansionary policies.

“This will motivate the Republican base that the administration will make good on the balance of trade and repatriating American manufacturing jobs, as well as national security concerns,” he explained.

The Tilney managing director is clear that this isn’t solely about China, the US Treasury has opened a one-month comment period on proposed $3bn of tariffs on EU imports.

“Technically this is a World Trade Organization-permissible response to illegal Airbus subsidies by the EU,” he said. “But the timing coincides with the US also considering aluminium tariffs on Canada and the EU deciding to ban US visitors.”

However, these actions have caused increasing concern about global trade uncertainties.

“There are of course big policy differences over things like policing reform and healthcare, but a lot of Democrats are also hawkish on China and both parties have advocated major infrastructure spending,” Hollands said.

“Despite misgivings around Trump, the markets would probably marginally prefer a Republican win, as the Republicans are in favour of tax cuts and are less aggressive in their attention to drug pricing controls.”

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Simon King, Vermeer Partners

“Despite what we might like to think, the US election definitely does matter,” said Vermeer Partners chief investment officer Simon King.

King noted that amid a burgeoning global recovery, a presidential election in one of the key players is instrumental in leading that recovery.

“Given that the US is likely to deteriorate in the coming months as its hit by a potential second and third wave of Covid-19,” he said. “The Trump administration turns its attentions to try and win the election, whoever wins that election will probably face an even worse starting position.”

While Biden is a favourite in betting markets, Trump’s original election and Brexit show how woefully inaccurate predictions can be.

“Biden represents a somewhat underwhelming candidate to many in the US,” said King.

“We would expect the rhetoric on trade wars to be toned down and while he may not return to the days of Obama’s laissez-faire attitude to trade deals, he will not be as combative.”

Trade wars with the EU and China will likely feature prominently in debates over the next few months, and China will favour another term of Trump over Biden, who has voiced concerns over Chinese more recently.

King said Biden may have to make concessions to the left wing of the party, but while healthcare could be an obvious target, he doesn’t pose the kind of threat to big pharmaceutical that a Bernie Sanders-type candidate would.

“We do not expect him to have any major impact on Fed stimulus, but his actions on fiscal issues will hopefully be more co-ordinated and predictable than Trump which would be useful for markets,” he said.

 

Andy Merricks, independent fund strategist

Merricks, manager of the 8am Global fund and independent fund strategist, said the US elections could have a significant effect on the markets as we get nearer November.

He echoed Simon King’s thoughts that the Chinese may value Trump’s protectionism as oppose to Biden’s willingness to work with Europe.

“Either way, a second wave is a worry – not of the virus in this case, but of the US-China trade war,” he said.

Considering that the US is still struggling to contain the virus in parts of the country, the timing of the election could put a self-limiting factor into the current equity rally.

“In the short term it may fret that a Biden win would lead to tax hikes, higher wages, and an increase in regulation,” said Merricks.

Opinion in the US point to the fact that only two of the past six presidents have lost their bid to re-election. Those two, Jimmy Carter and George H.W. Bush lost their bids for a second term in similar fashions, witnessing a slide in popularity due to their handling of crises.

A Trump re-election, said Merricks, may rally right through November but then correct around December.

“It will come with the realisation that relations between the US and China and an escalation in tariffs are likely going to get a lot worse,” he added. “2021 could get off to a rocky start.”

 

Didier Saint-Georges, Carmignac

Moving into the second part of the year, Carmignac’s managing director and strategist Didier Saint-Georges said uncertainty will matter more for markets as policymakers have already gone out of their way to support the economy. The outcome of the US presidential election is one of those uncertainties.

Trump faces serious questions about his handling of the Covid-19 crisis and a country in a recession, painful for a president who based so much of his 2016 campaign on restoring economic prosperity.

“The link between his mismanagement of the virus and the economic downturn is inescapable and therefore also constitutes a headwind for an incumbent who hoped to base his campaign on his economic achievement,” he said.

Since Trump was elected on 9 November 2016, the Dow Jones Industrial Average index – which Trump often uses as a benchmark for the success of his presidency – has returned 38.86 per cent in US dollar price terms –recovering well from the sell-off in March. However, critics have argued that protectionism and corporation tax cuts is responsible for the record highs of 2019.

Performance of the Dow Jones index throughout Trump’s presidency

 

Source: FE Analytics

The election aside, Republicans face a situation in that their majority in the Senate could be at risk during congressional elections due to take place at the same time, said Saint-Georges.

“A Democrat sweep has become a realistic possibility, which would open the way to a broad implementation of the Democrat economic platform, favouring Main Street over Wall Street.”

“Markets will certainly adapt to any winner over time,” he said. “But historically, a losing incumbent is rarely well received by investors, and given the circumstances, it is unlikely to be different this time.”

Saint-Georges said uncertainty between now and election day could affect the US dollar and equity markets, however, Biden’s choice of running mate could assuage market concerns.

“The choice of the younger and well-respected California senator Kamala Harris, rather than a more radical profile would certainly be perceived as reassuring by markets,” he added.

 

Rob Morgan, Charles Stanley Direct

Rob Morgan, pensions and investment analyst at Charles Stanley Direct, said that without Covid-19 the US presidential election would probably have been the most significant geopolitical event of the year.

“It’s still going to be highly influential, as the two candidates are offering very different economic approaches, which will have different impacts on the stock market as a whole and on individual sectors and companies,” he said.

Biden, said Morgan, offers a significantly different domestic outlook to Trump’s ‘America First’ policies. This includes tax increases, green policies that will hit the already troubled oil & gas industries and an extension of Obamacare.

The extent of Biden’s tax reform priorities is vast, proposing a $4trn tax rise over the next 10 years, and a massive green energy transformation. He has outlined plans to increase the rate of corporation tax from 21 per cent to 28 per cent and to impose a 12.4 per cent social security tax on incomes over $400,000.

“None of this would be much liked by Wall Street and investors,” said Morgan. “The US stock market advanced strongly under the early months of Trump’s presidency based on the large tax cuts he proposed making company income more valuable for shareholders.”

Undoing a large amount of Trump’s presidency would likely characterise the early years of a Biden presidency, noted the Charles Stanley Direct analyst. He would likely start his presidency by getting the US to re-join the Paris climate Treaty, which means pledging to make the US carbon neutral with 100 per cent clean energy by 2050. This combined with greener automobile and energy efforts would cause considerable impact to numerous industries in and outside the US.

“This is truly radical stuff if carried out, and a major departure from the status quo that will create substantial winners and losers at a corporate level,” said Morgan.

“If the US votes Biden in, it will be a decisive shift in the world approach to fossil fuels, with the US changing from being a proponent, to the leading advocate of their closure.”

This would no doubt dismantle traditional cyclical stocks but may be more suited to a structurally different world post-Covid-19.

“There will be some great opportunities for innovative businesses that can help fulfil Biden’s vision of a greener America,” he concluded.

Yields of up to 20 per cent are now available on certain value stocks – and this is even after factoring in a pessimistic forecast of how the coronavirus will affect the underlying businesses, according to Philip Matthews of the TB Wise Multi-Asset Income fund.

The growth stocks responsible for much of the gains in world markets in the recent past have continued to power ahead this year, while their value counterparts have borne the brunt of the economic lockdown.

Performance of indices in 2020

Source: FE Analytics

Yet Matthews said this diversion means there is now a “once-in-a-generation opportunity” for anyone willing to look to areas of the market where there is a higher degree of uncertainty about the outlook to profits.

“At its low point in March/April, that dispersion between value and growth had never ever been as wide,” he explained. “That's a pretty good starting point to think about value.

“People don't like investing into increasingly bad news, although sometimes that's the best time to do it, because everyone is panicking. The stage we're at at the moment, valuations are very attractive in absolute terms as well as being even more attractive on a relative basis.

“There is a high degree of disruption, but businesses are trading on incredibly distressed valuations and if things return to normal, there is significant scope for share price appreciation.

“Our job is to make sure we're picking the companies that have got the balance sheets to weather this particular storm, where we think they can come out of this without being permanently impaired and can grow over the medium term.”

As an example of the extreme valuation discrepancies currently available, Matthews pointed to NewRiver, a REIT that owns retail and leisure assets such as shopping centres, retail parks and pubs.

Unsurprisingly, it has run into difficulties this year, with a number of retailers failing to pay their rent and the income from the pubs side of the business completely drying up. Yet despite these problems, Matthews said the market still appeared to have priced in an overly pessimistic scenario.

Performance of index in 2020

Source: FE Analytics

“Looking at a reasonable assessment of where things may go from here, even if it has to sell some assets to reduce the gearing levels in its business and assuming it loses some rent in the process, you're getting up to a 20 per cent yield on the share price at the moment,” he continued.

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“And that feels to us to be way too high given the risks of what it is doing and the alternative-use value that sits within that portfolio.”

