Invesco analysts argue the presidential race is obscuring wider market issues
Investors would be forgiven for being stunned by Joe Biden’s sudden decision to step down from the presidential race this weekend, which has added further unpredictability to an already divisive campaign and brought greater volatility to the global market.
Biden’s decision to leave the race is not necessarily historic, in the 20th century, three sitting presidents chose not to stand for a second term. What is unique about Biden’s exit is the timing; with only four months left until polls open, it is unusual for an incumbent to withdraw this late into the campaign.
Although Biden has endorsed his vice president Kamala Harris as the Democratic party candidate, her nomination is unlikely to be confirmed until the party convention in August.
This period of uncertainty over the Democratic ticket will bring a new wave of volatility to the election campaign and give pause to those investors who had begun to regard former president Donald Trump's victory as inevitable.
With a potential Harris-led campaign now set to change the election, markets are reconsidering the consequences of a potential Democrat victory.
According to Kristina Hooper, chief global market strategist at Invesco, in the short term, Biden’s decision to withdraw will lead to four months of market volatility, as investors consider what could benefit from Harris’ success.
On the one hand, Biden’s endorsement of Harris avoids any large-scale market panic, and in the event of her victory, she brings continuity from the existing administration that may prove reassuring to existing investors.
However, in this period of enhanced volatility, the composition of the rest of the Democratic ticket will shape the campaign's overall market impact, particularly in terms of the choice of vice president.
While Harris provides continuity with Biden, she is also considered more left-wing by independents, meaning a potential vice president would need to attract the independent swing state voters.
Hooper suggested that an out-of-the-box pick such as billionaire Mark Cuban, an independent and fiscal conservative, may fit this bill, appealing to independents but also indicating to voters that this election season is more than just "politics as usual".
In turn, this greater enthusiasm will likely shape a much stronger market reaction to some of Trump’s statements, as the potential for a republican victory becomes less clear-cut.
The so-called ‘Trump trade’ such as defence, cryptocurrency and tech had been doing quite well for the past few weeks, as investors planned for his victory.
Source: Shore Capital
However, Harris’ entry into this race is unlikely to reverse these market developments fully, even if she wins.
Indeed, Lindsey James, investment strategist at Quilter Investors, said: “Markets will be unlikely to reverse the recent rotation for now given the signal for rate cuts is unchanged and it is still Trump’s election to lose. However, this news brings uncertainty and potential instability which investors crave more than anything.”
“Trump is favoured but if Harris, or another nominee, makes inroads then the recent rotation may lose legs and that volatility could take over.”
Forget the election
However, it is important to remember that most investors should not change their portfolios too drastically in response to political developments.
As Garret Melson, portfolio strategist at Natixis IM, stated: “At the end of the day, political impacts on markets are typically short-lived. There are indeed both upside and downside risks to consider… but corporates have proven their dynamism time and again.”
For Hooper, the more interesting developments affecting US markets over the next few months will be the potential for interest rate cuts, set to be discussed at the upcoming Federal Reserve meeting.
While cuts are not expected to occur next week, if the upcoming Personal Consumption Expenditure Report (PCER) finds evidence of economic deterioration, analysts believe it could lead to interest rate cuts as early as September, which would have long-term impacts on the US market.
James claimed: “For now, however, the expectations of rate cuts will remain the driving force for market returns, rather than a noisy election campaign.”
Additionally, the announcement of the earning growths of S&P 500 companies in the past quarter has further demonstrated the other underlying market trends that may direct US investment strategies in the coming months, more than the election.
Despite year-on-year growth for the S&P 500 reaching as high as 9.7% in the past three months, much of this growth owed to the strong returns of four of the ‘Magnificent Seven’ companies. If their contribution was removed, predicted earning growth would fall to just 5.7% year-on-year.
While double-digit growth is predicted for the rest of the S&P 500 during the fourth quarter, this is indicative that broader participation in earnings growth is still needed.
Hooper said: “This confirms my general view that no alarm bells are ringing yet, but cracks are starting to form in the US economy, and the Fed needs to act sooner rather than later.”
Overemphasising the election’s impact then, risks obscuring these wider market trends.
UK managers are suffering the most severe bear market of the past 30 years.
“Death by a thousand cuts” can refer to a form of torture and execution in Imperial China or a Taylor Swift song about heartbreak, but it’s also a fitting way of describing what UK managers have been feeling, trying to make money in a market that everybody snubs.
Whether he meant heartbreak or torture, the expression was chosen by Eric Burns, manager of the SDL Free Spirit fund (the small-cap sibling of SDL UK Buffettology), to describe his agony as UK-focused funds keep registering outflows.
“I've been in markets for just under 30 years and I can't remember a more prolonged death by 1,000 cuts than we have just seen over the past two and a half years,” he said.
“What we are going through is probably the most severe bear market in the UK in a very long time. We UK equity managers feel that strongly.”
Over the past year, small-cap equity funds have reduced in size by one-third each month, declining from £14.5bn five years ago to £9.8bn currently, based on data from the Investment Association. This decrease is attributed to both outflows and poor returns, which have averaged a 15% loss over the past three years.
In 2024 alone, investors withdrew £3.8bn from UK equity funds, the latest Calastone report showed, turning managers such as Burns into forced sellers of assets. The natural turnover in the Free Spirit portfolio is about 2%, he explained, but because of sales initiated to meet redemptions, the statutory turnover figure is higher than that.
Free Spirit contained approximately £80m one year ago, but suffered “a fairly large drawdown”, Burns admitted, shrinking by £16.7m to £68.8m over the past 12 months, with its £5.1m performance gains failing to offset outflows.
That’s even more alarming considering that, at its peak in September 2021, its assets under management amounted to £131.5m. The manager attributed the sharp fall to today’s levels to a 50/50 combination of performance and walk-outs.
Indeed, the fund is down 9.4% over the past three years, one of the worst records in the IA UK All Companies sector, yet it remains a top-quartile performer over five years.
This doom and gloom was not enough, however, to worry the manager in the least about the fund’s size and, above all, its viability.
“Categorically, the fund is fine in its current size. It would have to become a third of what it is now before a viability question was even asked,” he said.
“In terms of flows, funnily enough, from when we've seen that small turn in sentiment towards the UK, they have been better in Free Spirit than in Buffettology, probably because the greatest undervaluation within the UK market is at that smaller and mid-cap end.”
Buffettology went from £650.9m in assets under management at the end of last year to £483.8 today, with a positive performance effect of £48.9m and underlying outflows of £216m since the start of the year.
There were encouraging signs recently in the market, however, giving Burns hope things could turn around before the final, one-thousandth cut.
“What I will say, is things have started to change for the better. They're not brilliant, but they've got better with a definite mood shift in the past few months. That was reflected in our the turn in performance. And, of course, the great way of turning flows is to start delivering the performance.”
Performance of fund against sector and index over 1yr
Source: FE Analytics
Over the very short term, Free Spirit has re-emerged from the third performance quartile of performance against the IA UK All Companies sector over the past six months to the second quartile, which it maintained over three and one month, but it might be too soon to extrapolate from that.
Fund pickers have noticed a slight change in sentiment too and recommended funds and trusts to dip your toes back into smaller companies in this Trustnet feature.
The sector has to compete with cheap bond funds, but the current environment makes the range of strategies in the sector more appealing.
There’s an argument that those investing in absolute return funds should be among the least active investors. Granted the sector has an overly diverse range of funds – including long-only, long-short, UK centric, global and fixed interest funds – but those who can separate the wheat from the chaff should have no reason to move, given their desire to manage downside risk.
But this perception has not been the reality. The Investment Association Targeted Absolute Return (AR) sector has been among the most emotive for investors in the past decade or so, having seen steep inflows and outflows.
The sector still retains some popularity when markets face significant challenges but many investors have not forgiven its failure to protect assets in the past, most notably the challenges faced by a couple of significant funds which garnered large assets.
In a weird way the sector has delivered on the whole (it has produced positive returns in eight of the past 10 calendar years). Yet even after a strong 12 months, the dislike remains palpable with some £4.6bn of outflows.
Some fund managers we’ve spoken to believe it is because investors feel the sector offers no value to investors when you can get almost 5% in cash (the highest return for the sector in the past decade was 4.4% in 2019).
The detractors would say you can buy cheap government bond ETFs with decent yields for a few basis points. Many solid investment trusts also yield between 6 and 10% with reliable dividends.
The post quantitative easing (QE) world creates active opportunities
But the counterargument is that dispersion and stock selection are a bigger driver of markets today than they have been in the decade or so following the credit crunch. The pressure of QE is no more, with bond yields the leading factor in a growth-driven market. In short – sector and style dispersion creates opportunities.
Janus Henderson Absolute Return fund co-manager Luke Newman says performance of the fund has been impacted by the QE cycle. Today’s environment is similar to the first stage of the fund’s life (2004-2013), where the risk-free rate was >2% and equity dispersion was high. In this period the return over the risk-free rate was 8.2%.
The impact of QE saw the fund struggle between 2014 and 2020, with the risk-free rate at <2%. Newman says: “The spread of the risk-free rate on the fund fell to 1.1%. The challenge for us was how to dial down risk in the QE world – meaning more work around the bond market. We operated with less patience and booked profits sooner. All these things put a cap on deployed capital.”
He says today’s environment has been a pleasant return to normality – rather than markets being tied to monetary policy. Attractively-valued businesses, with positive catalysts, sound management and good balance sheets are the order of the day – investing in growth at any price is not a guarantee for success.
WS Ruffer Diversified Return co-manager Duncan MacInnes says he understands why investors would look to preserve their capital in cash, short-dated gilts and treasuries in this environment (a third of the portfolio is in the asset class). However, he says cash remains a terrible asset over the longer term.
He says: “When you go to cash you not only have to sell well (at the right time) you also have to time the move out of cash and back into the market, because you know over the longer term cash will give you a poor real return.
“I understand the de-risking, but timing the market is impossible. Clearly, there are moments where the performance comes thick and fast and you need to be invested at that point. You can have a cash buffer at this point, but this is not a permanent position and returns can come fast.”
I’ve said for a number of years that, despite there being a cloud over this sector, there remain a number of good funds that are delivering for investors over the long term.
Many have been waiting for an opportunity to stand out, and a world of higher interest rates may well be the perfect time to generate true and consistent alpha, and separate themselves from funds with mediocre performance.
Dispersion in performance used to be a bad thing for the sector (various fund types meant performance was all over the place), but now it is a good thing for managers.
Good examples to consider include the BlackRock European Absolute Alpha fund, which has returned 56.4% in the past 10 years. Those looking towards the bond market, might also consider the likes of the Artemis Short-Duration Strategic Bond fund, managed by Stephen Snowden.
Darius McDermott is managing director of FundCalibre and Chelsea Financial Services. The views expressed above should not be taken as investment advice.
