Model Portfolios Review: our models are poised for value to have its day in the sun

Growth-oriented funds were the second quarters stellar performers, but our portfolios are well placed for value to come back into fashion.

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Money Observer’s models put up a strong showing during the second quarter as the world’s central banks’ increasingly dovish outlook propelled markets higher.

The S&P 500 index in the US gained more than 17% in the first six months of the year – its strongest first half since 1997. France’s CAC 40 and Germany’s DAX indices jumped by more than 17%, while the UK’s FTSE 100 index rallied by more than 10%. Some emerging markets fared even better: the Russian Trading System soared by almost 30%, while China’s CSI 300 added more than 27%.

The picture is very different from the scene in late 2018 when markets suffered a dramatic sell-off amid investor jitters over US interest rate policy. The direction of US interest rates is hugely significant, as it indicates the state of health of the world’s largest economy, and the market had been pricing in two to three rises this year to add to a run of nine quarter-percentage point increases since December 2015.

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In response to several perceived risks – a less certain global economic outlook, trade tensions and renewed financial market volatility – the US Federal Reserve’s volte-face in late January put interest rate rises on hold.

It has since signalled its willingness to cut rates. Markets are pricing in a 55% chance of three cuts by the end of this year. That would delight US president Donald Trump, who believes lower interest rates would lift the US economy “like a rocket ship”.

Mario Draghi, president of the European Central Bank, has said the Frankfurt-based institution could consider expanding its €2.6 trillion (£2.3 trillion) bond-buying programme, while Bank of Japan governor Haruhiko Kuroda has indicated that extra stimulus would be an option if consumer prices consistently fall short of its 2% inflation target.

Investors’ increasing confidence that central banks will support financial markets with looser monetary policy has buoyed appetite for risk assets – and our model portfolios. They added up to 7.5% in the three months to the end of June and as much as 18.7% in the first six months of 2019 – outstripping the rise in developed world markets.

All six of our growth portfolios have beaten a 12.1% rise in the FTSE UK Private Investor Growth index over the first half, while four out of our six income portfolios have outperformed an 8.8% rise in the FTSE UK Private Investor Income index.

Most model portfolio members record a rewarding quarter

To see a bigger version of this table, click here

Quarterly review of model portfolios table July 2019

Notes: Table shows performance, with income reinvested, of model portfolio constituents to 1 July 2019, ranked over three months. Quarterly rank is compared with Investment Association or Association of Investment Companies sector. (Not all constituents have been members of portfolios over the periods stated.) *Has converted to Reit status and is no longer a member of the AIC, but is retained in model portfolios Golf and Juliet. IT = investment trust/investment company. †Estimated share price discount or premium to net asset value. Source: FE Analytics.

Valuation dispersions

The Federal Reserves pivot from its hawkish stance at the start of the year to increasingly dovish rhetoric has heightened investors’ appetite for growth. As has been the trend for most of the past decade, the best-performing constituents of our models during the second quarter are growth-focused funds.

These include LF Lindsell Train UK Equity (+10%), Monks Investment Trust (+9.6%), CFP SDL UK Buffettology (+9.5%) and Ardevora Global Equity (+8.3%). The managers of these funds share a focus on generating growth over the long term, with many of them adopting a similar approach to legendary growth investor Warren Buffett – seeking high-quality firms with strong competitive advantages and holding them for the long term.

Conversely, many of the worst-performing constituent funds are focused on value stocks – unloved firms trading at valuations deemed below their intrinsic worth. These are often in bombed-out sectors such as financials and housebuilders.

While banks have largely been in the doldrums since the financial crisis, technology companies – particularly mega-tech stocks – have propelled markets higher. A lack of exposure to them has acted as a significant drag for value-focused fund managers.

Temple Bar Investment Trust (-2.2%) was the weakest constituent in the second quarter – a stark turnaround from the first quarter (+16%). Schroder Income (-1.6%) is also down, while Murray International (-0.6%) and Man GLG UK Income (+0.4%) have trodden water. Artemis Global Income (+4.4%) and Artemis Global Growth (+5%) are floundering in the fourth and third quartiles respectively, owing to their value biases.

The prolonged outperformance of growth and momentum-driven strategies – effectively buying what is doing well – has left some investors questioning whether value investment strategies remain relevant.