A period of reduced or non-existent earnings during the economic lockdown is not the only risk currently faced by value stocks. A perennial problem for bottom-fishing managers is ensuring they invest in a company that is being underestimated by the market and not a value-trap – a threat that has become more prevalent recently due to the heightened risk of disruption.

However, Matthews’ process involves looking for a number of tell-tale signs that indicate a company is falling behind the competition.

“A good starting point is, ‘has that business been able to grow it earnings over the past decade?’ as these forces of change have been very powerful over this time,” the manager explained.

“And a really good one to look at is, ‘just what percentage of profits has it actually converted into cash?’

“What you will see from a lot of potential value investments is that they tell you they're earning one level of profit, but actually because so much change is happening in that marketplace, they're constantly having to restructure and access that capital base they had beforehand to reposition for a new future.”

Matthews has seen examples in the past where the amount of cash a company was generating was less than half the level of profit it claimed. The manager said this was the case with Thomas Cook.

“It said it was earning one thing and I'm pretty sure that there was a period where I looked at it and cumulatively over a decade it had delivered no cash, because it was just constantly restructuring and it had a big pension fund deficit and stuff like that,” he added.

“Value investors have got to be highly cognisant that there is an awful lot of disruption taking place at the moment which is massively changing business models.

“But equally there are some businesses that are able to adapt and there are some businesses that have got cyclical earnings and, at a point in time when cyclical profits are in a trough, the market can  be overly pessimistic towards them and you can buy them on incredibly low valuations.”

Data from FE Analytics shows TB Wise Multi-Asset Income has made 8.93 per cent over the past five years, compared with 27.35 per cent from the IA Flexible Investment sector and 10.82 per cent from the CBOE UK All Companies index.

Performance of fund vs sector and index over 5yrs

Source: FE Analytics

The £85.5m fund has ongoing charges of 0.88 per cent and is yielding 6.7 per cent.

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The first six months of the year will likely be remembered as one of the most unprecedented periods in financial market history. This was not a typical downturn, and no one could have foreseen the scale of its impact in early January.

The outbreak of the Covid-19 coronavirus in Wuhan, China soon became a global pandemic and the ensuing lockdowns brought businesses to a standstill.

A broad-based market sell-off in March was one of the worst since the global financial crisis of 2008, and investors flocked to the relative safe havens of government bonds and gold.

Governments and central banks quickly embarked on fiscal and monetary policies to ease the shock to the economy and the decisive action allowed the market to rebound during April.

Since the sell-off, debate has centred around what shape the recovery might take, having been led by technology stocks as lockdown conditions have increased demand for services catering to those working from home and those who have been furloughed.

Top-10 best-performing IA sectors

 

Source: FE Analytics

As such, it is no surprise that the top-performing sector was IA Technology & Telecommunications.

Not only has technology allowed businesses and families to communicate effectively during lockdowns, they have seen profits surge.

Many of the funds in the sector have exposure to the technology giants in the US equity market, such as Microsoft, Apple and Amazon.

In second place was the IA UK Index Linked Gilts sector, where strategies invest at least 95 per cent of their assets in sterling-denominated AAA-rated, UK government backed index-linked securities.

Performance has been bolstered by two interest rate cuts and substantial quantitative easing programmes, increasing expectations of inflation.

In third was the IA China/ Greater China sector returning 12.97 per cent year-to-date. Despite being the epicentre of the virus, the lockdown and subsequent recovery was swift in comparison to the rest of the world. This allowed Chinese businesses to get back on their feet and encouraged consumers to start spending.

The latest growth predictions from the International Monetary Fund’s World Economic Outlook revealed the China would be the only major economy to grow in 2020, albeit by just 1 per cent. Meanwhile the outlook for the UK was more negative with the economy expected to shrink by 10.2 per cent.

Indeed, the three worst-performing sectors were focused on the UK: IA UK Equity Income (down 20.19 per cent), IA UK All Companies (-17.69 per cent),and IA UK Smaller Companies (-16.59 per cent).

The UK has been one of the hardest-hit nations in Europe, having delayed lockdown, while its traditional role in portfolios as a dividend stronghold for investors has been damaged following high-profile dividend suspensions.

Despite being at bottom for performance during the first half, the three UK sectors have performed well since the market bottom on 23 March.

IA UK Smaller Companies funds have performed particularly strongly, with the sector up by 32.8 per cent. While the lower-end of the market cap scale includes many domestically-focused cyclical industries – such as industrials, financials and consumer goods – there are also growth companies in sectors such as telecommunications and technology.

Top 25 best-performing funds

 

Source: FE Analytics

On an individual fund basis, Morgan Stanley US Growth had the highest return at 64.17 per cent, one of many US equity strategies among the top performers, including Baillie Gifford American, Morgan Stanley US Advantage and New Capital US Future Leaders.

Despite the US struggling to control virus cases and ongoing political and social divisions, it remains a well-loved region for investors and the Federal Reserve has injected huge sums into the system in an effort to stabilise the economy.

The $4bn, five FE fundinfo Crown-rated Morgan Stanley fund has also benefited from the strong performance of technology and media platforms and includes online retailer Amazon, music streaming service Spotify and e-commerce platform Shopify among its top holdings.

The technology boom has in part been responsible for this rise in US stocks, but how quickly the market rebounded after the sell-off was key.

Considering the strong performance of the IA China/ Greater China sector, it is unsurprising to see Matthews China Small Companies within the top three performing funds of H1.

Managed by Tiffany Hsiao and Lydia So, the $218.4m fund has returned 63.23 per cent in the first half of the year.

Chinese president Xi Jingping prioritised labour output, which allowed several smaller companies focused on software, automation and AI to resume production.

“Small businesses make up the bulk of companies of China’s private sector today,” said Hsiao. “Yet only about 2 per cent of the MSCI China index consists of small businesses. Chinese small companies remain an untapped universe that can offer genuine diversification benefits.”

Gold historically does well in a crisis, with fears of recession and inflation leading investors to turn to the yellow metal.

Inflation was what policymakers had hoped to avoid in the early days of stimulus, however in recent weeks disinflation and deflation has also emerged as a realistic possibility, weakening confidence in traditional currencies.

Amidst this backdrop and with fears of a second wave or prolonged continuation of the first wave, the price of gold rose to $1,800 per ounce, its highest level since 2011.

As such, the LF Ruffer Gold fund seems to have benefited from more bullish sentiment toward gold that has continued during the recovery returning 53.52 per cent.

Top 10 worst-performing funds

  

Source: FE Analytics

The theme among the worst performing funds is the presence of energy funds and those from Latin America, and more specifically Brazil, the largest market in the region.

Brazil has suffered the worst outbreak behind the US and faced similar criticism of its leadership to contain the virus and reveal testing data.

As such countries with large overweights to Brazil such as Invesco Latin American, MFS Meridian Latin America and Brazilian equity strategy HSBC Brazil Equity were among the first half’s worst performers.

However, the worst performing fund of the first half was the ASI UK Unconstrained Equity fund, the £275.2m fund overseen by Wesley McCoy, which made a loss of 33.36 per cent.

As mentioned, energy firms have also experienced a difficult period as first US-Iran relations worsened and an oil price war between Russia and Saudi Arabia made markets more volatile and saw oil prices crash as the Covid-19 pandemic took hold.

As such, Schroder ISF Global Energy and Guinness Global Energy are among some of the worst performers, making losses of 39.74 per cent and 36.41 per cent respectively.

In addition, the energy sector is also undergoing somewhat of a structural change as investors’ ESG (environmental, social & governance) concerns take centre stage and companies usher in a new era of renewable energy that threatens the oil & gas industry.

June appeared to be a turnaround month for some fund sectors, as what had flourished in May now languishes at the bottom of the returns table and vice versa.

Last month saw investors continue to put risk back on the table as many parts of the world continued to ease their lockdowns amid falling infection rates. Given this, June saw global equities and commodities make higher returns that defensive assets like government bonds and gold.

When it comes to how the Investment Association peer groups performed last month, the IA China/Greater China sector had the best performance for June with an average total return of 10.62 per cent.

 

Source: FE Analytics

The Chinese government launched a $500bn fiscal stimulus package last month and the country may now be feeling the positive effects of that, combined with its economy reopening from a prolonged lockdown period ahead of others.

This is despite China not announcing a target for its annual GDP growth for the first time in almost 20 years. This follow a contraction in the Chinese economy in the first quarter of 2020, the first time this has occurred since the country started reporting quarterly GDP in 1992.

Ben Yearsley, co-founder of Fairview Investing, said: “June was another risk on month with Asia and emerging markets firmly in the spotlight. China was the best performing fund sector, closely followed by Asia, emerging markets and more Asia.

“A multitude of factors is at play but having the virus early (and many countries handling it better) combined with much better debt and demographic numbers are all relevant to investment markets.”

 

Source: FE Analytics

At the other end of the table, the IA Japanese Smaller Companies sector was the worst performer in June as its average member made a loss of 1.14 per cent. It was the only equity sector to post a negative return in June and is a reversal from May, when it was the best-performing sector.