Schroder Investment Solutions is overweight emerging market equities and small-caps.
Schroder Investment Solutions is massively overweight emerging markets, entrusting Fidelity, Polar Capital and Artemis with about a third of its highest risk portfolios. The model portfolio provider is also bullish on small-caps, which it expects to benefit from rate cuts.
Its highest risk model portfolio, level 10, has 36% in emerging market equities from a combination of Asia and emerging market funds plus exposure within global funds. By way of comparison, emerging markets constitute 10.9% of the MSCI All Country World Index.
Emerging market exposure is then scaled back in accordance with risk appetite; Schroders’ medium-risk portfolios have about 50% in equities and of that, 11-13% is in emerging markets.
The firm favours emerging markets because they are less efficient than the US and fewer sell-side analysts cover them, so active managers have a greater chance of outperforming their benchmarks and uncovering hidden gems, said Rob Starkey, a multi-asset portfolio manager.
This is a high risk, high reward asset class, he continued. “If you're willing to risk the volatility, you should get the return in the long run.”
By contrast, US large-cap managers usually only manage to beat their benchmarks by 0.2% to 0.3% “if you’re lucky”. Because the alpha is so low, “we need to hammer them on fees,” he said. “But if we go to emerging markets, we don’t have the same hurdle to step over.”
Schroder Investment Solutions has chosen a range of emerging market equity managers to gain exposure to a variety of factors, styles and market capitalisations. It holds Artemis SmartGARP Global Emerging Markets Equity, Fidelity Emerging Markets and Polar Capital Emerging Market Stars.
Artemis SmartGARP is “a phenomenal franchise and they've just done extremely well combining the human element and the quantitative element,” Starkey said.
The fund’s co-manager Peter Saacke recently left the investment industry to become a maths teacher. Raheel Altaf, who has co-managed the strategy since inception, remains at the helm.
Nick Price’s Fidelity Emerging Markets fund has suffered recently due to its copper exposure and slightly cyclical style, but it has performed strongly throughout the cycle, Starkey explained.
Polar Capital Emerging Market Stars is managed by Jorry Rask Nøddekær, Naomi Waistell and Jasper Wright. They invest in high-quality businesses and although the fund has a growth tilt, they also pay close attention to valuations. They look for a catalyst to enable them to invest at the right time, Starkey explained.
Nine months ago, Schroders moved out of emerging market small-caps and invested in Polar Capital’s fund instead, just at the right time. “That’s been an exceptional trade for us,” Starkey said.
Performance of funds versus sector and benchmark over 5yrs
Source: FE Analytics
Schroders also has a range of sustainable model portfolios, which hold Robeco Sustainable Emerging Stars Equities for core/value exposure, Stewart Investors Asia Pacific Sustainability and UBAM Positive Impact Emerging Equity.
Robeco has an impressive track record and a strong investment process, he said. It is highly rated by Schroders for its sustainable credentials, having invested significantly in this area, which is a priority for the firm.
Stewart Investors has a quality focus and a bias towards India, away from China, which has been a tailwind for performance.
On the other hand, the UBAM Positive Impact fund, which is managed Union Bancaire Privée, has faced headwinds recently. Its mid-cap growth style has been out of favour and it is overweight China, he noted.
Performance of funds vs MSCI Emerging Markets over 5yrs
Source: FE Analytics
Starkey’s second asset allocation tilt is towards small-caps, which have had a tough couple of years but should recover on the back of interest rate cuts. Small-caps are so cheap that they are “primed for any upside surprise,” he said.
Indeed, US small-caps have outperformed large-caps significantly in the past couple of weeks in reaction to inflation data, with investors anticipating that the US Federal Reserve will soon begin to cut rates.
Starkey prefers to use active small-cap managers who have a proven track record of picking winners because so many small companies are unprofitable. He thinks regional specialists have an edge because the global small-cap universe is too vast.
Schroders uses Fisher Investments Institutional US Small and Mid-Cap Core Equity, River Group’s R&M UK Listed Smaller Companies, Morant Wright Japan and Morant Wright Nippon Yield.
Schroders’ model portfolios rebalance quarterly so Starkey wanted to find a core, nimble manager who could be pragmatic and react quickly to changes in the macro-economic outlook, which is why he chose Fisher Investments.
Meanwhile, River made some changes to its team in 2022 with George Ensor becoming the small-cap fund’s lead manager, but the investment process behind the strategy and its alpha potential remained strong, so Schroders’ conviction in the strategy held firm.
In Japan, the Tokyo Stock Exchange’s reforms are targeting companies with a price-to-book value below one and many of these companies are mid-caps, which is Morant Wright’s “hunting ground”, he said.
The Trump trade is “unpredictable”, but also “logical” and might work under Harris too.
Investors who have initiated a Trump trade – moving investment portfolios to align with a possible victory of Donald Trump against Joe Biden in the US elections – might have been taken aback as Biden withdrew from the presidential race on Sunday and supported Kamala Harris as the next democratic candidate, reinvigorating the democratic bid to the presidency.
For those who believe that Trump will still be the favourite, Trustnet recently published a guide of what to own for his return to the White House. While Harris’ entry might alter the course of the campaign, experts today believe the Trump trade has not run out of steam. In fact, albeit unpredictable, it’s still “logical” and might even work under a blue president.
Below is a list of funds for investing in the US, recommended by experts as the safest picks to navigate the current political uncertainty.
As a premise, investors shouldn’t change investment portfolios too drastically on the back of politics. As Ben Yearsley, director of Fairview Investing, put it: “Politics is so unpredictable – leave your portfolios largely alone.”
“Buying hedged Japan a decade ago was straightforward – it was obvious the yen was going to weaken, therefore you had to protect against that. But with Trump, it’s not the same,” he said.
“His policies of higher spending and tax cuts will lead to a bigger budget deficit and likely higher inflation, so it’s difficult to know which way to play this.”
Many US experts have recommended small- and mid-caps for the Trump trade, but because the equal-weighted S&P500 index has been left behind this year, as have small- and mid-cap indices, this is also the area where Yearsley would look – Trump or no Trump.
His picks were aligned with those recommended on Trustnet last week for the “Trump trade” – Artemis US Smaller Companies and De Lisle America.
While the former was already discussed here, the latter is a £164m strategy led by Richard De Lisle, who keeps a relatively low price-to-earnings ratio in the fund, which is overweight value by design.
Performance of fund against sector and index over 1yr
Source: FE Analytics
The rotation into value and income stocks as well as smaller companies is only “logical”, according to Rob Morgan, chief analyst at Charles Stanley, because with Trump – still “the most likely frontrunner” –, the chance that Republicans will control both Congress and Senate, easing the passage of new legislation, remains high.
“We don’t necessarily see an unwind of the so-called Trump trade trend, at least for the time being, as it is co-mingled with the concurrent trend of better news on short-term inflationary pressures and the Fed’s now odds-on to cut interest rates in September,” he said.
“This also favours the smaller, more indebted and economically sensitive parts of the US market and, although intertwined with fiscal trends and economic policy, rests on other moving parts unrelated to political machinations. So essentially the market rotation could gather more momentum without a political angle to it.”
Morgan’s choice went to the Premier Miton US Opportunities and the Fidelity American Special Situations funds, both with “a distinctive value-led approach” and able to help to keep a portfolio “nicely balanced” with more growth-led or passive funds.
Performance of fund against sector and index over 1yr
Source: FE Analytics
Premier Miton’s strategy is led by Hugh Grieves and Nick Ford, who were praised by FE Investments analysts for their “extensive knowledge, particularly in smaller- and medium-sized companies”.
They said: “The fund is a solid option as an active US-equity fund, providing exposure to the full spectrum of the US equity market and particularly smaller- and medium-sized companies at different points in the cycle”.
Fidelity American Special Situations has a FE fundinfo Crown Rating of five and is run by Alpha Manager Rosanna Burcheri, who has a strict valuation discipline and will buy cheap companies that demonstrate the ability to compound free cash flow, resulting in the share price reflecting this in due course.
FundCalibre managing director Darius McDermott remained in line with these picks and went for T. Rowe Price US Smaller Companies, Artemis US Smaller Companies, and Schroder US Mid Cap, adding to the list absolute return funds, designed to perform under various market conditions, that could serve as a defensive option amid market uncertainty, such as WS Ruffer Diversified Return and Janus Henderson Absolute Return.
The M&G Global Macro Bond has “no obvious replacement”. Experts suggest some less-obvious options available.
There aren’t that many direct and obvious replacements for Jim Leaviss, the veteran fixed-income manager of the M&G Global Macro Bond fund, who announced his retirement earlier this month.
The news that he will be leaving the industry on 1 August, will be a blow to many investors who have trusted him with their cash over a sterling career and they may be scratching their heads trying to identify established or even up-and-coming bond managers with a stance comparable to his.
Without Leaviss, the field is left short of big-profile managers, as most big names have struggled in the past year, according to director of Farview Investing Ben Yearsley.
This was true, for example, of the Janus Henderson Strategic Bond and the Jupiter Global Macro Bond funds, he said. Both got the US hard-landing investment case wrong and whose performance suffered accordingly, as illustrated in the chart below.
Performance of funds against benchmarks over 1yr
Source: FE Analytics
“Many macro bond managers have got their big calls wrong of late and I wouldn’t say there are many up-and-coming stars to look out for,” he said.
The Janus Henderson fund may also be under review based on a manager retirement as John Pattullo is leaving in March next year, although his long-time co-manager Jenna Barnard remains in place.
This makes the question of whether investors should keep holding the M&G fund or walk away “a difficult one” to answer, as Yearsley isn’t finding many alternatives, although the new lead manager at M&G, Eva Sun Wai, is “good and has been prominent on this fund for a while”.
On Yearsley’s radar is Nick Hayes, who, together with FE fundinfo Alpha Manager Nicolas Trindade, is in charge of AXA Global Strategic Bond, a “lesser-known” fund, but one that has been around “for quite a while”.
It was launched in October 2020, to build upon the success of another similar unconstrained, total return, AXA mandate that had been in the offshore market for nine years already.
Performance of fund against sector since launch
Source: FE Analytics
However, this isn’t a direct replacement for M&G’s fund, as its team is refraining from making any of the bold macro calls that Leaviss was renowned for, Yearsley noted.
That’s also the case for other funds that are doing well, such as Pimco Income, the $78.8bn strategy with a FE fundinfo Crown rating of five, managed by Alpha Manager Dankiel Ivascyn and Joshua Anderson, with Alfred Murata as deputy – and the trend is spreading across the board, with no one emerging as a leading figure in the space.
“The whole industry seems to be moving away from the funds that make big macro calls. Who needs to be a hero in the bond world, when it’s so easy to achieve high single-digits returns through gilts at 4% and investment grade at 6%?” he said.