What place do these bottom-of-the-pack funds have in our models? The simple answer is to achieve balance. While growth strategies have led the charge since the financial crisis, there is strong long-term – 100 years-plus – evidence that having a bias towards value helps a fund deliver market-beating returns.

Data also suggests that it could be time for value to stage a comeback. “Dispersions in valuations are very extreme however you measure them: value versus growth, value versus quality, levered companies versus unlevered companies, Europe versus the US, cyclical versus defensive,” says Jacob de Tusch-Lec, manager of Artemis Global Income.

He adds: “However you skin the cat, you end up with valuation dispersions in the 90th percentile or higher [among the most extreme] if you look over the past three or four decades.”

While the catalyst for value stocks to rerate is unclear, he reckons it is “better to be on the side of the cheapest stocks than the expensive stuff”.

Value investment boutique Oldfield Partners believes one driver for change is an increase in the share of economic growth being paid to employees, which has been declining. “We are beginning to see a political response to this, which suggests a reversal could be coming,” says partner Richard Garstang.

“To believe ‘it is different this time’ – five of the most dangerous words in investing – you have to believe that mean reversion is dead, profits and cash flow don’t matter when valuing a company and, ultimately, that ‘trees will grow to the sky’. We simply don’t believe these to be true.”

How the portfolios are performing - another strong quarter

  Total return (income reinvested) to 1 July 2019 after:          
  3 mths % 6 mths % 1 year % 3 yrs % 5 yrs % Since inception %
Alpha: Short Term Growth, Medium Risk 6.2 14.4 9.3 43.5 70.1 103.2
Bravo: Medium Term Growth, Medium Risk 5.8 13.9 7.4 50.6 77.3 132.9
Charlie: Longer Term Growth, Medium Risk 4.3 14.5 1.5 34.3 51.2 107.4
Delta: Short Term Growth, Higher Risk 4.2 13.3 4.3 38.9 63.7 113.0
Echo: Medium Term Growth, Higher Risk 7.5 18.7 3.9 46.1 46.1 93.0
Foxtrot: Longer Term Growth, Higher Risk 3.9 13.6 -1.6 53.9 53.5 122.7
Golf: Immediate Income, Medium Risk 2.8 8.2 1.5 23.9 26.1 76.9
Hotel: Balanced Income, Medium Risk 3.6 10.6 2.5 24.4 33.8 87.1
India: Growing Income, Medium Risk 4.4 12.7 3.7 37.5 56.8 131.5
Juliet: Immediate Income, Higher Risk 3.5 9.3 -0.5 24.3 34.9 94.6
Kilo: Balanced Income, Higher Risk 1.6 6.8 -4.0 22.1 32.6 103.8
Lima: Growing Income, Higher Risk 6.9 15.4 5.3 47.3 62.7 159.0
FTSE All Share index 3.3 13.0 0.6 29.5 35.8 87.2
FTSE UK Private Investor Balanced index 3.6 10.1 6.1 28.2 47.4 88.4
FTSE UK Private Investor Growth index 4.3 12.1 6.8 33.5 53.1 101.9
FTSE UK Private Investor Income index 3.2 8.8 5.6 23.0 41.3 72.0
FTSE World index 6.5 16.7 10.4 48.4 86.9 164.0

Notes: The inception date of our Model Portfolios is 1 January 2012. Source: FE Analytics, as at 1 July 2019.

Income Portfolios

Medium risk

Golf is the weakest among our medium-risk income models and second poorest overall. Its 2.8% quarterly return is respectable but falls short of a 3.2% rise in the FTSE UK Private Investor Income index.

Its standout performer is Picton Property Income* (+11.6%), which is benefiting from an overweight position in industrials and a spread of UK assets. Analysts at Stifel rate the investment trust a ‘buy’ in the belief its shares can continue to rerate, due to its strong income characteristics. It yields 3.2% at present.

Hotel and India, which focus on balanced and growing income respectively for medium-risk investors, are largely populated with equity income and strategic bond funds, with the addition of global investment trust Bankers (+7.4%) to India, intended to supercharge its growth prospects. It is one of eight funds across the 55 constituents of our models that retained a top 20 position from the first to the second quarter.

