Investment View October/November 2015
“Our wealth of experience as investors has taught us that the most effective approach to dealing with periods of widespread market dislocation is to take a step back from the panic and remain focused on the task in hand: to add value by investing in exceptional businesses and holding on to them for a long time”. This is a very appropriate and relevant recent quote from a Baillie Gifford fund manager with which we totally agree and is an attitude that we seek in all the funds we invest in.
Summer has now passed and as we head towards winter markets too have cooled down and the huge daily swings, both upwards and downwards, appear now to be substantially over. Volatility remains but at a less frenetic level. All risk assets suffered during the third quarter as investor anxiety about global growth resurfaced. The focus was on China where activity indicators continued to soften and official intervention in the foreign exchange and equity markets left investors puzzled about the direction of policy. There have also been questions about the authorities’ ability to control the economy.
The US Federal Reserve also contributed to the uncertainty by passing on the opportunity to lift interest rates in September, causing investors to ask whether the US central bank knew something they did not. We had hoped they would have made a positive decision and removed this uncertainty that will return towards the end of the year and indeed possibly into 2016. Meanwhile, the Greek crisis, which had dominated attention in the second quarter, paled as the EU agreed a new bail out.
The continued divergence between developed and emerging economies remains one of the key features of 2015 and leading indicators suggest it will persist in the coming months. The developed world would not be immune to a significant downturn in China. It is increasingly clear that the Chinese economy is slowing and policymakers are struggling to deal with a range of competing objectives; stabilising growth, managing the newly liberalised Renminbi, supporting the export market, rebalancing the economy and correcting financial imbalances. GDP growth is almost certainly slower than officially acknowledged by the authorities.
Every five years, around the end of October, market watchers turn their attentions towards China and the closely-guarded contents of the new five-year plan, essentially a meeting of top level members of the Communist Party in which social and economic development initiatives are agreed upon for the next half decade. This year, the thirteenth, is set for the 26 – 29 October, will be more eagerly awaited than most. Investors will want reassurance on how the authorities are going to tackle the issue of China’s slowing growth rate, likely to be set at 6.5% - 7% for the next five years, and whether or not the country’s transition from an export-driven economy to one based on domestic consumption is still on track.
Particular attention will be paid to how exactly the authorities intend to promote China’s ‘new’ economic industries – technology, healthcare, media and communications – at the expense of the ‘older’ more traditional industries of steel, shipbuilding and coal. These industries have, until recently, been the typical drivers of China’s growth rate. There is no doubt that economic indicators coming out of China will have a strong influence on global markets and will be monitored closely.
Our view on asset classes remains substantially unchanged as we move into the final quarter of the year. We continue to support UK direct property funds and their performance over the difficult summer was particularly welcome. Property provided positive returns, so essential in a post-retirement portfolio and welcome in any portfolio. UK direct property delivered around 2-3% over the last three months and although rising interest rates may well impact such funds, we anticipate that they will continue to make a satisfactory contribution to portfolios.
The fixed income market does not get any easier for fund managers. Undoubtedly, the consensus remains that Government and US treasuries remain unappealing and we share that view. We continue to support strategic bond funds as it provides a level of flexibility that we believe is essential in a challenging space. In addition, we continue to invest in high yield funds and in particular Royal London Sterling Extra Yield. Although the summer was not an easy time for the fund, and 2015 looks like it will be its weakest year for some time, we anticipate it will provide an acceptable return over the calendar year.
For some time we have tended not to favour FTSE 100 funds as they have been the home of several sectors that have been under considerable pressure since the global financial crisis – banks, oil, miners and commodities. We have preferred UK mid cap funds for many portfolios and as the chart demonstrates this has been handsomely rewarded over the last few years with very acceptable returns. We are very slightly moving the rudder and will be tending towards FTSE All Share funds, and the Invesco fund is likely to feature in portfolios from here. We still believe UK Mid Cap will perform and deliver but the FTSE All Share funds allow managers to select a wider opportunity set, including large caps, mid-caps and small caps. Many UK banks are becoming attractive opportunities for UK fund managers and doubtless oil, energy and commodity companies will be viewed in time as providing value. This allows these positions to be captured in an All Share fund.
Global Equities, Global Equity Income and UK Equity income remain the mainstays of almost every portfolio and that view remains unchanged. Income generating funds are important for creating value through the compounding effect over time.
Europe's recovery now seems to have taken root. We are beginning to see an improvement in domestic European earnings. Moreover, European equity valuations remain undemanding, given the earnings growth on offer. European economic data releases continue to indicate Europe’s slow economic recovery continues, and business and consumer confidence surveys indicate reasonably robust conditions. We also believe Japan offers value and their economy is at last progressing if only slowly.
North America is viewed as quite expensive, albeit opportunities exist. We will move slowly from passive funds here to a more active approach. Historically, passive funds have been hard to beat by Active fund managers but we view that for the moment this has changed.
Emerging Markets bore the brunt of the correction over the summer and indeed this asset class has struggled for a while. This sector does offer great potential and our approach through Pacific funds focusses more on new technology, which we believe will be rewarded.