A more straightforward solution to the conundrum came from FundCalibre managing director Darius McDermott, who opted to stay with M&G.
With Sun Wai set to become the lead manager and Rob Burrows’ promotion from within the business to support her, the transition “underscores the strength and depth of the fixed income team at M&G, and suggests that investors should continue to hold this fund”, he said.
“Although this was very much a macro-focused bond fund, it could be argued that all bond managers must pay close attention to macroeconomic data.”
McDermott also identified a few other options outside of the M&G fund. The Invesco Tactical Bond fund, for example, managed by Stuart Edwards and Julien Eberhardt, is “worth considering”.
The managers use an active style, continually adjusting risk according to market conditions, and the fund has the flexibility to invest across the entire fixed-income spectrum.
Another “excellent” option is Nomura Global Dynamic, managed by Richard Hodges, who “has repeatedly demonstrated his ability to accurately read economic environments and select individual investments accordingly”.
“Nomura Global Dynamic is a great choice for all market conditions, offering both yield and capital return,” McDermott concluded.
Performance of funds against sector over 1yr
Source: FE Analytics
Finally, Charles Stanley’s Rob Morgan said it is difficult for any manager to consistently get macro calls right and to combine that with good stock selection. One “appealing” option is Morgan Stanley Global Fixed Income Opportunities, a similarly benchmark-agnostic and flexible fund that utilises the “deep research resources at Morgan Stanley, crucial in running a flexible strategy”.
The approach is “truly global” and will always maintain a minimum of 50% investment grade bonds to maintain a good overall credit quality.
“However, there is willingness to invest sizeable allocations to emerging markets sovereign bonds and currencies, as well as opportunistic investments in asset backed securities,” he said.
“The ‘go anywhere’ approach makes it an all-weather vehicle and a possible ‘one stop shop’ for investors’ fixed income exposure. It continues to perform well and is appropriately costed with a 0.45% annual management charge.”
Vast swathes of the high-yield market aren’t rewarding investors, says Alpha Manager Mike Scott.
Coming out as the best manager of the decade is not easy, doubly so when you change companies and have to start afresh halfway through the period.
Yet it would be hard to argue that FE fundinfo Alpha Manager Mike Scott has not achieved this feat. His current fund, the £637m Man GLG High Yield Opportunities portfolio, has been the best performer in the IA Sterling High Yield sector since its launch in 2019.
Before that, he managed the Schroder High Yield Opportunities which, under his tenure from 2012 to 2018, was the best performer in the sector.
Performance of fund vs benchmark and sector since launch
Source: FE Analytics
Taking two funds to the top of the charts is impressive, yet it might not be the draw some would expect, given the asset class he invests in. Indeed, it is difficult for investors to like the high-yield sector at the moment – even by Scott’s own admission.
For example, in the US, high-yield spreads are trading in their lowest decile versus their own history – in other words, they are providing investors with little compensation for taking the extra credit risk. Across the globe, some 60% of the high-yield bond market is trading at spreads below 300 basis points.
“That means 60% of the market is not paying you for through-the-cycle risks in high yield,” he explained. “I can absolutely guarantee you that you’re going to see cheaper times for that 60% of the market.”
However, this is masking a huge amount of dispersion underneath the surface, Scott said.
Where many investors go wrong with high-yield is they look at rating buckets and miss idiosyncratic opportunities, the manager explained. “From a headline perspective, maybe BBs are expensive compared to BBBs but that doesn’t tell you anywhere near what’s actually going on, on a granular basis beneath the surface,” he said.
“If you just looked at the market from a top-down perspective or a rating bucket perspective, you would probably stop there. I think that’s absolutely the wrong approach to take because we see some really significant value that’s opening up in segments of the market. These may be areas that have seen fundamental repricing given the current market backdrop but that’s providing opportunities for us to exploit.”
There are 1,500 names in the high-yield universe all with unique drivers of risk, yet the largest 50 names comprise 26% of the ICE BofA Global High Yield index. Those issuers are the “most over-indebted and over-owned with the worst fundamentals”, he said.
“This is why I believe in not having the straitjacket of a benchmark.” Instead, he is moving into “under-covered areas of the market where we can find really unloved, undiscovered situations”.
European real estate is one such area. Commercial real estate in general was hurt by rapid interest rate hikes but Scott has found several issuers in Eastern Europe with extremely strong fundamental backing and “cycle-wide valuations” that are “entirely mispriced”.
In major cities in Poland, Slovakia and Czechia, vacancies are low-single-digit, even in offices and retail, and revenue growth is in the low to mid-teens. Collateral values have been more resilient than elsewhere, he added.
Eastern European countries raised rates faster than Western Europe and started cutting them earlier, which has strengthened the investment case.
Elsewhere, European financials have been a focus for his fund since the first quarter of last year. When Credit Suisse collapsed and the US regional banking crisis unfolded, investors shunned the whole financial services sector. Financial companies in other parts of the world that were unaffected by these events offered a huge amount of value, he said.
Scott invested in high-yield bonds issued by traditional mortgage lenders in Spain and Portugal, where all mortgages are floating rate, and to a lesser degree Greece and Cyprus.
He also invested in UK challenger banks in niche lending markets such as buy-to-let and second lien mortgages. These banks have conservative underwriting practices and won’t be loss making in an economic downturn, he said.
Scott thinks that pressure on issuers will grow as tighter monetary policy and higher borrowing costs work through the economy. Default rates rose then plateaued but they could pick up again as more companies are forced to refinance at higher rates, he predicted.
Against that backdrop, he has a preference for cash-generative businesses with strong pricing power and inelastic demand, where the bonds are backed by hard assets, such as supermarkets.
Will the recent improvement in sentiment towards UK mid-caps prove to be another triumph of hope over experience?
So close and yet so far. And so, the eternal wait for another major international tournament win for the England men’s football team continues for at least another two years.
Despite never quite managing to set the tournament alight in terms of attacking play, England somehow managed to find their way into a second successive European Championship final only to be pipped at the post once more. Congratulations must go to Spain who, to our untrained eyes, appeared worthy winners on the night.
Whilst we might be making a leap drawing parallels, our wait for some positivity towards the UK equity market has, at times, felt decades long too, particularly in the area of mid-market equities. On numerous occasions recently we have postulated that sentiment towards the UK was so poor that it surely could not get any worse, only for it to go and do so.
Now however, we are starting to see what we hope will be a definitive positive change in the outlook for our much-beleaguered asset class. Our long-standing reasons for positivity remain, including a much more resilient economy than expected, depressed sentiment, exceptionally cheap valuations, and ongoing corporate M&A activity – $47bn in UK M&A deals so far in the year to 24th June 2024 compared to $25bn for the whole of 2023.
In addition to the above, the potential for a sustained period of political stability under the new Labour government, prioritising economic growth as a key policy initiative, appears increasingly appealing in the context of an ever more volatile political picture abroad.
Throw in rebounding consumer confidence, headline inflation back to target, and potential interest rate reductions in the months ahead, then the positive narrative becomes even more compelling.
Whilst it has, of course, been an extremely difficult few years in the UK mid-market universe, the relative performance of the FTSE 250 Index (excluding investment trusts) to the wider market over the past 25 years offers a reminder as to why we remain such enthusiasts – significant, sustained, relative outperformance being the ‘norm’ historically.
Zooming in on the most recent five-year relative performance, it is suggestive, to us at least, that likely as a result of the factors mentioned above, the period of mid-market underperformance is coming to an end.
As is often the case at the start of new major moves, assets tend to rerate ahead of underlying fundamental improvements and indeed this appears to be happening in UK mid-caps now.
Both from an absolute and relative valuation standpoint, there would appear to be plenty of scope to rerate further in due course.
Indeed, whilst the ‘mood music’ towards UK equities, and mid-caps in particular, has been improving noticeably of late, we contend that if this is the start of a fundamental reassessment of the attractions of UK equities there is much further to go in the months and years ahead.
From an international perspective, Bank of America’s latest global fund manager survey showed that exposure to UK equities increased eight percentage points in July. Whilst that represents the highest allocation in two years, it still shows a net 4% underweight the UK.
Meanwhile, from a domestic retail perspective, there has been absolutely no let-up in the relentless outflows from UK-focused retail equity funds so far, with over £1.3bn taken out in April alone.
So, will this recent improvement in sentiment prove to be another triumph of hope over experience or the start of a sustained, material reappraisal of the attractiveness of UK equities?
Only time will tell of course, but we are certainly of the view that, after what has also felt like an eternity, positivity towards UK equities, and the mid-market specifically, is coming home.
Simon Murphy is manager of the VT Tyndall Unconstrained UK Income fund. The views expressed above should not be taken as investment advice.
Other movers include Fundsmith Equity, which has fallen to the bottom crown ranking.
Eight young funds with around three years of track record have been given a coveted five FE fundinfo Crown Rating at the first time of asking, following the latest rebalance.
Meanwhile, a further 82 incumbent funds improved their ratings to the top of the ladder, taking the total number of five-crown-rated portfolios to 354.
There were clear preferences for technology stocks, with many of the top-rated funds benefiting from high exposure to ‘Magnificent Seven’ names such as Nvidia.
However, there were some opportunities elsewhere too. For example, funds with low interest rate sensitivity and high credit exposure benefited from fewer interest rate cuts than expected, while cyclical investment strategies, driven by the global economy largely avoiding recession, also did well.
Charles Younes, deputy chief investment officer at FE fundinfo, said value investing has “proved its worth” in the equity bucket, while the lack of interest rate cuts from the Federal Reserve and the Bank of England meant many of the top-performing bond funds were low duration.
“Many of the standout performers in this rebalance, such as GQG, were strategic in this volatile market, adapting to changing forecasts and finding consistent returns for clients - especially in AI [artificial intelligence] stocks,” he said.
“And they were not alone, with the AI boom driving investors to the haven of ‘Magnificent Seven’ stocks, amidst choppy waters in the bond markets at the start of 2024.”
Among the new entrants, the most popular among investors has been Pictet Multi Asset Global Opportunities, which has raked in £4.5bn since its launch three years ago. The only other fund on the list with assets under management (AUM) of more than £1bn is GQG Partners U.S. Equity, which took in £1.2bn.
Source: FE fundinfo
The latter is also the only top-quartile performer in its sector over three years, returning 60.6%.
Recommended by FE Investments analysts, the fund buys exclusively large and mega-cap quality-growth stocks in the US, but is flexible based on macroeconomic factors – meaning turnover can be high but so can its potential for outperformance.
“The macro ‘switch off’, whereby entire sectors can be exited quickly in the event of new risks emerging, has been highly successful at limiting damage in falling markets,” the analysts said. The cost – it has an ongoing charges figure (OCF) of 55 basis points – is also “incredibly competitive”.