The IA Japan sector also featured low down the table with an average return of just 0.33 per cent.

Another poorly performing sector was IA UK Smaller Companies, which had a total return of 0.26 per cent. Although a large number of non-essential UK businesses were allowed to reopen in June the country remains under lockdown – with some easing – and remains persistently unpopular with investors.

Yearsley said: “It’s difficult to know whether to be optimistic or pessimistic about markets, however despite some new lockdowns and partial closures of UK, Germany and the US, developed world markets seem to have moved out of the coronavirus funk recording some of the best quarterly returns on record.”

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Moving onto the individual funds and the sector story is very much reflected as China focused portfolios dominated the top of the table.

 

Source: FE Analytics

The best performing strategy overall was the $1.5bn Barings Hong Kong China fund, which is co-managed by Nicola Lai, William Fong and Titus Wu. It made a total return of 14.53 per cent in June.

Its manager use an all-cap process to invest in what call a ‘flexible investment universe’, which covers domestic Hong Kong listed, onshore Chinese (A-shares), Taiwanese and multinational companies with significant exposure to China.

Other high performing funds that focus on this part of the world included GAM Star China Equity (12.71 per cent), Allianz China Equity (12.83 per cent) and Invesco China Equity (UK) (13.08 per cent), to name a few.

Breaking up the top performing China funds are numerous emerging market funds, namely driven by a strong performance from Brazil.

Brazil is the largest and most liquid market in Latin America, making up more than 60 per cent of the MSCI Emerging Markets Latin America index, which outperformed the MSCI World index in June. But MSCI Brazil beat both of these broader indices in June with a 7.45 per cent return.

Coming into the crisis, Brazil had strict statutory limitations on fiscal spending had to be overcome. But the country announced a $30bn fiscal stimulus package in March while last month Congress granted the Banco Central do Brasil (BCB) crisis powers which would allow it to buy a range of private and public assets to shore up on liquidity.

This strong performance in Brazil shown through funds like FP Carmignac Emerging Markets (13.65 per cent) and Janus Henderson Latin America (12.44 per cent) funds featuring amongst the top performers.

 

Source: FE Analytics

At the bottom of the funds table, however, is the stricken LF Equity Income fund - formerly LF Woodford Equity Income – which made a loss of 18.29 per cent in June.

Last year, the investment firm and fund that carried manager Neil Woodford’s name was closed following a period of disappointing performance, a flurry of redemption requests and concerns over illiquid holdings.

It was handed over to BlackRock and brokerage Park Hill by administrator Link Fund Solutions. Park Hill wrote to investors last week after an agreement to sell a significant portion of the remaining assets in the LF Equity Income fund was reached.

Adrian Lowcock, head of personal investing at Willis Owen, said: “The sum is below the $300m that was speculated, and only accounts for about 50 per cent of the market value of the fund as of 3 June.

“Rather disappointingly there is no detail on what was sold, for how much and what the losses were on those investments. Investors should be given an idea of what the costs incurred for this deal are and what they could expect to see back. It would also help to have an update on the progress with the remaining investments, but these are most likely the ones that the fund will find hardest to sell.

“Investors should find out by the end July how much they can expect to get paid in the third distribution and when that will be paid to them, possibly in August.”

Lowcock added: “It is frustrating for investors in Woodford, but unfortunately winding up funds is a messy business, especially when it involves illiquid assets at a time when the UK faces the deepest recession in history.”

Other funds at the bottom of the table reflected the sector pattern of Japan and UK underperformance, with funds such as Polar Capital Japan Value, M&G Japan Smaller Companies, Ardevora UK Equity and Aviva Inv UK Property all making a loss in June.

It’s worth noting that, on the fund side specifically, those with a value investment bias fared worse off as the gap between value and growth continues to widen with growth continuing its outperformance after another rally.

Indeed, comparing the two throughout 2020 so far and MSCI World Growth index has made a total return of 13.39 per cent, whereas the MSCI World Value index has made a loss of 12.03 per cent.

Funds that invest in Asian equities and those that specialise in responsible investment were of greater interest to professional investors last month, Trustnet analysis suggests.

In this regular series, Trustnet identifies the recent fund research trends of the independent financial advisers, wealth managers and other professional investors who use FE Analytics.

To do this, we examine the change in the share of research that each fund has received over the past month compared with a ‘baseline’ from the previous 12 months.

After collating funds by their Investment Association sector, it is clear that there was a big uptick in interest in IA Asia Pacific Excluding Japan funds in June.

Change in sector research in Jun 2020

 

Source: FE Analytics Market Intel Tool

Over the 12 months to the end of May 2020, the IA Asia Pacific Excluding Japan sector accounted for 3.23 per cent of all research carried out into the Investment Association universe but this jumped to 4.38 per cent in June.

The sector has performed strongly over the past month, with its average member posting a total return of 7.87 per cent. This makes it the second highest returning fund sector, after IA China/Greater China’s 10.23 per cent gain.

While Asia was the region to be first hit by the coronavirus pandemic, it had more experience than the West in dealing with such outbreak after its previous brushes with the likes of SARS and came out of lockdown first.

The IMF also expects the region’s economy to be much stronger than the developed world; its latest estimates say emerging Asia’s GDP will contract by 0.8 per cent this year, compared with a 8 per cent fall for developed economies.

Schroder Asian Income, BNY Mellon Asian Income and Schroder Asian Alpha Plus are the most researched members of this sector, but the funds with the biggest increase in their research share were Guinness Asian Equity Income, Fidelity Asian Special Situations and Baillie Gifford Pacific.

Turning to individual funds and it was Baillie Gifford Positive Change that benefitted from the biggest increase in FE Analytics research in June – a position that it also held in May.

 

Source: FE Analytics Market Intel Tool

The fund invests in companies that can deliver positive social change in one of four areas: social inclusion and education, environment and resource needs, healthcare and quality of life, and base of the pyramid, or addressing the needs of the world's poorest populations.

Baillie Gifford Positive Change’s recent performance has been very strong. Its 32.56 per cent total return in 2020 so far is the third highest in the IA Global sector (where the average member is down 0.07 per cent). It’s also the peer group’s second best fund over one and three years.

This performance, alongside inflows, means the fund’s asset under management have climbed from less than £200m at the start of 2020 to around £700m today.

In May’s article on research trends, Trustnet noted how many of the funds that are being looked at more often were, like Baillie Gifford Positive Change, those with an environmental, social, and governance (ESG) approach.

This trend remained in play during June as a notable amount of the funds that were being researched by professional took this approach.

These included Royal London Sustainable Leaders Trust, Kames Ethical Corporate Bond, Unicorn UK Ethical Income, Royal London Ethical Bond, Rathbone Ethical Bond, Premier Ethical, Stewart Investors Asia Pacific Sustainability and EdenTree Amity UK.

However, the above list shows that some fund groups also seem to have benefited from more attention in FE Analytics.

Of the 30 funds we’ve shown in the table, five are run by Baillie Gifford. This firm has a strong long-term track record and many of its funds are currently in the top quartile of their respective peer groups over one, three, five and 10 years.

Royal London also has four funds on the above list, a reflection of its own strong track record when it comes to ESG investing.

Guinness Global Equity Income is the fund with the second highest increase in its FE Analytics research share in June. This is another fund that is in the top quartile of its sector in 2020, as well as over cumulative one-, three- and five-year periods.

Allianz Strategic Bond is in third place. This is another fund that has delivered high returns this year – it’s 25.83 per cent return is well above the 0.97 per cent made by its average peer and it’s the highest returning strategic bond fund over one, three and five years.

 

Source: FE Analytics Market Intel Tool

The above list shows the funds that had the biggest falls in their research share on FE Analytics last month.

Topping it is Invesco High Income (UK), which has suffered a run of lacklustre performance and outflows in recent years. Manager Mark Barnett, who took over the fund from Neil Woodford, recently resigned from Invesco.

The interventions of central banks following the global financial crisis of 2008 and the Covid-19 pandemic will have a significant impact on financial markets over the long term, according to Unigestion’s Fiona Frick.

Frick (pictured), the asset manager’s chief executive, said the scale of support from central banks aimed at saving the global economy has had an impact on the financial concepts that have been studied and applied “for decades”, such as portfolio construction and the influential ‘modern portfolio theory’.

First conceived in the 1950s by Harry Markowitz, modern portfolio theory provided investors with a means to measure risk and diversification, said Frick, and allow them to quantify the benefits of adding new exposures.

“While modern portfolio theory was a dramatic leap forward in financial thinking, we believe many of its foundational assumptions hold with difficulty in real life,” she said. “This is especially true in the current environment, where large-scale quantitative easing has structurally modified the relationship between assets’ risk and return expectations.”

The “massive evolution” of fiscal and monetary policy that started as a result of the global financial crisis and has been accelerated during the pandemic means that the very nature of risk has changed.

As such, investors need to move away from traditional risk measures – such as historical volatility – and instead focus on ‘true risks’ such as permanent loss of capital.

