Market Update from Jilly Mann
It has been a few weeks since our last update, but we have continued to be active with regard to portfolio changes during this time.
In this update, we will cover the following:
- Value vs Growth strategies and what this means in practice for portfolios
- Inflationary concerns and the reaction of Central Governments
- Asia, China and the Emerging World
- US exposure within the portfolios
- Commercial Property and the challenge of Fixed Income
Value vs Growth strategies and what this means in practice for portfolios
I have lost track of number the times I have ended up thinking in terms of value and growth investing, although I’m aware that such phrases mean little to the wider world. However, the investment world is consumed by these two concepts at the present time, and perhaps rightly so.
In previous updates, I have covered the difference between a growth stock, which is often synonymous with a technology stock which seems to rise exponentially based on momentum if not substance, compared to a value stock, which is often a much more boring entity with a strong dividend focus that has been deemed as unattractive in the wake of more exciting momentum trades in recent years.
The chart below compares the performance of global growth stocks versus global value stocks over the 3 years to the 8th November 2020. World growth in yellow has hugely outperformed value by over 62% during that time.
If we look again though at the same two indices of global growth and value since “Pfizer Day”, i.e. the 9th November 2020 when the efficacy of the Pfizer Covid jab was announced to the world and the story is quite different.
This graph shows that global value has outperformed global growth by around 12% since November 2020. Admittedly, this is not a vast period of time and there remain challenges across the globe in terms of Covid and jab supplies, but the rotation towards value has been as sustained as we have experienced for quite some time. We started to position our portfolios towards value during the first UK lockdown and have continued down this path, as we believe that there remain significant upside opportunities in value stocks across the globe as the world emerges from the depths of Covid 19.
It is important to note that our portfolios are not completely tilted towards value stocks, we have maintained a balance in the portfolios, but it is quite a linear balance. There is a much greater bias towards global smaller company funds alongside traditionally value biased larger company funds, with not much in between.
In the UK, we have seen our holding in the Threadneedle UK Smaller Companies fund perform extremely well, returning over 78% since the start of April 2020. Such strong performance does lead us to continually monitor the underlying funds within our portfolios. It would be easy to rest on such returns blindly, but a consequence of strong performance is that we could easily find ourselves weighted too strongly to any one fund, so we are looking to take some profits from the Threadneedle fund and allocate some of our UK Smaller Company weighting to the Marlborough UK Micro Cap fund, which allows us to access complementary assets to run alongside Threadneedle.
Inflationary concerns and the reaction of Central Governments
In recent days both the US and UK have released updates on their monetary policy. The US Treasury released their six month Economic Summary and struck a balance between encouraging reports of GDP growth, virus control and reasons for broad inflation to be pegged back for now against the contrary risks of increased unemployment, further Covid waves and short term wage inflation. It was very much a give with one hand and take with the other statement, but on balance the expectation was for a relatively positive remainder of 2021 for economic growth with a constant eye on longer term challenges, which even Joe Biden’s record stimulus package may not contain.
Within the UK, the Bank of England have indicated that they may slow the effective Quantitative Easing policy which has been running since March 2020, to coincide with Government subsidies for Covid disruption diminishing. In essence, the Bank of England have been shoring up the Gilt market in the UK for the last year, much as they did in 2008/09 at the time of the Global Financial Crisis. This has led to the economy being in a relatively strong place for a recovery as Lockdowns and Covid restrictions ease, but has kept an artificial cap on the gilt market and traditional measures of economic health.
As the Bank of England announced their intentions to let go of the reins, UK gilts did signal something of an upturn, but this was more evident in Index Linked Gilts than in conventional Gilts. The Bank of England has not indicated any impending interest rate rises, such rises would potentially hinder economic recovery in the early days and so the UK is facing a further period of low interest rates for longer.