Three IA UK All Companies funds gained the top crown rating at the first time of asking, while there were three from the IA Unclassified sector.
There were also some big movers among funds with longer track records. On the downside, WS Ruffer Total Return slipped from five crowns to one. It resides in the third quartile of the IA Mixed Investment 20-60% Shares sector over three years but has been the worst performer over 12 months, losing 0.1%.
Oasis Crescent Global Income and Threadneedle Index Linked Bond were the only other names to suffer the ignominious drop, while others such as BlackRock US Mid-Cap Value, Dodge & Cox Global Stock and Dodge & Cox US Stock dropped from five to two crowns.
Popular fund Fundsmith Equity meanwhile dropped down a crown, from two to one, as Terry Smith’s flagship portfolio continues to struggle to beat the MSCI World index, while all four Lindsell Train portfolios are now rated with one crown after WS Lindsell Train North American Equity was downgraded from two crowns, joining the firm’s other three portfolios at the base of the rankings.
On the upswing, Nedgroup Contrarian Value Equity leapt from a one-crown rating at the previous rebalance to a five-crown rating this time around. It was the only one to make such a leap after the fund’s recent run moved it into the first quartile of the IA Global sector over one, three and five years.
Epworth UK Equity For Charities and IQ EQ Defensive Equity Income moved from two crowns to five, while VT Price Value Portfolio moved from one to four – marking the other big movers.
Overall, in sector terms, the top performer was IA Specialist, with 23.8% of the peer group gaining a five-crown rating, followed by the IA Sterling Strategic Bond and IA Japan sectors, both scoring an average of 21.5%.
Going the other way, the IA Infrastructure sector – a leading peer group a year ago with six of 21 funds (29%) five-crown rated – continued its long-term decline in fortunes and now has no five-crown-rated funds.
In terms of fund groups, among those with more than 10 portfolios, investors have the best chance of owning a five-crown-rated fund from Royal London, where almost a third of its funds have the top ranking.
Source: FE fundinfo
In the latest rebalance, big winners included Evelyn Partners, which gained three top ratings, and GQG Partners, which added two five-crown-rated funds. All of its funds are now five-crown rated.
On the other side, M&G lost four top ratings and Lazard lost three. There were 15 other groups that lost multiple five-crown ratings.
Experts explain how retail investors can make the most of fund factsheets.
Retail investors face a disadvantage when selecting funds because they lack direct access to fund groups and managers to discuss underlying strategies before purchasing units.
Often, the information on fund factsheets is crucial, as it is the only up-to-date information available to them, meaning their decisions can be dependent on what they find in these monthly updates.
Although fund factsheets vary wildly, with some providing only limited and insufficient information, there are certain details investors must ensure are available before buying and should be cautious if they are not.
Meera Hearnden, investment director at Parmenion, said: “It’s difficult to make a judgement on whether or not to buy or sell a fund on the factsheet alone, but it’s a start for any investor to get an initial flavour of how the fund’s performed and its positioning, to then do further research.”
Cost disclosure
Fees are critical to the performance of any fund, as higher costs can eat into returns. Therefore, investors need to know exactly how much they will be charged and ensure it is appropriate.
As a result, a fund’s ongoing charge figure (OCF), annual management cost (AMC) and any additional costs such as performance fees or transaction costs should be clearly listed on the factsheet, with explanations of how they are applied.
Hearnden said: “One thing that isn’t provided but should be is how these fees compare to the sector average. This would really separate the wheat from the chaff and hopefully drive fund managers to be more competitive. It would also highlight if the fund is truly offering value for the risk-adjusted returns offered.”
Performance
‘Past performance is no guarantee of future results’ is one of the industry mantras. Yet, investors ought to know how the fund has performed historically to assess the manager’s skills and to put it in the context of the macro-environment.
Hearnden said: “The key question for any investor to ask is ‘what has driven that performance’. It’s easy to rule out a fund based on poor one- and three-year performance, but that could be because a fund’s style has been out of favour, for instance, and it could be on the cusp of a turnaround so it might be a mistake to rule it out purely on that basis. Alternatively, a period of very strong performance should also lead to further questions on whether that is sustainable going forward.”
Here, relevant benchmarks are a must. If a value fund is benchmarked against a broader market index, for example, it will have struggled over the long term versus a growth-heavy index, but may have performed well relative to its peers and a value orientated benchmark.
She added that she would like risk metrics to be included on factsheets alongside performance. While it isn’t the norm, they would enable investors to understand how the performance has been achieved on a risk-adjusted basis.
Top 10 holdings
A fund’s top 10 holdings can provide insight into the strategy, such as the manager’s investment style and the portfolio's level of concentration.
For example, an investor seeking a value strategy might be deterred by a top 10 holdings list filled with highly valued US tech stocks, while another looking for growth may avoid a fund dominated by high street banks and oil companies.
Similarly, a high level of concentration might be seen as either desirable, indicating active management, or undesirable, representing increased risk. Additionally, the top 10 holdings could reveal specific securities that investors might wish to avoid.
Worryingly, however, sometimes even this basic amount of detail is lacking, with some fund groups preferring other options such as top overweights and underweights relative to a benchmark, or listing the names without their weightings.
Nick Wood, head of fund research at Quilter Cheviot, said: “If an investor is relying on the factsheet for their ultimate investment decision, then being aware of the top 10 holdings, whether they match the investment strategy and how concentrated the portfolio is are all important to understanding the risk of the portfolio and how it might fit with other investments.”
Sector and regional breakdowns
Sector and regional breakdowns can reveal significant geographical or sectoral biases that an investor might find uncomfortable.
Hearnden argued that sectoral and regional positioning should be compared to the fund’s most relevant benchmark. This comparison would allow investors to evaluate how actively the fund is positioned and to understand the associated risks.
She said: “For example, a fund with over half the portfolio in just two sectors would raise eyebrows on diversification, or indeed a global fund with a high percentage in emerging markets would also lead to questions around risk.”
Fund features
Other key details such as fund size, launch date, and manager’s appointment date are crucial for assessing the fund’s liquidity, evaluating its historical performance and determining how much of this performance is attributable to the current manager.
Yield (if applicable) and the benchmark are also important, as they enable investors to calculate the amount of income they can expect and assess whether the fund is adding value compared to a tracker.
Hearnden concluded: “For bond funds you might want to include duration and the credit rating of the fund. This may be little bits of information but can amount to something useful when used together to form a view of the fund.”
Presentation and formatting
Lastly, while perhaps a strange thing to consider, monthly factsheets are an essential element of their marketing and therefore fund groups should make sure they are well presented and easy to understand. However, this is not always the case.
Wood noted that some factsheets are crammed with tables, numbers, charts and text that are difficult to read or understand. This can be more detrimental than helpful for retail investors.
He said: “These are public facing documents and as such, time and effort needs to be spent making them look appealing to investors and provide the critical points in a genuinely informative and engaging way.”
Trustnet looks for top-rated funds consistently delivering for investors.
Just 18 funds have completed the trifecta of being managed by a top manager while producing excellent short-term returns and even more impressive long-term performance, according to a study by Trustnet.
To measure this, we looked at funds run by FE fundinfo Alpha Managers, who are selected for the title based on their performance for their entire career. Factors include risk-adjusted returns and outperformance of their benchmark, with only the top 10% of fund managers achieving the rating.
Next, we filtered for those funds with a top FE fundinfo Crown Rating of five. This metric focuses on three-year performance and includes metrics such as alpha generation and relative volatility.
Lastly – and most straightforwardly – we filtered out any funds that had failed to make a top-quartile return over the past 10 years in their relevant sector.
This left us with 18 names, including three from Asia, three from Japan, two investing in European stocks, four multi-asset picks, four bond specialists, one global equity income and one China fund, as the below chart shows.
Source: FE Analytics*
The best long-term performer on the list came from the IA Global Equity Income sector, with Aviva Investors Global Equity Income making 224% over the past decade. The £581m fund has been the second-best performer in its sector over 10 years.
Managed by Alpha Manager Richard Saldanha since 2013 and co-manager Matt Kirby since 2017, it predominantly invests in large and mega-caps and is most heavily overweight the UK (17.2% of the fund) relative to its benchmark – the MSCI ACWI – while underweighting the US (38.9%).
However, there were some that made lower returns, but took the top spot among their peers. NB Strategic Income made the best returns in the 11-strong IA USD Mixed Bond sector over 10 years, up 74.5%, while Invesco Pacific (UK) led the eight-fund IA Asia Pacific Including Japan sector over the period.
M&G Japan Smaller Companies also topped its peer group, beating the other 67 funds in the IA Japan sector to the top spot over the decade. Run by Alpha Manager Carl Vine, the fund focuses further down the market capitalisation than many of its peers – a happy hunting ground over the past decade.
Analysts at FE Investments said the manager has a “very strong track record” in the region and highlighted its strong environmental, social and governance (ESG) credentials.
After screenings, the managers end up with around 250 stocks they can choose from, which tend to slightly tilt the portfolio towards the value style.
“Even when the fund’s style hasn’t been in favour, it had the ability to generate superior performance than its benchmark and sector through stock picking,” the analysts said.
It was one of three names from the IA Japan sector, including Vine’s other fund – M&G Japan – which is more of an all-cap portfolio, as well as Mark Pearson’s Arcus Japan.
The sector with the most entrants however is IA Mixed Investment 40-85% Shares, with four names on the list. BNY Mellon provided two – BNY Mellon Multi-Asset Balanced and BNY Mellon Multi-Asset Global Balanced – but it is Orbis Global Balanced that has the highest returns of the group over the decade, up 151.6%.
Alpha Manager Alec Cutler is currently 75% invested in equities with 19% in bonds and 6% in commodities – a position he defended last year.
John Chatfeild-Roberts’ Jupiter Merlin Balanced Portfolio, which he runs alongside Amanda Sillars, David Lewis and George Fox, is the other fund from the sector on the list.
PIMCO GIS Income is the largest fund with an Alpha Manager, five crowns and a top-quartile return over the decade. It has some £6bn in assets under management (AUM). Headed by Alpha Manager Daniel Ivascyn alongside Joshua Anderson, the fund is a collection of the wider firm’s best ideas, according to RSMR analysts.
Close behind is the £4.5bn Fidelity European run by Alpha Manager Samuel Morse and Marcel Stotzel, who aim to have similar sector allocations to the MSCI Europe ex UK benchmark, but with a preference for quality stocks.
FE Investments analysts said the managers have a ‘three reasons’ sheet, “ensuring they do not fall in love with any one name”.
“They believe that being fully invested is key to long-term success rather than trying to time the market,” they added, suggesting the fund “would suit an investor looking for core European exposure amongst a diversified portfolio of funds”.