Both portfolios own value-oriented equity income funds run by Man GLG and Artemis. Tusch-Lec points to the “tightrope” an income manager must walk. To achieve a decent income, he cannot hold the best firms in the world (which yield around 1.5%), and is instead “pushed towards firms with slightly more gearing or maybe more cyclicality, because otherwise he wouldn’t be able to get a yield above 4%”.

Income-oriented portfolios

MEDIUM RISK          
Golf - Immediate Income % Hotel - Balanced Income % India - Growing Income %
Artemis High Income 15.6 Artemis Global Income 16.3 Artemis Global Income 17.2
Baillie Gifford Strategic Bond 14.1 Baillie Gifford Strategic Bond 16.8 Bankers IT 21.0
City of London IT 18.5 City of London IT 15.1 Guinness Asian Equity Income 13.0
Fidelity Multi-Asset Income 15.4 Kames Diversified Monthly Income 10.0 Henderson International Income IT 14.9
Jupiter Strategic Bond 11.6 Man GLG UK Income 13.5 Man GLG UK Income 10.5
Picton Property Income IT 11.8 Sanlam (Man GLG) Strategic Bond 13.0 Royal London Sterling Extra Yield 11.4
Schroder Income Maximiser 13.0 Sarasin Global Higher Dividend 15.3 Troy Income & Growth IT 12.0
Weighted yield 4.7 Weighted yield 4.2 Weighted yield 3.9

Notes: †As at 1 July 2019. See our Model Portfolios page for more information.

Higher risk

Our higher-risk income models are a mixed bag this quarter. Lima, which aims for growing income, is our best income portfolio and second best overall, having returned 6.9% over the quarter. Strong returns from Utilico Emerging Markets (+12.4%), our top-performing portfolio constituent, JPMorgan European Investment Trust Income shares (+11.1%), Fundsmith Equity (+7.9%) and Schroder Oriental Income (+7.6%) more than off set sluggish performances from Temple Bar and Lowland (+2.6%).

Kilo, targeting balanced income, is bottom of the table with a 1.6% return – half the benchmark return. That’s no surprise given that its top constituent is Artemis Global Income and its bottom two, Schroder Income and Murray International, are among five funds that lost money.

Murray International, a newcomer to Kilo at the start of 2019, hit the brakes after making 5% in the first quarter’s marketwide rebound. It was added to widen Kilo’s global exposure and complement its holding in Artemis Global Income. Although both have had a difficult time of late, their focus on value and refusal to be more benchmark-aware will serve the portfolio well when momentum-driven strategies lose steam.

Juliet, our higher-risk, immediate income portfolio, produced modest returns from strategic bond funds. Picton Property’s double-digit rise helped deliver a 3.5% uplift overall.

Income-oriented portfolios

HIGHER RISK          
Juliet - Immediate Income % Kilo - Balanced Income % Lima - Growing Income %
Artemis Global Income 15.4 Artemis Global Income 16.0 Baillie Gifford Strategic Bond 12.0
Axa Framlington Monthly Income 18.6 Baillie Gifford Strategic Bond 12.1 JP Morgan European IT - Income 16.1
Picton Property Income IT 13.4 Lowland IT 15.5 Lowland IT 8.4
Royal London Global Bond Opps 9.6 Murray International IT 12.9 Temple Bar IT 10.2
Sanlam (Man GLG) Strategic Bond 16.1 Sanlam (Man GLG) Strategic Bond 12.2 Schroder Oriental Income IT 17.5
Schroder Income Maximiser 9.9 Schroder Income 15.3 Fundsmith Equity 18.4
TB Wise Multi-Asset Income 17.0 TB Wise Multi-Asset Income 16.0 Utilico Emerging Markets IT 17.4
Weighted yield 5.0 Weighted yield 4.3 Weighted yield 3.2

Notes: †As at 1 July 2019. See our Model Portfolios page for more information.

Growth Portfolios

Medium risk

All our medium-risk growth portfolios have matched or beaten a 4.3% quarterly rise in the FTSE UK Private Investor Growth index.

Alpha boasts the largest rise at 6.2%, having done well from growth-focused funds such as LF Lindsell Train UK Equity, also Charlie’s biggest riser, and Fundsmith Equity. Their managers, Nick Train and Terry Smith respectively, back a select band of high-quality, resilient, global growth firms and are renowned for their stockpicking skill. They had strong momentum from the first quarter to the second.