That said, globally there is a supply and demand imbalance in a way that hasn’t been experienced for quite some time. With inventories running low across the globe and trade still impeded by Covid restrictions, it will take some time to restock supplies at a time when demand will be greater from people released from Lockdown, who want to enjoy their new-found freedom. This imbalance won’t last forever, the world will restock eventually, but in the short term, there are real inflationary pressures that could result in higher prices. These inflationary pressures are already being seen in the commodity market and shipping costs, but could feed through to the end consumer. Suppliers then have a decision to make as to how much of that inflation to pass on to consumers just as employers have a decision to make on real wage inflation, but whereas inflation threatened to emerge after the Global Financial Crisis, yet never did, this time, there are enough signals to suggest some level of inflation threat could well become a reality both in the UK and across the globe. In such an environment, inflation linked assets such as Index-Linked Gilts will likely rise.
Equally, in such an environment, there are three main cyclical sectors which could do well post Covid due to how unloved they were prior to the Virus taking hold: Value, Europe and Emerging Markets.
The above graph shows the performance of each of these sectors since the start of 2021. As can be seen, the Schroder Global Recovery fund (the proxy for global value) and the Janus Henderson European Smaller Companies fund have both performed well, returning over 17% and 13% respectively. This supports the view that some level of inflation and market rotation is taking place.
Asia, China and the Emerging World
Comparatively, the above graph shows that the JPM Emerging Market fund has underperformed, returning a negative 3% over the same timeframe. We reduced our weighting to Emerging Markets a few weeks ago, reducing our JPM exposure, but also selling entirely the Baillie Gifford China fund. Emerging Markets are dominated these days by Chinese influence, which has proven hugely successful for us whilst Chinese markets have risen, which they did largely through 2020, but if there are jitters about the Chinese economy, it can have wider implications.
China is very much a sector where timing matters. It isn’t a sector that will always form a part of our portfolios. We are not afraid to own it and increase our portfolio weighting across Asia and Emerging Markets to capture Chinese exposure when we see a positive economic outlook for the region, but we equally aren’t afraid to reduce it back down when we feel the need to do so.
January 2011 marked the launch of the IMA (Investment Management Association) China/Greater China sector. The sector has just passed it’s 10 year anniversary and, over that time, the Chinese economy has continued to thrive, becoming the world’s second largest economy. We simply cannot ignore it when constructing portfolios, accepting the moral maze that comes with it. That said, it surely cannot be long before the IMA starts mulling over when China ceases to qualify as an Emerging Market and when China’s dominance of the Asia Pacific sectors becomes too great.
Japan clearly falls within Asia and was once the world’s second largest economy, but has been excluded from the IMA’s Asia Pacific sector for quite some time. Why I think this matters is that China currently makes up around 42% of the Emerging Market index and so if we do have short term concerns about Chinese financial policy and the potential for them to dampen down the pace of economic recovery through late 2021, we inevitably need to look at reducing our wider emerging market allocation and potentially look at more region specific funds for exposure to other emerging markets, such as Latin America, Emerging Europe and India.
The reason we haven’t fully sold down the JPM fund is that the fund isn’t solely exposed to China and is adjusting it’s own underlying investment strategy ongoing, so there remains scope for strong returns from the fund, but we simply feel that the sector is slightly lagging other markets in terms of a recovery at the moment, but will come back strongly in the same way that European and Value stocks have and when it does, we want to have some exposure to this.
India is suffering hugely at the moment from Covid 19, although it’s stock market recovery through 2020 was exceptional, so we are weighing up our options with regard to exposure to these specific markets. If the adage of when is best to invest is when it feels most uncomfortable, that time may well be imminent for some of these markets, albeit we need to be careful how we invest there and in what proportions.
US exposure within the portfolios
We have added back into our portfolios the Artemis Global Income fund. Many of our longer term investors will recognise this fund as we have held it for a number of years in the past. When we sold the fund a couple of years ago, we felt that the manager remained high quality, but the fund was simply not going to succeed in the market environment at the time. The fund has always had a strong dividend focus, with a genuinely global spread, but the stocks it owned weren’t being rewarded in the growth phase the world was operating in. Covid 19 has changed that and the fund has really started to outperform strongly again. We don’t consider this to be a flash in the pan either, we think the Artemis Global Income fund really fills a gap in our strategy and that current market conditions are designed for a sustained period of strong returns.