Morgan Stanley Global Fixed Income Opportunities and the aforementioned BNY Mellon Multi-Asset Balanced and M&G Japan funds are the other notably sized names, all with AUM of above £3bn.
*These rankings were correct before the FE Crown Ratings rebalance today. After the rebalance, NB Strategic Income has been dropped to four crowns.
Investors “can lose a lot of money” by focusing too much on GDP growth when investing in emerging markets, managers warn.
Investors often allocate to emerging markets to benefit from the higher economic growth prospects in those regions.
However, moving into emerging markets based on top-down views often misleads investors, according to FE fundinfo Alpha Manager Douglas Ledingham, portfolio manager of Pacific Assets Trust.
He said: “Many investors confuse top-down trends with the potential for long-term returns. There's a real dichotomy between that top-down view of wonderful levels of economic growth, educational attainments or healthcare outcomes and investment returns.”
China serves as a case in point to illustrate that impressive economic growth does not always translate into stock market returns. Despite the Chinese economy regularly delivering double-digit GDP growth over the past 30 years, its stock market has not rewarded investors.
The MSCI China index has failed to outperform the MSCI World, MSCI Emerging Markets or MSCI USA indices and has severely lagged its emerging markets rival, the MSCI India index, over the past 23 years.
Performance of indices since 1 Jan 2001
Source: FE Analytics
Ledingham added: “You can lose a lot of money by simply assuming that a country or a thematic is going to grow very quickly and choose to get an exposure to those based on a top-down view.
“The focus should be on the companies, not on a country’s economic prospects or thematic trends.”
Despite Chinese equities now trading on very low valuations following a multi-year rout, Ledingham and his colleagues at Stewart Investors have not been tempted by the cheap prices. Indeed, Chinese equities account for a modest 7.4% of the Asia Pacific investment trust’s portfolio.
This is because a large number of Chinese companies are either state-controlled or state-owned.
“As stewards of other people's capital, we're uncomfortable handing their hard-earned savings to the state. A distinction must be made between the best interests of the economy or the country on the one hand and the best interests of minority shareholders on the other. We know that state-owned companies will always pick the former,” he explained.
“We much prefer to be handing our clients’ capital to management teams and stewards who are very much aligned with our time horizon and our view of risk and are making decisions today that will make their business better in 10 years’ time.”
Unlike the managers of Pacific Assets Trust, Chris Tennant, manager of Fidelity Emerging Markets, has taken advantage of the low valuations in China to top up his high-conviction ideas.
He said: “Sentiment towards China is the worst it’s been in the past 15 years. International investors have thrown in the towel, so there are a lot of very compelling value opportunities.”
While the crisis in the real estate sector has plagued China in recent years, Tennant believes that the worst of this “painful, but necessary adjustment process” is now behind us.
As a result, he has been allocation to consumer names, as an improvement in the real estate sector could boost consumer confidence.
“I think once the government sets a floor on house prices, we could see a recovery in consumption,” Tennant said.
“There’s been a similar level of excess savings relative to GDP built up in China through the Covid period as we saw in the rest of the world. The difference is that the Chinese consumer didn't go out and spend once the economy reopened because of what was going on in the housing market.”
Yet, Tennant warned that there are still “massive problems” in China, making many sectors “completely uninvestable” because of their supply and demand dynamics.
One such sector is banking, which has been “encouraged or forced” to lend to real estate developers to prevent insolvency.
Additionally, the government has been decreasing interest rates to support the property sector, adding pressure on margins in the banking sector.
However, Tennant stressed that this does not mean China is facing the risk of a banking crisis, but rather that banks will likely see bad debts appear on their balance sheets in the coming years, which will lower the quality of their books.
Another sector Tennant avoids is industrials, as China has built up significant capacity over the past decade and is now facing overcapacity issues in several areas, including solar and automotive.
“That excess capacity is now being exported to the rest of the world. That's one of the reasons why you're seeing tariffs being increased on China,” he said.
Hosting the Olympics is unlikely to boost Paris’ luxury brands as discerning consumers turn their attention elsewhere.
With visitors heading to Paris for this summer’s Olympics, which French companies stand to benefit? Many look to France’s luxury powerhouses – LVMH, Hermes, Cartier, etc. But contrary to what you might expect, the overall effect of hosting the Olympics could be neutral or even negative for luxury goods demand.
Some gains may accrue from increased customer loyalty and long-term goodwill, on the part of those treated to the lavish hospitality and events, although this is hard to quantify.
Air France recently issued a profit warning, citing reduced numbers of flyers into Paris during the summer. In terms of visitors, there may well be a crowding out effect, whereby the headline number of ‘Olympic visitors’ doesn’t reflect the net number, or those who choose not to travel to Paris.
Moreover, the target audience for the Olympics skews lower down the income distribution in comparison with higher-end consumers who would be expected to spend the most on luxury products. They will likely skip the traffic and the crowds all together, and potentially shop instead on holiday in other countries.
On top of this, given increased hotel prices and flight costs, those who do travel have less scope for goods shopping – particularly high-end goods.
Where Chinese tourists were a significant factor in luxury goods demand in the European countries they visited pre-Covid, this has now changed. While the numbers of Chinese holidaying abroad have risen significantly since the end of Covid restrictions, many are choosing Japan now, given the proximity and extreme weakness of the yen.
Organised Chinese tour groups also tend to visit Europe to travel to more than one destination; if a key city like Paris is deemed less attractive, then the whole trip may be cancelled.
Furthermore, the 80/20 shift that used to exist between external luxury purchases and domestic ones has now swapped, such that 80% of Chinese luxury purchases are now domestic. Therefore, any significant gains to Paris-based luxury houses from Chinese buyers attending the Olympics is unlikely.
Add to this weaker than normal French domestic demand – with consumers staying away from Paris due to traffic, travel restrictions, crowds and higher than normal prices for experiences and accommodation, and there is a weaker short-term picture for French luxury businesses.
Events and sponsorship may have some longer-term intangible benefits. LVMH is one of the premium sponsors of the Olympics and is hosting a variety of events and exhibitions in the run up to and during the games.
Italian luxury names could be relative beneficiaries from these dynamics, with more travellers heading to Italy instead of France. Italy also recently lowered its tax-free shopping threshold to encourage tourist spending. We do not, however, hold any of these Italian names in our strategy, given other fundamental considerations to do with these businesses.
The luxury sector has had a tough time over the past 18 months. Aspirational consumer demand globally remains weak, although the wealthiest consumer segment is proving resilient.
The US remains weaker than expected, given the hoped for ‘wealth effect’ from stock market gains. Companies now sound more pessimistic about a hoped-for inflection in US demand from the second half of this year. Recovery in China has been slower than expected.
On a longer-term basis, however, we continue to like the companies we hold in this sector. We have used the recent weakness in stock prices to add to some of these names at attractive prices.
Over the past two years, we have been working hard to identify pricing power winners – those firms which can mitigate the effects of inflationary pressures through increased pricing. Products with inelastic demand such as luxury goods are a good example of this. Some may even be ‘Veblen goods’ where demand increases as price increases.
Though inflationary pressures in Europe and elsewhere are now falling, this is still an important criterion for us when selecting stocks. This pricing power protects dividend growth in times of inflation. And sustainable dividend growth is the holy grail of our approach – leading hopefully to outperformance versus regional indices over time.
Marcel Stotzel is co-portfolio manager of the Fidelity European fund and Fidelity European trust. The views expressed above should not be taken as investment advice.
The wealth manager argues that equity income strategies play to the UK’s strengths.
The FTSE 100 has reached record highs this year but remains attractively valued and offers higher dividend payouts than elsewhere, according to RBC Brewin Dolphin.
Although the UK is unlikely to match the growth prospects of the tech-heavy US stock market, Rob Burgeman, senior investment manager at RBC Brewin Dolphin, thinks that income-focussed strategies are the best way to play to the UK’s strengths.
“The real value is in the dividends some of the market’s biggest companies are paying out and, almost more importantly, the cashflow they are generating, which is increasingly being used to buy back their own shares,” he argued.
With a forecasted price-to-earnings (P/E) ratio of 12x, the UK has generally been cheaper than its international counterparts, and this year is proving no different. For example, the MSCI Europe index has a P/E ratio of almost 14.4x this year, with the S&P 500 at 18.8x. Burgeman attributed this relative affordability to the FTSE 100’s composition, with almost 40% of the index comprised of energy, resources and financial firms.
For investors seeing exposure to UK-listed stocks with ample cashflows and dividends, Burgeman recommended three funds and three stocks, below.
Man GLG Income
Led by FE fundinfo Alpha Manager Henry Dixon, Man GLG Income aims to invest in under-valued assets. The fund offers a strong level of income and the prospect of further capital growth, Burgeman said.
While many of the fund's top holdings are in established businesses like HSBC, smaller companies such as Lancashire Holdings are also featured.
The £1.2bn strategy has consistently ranked in the top quartile over the past five years. During this period, Man GLG regularly featured amongst the sector's top 10 performing funds and was one of the most bought funds in the first half of 2024.
WS Gresham House UK Multi Cap Income
Burgeman also suggested the WS Gresham House Multi Cap Income fund, which he believes has strong growth opportunities.
Led by Brendan Gulston and Ken Wotton, the fund invests in 41 companies across the UK, including major names such as the investment trust 3i Group and the discount retailer B&M.
The fund holds almost 40% of its assets in financial services and 22% in consumer businesses.
With £874m under management, the fund has ranked in the top quartile over both a one-year and five-year period.
Ninety One UK Equity Income
Burgeman also drew attention to smaller funds such as the £81.5m Ninety One UK Equity Income fund, led by fund managers Ben Needham and Anna Farmbrough.
As a more traditional strategy, it offers a comparatively lower yield of 2.19% and only ranks in the third quartile over the past three years.
It is far less volatile than some of its competitors, with most of its top holdings being in market-leading companies such as the London Stock Exchange Group.
This lack of volatility is demonstrated in the table below, which shows how the Ninety-One UK Equity fund generally matches or slightly exceeds the benchmark over three years, but rarely sees large shifts away from the benchmark.
Performance of funds vs benchmark over 3yrs
Source: FE Analytics
Dividend payers worth backing
Equity income funds are not the only way to benefit from attractive valuations and high dividends. Investing directly in individual companies such as Unilever also has the potential to deliver strong returns and can add significant diversification to an investor’s portfolio, Burgeman said.
Despite selling its underperforming ice cream business, Unilever still operates in over 190 countries with over 3.4 billion customers.
With an average P/E ratio of 18.2x, shares in Unilever are reasonably valued, he said.
Burgeman also highlighted the insurer Legal & General. Although insurance companies have increasingly fallen out of favour, Legal & General’s shares are relatively cheap, trading on a P/E ratio of 10.7x, and they are yielding more than 8%.