To do this, investors need to understand the “multi-dimensional” nature of risk, said Frick, and take an active approach to risk management taking account of key risks, including: credit, government intervention/financial repression, liquidity, and ESG (environmental, social & governance).

On credit risk, she warned that while central banks' quantitative easing and fiscal policies have helped survive an economic decline “that would otherwise be devastating”, they could also have serious side effects in the future.

“Credit risks are growing in the economy due to credit misallocation and increased solvency risks,” she explained. “We are experiencing a situation in which many countries and companies, already highly leveraged, are taking on more debt.”

Frick said investors have favoured companies that use debt or implement stock buybacks to improve profitability in recent years. Yet the pandemic has shown that prioritising profitability can create fragility in markets.

“Fundamental ratios that have been forgotten over the past decade, such as debt-to-equity, interest coverage and cash flow robustness, will move centre stage,” she added. 

The risk of government intervention or financial repression must also be considered, said Frick, as the huge sums of government debt accrued during the Covid-19 crisis will need to be repaid – whether through higher taxes, inflation or other means – which could have implications for asset allocation.

“In emerging markets, government regulations, such as de facto caps on profits for utilities, have been quite common, but we could now see similar situations arising in developed countries across various industries, such as utilities, automobiles or airlines,” she said.

“This new type of risk, which econometric models can only assess retrospectively, highlights the importance of combining systematic analysis with forward-looking fundamental research.”

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While volatile, liquidity risk “generally strikes at the worst of times, so it is better to be prepared for it”. In March and April, there was an unprecedented liquidity crisis in financial markets where even government bonds were impacted, highlighting how critical it is to portfolio construction.

Finally, ESG risk is becoming an increasingly important consideration for investors as awareness of these issues continues to grow.

“Companies that do not pursue sustainable practices on a day-to-day basis create operational and reputational risks within their businesses and to their business model,” said Frick. “Meanwhile, new regulation can make or break entire industries and can have a direct impact on the companies in which we invest.”

Another key concept that needs to be revisited is diversification – a cornerstone of investing since Markowitz published his article on portfolio selection in 1952, according to the Unigestion chief.

“The benefits of diversification across assets have been challenged over the last 10 years, when few strategies would have beaten a simple 60/40 portfolio comprising US equities and government bonds,” she said.

“The magic behind diversification is that a portfolio of assets will always have a risk level less than, or equal to, the riskiest asset within the portfolio.

“The theory has its shortcomings, however, and unfortunately, diversification can fail dramatically during market crises, just when investors need it most.”

This has been exacerbated during the pandemic when there has been an “unprecedented rise in correlation between different asset classes”, she said.

“Certain assets have fared better than others, but the list of winners during the initial sell-off was very short and bonds did not offer the level of protection they have in the past, in part due to their low level of yield,” said Frick.

Furthermore, diversification across global equity markets did not pay off as global stocks once again behaved in similar fashion, having been impacted by structural changes such as the rise in passive strategies, high-frequency trading and factor investing.

Nevertheless, the failure of diversification more recently is likely to be a cyclical phenomenon caused by central bank action, according to Unigestion’s Frick, and it expects correlation and dispersion to favour diversified portfolios after the current crisis.

She added: “Generally, diversification does not tend to pay off during the first leg of a significant market correction, when systematic de-risking negatively affects all stocks indiscriminately, but we expect more dispersion to materialise in the coming months.

“Furthermore, prior to the Covid-19 outbreak, economic growth had been the key driver of market performance for more than a decade. This should change as we move into a more volatile economic environment that should be discriminatory in terms of countries, sectors and styles.”

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While gold has been grabbing the 'safe haven' headlines so far in 2020, the world’s other once monetary metal has also seen record investment inflows. Silver-backed exchange-traded products (ETPs) have expanded by over 25 per cent since New Year, and net demand for physical silver on BullionVault set a three-month record from March to May, growing total client holdings by that same proportion.

More driven by retail investors than gold’s heavy inflows, this surge is more likely to reflect conviction buying, and it could also offer an edge to asset managers concerned about the risks from today’s unprecedented peacetime sovereign deficits and central bank balance sheet growth of a secular upturn in inflation. Because unlike gold, where private banks are now urging 10 per cent allocations to clients who could have taken that position at a 20 per cent discount this New Year, silver has yet to start attracting generalist investors. It also starts the second-half of 2020 where it began.

Why consider the grey precious metal as an alternative or addition to gold? First, it’s hard to find any two assets normally so closely correlated with each other. Both day-to-day and also on a 12-month basis, the price of silver has moved in the same direction as gold 76 per cent of the time over the last half century. That means the forces driving gold typically encourage more money into (or out of) silver as well. But because its market is only one-tenth the size by value, even a much smaller flow can mean an out-sized response in price, and for every 1.0 per cent daily move in gold, silver has historically moved 1.9 per cent on average. That applies both up and down, hence its tag as "the devil’s metal" among traders.

Price aside, where the two metals diverge is in their supply and demand fundamentals, an issue best summed up in a name: Warren Buffett. Famously dismissive of gold as a ‘useless’ asset, the Berkshire Hathaway boss bought a massive amount of silver in the second half of 1997, buying around 25 per cent of that year’s entire global mine output because – as a more industrially useful metal – the data then pointed to a shortfall of supply to meet demand. A quarter of a century later, silver now finds more than half its annual end-user demand from productive uses, compared to less than one-tenth for gold. That’s why silver fell harder in price than gold, and then struggled to recover as quickly, during the global deflationary crash of 2008 and again during this year’s sudden hit-the-wall slump of coronavirus lockdowns.

Prior to the pandemic, silver was already lagging gold’s underlying performance, most likely because it lacks the central-bank demand which helped support the yellow metal in 2017-2019. But with jewellery and silverware pretty constant around one-fifth of total demand so far this century, investment demand has grown at the expense of industry’s share, rising from 10 per cent before the financial crisis to average 22 per cent over the last five years on data compiled for the industry’s Silver Institute by specialist analysts Metals Focus. They now project that coin, bullion bar and ETP demand could breach the 2011-2013 peaks this year to reach 31 per cent of total silver use, again with industry’s share falling back.

On the supply side, only one-third of new silver comes from primary mining; most comes as a by-product of digging up gold, copper or zinc. So supply is less responsive to prices than gold, and it’s likely to fall as base metal demand suffers from the economic slump. Mine production already slipped by more than 6 per cent by 2019 from its record-peak plateau of three-to-four years earlier. Specialist analysts Metals Focus already forecast a further 5 per cent drop for 2020 in April, before the true scope of the Covid crisis became clear. Supply from existing above-ground stockpiles meantime looks constrained unless prices rise steeply. With silver currently trading around half its full-year average price of 2011, recycling flows from private-sector holders (household jewellery and silverware) is running nearly 30 per cent lower, and sales from government stockpiles are running at one-fifth the level of a decade ago, thanks to China disgorging most of what remained from its Silver Standard days (ending 1935) back at the top.

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While gold is now threatening its all-time highs of nine years ago above $1,780 per ounce, silver sank to its cheapest since 2009 only three months ago. Despite having recovered that 33 per cent ‘Covid crash’, silver is still trading unchanged year to date, yet gold has risen 16 per cent. Priced against its dearer cousin in fact, since has never been cheaper than it has been this spring, sinking through the early-1990s’ recession low of 100 ounces per ounce of the yellow metal, which is where the gold/silver ratio now stands as the second-half of 2020 begins.

With both real money and leveraged funds awash with liquidity, it may seem odd that the ‘hot money’ hasn’t yet climbed aboard. The level of speculative betting on silver prices (as reported by positioning in US Comex derivatives) currently stands 7 per cent below its 10-year average, and it matches barely one-third the size of mid-February, just before the coronavirus crisis sent prices tumbling. Bullish betting on gold, in contrast, is 45 per cent larger than its 10-year average. Should the inflation thesis start to become consensus – whether as follow-through from a ‘V-shaped’ recovery (if it delivers) or via monetary analysis (such as perma-deflationist Albert Edwards’ recent conversion) – there is much greater scope for leveraged inflows to silver than for gold, and when silver gets the bit between its teeth, the pace of appreciation can be dramatic.

Witness the metal’s record spikes of late 1979 and early 2011. Both saw silver prices more than double in a matter of months, and both topped out at $50 per ounce (in nominal dollars). What those surges also had, and what silver has lacked over the last decade, is a new and compelling narrative. A return to some kind of metal-backed currency system was widely discussed as the 1970s’ long inflationary crisis peaked. Silver’s crucial role in photo-voltaic cells then gained mass coverage in late 2010, led by Beijing’s plans to cover China with solar panels as part of its post-financial crisis stimulus. Here in 2020 governments everywhere are hoping new infrastructure spending could accelerate their national recovery. Leading those plans (and following China’s example) is 5G technology, where the massive rollout of base stations, additional data storage and new 5G-enabled devices is certain to boost the electrical and electronics sectors' demand for silver.