Global equities investment trust Mid Wynd International (+9.2), a newcomer to Alpha at the start of 2019, is another fund with a top 20 position in both quarters. It has made 22.6% over six months.

A 5.8% second-quarter gain for Bravo was led by Fundsmith Equity and CFP SDL UK Buffettology , while Charlie’s 4.3% rise was helped by Fidelity Emerging Markets (+7.3%), another leader over both quarters.

Bravo owns Artemis Global Growth, whose large value bias alongside its overweight to emerging markets and underweight to the US has held back performance. However, manager Peter Saacke believes “going through painful and, at times, protracted periods of lacklustre short-term performance is the price to pay for long-term outperformance”. We remain confident that patient investors will be rewarded.

Growth-oriented portfolios

MEDIUM RISK          
Alpha - Short Term Growth % Bravo - Medium Term Growth % Charlie - Longer Term Growth %
Capital Gearing IT 13.7 Artemis Global Growth 12.9 Capital Gearing IT 11.0
Fundsmith Equity 17.0 Capital Gearing IT 9.9 F&C IT 19.9
Jupiter Strategic Bond 13.2 CFP SDL UK Buffettology 16.3 Fidelity Emerging Markets 11.0
LF Lindsell Train UK Equity 18.1 F&C IT 17.4 LF Lindsell Train UK Equity 10.3
Mid Wynd International IT 10.7 Fidelity Global Dividend 10.3 Mercantile IT 13.0
Quilter Inv Cirilium Conservative Port 11.0 Fundsmith Equity 23.9 Merian Global Equity 19.2
Royal London Sustainable Diversified 16.3 Jupiter Strategic Bond 9.3 Schroder Asian Total Return IT 15.6

Notes: †As at 1 July 2019. See our Model Portfolios page for more information.

Higher risk

Echo, our higher-risk, medium-term growth portfolio, is our top model over three and six months, with rises of 7.5% and 18.7% respectively.

This is largely owing to our decision to allocate 15% of this model to Monks at the start of the year. It has since been Echo’s top performer, due to its focus on global growth stocks and a hefty allocation of almost half of its assets to US equities. It led the pack across all constituent funds during the first half of the year with a rise of 26.5%. Other Echo standouts are Ardevora Global Equity (+8.3%) and Standard Life Investments Global Smaller Companies (+8%) .

Foxtrot, the riskiest of our portfolios, given its higher-risk, longer-term growth remit, and Delta, our higher-risk, shorter-term growth portfolio, underperformed the FTSE UK Private Investor Growth index over the quarter, albeit modestly, with returns of 3.9% and 4.2% respectively, versus 4.3% for the benchmark.

Schroder Recovery (-1.7%) held Delta back, while Pantheon International (1.2%), a private equity trust trading on a near-18% discount, and Baillie Gifford Shin Nippon (1.8%), a Japanese smaller companies trust that trades on a premium of more than 4%, hampered short-term returns for Foxtrot. Given the riskier nature of their investments, investors must be prepared to hold them for the long term.

Growth-oriented portfolios

HIGHER RISK          
Delta - Short Term Growth % Echo - Medium Term Growth % Foxtrot - Longer Term Growth %
Capital Gearing IT 9.2 Ardevora Global Equity 16.6 Baillie Gifford Shin Nippon IT 9.9
Fundsmith Equity 22.7 CFP SDL UK Buffettology 12.5 Henderson Smaller Companies IT 17.8
Rathbone Income 14.0 LF Miton UK Value Opportunities 9.6 Hermes Global Emerging Mkts 13.3
Royal London Sustainable Diversified 11.9 Monks IT 16.0 Pantheon International IT 13.1
Schroder Asian Total Return IT 16.6 Seneca Global Income & Growth IT 16.1 Scottish Mortgage IT 16.9
Schroder Recovery 9.8 SLI Global Smaller Companies 17.5 Seneca Global Income & Growth IT 9.8
Witan IT 15.8 JPMorgan Emerging Markets IT 11.7 SLI Global Smaller Companies 19.2

Notes: †As at 1 July 2019. See our Model Portfolios page for more information.

Note: We no longer have factsheet information for Picton Property Income Investment Trust. This is because the trust is now a REIT and on conversion ceased to be part of the Association of Investment Companies (AIC), which produces the factsheet information in conjunction with Morningstar.

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