“By international standards, Legal & General is a relatively small insurance group and, given it is rated so cheaply and is almost entirely UK-focussed, you wouldn’t be surprised to see a larger overseas peer take an interest in the company,” Burgeman concluded.
The business with the greatest opportunities for equity investors, however, is Barclays, Burgeman argued. Despite the recent rise in its share price, the bank trades at just 7.8x and benefits from a strong balance sheet and a diverse business portfolio.
Crucially, the firm has committed to returning nearly a third of its value to shareholders in share buybacks and dividends, predicted to reach a total of almost £10bn over the next three years.
“Whatever you think of the prospects of UK banking, that is a lot of capital to return to shareholders and, all things being equal, should make for reasonable returns,” Burgeman said.
The UK may never be where investors hunt for the “next big thing”, but there are several businesses and funds which are taking advantage of the current market conditions to offer opportunities for further growth, he said.
The platform recommends a portfolio worthy of a modern pentathlon.
As investors prepare for their financial summer and review the versatility and endurance of their portfolios, athletes are training to build up their own stamina and skills ahead of the Paris Olympics, which open this week.
Victoria Hasler, head of fund research at Hargreaves Lansdown, found several similarities between a well-constructed portfolio and the Olympics, and recommended one fund to reflect each of the five pentathlon disciplines.
Fencing: Troy Trojan
For fencing, Hasler picked the defensive Troy Trojan fund, run by FE fundinfo Alpha Manager Sebastian Lyon and Charlotte Yonge.
Performance of fund against sector and index over 5yrs
Source: FE Analytics
Rather than trying to shoot the lights out, the fund aims to grow investors' money steadily over the long run, while limiting losses when markets fall.
“The use of what are essentially swords may make fencing seem like an aggressive sport, but in reality, there is just as much skill in defending,” she said.
“The managers of the fund work with a similar philosophy, aiming to shelter investors' wealth just as much as grow it. Nimble, smart and defensive – all attributes that a good fencer needs.”
Hasler commended this popular £5.2bn strategy for its investment process, which involves four buckets. First, Lyon and Yonge invest in established companies that can grow and endure tough economic conditions. Next, there is an allocation to bonds and US index-linked bonds, which could shelter investors if inflation rises. Troy also holds gold-related investments for to protect giants inflation and market shocks. Finally, cash “provides an important shelter when markets stumble, but also a chance to invest in other assets quickly when opportunities arise,” according to Hasler.
Freestyle swimming: BNY Mellon Multi-Asset Balanced
Freestyle swimmers are able to swim any stroke they wish, just like managers of multi-asset funds have the freedom to invest in the markets and instruments they believe are most likely to succeed.
For this category, Hasler picked the BNY Mellon Multi-Asset Balanced fund, which focuses on companies with good long-term prospects from across the globe – along with some bonds and cash to act as diversifiers.
Performance of fund against sector and index over 5yrs
Source: FE Analytics
“The underlying universe of potential investments for this fund is large and includes emerging markets, smaller companies, high-yield bonds and derivatives,” she said.
In the past five and three years, the fund remained solidly anchored in the first decile of performance against the IA Mixed Investment 40-85% Shares sector; over 10 years, it was in the second.
“For investors who like a freestyle approach but don’t want to have to think about the asset allocation decisions themselves, a fund like this could be a good choice,” Hasler continued.
Equestrian showjumping: Invesco Tactical Bond
Bond markets are full of obstacles such as global economics and geopolitics, but riders (or managers) with “real skills”, such as Stuart Edwards and Julien Eberhardt of Invesco Tactical Bond, can navigate them while appearing calm and totally in control.
Performance of fund against sector and index over 5yrs
Source: FE Analytics
The fund can invest in all types of bonds, with very few constraints.
“The performance of the fund hinges on the team’s ability to interpret the bigger economic picture. Edwards and Eberhardt aim to shelter the portfolio when they see tough times ahead and seek strong returns as more opportunities become available,” Hasler said.
“Depending on the managers’ views, at different times this can be a relatively high-risk bond fund or can be run on a conservative basis. Calm, collected and always in control – a showjumper’s dream.”
The team’s recent performance, as shown above, granted the vehicle an FE fundinfo Crown Rating of five, the highest score.
Pistol Shooting: Rathbone Global Opportunities
A skilled and deliberate skill, pistol shooting “should be used with caution and control”, akin to the skillset of Alpha Manager James Thomson, who is in charge of the Rathbone Global Opportunities fund.
Performance of fund against sector and index over 5yrs
Source: FE Analytics
“Undoubtedly a skilled investor and one of only a few global fund managers to show they can pick great companies and perform better than the broad global stock market over the long term, his success can be put down to a straightforward, skilled but disciplined approach, and a willingness to view the world a little differently,” Hasler said.
“Global equity markets can be a minefield, but Thomson navigates them with ease. He shows all the hallmarks that a great pistol shooter should have – skill, caution and control.”
The fund’s performance against its IA Global peers was first-quartile over the past 10 years, but has been declining in the mid-term, falling to the second and third quartile over five and three years. It recovered recently with a second-quartile position over the past 12 months.
Cross Country Running: iShares Emerging Markets Equity Index
Emerging markets funds offer “a lot of potential as part of a portfolio for investors looking for long-term growth opportunities”, according to Hasler. They can be volatile, however, and require investors to stay the course and be adaptable, like cross-country runners.
The iShares Emerging Markets Equity Index fund aims to track the performance of the broader emerging stock market and is one of the lowest-cost options available to investors in this area, charging only 0.19%.
Performance of fund against sector and index over 5yrs
Source: FE Analytics
Hasler described the fund as a convenient way to invest in a broad spread of companies in a wide range of emerging countries.
Back-tested performance of portfolio against indices over 5yrs
Source: FE Analytics
Fund selectors recommend strategies with broad, diversified portfolios to invest in the US, emerging markets and UK small-caps.
While concentrated, high-conviction portfolios have their merits, holding a larger number of stocks can enable equity managers to spread their bets more widely and gain exposure to different themes. Diversification increases the odds of finding winners while reducing the impact of misses.
This is particularly pertinent for higher risk strategies such as small-caps where individual stocks can plummet in value. By diversifying their portfolios across a wide range of stocks, managers can limit the detrimental impact of any individual company turning sour.
Below, experts explain which highly diversified funds they use.
Rowe Price US Structured Research Equity
Sam Buckingham, an investment manager at abrdn Managed Portfolio Service, recently allocated to T. Rowe Price US Structured Research Equity.
“The fund is an analyst-driven research portfolio, combined with a portfolio oversight team to enable alpha via stock selection with benchmark-like volatility and characteristics,” he explained.
“There are approximately 30 analysts on the strategy who each are responsible for all stocks within certain sub-sectors. The portfolio oversight team are then responsible for monitoring overall portfolio exposures in conjunction with analysts to maintain benchmark-neutral sector/factor exposures.”
Performance of fund since launch vs sector and benchmark
Source: FE Analytics
The strategy has been running for more than 25 years in the US and T. Rowe Price launched a version for UK-based investors late last year.
Buckingham said this is one of the few funds with a track record of outperforming the S&P 500 and doing so with minimal tracking error.
He added that its diversified nature means the outperformance has been broad-based and not concentrated in the technology sector.
First Eagle US Small-Cap Opportunities
Simon Evan-Cook, a fund manager at Downing, invests in First Eagle US Small-Cap Opportunities, which holds approximately 250 stocks.
Manager Bill Hench applies a deep-value investment strategy, which partially explains why he holds so many stocks.
Evan-Cook said: “Some of the companies Hench’s team looks at are in a life-or-death situation, in which a factor such as tough macro conditions or bank debt rolling over could mean them going bust. If they go bust, they’ll lose their stake, but if they survive, the share price might rally several hundred per cent in relief.
“Clearly, such an approach doesn’t lend itself to a concentrated approach of, say, holding 10% positions in any one of these companies.”
Performance of fund since launch vs sector and benchmark
Source: FE Analytics
The fund has been available in the UK since February 2022 and has so far outperformed its benchmark, the Russell 2000 Value index.
Fidelity UK Smaller Companies and Teviot UK Smaller Companies
Evan-Cook also pointed to Fidelity UK Smaller Companies and Teviot UK Smaller Companies as examples of funds that make good use of high diversification.
Like First Eagle US Small-Cap Opportunities, these two funds employ a value strategy to invest in UK small-caps.
“They’re not quite so extreme as First Eagle’s approach, and run on or around 100 stocks, but many of the principles are similar: find stocks with fantastic risk-reward characteristics, but acknowledge that any one of them might be vulnerable by not betting the ranch on them using a concentrated approach,” he explained.
Performance of fund over 5yrs vs sector and benchmarks
Source: FE Analytics
Both funds have comfortably outperformed their average sector peers and benchmarks, a trend supported by the value rotation in recent years (excluding the USA).
M&G Global Emerging Markets
Chris Metcalfe, chief investment officer at IBOSS, added M&G Global Emerging Markets, to his portfolios in May 2023.
The fund, which holds about 80 stocks, invests across the whole market-cap spectrum, with circa 30% each in mega-, large- and mid-caps and then 10% in small-caps. It is managed by Michael Bourke.
Metcalfe said: “Intuitively, having all these positions could cause concern about creating a tracking-like product, but this fund certainly doesn't exhibit tracker-like outcomes.
“Except for the Covid drawdown period, where the fund suffered drawdowns larger than the sector average, performance has been consistently strong. The fund is very much actively managed. For example, three years ago, it had an allocation of around 10% to Consumer Products, now a 20% allocation.”
Performance of fund over 10yrs vs sector and benchmark
Source: FE Analytics
Chris Rush, IBOSS investment manager at Kingswood Group, recommended pairing M&G Global Emerging Markets with Federated Hermes Asia ex-Japan to gain broad exposure to emerging market equities.
Fund managers are hoping that South Korea can take a leaf out of Japan’s book and implement corporate governance reforms to close the ‘Korea discount’.
Corporate governance reforms have brought Japan’s 20-year bear market to an end and propelled its stock market to all-time highs. Now fund managers are wondering whether a similar phenomenon could happen in nearby South Korea, where poor corporate governance has led to an entrenched ‘Korea discount’.
Korean management teams have not historically given much thought to capital efficiency and balance sheet management, said Ben Preston, head of Orbis Investments’ global sector research team, but “they’ve looked across the water to Japan” and seen a rising stock market and international investors pouring money into Japan’s economy.
Performance of Korean and Japanese equities vs global over 10yrs
Source: FE Analytics, performance in sterling terms
South Korea’s Financial Services Commission introduced the Value Up program on 26 February 2024 to encourage companies to voluntarily improve their corporate governance standards and transparency, and to better align the interests of controlling and minority shareholders. These measures aim to “unlock hidden value”, Preston said.
