Even though we have seen a number of equity markets hitting record highs this year, this should not deter advisers and their clients from putting cash into markets, says Ben Willis, Head of Research at Whitechurch Securities, based in Bristol.
Asset allocation decisions are always challenging, however today’s turbulent political situation adds a new dimension, and one which emphasises the need for detailed due diligence. That being said, although we would be very surprised to see equity markets deliver a repeat of last year’s performance, we certainly feel that equities can provide many opportunities for those prepared to ignore short-term political noise, focus on valuations and take a longer-term perspective.
The UK market – still providing opportunities
The first place we start when looking at gaining equity exposure is at home and all clients would have some exposure here. For those with a cautious risk profile, this would be limited to between 20-35% of the portfolio depending on their capacity for loss. Despite inflation ticking further upwards recently, a low growth environment and ongoing uncertainty regarding the shape of Brexit will mean UK interest rates are likely to remain at emergency levels. With equities providing considerably higher yields than cash and bonds a relatively defensive fund such as Trojan Income is an excellent core choice given its strong risk-adjusted return profile.
The continued resilience of the UK economy and the current stability in sterling (despite the triggering of Article 50) has seen investors re-appraise UK mid and smaller companies, which were out of favour for much of last year. For higher risk clients our long-term preference here is Aberforth UK Smaller Companies. The managers of this fund take a contrarian stance, looking for undervalued smaller companies, on cheap valuations that are being overlooked by the broader market.
US looking peaky
At odds with many of our peers, one market which we currently do not favour is the US. US equity performance has been exceptional, much of it driven by its global leading businesses but also underpinned by the recovery in the US economy too. President Trump’s election last year, along with his pro-growth policies certainly affected investor sentiment, spurring US equity indices upwards. This has led to excessive valuations in many areas of the US market, and relative to other equity markets. In addition, although corporate profits have been strong over the years we feel that these are at peak levels.
However, the US market is so important that we cannot ignore it. Our core preference is for equity income exposure and we have recently invested into a new fund launch, Schroder US Equity Income Maximiser. This aims to deliver a 5% income from writing covered calls whilst tracking the S&P 500. In addition, for higher risk clients we are playing a Trump card by investing in Artemis US Smaller Companies, where the manager is targeting energy, defence and infrastructure stocks in light of the President’s policies.
Europe looks good value
Forget Brexit, forget elections, European equities are our favoured market currently. There are several indicators that are pointing to potential outperformance. The European Central Bank still remains supportive, although monetary stimulus is coming to an end, economic growth is gradually recovering and inflation is ticking up. Most importantly, after years of stagnation there are signs that corporate profits growth is coming back.
From a valuations perspective it is hard to argue that European markets are cheap. However, they are at a substantial discount to the US in particular. Within European markets there is significant disparity in valuations between quality global leaders and domestic cyclicals where European recovery would be amplified into robust earnings growth as margins expand. As such, we adopt a ‘barbell’ approach to investing in Europe, combining both growth and value styles of investing.
Our core position is in Crux European Special Situations managed by Richard Pease, who pays no attention to the economy or politics, focusing on medium-sized companies that the manager believes have good quality management. To complement this we hold Neptune European Opportunities which is more focused on economically sensitive areas. This is highlighted by the fund’s overweight stance in the banking sector, where shares are trading on cheap valuations but have spent years recapitalising and restructuring and should benefit from further economic recovery.
Selective in Japan
We also adopt the ‘barbell’ approach when investing in Japan. The authorities have embarked on unprecedented monetary stimulus but the real changes come from structural reforms on corporate dividend policy and improvements on return on equity, although these will take time to come through. Our favoured positions here are in Man GLG Japan Core Alpha, which focuses on ‘cheap’, economically sensitive large company stocks, and the Baillie Gifford Japanese Income & Growth Fund, which aims to tap into the growing dividend culture.
Asia and Emerging Markets still showing promise
Outside of the developed markets, we favour Asian and Emerging Market equities but only for clients with higher attitudes to risk. For the most adventurous clients we will invest in country-specific funds such as China and India, although in the main we take a broad-based approach to investing in these markets.
The biggest short-term risks facing these markets emanate from the US with the strength of the dollar, US interest rates, Treasury yields and protectionist policies all short-term potential headwinds. Also, renewed optimism over China should not let investors become complacent over the longer-term risks of instability in the world’s second largest economy.
However, the past year has seen a steadier economic environment in Asia and Emerging Markets. Given that commodity prices and Chinese growth are more stable now, we think the fundamentals remain attractive. Structural reforms, better corporate governance, greater consumerism and cheaper relative valuations, still make these markets attractive for longer term, higher risk investors.
Our core position in Asia has always been Stewart Investors Asia Pacific Leaders, which has produced exemplary, long term risk adjusted returns from investing in these markets. With regards our emerging market exposure, we have been utilising the cost efficient, BlackRock Emerging Markets Equity Index Tracker.
Given the higher volatility of these markets we would only invest in these markets for higher risk clients, those who are comfortable with investing between 85-100% of their portfolio in equities. Even then, their investment objective would determine the actual position weighting. For example, an investor seeking long-term capital growth may hold up to 20% in these markets, whereas as an investor looking to maximise income may only have 10%.