Bottom line? While silver tends to act like gold on steroids, it sometimes seems more like gold on crack. But the number of private individuals seeking stability and diversification with precious metals has never been greater. Gold’s timeless use as the ultimate store of value shines out amid 2020’s rolling crises. Today’s unprecedented central-bank and government stimulus put a spotlight on silver’s stronger industrial use and its potential as a high-octane inflation play.

 

Adrian Ash is director of research at allocated precious-metals exchange BullionVault. The views expressed above are his own and should not be taken as investment advice.

There are a handful of top-rated investment trusts trading at discounts to net asset value, according to research by Trustnet, potentially offering investors an opportunity to buy in at an attractive entry point.

As investment trust shares are traded on the stock market, they can trade at a discount to the net asset value (NAV) of its underlying portfolio when its strategy, asset class or manager is out of favour.

The trusts with the highest crown ratings trading at discount

 

Source: FE Analytics

Below Trustnet takes a closer look at some of the investment trusts with a five FE fundinfo Crown rating – the top 10 per cent of UK retail funds based on scores for alpha, volatility and consistently strong performance – trading at the widest discounts.

Caledonia Investments

Trading at the widest discount of 18.96 per cent to its NAV in our list (as at 31 May), is the £1.8bn Caledonia Investments trust.

The trust aims to grow the NAV and annual dividends paid to shareholders over the long term by investing in “proven, well-managed businesses that combine long-term growth characteristics with an ability to deliver increasing levels of income” from around the world.

 As such, Caledonia Investments invests in four pools (and a range of assets) to achieve this aim, including: Quoted Equity: Capital, Quoted Equity: Income, Private Capital and Funds.

Its Quoted Equity: Capital pool includes companies “that demonstrate excellent operational capability and capital discipline” including names such as tech giant Microsoft, asset manager Polar Capital and drinks company AG Barr.

The Quoted Equity: Income pool, meanwhile invests in top quality, high-yielding names able to grow their dividends, such as Unilever, British American Tobacco and National Grid.

Its private capital holdings include unlisted, UK mid-market companies valued between £25m and £125m; while its fund holdings include private and public equity strategies giving it broader geographic and sector spread.

Caledonia Investments is also one of the Association of Investment Companies’ ‘dividend heroes’, having increased its annual dividend for each of the last 52 years.

Performance of trust vs sector & benchmark over 3yrs

 

Source: FE Analytics

 Caledonia Investments has made a total return of 1.23 per cent over three years compared with a 1.09 per cent loss for the average IT Flexible Investment peer and 6.54 per cent loss for the FTSE All Share benchmark. The trust is not geared, has a yield of 2.2 per cent and ongoing charges of 0.88 per cent.

 

Gresham House Strategic

Next up is the £42.8m Gresham House Strategic trust, the UK equity strategy trading at the widest discount of 13.84 per cent to NAV.

The U strategy is managed by Tony Dalwood and Richard Staveley and uses private equity style techniques in the UK small-cap space, focusing on profitable, cash-generative companies that it believes are “intrinsically undervalued."

Performance of trust vs sector over 3yrs

 

Source: FE Analytics

Over three years, the Gresham House Strategic has made a total return of 24.22 per cent compared with a loss of 5.01 per cent for the average IT UK Smaller Companies trust. It trust has a yield of 2.1 per cent, is not geared and has ongoing charges of 3.15 per cent.

 

JPMorgan China Growth & Income

A slightly different strategy is JPMorgan China Growth & Income, managed by Howard Wang, Shumin Huang, Emerson Yee Shun Yip and Rebecca Jiang.

Trading at a discount of 9.15 per cent to NAV, the £407.1m trust aims to provide long-term capital growth by investing in companies listed in China, Hong Kong and Taiwan. And aims to outperform the MSCI China index.

Over the past three years, the trust has returned 91.28 per cent, in comparison to MSCI China which returned 32.01 per cent and the 10-strong IT Country Specialist: Asia Pacific returning 3.28 per cent.

Performance of trust vs sector & benchmark over 3yrs

 

Source: FE Analytics

JPMorgan China Growth & Income is 8 per cent geared and has ongoing charges of 1.26 per cent.

 

Fidelity Japan

The only Japanese equity strategy on the list is the £317.2m Fidelity Japan trust trading at a discount of 8.99 per cent to NAV.

Managed by Nicholas Price, who has worked at Fidelity Investments Japan as a portfolio manager since 1999, the trust follows a growth at a reasonable price (GARP) investment approach.

Its 10 largest holdings include Japanese technology companies Olympus, Murata Manufacturing and Keyence, that have been key in driving the performance of the trust. Over the last three years, Fidelity Japan has returned 40.48 per cent compared with 16.13 per cent for the IT Japan sector average.

Performance of trust vs sector over 3yrs

 

Source: FE Analytics

The trust is 22 per cent geared and has ongoing charges of 0.83 per cent.

 

JPMorgan Emerging Markets

Finally, the £1.1bn JPMorgan Emerging Markets trust whose objective is to provide long-term capital growth, under the stewardship of Austin Forey, which is currently trading at a discount of 7.8 per cent. A recent amendment to the investment policy allowed for the trust to hold more than 50 per cent of their assets in a certain region if that region was performing strongly in these exceptional circumstances.

Chinese equites make up 38 per cent of the portfolio, with the technology giants Tencent and Alibaba amongst the top holdings.

Increasing exposure to any one region can be risky in terms of a fall in the NAV and declining share price. However, Forey has managed the trust during similar crises and the new investment policy is a temporary measure tailored for this crisis and the limit will likely revert to a 40 per cent maximum for any one region in the portfolio.

The JPMorgan Emerging Markets is not geared and has ongoing charges of 1.09 per cent.

As the coronavirus lockdown begins to ease in the UK, the true damage to the economy may begin to be revealed.

However, the furlough scheme implemented earlier in the year was designed to prevent mass redundancies could be masking what will be the true level of job losses in the UK, according to Invesco’s Jonathan Brown.

“If history is a guide then unemployment could be really quite sticky,” he said.

“It leads to second-round effects of companies experiencing lower demand because of unemployment, seeking to reduce costs further, and certainly deferring capital expenditure expansion plans within their businesses.”

The manager of the £573m Invesco UK Smaller Companies Equity fund believes that there will be a hangover from the crisis and it will manifest itself in a depressed level of economic growth.

He has therefore positioned his portfolio based on this scenario, focusing on companies with self-help characteristics that can grow even in more difficult times.

Brown, who has been managing funds since 2002, said that he had a strong feeling of what worked after a market correction and had kept a number of stocks on his watchlist for a recovery story.

These were companies he believed had good margins, good cash flows, strong market positions, but hadn’t yet met his valuation criteria.

One such company he cited was Gym Group, the low-cost gym operator which listed in 2015.

“We know the business well, we saw it IPO, I visited a number of their sites, and we do think they are genuinely disruptive and one of the market leaders in the space,” Brown said.

He revealed that he did not take a position in the Invesco UK Smaller Companies Equity fund previously because he was concerned that the market was attributing too high a valuation to the stock. The manager had some concerns having seen in previous cycles health clubs experienced some overinvestment and ran a risk that at some stage the market would get saturated and mature.

When the coronavirus sell-off caused Gym Group’s share price to fall by 76 per cent, Brown believed the valuation was discounting a huge amount of negativity regarding its recovery from lockdown.

He argued that Gym Group was a high-quality name with a number of aspects to its business model that put it in a very strong position for a recovery.

Gym Group operates an electronic pod required for entry which “allows them to know exactly how many people are on site”, and “control very accurately the social distancing in their properties,” he explained.

The Invesco manager added that they also tend to operate relatively large sites “so the ability to move equipment apart to meet social distancing is going to be easier for them than others”.

Brown reckons that a number of independent gym companies will suffer and the competitive threat will be diminished, meaning Gym Group will likely “emerge from the crisis in a stronger position than they entered it”.

He said: “The early signs from looking at markets in Sweden, Switzerland and China, indicate that gym goers want to go back to the gym, memberships have held up well, and attendance has been strong.”

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Another name Brown invested into during the crisis was Mitchells & Butlers, the pub, bar and restaurant company.

The stock fell by 78 per cent during the sell-off, which Brown said caused it to trade at 20 to 25 per cent below its underlying asset value.

“This is a high-quality, well invested, freehold estate of pubs and restaurants,” he said. “Clearly there are issues with lockdown and we did a lot of analysis to understand their financial position and their cash burn.”

He said that the furlough scheme, the government assistance in deferring tax payments, and the landlord assistance has been extremely helpful in managing their cost base.

Looking at the valuation on a two-to-three year view, he believes people will return to normal and the company will return to historic levels of profitability.

Grafton Group was the third name that the Invesco UK Smaller Companies Equity fund invested into during the sell-off.