Elli Lee, a portfolio manager at Matthews Asia, said the Value Up program is “far-reaching” and “ambitious”, but shareholders are disappointed by the voluntary nature of its proposals.
“Most shareholders were hoping for stronger enforcement and for other reforms including stricter fiduciary responsibility for boards of directors and even a lowering of inheritance tax, which is seen by many as a key reason why South Korea’s large corporates are reluctant to improve capital efficiency and shareholder value,” she explained.
About 90% of companies in Korea have controlling shareholders that prioritise their own interests at the expense of minority shareholders, said Jonathan Pines, lead portfolio manager of Federated Hermes’ Asia ex-Japan strategy.
For instance, “when a founder of a company dies in Korea, the stock price generally rockets”, he said. Prior to that, controlling families have an incentive to depress the share price to minimise inheritance tax, which in Korea is 60%.
As another example, the ex-wife of SK Group’s chairman was awarded a huge divorce settlement a couple of weeks ago and the company’s stock price rose in reaction.
Both of these anecdotes “tell the same story – that it is within the power of directors to raise share prices and they don’t do it. It tells you in South Korea that something is broken and you get all these strange side effects as a result,” Pines explained.
As part of Value Up, financial authorities have proposed revising the Commercial Act to make corporate directors responsible for protecting minority shareholders’ interests. If this is enacted, Pines thinks it would be a game changer, but there has been heavy resistance from the Chaebol (large industrial conglomerates controlled by a single family).
Meanwhile, “a huge number of companies are trading on very cheap price-to-earnings multiples,” Pines said. Some smaller companies are trading well below net cash, “which is crazy because the company could pay the entire market cap as a dividend”.
Non-voting common shares are on a 75% discount to common shares (whereas in the US, the average discount is about 2%).
As a value-oriented fund manager, “you see all these amazing things and you think, I’m going to make a fortune in this market because there’s incredible value”. However, he warned that Korea could be a value trap because the ‘Korea discount’ has persisted for a long time.
Despite Pines’ reservations, his Asia ex-Japan strategy has progressively built up an 18% overweight position in Korea versus its benchmark. “We’ve never been this overweight Korea,” he said.
The fund has an equally large underweight to India, which has “a great top-down story” such as favourable demographics and economic growth, but is “the most expensive market in the world,” he said. “Korea is the opposite. The market is rewarding India too much and penalising Korea too much.”
Valuations are so cheap in South Korea that Pines believes the potential upside outweighs the downside risk. “If a stock is trading below cash, we think to ourselves, we can’t really lose,” he said.
There are plenty of catalysts. Since the Covid pandemic, the number of Koreans owning shares has increased dramatically to about half the population, so more people are interested in share prices and are pushing for reforms.
Preston argued that Value Up could spur a gradual stock market recovery so, in addition to South Korea’s attractive valuations, “you’ve got change in the air”.
The Orbis Global Equity fund had about 15% in Japan a year ago but has taken profits and built a 15% position in Korea instead. Orbis owns several Korean banks – the one industry not dominated by controlling shareholders. As such, it has outperformed other sectors, but valuations are still attractive with several banks trading at half their book value. They are priced as if “something terrible is going to happen”, Preston said.
Orbis owns KB Financial Group, which he said is “the biggest and the best”, as well as Shinhan Bank, Hana Bank and Woori Financial Group.
South Korea also has a thriving tech sector with Samsung Electronics, SK Hynix and Micron all making memory chips. Orbis owns Micron and has exposure to SK Hynix.
Orbis and Hermes both hold Samsung Fire & Marine Insurance, whose management is “amenable to doing the right thing,” Pines said.
Why investors ignore Asia at their peril…
June ushered in the eighth consecutive month of net inflows into emerging market funds, with Asia (ex-China) taking the lion’s share. So why have investors been adding Asian equities to their buy lists? Well, recent performance has certainly played its part, with the MSCI Asia Pacific Index chalking up a healthy total return of almost 9% in sterling terms, in the first half of 2024.
But this ignores the bigger picture: put simply, the region is becoming increasingly difficult to ignore. It is home to around 60% of the world’s population and generates almost half of the world’s GDP (on a purchasing power parity basis). And it’s the growth story in particular that has been grabbing the attention of investors, with Asia forecast to generate more than twice the GDP growth of the G7 countries, thanks to three key mega-trends.
The first is the shift in the global consumer class from West to East. Asia has been the primary driver of growth since 2000 and India is forecast to contribute more to the newly-minted consumer class than Africa, Latin America and the rest of the world combined in 2025, as shown in the chart below.
This burgeoning middle-class will drive a significant increase in domestic consumption, enabling economies to reduce their dependence on export-led growth and proving a boon for consumer products firms such as Samsung, Toyota and JD.com.
Source: The World Consumer Outlook 2025, World Data Lab
Next on the list is the ‘re-shoring’ trend, prompted by the disruption to supply chains during the pandemic and ongoing geopolitical tensions, with Vietnam, Malaysia and Thailand benefiting from this so-called ‘China plus one’ strategy. And as a key supplier of nickel to electric vehicle manufacturers, Indonesia has demonstrated its ability to maintain strong relations with both the Chinese and North American markets.
Finally, Asia is well-positioned to ride the tailwinds of the net-zero transition and roll-out of artificial intelligence (AI). China is a global leader in clean energy and installed as much solar power as the rest of the world combined in 2022. It is also a leader in battery cell manufacturing and home to a booming electric car industry, with China accounting for nearly 60% of new car registrations in 2023, according to the IEA.
And on the AI front, Asia boasts the largest semiconductor foundry in the world in TSMC (which supplies Nvidia, Apple and Advanced Micro Devices, amongst others) and is tapping into soaring demand for chips as the ‘picks and shovels’ of the AI revolution.
In fairness, it has not been all plain sailing, with Japan only recently emerging from its ‘lost decades’, a prolonged period of economic stagnation, and China continuing to grapple with structural issues. That said, the broader macroeconomic backdrop is supportive as Asian economies haven’t faced the inflation-led macroeconomic problems of the West, nor their record levels of public debt.
However, treating the region as a homogenous unit ignores one of its key selling points as a diverse universe of sectors and countries, from the more mature economies of Singapore and Hong Kong to their high-growth neighbours in India, Thailand and Indonesia. Valuations also look relatively undemanding, with the MSCI Asia Pacific Index trading on a forward price-to-earnings ratio of 14.2x, some 30% below that of the MSCI World Index (as at 28 June 2024).
The investment case for Asia may be compelling but it is worth acknowledging the challenge for retail investors due to the breadth and complexity of the region, together with a relative lack of equity research. One option is an actively-managed Asian fund that provides a ready-made, diversified portfolio created by managers with the expertise to exploit pricing opportunities in relatively inefficient markets.
One such example is Schroder Asia Pacific, which is managed by Richard Sennitt and Abbas Barkhardor, who have a combined experience of nearly 50 years working in Asian and emerging markets teams at Schroders. They are supported by the 40-plus strong Schroders research team based in six offices across the region.
The managers are bottom-up stock pickers, aiming to hold a portfolio of around 60 ‘quality’ companies with sustainable earnings, sound balance sheets and good corporate governance. The trust’s tilt towards Taiwan and India has helped to drive superior returns, delivering a one and five-year total net asset return of 13% and 31% respectively (as at 12 July 2024).
Alternatively, investors looking for country-specific exposure could cast their eyes over Ashoka India. It is the top-performing trust in the AIC India & Indian Subcontinent sector over the past five years, with a net asset value total return of 160%, with recent performance boosted by its overweight position in small and mid-caps.
Japan continues to be among the top-performing countries and Schroder Japan aims to deliver capital growth from a diversified portfolio of around 60-70 companies. The trust has achieved a five-year net asset total return of 50% and recently announced an enhanced dividend policy with 4% of the average net asset value to be paid in dividends each year.
Due to its higher volatility, Asia is best suited for investors willing to take a longer-term view. However, given its ever-increasing dominance on a global scale, this may be an opportune time for investors to review their portfolio allocation: the sun may not be setting on the West but it is certainly rising in the East.
Jo Groves is an investment specialist at Kepler Partners. The views expressed above should not be taken as investment advice.
Trustnet researches the cheapest active funds in the IA Global Emerging Markets sector with less than £100m under management.
Small funds face fewer liquidity constraints than larger strategies, enabling them to explore less liquid opportunities.
Emerging market equities typically have a lower liquidity profile than developed markets, so a case can be made for choosing smaller funds.
However, higher fees are a common feature of smaller funds because they lack the scale to spread costs across a large pool of investors.
As such, Trustnet has found nine active funds in the IA Global Emerging Markets sector with less than £100m in assets and fees under 1%.
Source: FE Analytics
The cheapest small fund in the IA Global Emerging Markets sector is the $73.2m (£56.4m) Ashoka WhiteOak Emerging Markets Equity fund, which charges 0.55%.
The fund is relatively new, having been launched in 2022, building on the success of Ashoka India Equity, and is also available as an investment trust.
Manager Prashant Khemka and his team use a valuation framework called ‘OpcoFinco’, which enables them to analyse companies through the prism of return on investment capital and then to quantify the value of return on incremental capital.
Performance of fund since launch vs sector and benchmark
Source: FE Analytics
Next is the £77.4m FSSA Global Emerging Markets Focus fund, managed by Rasmus Nemmoe and Naren Gorthy, which charges 0.60%.
The fund follows a similar process to its peers in the FSSA range, employing a bottom-up approach with an absolute return mindset and an emphasis on quality and stewardship.
Analysts at Rayner Spencer Mills Research said: “The team looks for founders and management teams that have high governance standards and are well aligned with minority shareholders. These will be strong franchises with the ability to deliver sustainable and predictable returns comfortably in excess of the cost of capital.“
Performance of fund over 5yrs vs sector and benchmark
Source: FE Analytics
The fund sits in the second quartile of the IA Global Emerging Markets sector over five years and has been a top-quartile performer over three years.
In third place is the $90.8m (£70m) Polen Capital Emerging Markets Growth fund, which levies 0.61%.
Another inexpensive minnow is the £20.2m Dodge and Cox Emerging Markets Stock fund. It follows Dodge & Cox’s house style of investing in stocks that appear to be temporarily undervalued by the market but have a favourable outlook for long-term growth.
It is also overweight small- and mid-caps relative to the benchmark and boasts an active share of 78.8%.
Performance of fund since launch vs sector and benchmark
Source: FE Analytics
While the fund has a short track record, having been launched in 2021, it sits in the top quartile of the sector over three years.
Finally, the £5.1m Guinness Emerging Markets Equity Income fund stands out in the list due to its income mandate.
Managers Edmund Harriss and Mark Hammonds aim to provide investors with exposure to dividend-paying businesses across emerging markets.