Firstly, the fund will benefit from the global dividend story. We have never known the dividend payable on the fund to be as low as it has been of late, but with companies returning to paying dividends through 2021, there will be a re-rating upwards for many of the stocks in the fund. Equally, the fund gives us exposure to an area of the US stock market which we have been struggling to access, which is US Value holdings. By no means is the Artemis fund a proxy for the US market, but there are some core holdings within the fund which give us exposure to those areas of the US economy which should prosper as a result of Biden’s stimulus package.
General Motors (GM) is a fine example of a stock that the fund has owned consistently throughout it’s existence. GM has been challenged on occasion by issues of environmental governance, however, the company have committed to eliminating tailpipe emmissions for new light duty vehicles by 2035 and is building a strong brand in the electrification of new vehicles. US car ownership is soaring at the moment in spite of Covid, something which GM is benefitting from, but the Artemis fund also owns finance companies with high exposure to car lease finance. This area of the market has an historically low default rate and so security is relatively high, margins are also relatively high on finance lending at the moment and the prospects for the sector appear strong thanks to the huge US financial response to Covid, which has left many people with surplus cash in their pocket rather than cash worries.
As the graph above demonstrates, fund selection is key more so now than for a long time. Now is not the time to simply own the US stock market just because Joe Biden has pumped so much money into it. Now is the time to own the right parts of the US stock market to benefit from this stimulus package. The comparison between the Baillie Gifford American fund (brown line) which did so well for us last year and the Artemis Global Income fund (green line) since “Pfizer Day” is significant, around 23%, and represents the type of strategic changes to portfolios we are making at the moment. The Baillie Gifford fund is heavily technology and Growth focussed and as the world becomes a little less dependent upon technology we are seeing a falling back of the stocks that fund owns in comparison to the Value bias favoured by the Artemis fund.
Commercial Property and the challenge of Fixed Income
Finally, I wanted to touch on commercial property. The BMO UK Property fund has reopened to trade, albeit there remains a price reduction for selling the fund at the present time. We met with the manager, Guy Glover, recently and he was as bullish about the prospects for the coming year as we have ever known him. Guy is someone who will readily tell us when it is not a good time to invest, as when it is. However all property funds are not the same and it is important to recognise that now is not a great time for most of the UK Property funds out there, their prospects, especially the likes of M&G, who are not looking strong. The BMO fund is different, the cash weighting within the fund remains over 20% which represents a strong cash buffer. There are minimal redemptions from the fund across current investors, they continue to pull in rents from over 90% of tenants on time in spite of Covid, they have renogotiated leases upwardly on a number of existing holdings and are actively looking at property to purchase.
When the fund starts to purchase new property, the price within the portfolio will likely swing and any reduction for leaving will be removed. This will be good news for existing investors and I don’t think it will take too long to happen, however, it does also represent an opportunity to potentially top up our holding in the fund with the prospect of a near term uptick in return of around 5% expected. We monitor our exposure to this fund very closely, but at a time when gilts and fixed income aren’t overly attractive, an extra couple of percent into the BMO UK Property fund could be a sensible option to take.
To provide a final piece of context to the challenges we have in managing the lower risk end of our portfolios at the moment, i.e. fixed income, we remain satisfied with much of our bond fund exposure, but you may recall we sold the M&G Emerging Market Bond fund a few months ago in lieu of increasing our exposure to the JPM Global Macro Opportunities fund.
The JPM fund is in blue with the M&G fund in red. The difference in return from the start of 2021 between the two funds has been around 7%. That number is significant when we are looking for stable, modest returns in a lower risk, lower return environment. This is the challenge we face with fixed income at the present time and so we are constantly looking for the right opportunity to generate extra returns without taking on too much additional risk, something which the BMO Property fund may assist us with.