Brown described the builders’ merchant as a high-quality name, which he invested into when the shares fell 64 per cent during the sell-off, after the valuation reached what he felt was “pretty attractive levels”.

The management team were formerly at BSS Industrial, which was acquired by Travis Perkins in 2010 for £553m.

Brown believes that Grafton Group is a best-in-class operator and he is betting that the government will continue their investment into construction and infrastructure as part of the economic recovery, and that Grafton Group will benefit.

Indeed, UK prime minister Boris Johnson has recently announced a new deal to accelerate £5bn worth of infrastructure projects.

Brown said Grafton Group has a strong balance sheet and that it “effectively went into the crisis effectively unlevered”.

“We believe strong businesses become even stronger after a crisis, as they more rapidly consolidate the sector and derive those scale benefits”, he explained.

He said that the crisis presented a good opportunity for some firms to take a lot of market share over the next few years.

Performance of the fund of sector vs benchmark over 5yrs

 

Source: FE Analytics

The Invesco UK Smaller Companies Equity fund has delivered a total return of 41 per cent over the last five years, compared with the IA UK Smaller Companies sector’s 31.29 per cent gain.

It has an ongoing charges figure (OCF) of 0.92 per cent.

News that small-cap veteran Harry Nimmo will head up the ASI Global Smaller Companies fund after the departure of former manager Alan Rowsell should act as a source of reassurance for investors in the £1bn fund, according to experts.

It was announced last week that Rowsell is to leave Aberdeen Standard Investments after 14 years; the manager was on the Standard Life Investments side of the merged business for the bulk of this period and launched ASI Global Smaller Companies in January 2012.

Rowsell will be joining Premier Miton Investors to launch a new global smaller companies fund. Imogen Harris, an investment analyst in his team at Aberdeen Standard Investments, will be joining with him.

FE fundinfo Alpha Manager Nimmo – who runs the flagship ASI UK Smaller Companies fund – was a co-manager on the global strategy from launch until he stepped down in late 2016, leaving Rowsell as sole manager.

While Nimmo worked on ASI Global Smaller Companies fund it made a total return of 102.03 per cent, outperforming the IA Global peer group (67.31 per cent).

Performance of fund vs sector under Harry Nimmo

 

Source: FE Analytics

Upon his return Nimmo will be working alongside co-manager Kirsty Desson, who has been a part of the ASI Smaller Companies Team for eight years.

Commenting on both Nimmo’s return and Rowsell’s departure, FundCalibre managing director Darius McDermott said: “It’s a shame that Alan is leaving, but the fund could not be left in better hands.

“Harry was the co-manager at launch and has considerable experience and success running smaller companies’ funds. Co-manager Kirsty Desson was appointed relatively recently but has been involved in the fund for some time.”

Rowsell used the Matrix tool that Nimmo built as part of the process for ASI Global Smaller Companies, as well as the 'Focus on Change' philosophy that is used by the group’s smaller companies team.

It is worth noting however that FundCalibre has had to strip the ASI Global Smaller Companies fund of its Elite Rating because it was based on Rowsell’s performance. However, the firm said this is not a commentary on Nimmo’s appointment or expectations surrounding his capability to run the fund.

In fact McDermott pointed out that the fund will continue to be run using the same process, adding “because we have confidence in Harry and Kirsty’s fund management skills, we will move the fund to an Elite Radar until a new three-year track record has been achieved”.

AJ Bell head of active investments Ryan Hughes agreed that while the departure of Rowsell came “as a bit of a surprise”, the good news for investors is that the fund is being left with a strong team and process.

“The fact that the hugely experienced Harry Nimmo has been re-appointed to the fund to work alongside Kirsty Desson is a positive given how he has managed the fund previously and been leading the small cap team until very recently,” Hughes said.

“As a result, he has first-hand knowledge of the approach and should bring important continuity to the fund.”

While Nimmo stepped down from managing the ASI Global Smaller Companies fund several years ago, he runs the £1.7bn ASI UK Smaller Companies fund and the £498.3m Standard Life UK Smaller Companies trust, both of which hold an FE fundinfo Crown Rating of four.

Performance of fund vs sector under Harry Nimmo

 

Source: FE Analytics

He also co-manages the new ASI Global Mid Cap fund, which was launched in April this year. This fund shares the same investment philosophy and process as the rest of the smaller companies range.

Nimmo stepped down as ASI’s head of smaller companies in February after 27 years in order to have a greater focus on portfolio management. Hughes said this could be beneficial given the number of strategies he is now working on.

 

“As a result of the strength of the team and the involvement of Nimmo, we remain comfortable keeping the fund on our Favourite funds list,” Hughes said.

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But there are some concerns to bear in mind, according to Ben Yearsley, co-founder of Fairview Investing.

Yearsley thinks that “if you are already an investor in this fund, the announcement should cause no concern”, as Nimmo has a long and strong track record both with the fund and in the small-cap space.

But Yearsley added that Nimmo’s re-appointment to the fund may not be permanent: “Obviously ASI need to recruit to replace as strength in depth is important.

“One issue I suppose is that Harry also co-manages the recently launched Global Mid Cap fund – will this blur the lines between the funds?

“The other thing I would say is this is probably not a long-term solution as Harry has already given the fund up once.”

But bearing that in mind, Yearsley was still positive overall at Nimmo’s return to the fund, adding “however if you are an existing investor there is no need to sell”.

Since the ASI Global Smaller Companies fund launched, it has made a total return of 219.77 per cent, outperforming its IA Global peer group (127.61 per cent).

Performance of fund vs sector since launch

 

Source: FE Analytics

The fund has an ongoing charges figure (OCF) of 1.05 per cent.

Equities were battered in March, but have rebounded to levels that almost exceed where they were before coronavirus struck. This has led some investors to question whether the asset class now looks expensive given the extreme economic uncertainty that threatens the earnings of many companies.

Timothy Woodhouse, manager of the JP Morgan Global Growth & Income trust, said that because the equity risk premium looks elevated versus history, it suggests that stocks, on a long-term basis, remain cheap.

“I think the rebound has been very impressive,” he said. “What happens when you plunge into a recession and come out of it, short-term multiples do start to look stretched.

“This is because earnings collapse and the markets move in advance of earnings recovery.”

The manager of the £495.6m global equity investment trust, warned investors against focusing too much on short-term multiples.

“When you look two and three years out, they don’t look especially cheap anymore, but I think you have another dynamic at play, which is the action from central banks and governments around the world,” he said.

“If you look at things with an equity risk premium hat on, looking at the yield on equities minus the Treasury yield, or whatever you choose the risk-free rate to be, stocks do look cheap on a long-term basis”.

He explained that when interest rates are low, mathematically it implies that near term multiples should be higher.

Performance of equity indices YTD

 

Source: FE Analytics

Woodhouse said that with rates being so low, and in the US with asset allocators talking about negative rates, he could not see how a long bull market in bonds can continue going forward.

Therefore, he said, pension funds will have to switch more of their allocation to equities in order to continue to generate the returns that they need.

“We’ve seen some large pension funds in the US starting to talk more about putting more leverage into some of their funds to generate some of the returns they need,” he said. “I think that does speak to people having to really reach.

“If you are a large asset allocator, a pension fund for example, and you’re looking to generate significant returns, well equities is probably the place you have to continue to allocate more and more money to, and that is a longer term tailwind.

“That tells you that the asset classes that offer better returns, will continue to see flows over the coming years,” he added.

However, Woodhouse admitted that with the equity risk premium, investors do have to take a longer-term view on rates.

But he said if one were to ignore what Federal Reserve chair Jerome Powell and the Federal Open Market Committee has indicated, and look beyond 2022, “it's still very hard to see what the sources of inflation would be that would lead them to have to raise rates”.

He argued that the continued progress of technology has been deflationary for the past decade and there is reason to believe that will continue.

“We are going to see jobs replaced by automation, by software, and we are going to see technology find ways to make us more efficient,” he explained. “That does bring deflationary pressure.

He said over the long term, especially when considering demographics, he still sees inflation remaining low and therefore rates remaining low around the world.”

The manager conceded that the market clearly is pricing in something akin to a V-shaped recovery.

“That could still happen, there are a lot of variables at play, but I think the risks in the very short term are probably slightly more to the downside,” Woodhouse said.

Nevertheless, he said it is very important for investors to stay invested, because trading in and out of the market risks missing the very best days.

“There is data out there that suggests over the course of the past decade if you missed the best 20 days, your returns would have been pretty much halved over that decade,” he explained. “And those times are predictably often when there is a lot of volatility and a lot of controversy.”

The JP Morgan Global Growth & Income trust’s top three holdings are Microsoft, Amazon and Alphabet, US technology companies typically held by global growth funds. Woodhouse said one of the unique things about the global equity income trust was its holdings in these types of companies.

“We completely understand the requirements of shareholders and their desire for capital, but we think it would be detrimental if we were forced to buy things like European banks or large-cap energy companies where we have real questions over the structural outlook, but are forced into holding them simply because of the yield,” he said.