They focus on companies with a market cap of at least $500m (£385.4m) that have proven their ability to achieve higher returns on invested capital, are well positioned to continue doing so and are capable of growing their dividends.
Performance of fund over 5yrs vs sector and benchmark
Source: FE Analytics
The fund sits in the sector’s second quartile over five years but is a top-quartile performer over three years.
The government aims to boost pension pots for defined contribution scheme savers by £11,000.
Chancellor Rachel Reeves has launched a pensions review to increase defined contribution (DC) schemes’ investments in the UK economy, grow pension pots and tackle waste in the pensions system.
This new Pensions Bill, confirmed in the King’s Speech, aims to encourage defined contribution (DC) schemes to raise their domestic exposure by £8bn collectively.
As DC schemes are set to manage around £800bn in assets by the end of the decade, the government believes that even a 1% shift of assets into domestic investments could help grow the UK economy and build vital infrastructure.
Meanwhile, the government aims to increase pension savers’ pots by more than £11,000 through further consolidation of DC schemes and broader investment strategies to deliver higher returns.
The Pensions Bill also introduces a ‘value for money’ framework to promote better governance and higher returns for DC schemes.
This review will also examine ways to “unleash the full investment might” of the £360bn Local Government Pension Scheme (LGPS) and address the £2bn spent on fees.
Reeves said: “The review is the latest in a big bang of reforms to unlock growth, boost investment and deliver savings for pensioners..”
These initial plans are the first phase in reviewing the pensions landscape and will be led by pensions minister Emma Reynolds.
The Chancellor and the pensions minister will chair a roundtable with the pensions industry today to initiate industry engagement for the review.
Reynolds said: “Over the next few months the review will focus on identifying any further actions to drive investment that could be taken forward in the Pension Schemes Bill before then exploring long-term challenges to ensure our pensions system is fit for the future.”
So far, the pension industry has welcomed the government’s ambitions.
António Simões, group chief executive of Legal & General Group, said: “Driving pensions capital into areas such as science, technology and infrastructure can help support better returns for millions of retirement savers, as well as stimulate much needed long-term growth for the economy.”
Andy Briggs, chief executive officer of Phoenix Group, added that this review, especially the focus on pension adequacy, is “vitally important” as only one in seven people in the UK are saving enough for a decent standard of living in retirement.
The next phase, starting later this year, will explore additional steps to improve pension outcomes and increase investment in UK markets, including assessing retirement adequacy.
Additionally, the Chancellor will chair the first Growth Mission Board on Tuesday, supporting the government’s aim to achieve the highest sustained growth in the G7.
New measures have already been announced to fix the planning system, create a new National Wealth Fund and overhaul the listings regime to boost UK stock exchanges.
Investors confirmed their preference for global passive funds over the UK and active management.
Losing a few pounds just before the summer might be good for the beach but not necessarily for funds, especially if they are left skinnier by unsatisfied investors deciding to cash in and walk away.
FE fundinfo fund flows data covering the second quarter of 2024 shows a skinnier UK and an ever-fatter pool of global funds – particularly index trackers.
Between April and June, investors reinstated their preference for global passives over actively managed domestic strategies, further cementing a trend that seems more and more impossible to counter.
Below, we reveal the IA funds that have seen the largest market movements in the second quarter of 2024.
All the main losers across the key Investment Association sectors – those that have seen redemptions greater than £500m – had a focus on the domestic market.
Two were in the IA UK All Companies sector – Royal London UK Core Equity Tilt and Jupiter UK Special Situations – and one, Aviva Inv Corporate Bond, in the Sterling Corporate Bond sector. However for at least two of these, idiosyncratic reasons rather than broader market considerations might have moved the needle.
On the opposite side of the spectrum, three other funds gained inflows greater than £500m, all of which were passively managed. Two invest globally and one in Europe, as the table below shows.
Source: Trustnet
The biggest outflow was that of Royal London UK Core Equity Tilt, from which investors withdrew £1.4bn.
Before August 2021, the strategy was called Royal London FTSE 350 Tracker, but then it changed its mandate to include a carbon control strategy into the process and now aims to maintain a carbon intensity that is at least 10% lower than its benchmark, the FTSE 350 index, whilst also considering a company’s ability and willingness to transition and contribute to a lower carbon economy.
Since then, the fund’s size has shrunk by 17%, with the steepest drawdowns happening between February and June 2023 and in May this year. A spokesperson for the fund said this was an internal move, with the money leaving the fund being retained in the firm’s other ranges.
Square Mile analysts rate the fund, basing their conviction upon “the suitability of the index tracked, the management group's commitment to operating passive strategies, the size of the fund, the fund's cost and its good historic record of tracking the index”.
“Alongside this, we are confident in the team’s ability to improve the responsible investment and ESG credentials of the fund, particularly given the strong responsible investment team at Royal London,” they said.
Turmoil around the managing team of Jupiter UK Special Situations has lost the fund £503m, as manager Ben Whitmore is set to leave the firm and to be replaced by FE fundinfo Alpha Manager Alex Savvides by the autumn.
Square Mile has suspended its rating of the fund as the passing of the baton takes place and so has RSMR. While experts were torn as to whether to stick with the fund or not, investors were more resolute to pull money out – since the beginning of the year, assets under management (AUM) dropped more than 35% from £2.2bn to the current £1.4bn.
Performance of funds against sector over the past year
Source: FE Analytics
Turning to funds that attracted more than £500m, unsurprisingly two of the three that made the list were in the IA Global sector – and all were index trackers.
The £15.9bn giant Vanguard FTSE Developed Europe ex-UK Equity Index gained £581.3m from keen investors while also building up £384.2m from performance – the best result of all funds listed here.
The vehicle has the maximum FE fundinfo Passive Crown rating of five and is highlighted by FE Investments analysts for its fully physical process with lending – meaning that it replicates the performance of its benchmark, the FTSE AW Developed ex UK Net index, by direct ownership of all the underlying securities and compensating for the trading costs through stock lending.
Another fund that convinced investors was the L&G International Index Trust, another product physically replicating an index, the FTSE World (ex UK), but that does not engage in stock lending.
RSMR analysts said: “The lack of securities lending in retail facing products is a standout feature of LGIM passive products. The team believes that it should minimise retail customers’ exposure to additional risks and keep their index funds as transparent and easy to understand as possible,” they said.
“This fund can be used as a core holding across a range of client risk profiles.”
Performance of funds against sector over the past year
Source: FE Analytics
Finally, the fund that gained the most in investor’s faith was iShares Continental European Equity Index (UK).
It tracks the European market as defined by the FTSE World Europe ex UK index, and with Europe being tipped as the market that could overtake the US, investors piled in with north of £850m.
Square Mile analysts praised it for the suitability of the index tracked, the management group's commitment to operating passive strategies, the size of the fund, the fund's cost and its good historic record of tracking the index.
The bank paid the fourth largest one-off dividend in 17 years but forecasts for the rest of the year have been revised down.
HSBC paid out some £9.3bn in dividends this quarter, representing 25% of all payouts between April and June, according to Computershare’s recent Dividend Monitor Report, but the underlying picture for UK dividends is weaker than expected.
One-off special dividends totalled more than £4.1bn in the second quarter of 2024, more than the previous six quarters combined, headlined by HSBC’s £3.1bn, the fourth highest one-off dividend in 17 years. This majority of this payment came from sales proceeds of HSBC’s Canadian branch.
Other big specials between April and June included software company Ascential, which paid out £450m, and Pinewood Technologies (£358m).
Source: Computershare
As seen above, this payment made HSBC the leading dividend payer this quarter, beating out companies such as Rio Tinto, Shell and NatWest.
More widely, Computershare’s research indicates that most sectors also had great success in this period, with 16 out of 21 industries increasing their dividend payouts over the three months.
This surge in special dividends, has contributed to an 11% rise in dividend payouts from last year, with the market paying out a total of £36.7bn, the third highest second quarter in the report’s history.
Source: Computershare
The banking sector as a whole was one of the strongest contributors to dividend growth last quarter. Banks distributed a total of £12.7bn in the three months, 50% more than last year, with banks such as Lloyds and NatWest among of the top 10 payees in the period.
The insurance sector also contributed to a positive picture in the quarter. Businesses such as Direct Line restored payouts after the 2023 cancellation, and Aviva and L&G also made “healthy increases” the report noted.
Other sectors such as healthcare also improved notably in this period, with payouts rising by 25%, due to significant increases and for companies such as Haleon.
Mark Cleland, chief executive of issuer services for the United Kingdom, Channel Islands, Ireland and Africa (UCIA) at Computershare noted the UK economy has started to pick up, resulting in higher profits. Consequently, sectors are paying more in dividends and spending more cash on share buybacks, resulting in greater optimism towards the market.
Despite these positive results, Computershare’s underlying growth forecast for the rest of the year has settled at just 0.1%, well below the initial estimate of 1.5%.
Cleland attributed this to large cuts in other sectors, which masked the wider market strength. These cuts were so significant that the combined contribution of some of the biggest sectors such as banks, oil and healthcare was necessary just to offset the drag.
As an example, the decision by Vistry to scrap dividends in favour of share buybacks had an impact, as did cuts from companies such as Barratt Developments, which suffered from a tough housing market. In total, housebuilding dividends fell by 37% year-on-year.
Easily the most influential sector shaping this lower forecast for underlying growth, however, was the mining sector, which faced a difficult quarter characterised by a second year of consecutive spending cuts.
Despite making up £1 of every £11 of UK dividends since 2015, the mining sector was responsible for a third of the market’s volatility, with dividend payouts dropping by £2bn to just £3.8bn in total last quarter.
This decline was attributed primarily to companies such as Glencore, whose total payout was £1.5bn lower than the second quarter of last year.
“The mining sector has helped drive faster growth for UK dividends over the longer term, but the highly cyclical nature of the industry means it has introduced much more volatility into each year's overall UK dividend picture” Cleland said. “The gravitational pull of mining companies on UK dividends is hard to escape”.
Moving into the rest of the year, Cleland noted that the volatility of the mining sector will act as the major obstacle to further progress.
Dividend payouts in the mining sector are expected to decline by $3bn in total by 2025. Mining is still the second largest sector in terms of dividends, meaning this will have a big impact on the wider dividend picture.
This largely offsets the underlying growth of the wider market, but Cleland noted that this is not currently cause for concern. Overemphasising the mining sector obscures the significant progress made by many other sectors.
Source: Computershare
Indeed, if the 'mining effect' were removed from the dividend report, underlying dividend growth for the period would have reached 8.6%, a much more impressive figure.
Cleland concluded: “The second quarter figures show that most sectors are delivering growth, and we expect that to continue in the second half of the year”, with banking, insurance and oil expected to be the drivers of further growth.
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