Aside from the occasional speed bump, 2018 has proved relatively benign for investors so far, says Darius McDermott, Managing Director of Chelsea Financial Services
While emerging markets have come under pressure, developed stock markets have largely shrugged off macro headwinds and delivered growth for investors. These headwinds include the escalation of trade tensions between the US and China (largely driven by the actions of US president Donald Trump), the unwinding of extraordinary monetary policy measures across the world, and the UK’s impending departure from the European Union (EU).
As the nights draw in and we dust off our autumn jackets, it feels like a good opportunity to review the asset classes that have performed well so far this year – and those that have the potential to deliver returns looking ahead. I will also throw in some areas to avoid for good measure!
US leads the way
The US is a good place to start, given the S&P 500 has recorded the longest bull run in history. This accolade was achieved on 23 August, marking a period of 3,453 days in which the market avoided a fall of 20% or more. Investors with exposure to the world’s largest economy are likely to have experienced a smooth ride, with the S&P 500 up 15% (in sterling terms) year-to-date.
Can this run of performance continue? Some suggest that the US market’s fate will depend on the performance of the so-called FAANG stocks (Facebook, Amazon, Apple, Netflix and Google). Although their influence on our day-to-day lives is undeniable and their contribution to stock market gains has been significant this year, I think it is important to look at the market as a whole. For example, the equal-weighted S&P 500, which strips out the dominance of the FAANGs, is up by 11.1% this year.
David Coombs, Manager of the Rathbone Strategic Growth fund, recently pointed out that the US market offers a few pockets of value. For example, US industrials look cheaper than their European peers.
The fund manager also noted that US companies across a number of sectors appear to be in better health than their UK counterparts. For example, USbased home improvement supplies retailer Home Depot saw revenues climb by 8.4% to $30.5 billion during the second quarter of 2018. Meanwhile, its share price has performed very well over the past two years – up 59% at a current price of $205.31 per share.
By comparison, DIY retailer Homebase is struggling. It recently took the decision to shut 42 stores under new owner Hilco Capital, which bought the business from Wesfarmers for a nominal £1 in June. This could indicate that the US consumer is in better health or that Home Depot’s staff provide better service. Alternatively, it may be that the business is responding successfully to changing consumer trends.
When it comes to the US, I would suggest backing a fund manager who is able to invest across the market and has established a solid track record of identifying interesting companies away from the herd. Here, Elite Rated Hermes US SMID Equity represents a good option. Fund Manager Mark Sherlock has been buying high quality, cash-generative businesses which have been overlooked by other investors.
UK offers value
Across the ocean, the UK market has been far from exciting. Year-to-date the FTSE 100 is down 0.1%, which reflects the uncertainty surrounding the UK’s exit from the EU.
You can then throw in prime minister Theresa May’s seemingly precarious position and the prospect of a far left government under Jeremy Corbyn – and it’s easy to see why a continuous stream of negative headlines has caused investors to take fright. Figures from the Investment Association show that £10.2 billion has been withdrawn from UK equity funds since the Brexit vote.
However, beyond the negative headlines and political noise, I believe the UK offers some attractive investment opportunities right now. From Fever-Tree to Boohoo, the UK is home to a raft of success stories – and I don’t see that stopping any time soon. Whatever happens with Brexit, the UK entrepreneurial spirit will live on.
For investors seeking exposure to smaller companies, I would highlight the Elite Rated Liontrust UK Smaller Companies fund. Managers Anthony Cross and Julian Fosh have a clear investment process, which focuses on quality businesses that enjoy a competitive advantage. This may be down to intellectual property, a strong distribution network or recurring revenues.
Access to private companies
Outside of the public market, there are exciting growth and income stories that investors might consider tapping into, particularly as data suggests that UK companies are staying private for longer. VCTs are a good way to access private companies, particularly for clients with high tax bills, an appetite for taking on risk and a long-term outlook. VCTs offer 30% tax relief, while any income or dividends that are paid from VCTs are free of income tax. In addition, any gains made within the VCT are free of capital gains tax
VCTs are a good way to access private companies, particularly for clients with high tax bills, an appetite for taking on risk and a long-term outlook
I believe the UK offers some attractive investment opportunities right now. From Fever-Tree to Boohoo, the UK is home to a raft of success stories – and I don’t see that stopping any time soon
Here, I would highlight Pembroke VCT which backs entrepreneurs who are seeking to build brands of the future. For example, the portfolio includes model Alexa Chung’s womenswear range and burger restaurant Five Guys.
Bearish on bonds
In light of August’s jump in inflation and the prospect of higher interest rates in the UK, I would suggest treading with caution when it comes to bonds. Inflation and higher interest rates erode the fixed income that a bond provides, which creates the potential for prices to fall and yields to rise (as the two move inverse to each other).
Year-to-date, the performance of UK bond funds has been disappointing. The Investment Association (IA) Sterling Corporate Bond sector is down 2% on average, followed by the IA Sterling Strategic Bond sector which is down 1.4%. Over the same period, the IA Sterling High Yield sector is up only 1%.
Historically, investors have sought to diversify risk by holding absolute return funds as an alternative to fixed income. However, the IA Targeted Absolute Return sector has also fared badly since the start of the year – down 0.65% on average.
For example, one of the best known funds in the sector – Standard Life Investments Global Absolute Return Strategies (GARS) – is down 4.5% since the start of the year.
Outside of bonds, investors may consider supplementing income from alternative asset classes. For example, investment companies can offer attractive yields and exposure to a range of ‘real assets’, such as infrastructure, specialist property and renewable energy. However, it’s important to ensure that the risks associated with these areas are appropriate for your underlying client and they are comfortable having exposure to these assets.
As we enter the final quarter of the year, there are a number of factors which have the potential to rattle markets – not least Trump who is able to do so at the drop of a tweet. From Brexit through to the trade war, I would suggest fastening your seatbelt in preparation for turbulence.
However, in spite of these potential headwinds, investment opportunities remain for savvy investors who are able to keep their cool.