“That would mean you couldn't own things like Amazon where the opportunity ahead of them is incredibly significant.”

And the manager has also taken the opportunity to add some names to the trust during the sell-off in March with NXP Semiconductors, Adidas and American Express.

He said that at any point in time the underlying portfolio will provide between a third and half of the roughly 4 per cent yield, the rest being paid out of reserves.

“We can continue to do that even if there were no NAV growth, for well over 20 years,” he added. “We are looking for the best companies that we can find around the world based on the in-depth fundamental research that we do, and we have a vehicle from which to take advantage of those, but also to generate and pay a very good dividend to our shareholders.”

Performance of trust vs sector & benchmark under manager

  Source: FE Analytics

During Woodhouse’s tenure since September 2017, the JP Morgan Global Growth & Income trust has delivered a total return of 20.06 per cent versus 22.56 per cent from the MSCI AC World index and 7.169 per cent from the six-strong IT Global Equity Income sector.

It is currently yielding 3.94 per cent, has ongoing charges of 0.57 per cent, is -0.4 per cent geared, and is trading at a premium to net asset value (NAV) of 2.8 per cent as at 29 June.

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In today’s stock market, value investments tend to be clustered in certain sectors. These sectors are often viewed as cyclical, leveraged, over-regulated, and populated by individual companies that are financially weak or poorly managed.

Looking at these sectors in more detail, it’s clear there are many companies to be best avoided. However, there are also genuinely misunderstood value assets, which not only offer good long-term prospects, but have performed robustly in the current crisis.

 

Best-in-class miners are overlooked

Mining is the classic cyclical sector. People build during booms, then stop building during recessions. Mining companies deplete resources in the good times, overpay for replacement resources at the top of the cycle, borrowing huge sums in the process, and then, during the ensuing slump, are forced by their banks to reduce debts by off-loading assets at fire-sale prices.

A mining boom that lasted from 2001 to the end of 2010 gave rise to the idea of a ‘commodity super-cycle’ expected to last into the mid-2020s. Instead, it was followed by a savage recession, and miners’ share prices declined by around 75 per cent.

During this period, the world’s largest mining companies became more shareholder-friendly, more discriminating over what assets they bought and, in the process, reduced debt levels, and materially increased dividends. These well-financed, prudently managed, world-class businesses will benefit from an infrastructure boom, as the fiscal spending takes over from monetary policy to fuel economic growth. They also remain cheap.

For example, Rio Tinto trades on less than nine times last year’s earnings, and offers a dividend yield of 7.9 per cent. In 2019, it paid its final dividend in full. Rio’s main business is selling around 330 million tons of high-grade iron ore a year to the Chinese from its mines in Australia. During the crisis, the price of iron ore has crept up from $80 dollars a ton to $100. Rio is one of the world’s lowest-cost producers, with an extracted cost for iron ore of $15 dollars a ton. Environmentally, the company is moving in the right direction too, investing in wind farms and divesting its coal assets.

 

Fiscal stimulus will boost construction and housing

The construction sector is another direct beneficiary from fiscal stimulation through infrastructure spending. The last decade has been dire for the sector. However, a UK government, which dropped the Covid-19 ball, needs to realise election promises to develop the country as a place to do business and ‘level up’ the regions. Construction companies can help deliver these goals.

Construction companies in our investable universe have experienced management teams who understand the cyclicality of their business and usually have net-cash balance sheets. They have all either adopted, or are adopting, realistic carbon-reduction targets.

The housing sector is a crucial part of the UK economy, and is likely to receive government support as part of any recovery package. However, such considerations didn’t prevent the price of Taylor Wimpey falling 57 per cent between 17 February and 17 April. Its peers received a similar treatment.

It appears this reaction is overdone. Several housebuilders have expressed surprise at the continuing level of demand underpinned by a steady level of new reservations, few cancellations, and little pricing pressure.

 

Selective opportunities in financials

The financial sector is the largest of the ‘value’ sectors covering a wide range of companies, from banks to financial advisers. Within this group, there are an array of high-quality financial companies, where we selectively find value opportunities. Many appear cheap to us, for no other apparent reason than investors see the sector as cyclical and have been avoiding it in anticipation of a downturn.

The sector fared badly during the GFC because companies allowed finances to become overstretched. Today’s financial companies run more conservative balance sheets, many with piles of cash and no debt.

For illustration, we have selective positions in high-quality insurers overlooked by the market. L&G, for example, has two world-class businesses. ‘Bulk Annuities’ relieves large companies of the administrative burden and unlimited financial responsibility of final-salary pension schemes. LGIM, the UK’s largest asset manager, looks after over £1trn of assets, mostly for investing institutions through low-cost index-trackers. LG Capital invests in long-term income-producing assets mainly in the UK, including build-to-rent housing and urban regeneration.

L&G is a genuine growth company. In 2016, the company set itself the target of increasing its earnings per share by 50 per cent over five years. In March this year, the company announced it had delivered 58 per cent EPS (earnings per share) growth in just four years. This growth is not reflected in the share price, which is lower today than it was five years ago.

Even after a recent rally, the company trades on a price/earnings ratio of 7.9x, roughly half the long-term average multiple for the UK market, and offers a dividend yield of 7.8 per cent. The company also paid its dividend in full, unlike the majority of its peers. Legal & General could also be a beneficiary of Covid-19, as the extension of zero interest rates will place renewed pressure on the finances of final-salary pension schemes.

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Can retail return?

At the end of last year, the online share of total UK retail spend was a little over 20 per cent. It will be significantly higher now. Equilibrium will be reached at some stage. We do not know where that stage might be, though we doubt the final proportion will be online 100 per cent/physical 0 per cent. Again, we believe there are selective opportunities following the sell-off.

The fund’s exposure to this sector is around 5 per cent, including 0.9 per cent in easyJet, which we see as a very well-run company. It is also the most environmentally aware of the UK-listed airline stocks, and ultimately a potential beneficiary of the shake-up in the industry.

The fund’s other consumer-facing holdings include: Bakkavor, which manufactures and sells food to supermarkets; Alliance Pharma, which acquires and markets non-prescription medicines; and Shoe Zone – an importer and retailer of budget shoes.

 

Indiscriminate property carnage signals value

Commercial property, unlike the housebuilders, has barely started to recover since the sell-off. We fully understand investors’ concerns about physical property. Retail is dying, and offices may be going the same way.

Apart from a few specialist niches, it seems the only properties investors want to own at present are the retail warehouses serving online shopping trade. These, in consequence, appear fully valued. It is worth bearing in mind that most of the retail properties we own are in retail parks, which have fared better than shopping centres, which in turn have fared better than high street shops.

Over half the floor space in the retail parks owned by Ediston Property, the fund’s largest property holding (2.6 per cent) is let to ‘essential’ retailers, who have remained open and busy throughout lockdown. Ediston report collecting around 70 per cent of rent due since the shutdown. It expects to collect nearly all the remainder in due course through arrangements under which, post-lockdown, arrears will be repaid over an extended period.

Property funds went into the global financial crisis with high levels of debt. Today, debt is far cheaper than it was then, and in aggregate, the companies we own have less than half the level of indebtedness considered normal in 2007. The above considerations may go some way to explain why Brookfield Investments, a large investor based in Ontario, Canada, has built up a 7.3 per cent stake in British Land over the last few weeks. It is often easier to see things more clearly from a distance.

 

Tony Yarrow is a fund manager at Wise Funds. The views expressed above are his own and should not be taken as investment advice.

Stocks that were expensive before the March sell-off have become even more so in the rally that has been seen in the months since, prompting IBOSS Asset Management to tilt away from the best performing region this year in favour of more attractive valuations elsewhere.

Chris Rush (pictured), senior investment analyst, said the firm aimed to seek out areas of the market where there is greater value on offer when making allocation decisions in the IBOSS managed portfolios and open-ended multi-asset range.

“What we try and do when we’re putting portfolios together… we’re trying to kind of tilt the portfolios away from the areas that look expensive relative to history and towards the areas that look like there could be some value there,” said Rush.

“And that’s not just value in the traditional sense, but also in the sense that in most scenarios – obviously coronavirus is different – if you are positioning yourself away from the most expensive areas, then you’ve got some more upside. Also, you’ve got potentially less downside.”

Indeed, the coronavirus period has been very different to past market environments in that everything sold off together, said Rush.

However, the analyst said such a broad-based sell-off meant the stocks that were expensive before the pandemic started remained expensive after it began.

“What has happened since then… is that this has perhaps been exacerbated even further, whereby the areas of the markets that looked expensive bounced back faster and the markets that look relatively cheap have bounced back less,” he explained.

Rush highlighted the strong performance of US stocks over the past five years and its representation in global benchmarks such as the MSCI World index, something that will have benefited passive investors. It’s been a similar story in terms of sector allocation.

Performance of indices over 5yrs

 

Source: FE Analytics

“Looking at a sector-weighted sample, it’s been all about how much you’ve had in the US and how much technology for the last for the last five years,” he said. “And if we go to year-to-date returns, basically nothing has changed.

“So, essentially, you’ve been rewarded – year-to-date at least – for basically having more of a benchmark position. Or if you’re an active manager having an overweight in US and technology stocks and that’s something that many investors have obviously gotten used to.”

However, while US stocks – and US tech stocks in particular – have been rallied strongly since the sell-off earlier this year, it means that they have just become more expensive to own.

“All the things that have worked in the past five years continue to look expensive to where we are today,” said Rush. “And that differential between the most expensive stocks and the least expensive stocks has gotten wider than it’s been for quite some time.”

While expensive growth stocks have continued to get more expensive, the gap with cheaper value stocks has widened since the start of the year. Rush noted that the returns from the growth and value styles this year were in line with the prior five-year period.

However, this does mean that there are many areas for investors to find opportunities.

---

 

As such, the asset manager has moved to an underweight position in US equities and is now overweight UK and emerging market stocks.

“If you look at the MSCI United Kingdom index including the bounce-back that we’ve had more recently, in price terms, we’re trading back at levels but last seen in 2016 or February 2016,” he explained. “And that isn’t the case anywhere else that valuations look as cheap as they do in the UK.”

Price performance of index over 10yrs

 

Source: FE Analytics

Domestic stocks have continued to lag their international peers in recent years as Brexit headwinds have taken their toll on the UK economy. But they had picked up significantly following the election of Boris Johnson in December and before the coronavirus took hold.

And this is why the managers Rush and IBOSS' Chris Metcalfe have been adding to their UK exposure, favouring funds with experienced management teams and proven stockpicking ability to weather short-term headwinds.

UK funds in the portfolios include Artemis UK Select, Franklin UK Equity Income, JOHCM UK Dynamic, JOHCM UK Opportunities, Man GLG UK Income, Polar Capital UK Value Opportunities, SVM UK Growth and Unicorn Outstanding British Companies.

In emerging markets, the managers have seen a similar valuation gap – relative to developed markets – opening up. However, given the varied nature of emerging markets Rush and Metcalfe have opted for active strategies that can make specific allocation decisions (BlackRock Emerging Markets and Baillie Gifford Emerging Markets Growth) as well as broad-based exposure through a passive tracker fund (L&G Global Emerging Markets Index).

Something else that investors need to be aware of is the currency impact on UK investors’ portfolios.

Sterling investors in international assets have benefited from currency weakness in recent years, something which has again been highlighted in recent years.

Performance of sterling in US dollar over 5yrs

 

Source: FE Analytics

“A weaker sterling in periods of market crisis helps sterling investors, as all of a sudden your international equities are worth more pounds than they were beforehand,” said the IBOSS analyst. “But as we’ve seen in the rally – and this is this is definitely a risk to investors going forward – is what has been a huge tailwind for the majority of the last five years can quickly become a headwind.”

He continued: “I think lots of investors have basically become comfortable with the idea that there is no risk to holding international assets from a currency perspective. So, they haven’t been hedging, because they’ve just been basically riding this wave of US dollar strength.”

Portfolio manager Metcalfe added: “We’ve written a lot about over the years – right back to Brexit, when it first really came to a head – but a lot of investors I’m not sure really appreciate just how many times the pound’s falls have coincided with market rallies.

“The big danger is that the equity markets sell off at the same time as the pound is rallying, but it’s just not happened in the last four years, but it could potentially happen one day.”

As such the pair have aimed to neutralise the impact of currency on their portfolios given the surge in the US dollar over time in much the same way as it has tilted its portfolio towards the more undervalued parts of the market.

“That’s not necessarily making a call one way or another, but just being aware that there’s a lot of investors piling into US equities, and many of these very popular [areas] – whether its growth, whether it’s North American equities or anything else – that have all benefited from very similar tailwinds over such a long period of time,” finished Rush.

March’s coronavirus crash hit the £821m BMO MM Navigator Distribution fund harder than most, with its managers conceding that no other event over their lengthy careers left them prepared for that particular sell-off.

The fund – which is run by Rob Burdett and Gary Potter’s longstanding multi-manager team – lost 17.58 per cent in March, making it the second-worst performer in the IA Mixed Investment 20-60% Shares sector.

Burdett and Potter are among the best-known multi-managers in the business and next year will mark 25 years of them working alongside each other. But Burdett said they were still blindsided by the crash, despite their years of experience.

Performance of fund vs sector in March

 

Source: FE Analytics

“Unfortunately, none of that really helped. March was our worst relative month ever. In pretty much every other bear market we've outperformed, especially in the sharp downward months,” the manager said.

“The overused ‘unprecedented’ word is hard to get away from when we look at the entire shutdown of an economy. And that clearly renders most of your diversification efforts worthless. In some ways, it exacerbates them.”

This heavy underperformance is something of a rarity for BMO MM Navigator Distribution. On a 12-month rolling basis, calculated quarterly, the fund has only been in the bottom quartile four times – and all of these periods occurred in the fairly recent past.

What’s more, the relative return that hit the fund is by far the worst it has delivered since launch in October 2007. Its second-worst monthly underperformance was in August 2011, but then it lagged it average peer by just 2.2 per cent.

Burdett (pictured) said that March’s underperformance was down to several factors, but among the main ones were the underweights to government bonds and expensive growth stocks like the so-called FAANGs (Facebook, Amazon, Apple, Netflix and Google-parent Alphabet).

Both of these areas held up in the sell-off, while pretty much every other asset tanked. The manager said this meant that efforts to build a truly diversified portfolio essentially worked against the fund.

BMO MM Navigator Distribution’s 1yr rolling sector ranking

 

Source: FE Analytics

“Things like government bonds, with the UK 10-year gilt was yielding about 0.7 just before this crisis, are sort of uninvestable on a sensible risk-reward outlook,” he said.

“The only way you cannot lose money in government bonds over 10 years is through the ‘greater fool’ theory, or somebody else paying more for them later. And that is one of the few areas that went up dramatically in the crisis.

“We've also seen the sort of FAANG effects in the US and versions of that to a greater or lesser degree in other markets. [The market] was close to peak levels: whether it's value to growth, cyclicals to defensives, all these things are stretched. But although we try to have a balance of styles, unless you were all-in those areas, you were going to underperform.”

Other factors that impacted BMO MM Navigator in the sell-off include falling interest rates hampering the value investing style, widespread cuts from the biggest dividend payers in the market and an “absolute hammering” for some of the alternative income investment trusts it owns.

“Could we have done something different?” Burdett said. “We spent a lot of time looking at the virus outbreak in January. We concluded wrongly that it did show signs of following the pattern of SARS and bird flu. Clearly that turned out to be wrong.

“But in defence of our situation going in, we were already neutral equities with a balance of styles and in credit we didn't have any high yield direct exposure. We felt we were relatively conservatively positioned.

“What makes our fund for so poorly over the long term at the moment is a lot of things we've talked about in the crisis have been happening for a while – falling government bond yields, rising FAANG stocks and the like. Style diversification was a hindrance rather than a help. It has been a very binary market.

“The tidal wave of March washed over a lot of hard work and outperformance of the preceding 11 years, unfortunately. Our other funds have been less affected but the Distribution fund in particular has been in the eye of all of those storms.”

Performance of fund vs sector over one month

 

Source: FE Analytics

However, the fund has beaten its average peer in the IA Mixed Investment 20-60% Shares sector over the past three months, moving into the top quartile of the peer group, as the coronavirus recovery favoured areas other than quality-growth and government bonds.

“Things have got a lot better in relative performance but they need to continue for us to cover that gap,” Burdett said.

“But I think we've definitely seen the move to value come through. We've seen credit start to behave in various forms in a rational way. And I think a key area where active management should do well is bonds, where there is an asymmetric risk-reward.

“There's a bright future, I think, for diversification but we've got a lot of work to do to deal with the washback of the March hiatus.”

In coming articles, Trustnet will look at why the BMO multi-manager team is positive on the outlook for the value style and believes we are on the brink of having a “healthy” bond market after a decade of distortion, as well as the funds they hold in these areas.

“In terms of the future we're in an environment where these scenarios generally lead to some form of regime change, be it economically, fund management style, politically or in consumer attitudes and behaviours,” the manager said.

BMO MM Navigator has moved underweight equities as the team expects the markets to enter another volatile period in the not-too-distant future. Its managers noted that history suggests there are many more 3 per cent plus daily moves in markets in the year or so after a crash like we have just had.

“There's going to be a lot of noise,” Burdett finished.

“At the moment, the market seems to be totally sentiment-driven, certainly talking about equities. It wants to respond to loosening of lockdown, reduced infection rates, possible medical developments or extra government stimulus. It's taking all those positives as hopeful for the future.

“But it seems to have complete fatigue, ignorance or acceptance of big negative numbers in almost any data point. They've almost all been worse than even any prediction but the market is so much higher than it was three months ago.”