Global funds, thanks to the diversification they offer, have proved a big hit with investors, particularly since the financial crisis when many UK investors suffered burnt fingers for placing too much faith in their home market.
Over the past decade, global funds have seen their assets jump from £30 billion to £90 billion, while today around £16 billion is held in global equity income funds – an Investment Association (IA) sector that has only been around since the start of 2012. In terms of global growth funds, Fundsmith Equity is a firm favourite with investors, while among income funds Artemis Global Income features highly in the popularity stakes. Both have been stellar performers on a five-year view, positioned 2/208 and 1/27 in their respective sectors at the end of September.
But the views and investment philosophies of the fund managers at their helms – Terry Smith and Jacob de Tusch-Lec – couldn’t be more polarised. Smith focuses on ‘quality growth’ and believes the secret to investment success is to buy and hold a small selection of long-established firms with big brands and a high return on capital. In stark contrast, de TuschLec is a value investor; while acknowledging Smith’s success over the past five or so years, he argues that there will be different winners when the interest rate cycle turns.
According to de Tusch-Lec, shares that fit the quality growth description have been the big winners from unorthodox monetary policy in the form of quantitative easing (QE). But, he argues, this tailwind is now coming towards an end. ‘This bull market has been odd as it is being driven by low interest rates and boring bond proxies, rather than by earnings or growth,’ he says. ‘Once you press interest rates down, all the bond proxies go up. But, in my opinion, when interest rates rise you can’t expect the same thing to happen – there will be different winners, and I’ve positioned my portfolio accordingly.’
It is over 10 years since an interest rate rise in the UK, but while the Bank of England’s Monetary Policy Committee has previous form for hinting that a future rate increase is on the cards, only for it not to materialise, the general feeling is that it is now only a matter of time before rates do start to move upwards. Moreover, there is talk of QE being reversed in the US and the UK, although the policy is likely to remain in place in Europe.
In the US, the Federal Reserve has already moved interest rates higher twice in 2017, a trend that de TuschLec is hoping will benefit the big sector bet he is currently running in the portfolio – a 40.9 per cent weighting to financials. De Tusch-Lec does not shy away from the risk involved. ‘It is big enough to lose sleep over,’ he says.
According to de Tusch-Lec, banks are one of the two value plays in town, alongside miners, but the latter is largely hamstrung by the performance of the oil price. ‘Rather than trying to second-guess the oil price, I can more accurately predict that when interest rates rise the yield curve will change, resulting in bond yields rising. In this scenario banks will be the biggest beneficiaries,’ he argues.
Banks have cleaned up their act since the dark days of the financial crisis yet remain cheap, he notes. Over the summer months he added to a selection of banks, including Citigroup, Nordea, Danske Bank and Intesa Sanpaolo.
He puts the cut-price valuations on offer down to market participants being obsessed over the ‘good stuff ’ – consumer staples, the likes of Unilever and Diageo, as well as tomorrow’s perceived success stories such as the US tech-based giants. ‘Banks are becoming dividend machines, but the market is not giving them the credit. The market is instead more interested in paying a higher price for the future, so Tesla, for instance, is preferred over say General Motors, one of my holdings. But from where I am sitting, General Motors is on a low earnings multiple and has a rock solid dividend, so I think it is worth investing in,’ he says.
Turning his attention towards consumer staples, which over the past 10 years have been one of the hottest areas of the stock market, de TuschLec cautions that the sector’s best days may soon come to an end. ‘Gearing levels are much higher than they were 10 years ago, so some of these bond proxies may find themselves in trouble when interest rates go up.’ Moreover, he adds that in a world where deflationary forces such as competition-boosting internet comparison sites are at work, even well-established companies will find the going tough to maintain pricing power and their grip on customers.
European stocks in favour
Another area that carries rich valuations is the US stock market, a consideration that de Tusch-Lec acknowledges and is reflected in his portfolio’s modest 28 per cent exposure to North America. In contrast, the average global fund holds 47 per cent, according to figures supplied by Morningstar.
Instead, de Tusch-Lec favours Europe, which accounts for 45 per cent of the fund. While dividend payments are important, given the fund’s income obligations, de Tusch-Lec also ‘wants to make money on the shares’, which is why he places a heavy emphasis on not overpaying.
In the case of Europe he points out that he can find shares offering sky-high dividend yields of 7 per cent or higher. ‘Europe’s economy is going gangbusters. It may not be contrarian anymore, but I am still finding value. We have over 10 per cent in Italy, for example, which may be viewed by some as risky, but I’m not losing sleep over that position.’
Elsewhere, emerging markets have been an area where de Tusch-Lec has been focusing more attention, in August moving to an ‘overweight’ position. The weak dollar has postponed any risk of an ‘emerging market meltdown’, he says, while adding that as long as global economic growth continues to look healthy, the emerging market rally that started around 18 months ago still has legs. ‘I do think there’s more to come, so we have been beefing up our exposure to emerging market banks. There are risks, however, most notably a mountain of debt in China that needs to be dealt with at some point.’
Outside of financials, the rest of Artemis Global Income is split across a wide range of sectors, including telecoms, industrials and businesses in the information technology field. De Tusch-Lec describes the way he invests as ‘contrarian’ and multi-cap’, and he avoids any prescriptive set of rules – such as a minimum yield requirement for each individual holding. ‘We mix it up, holding firms that are returning to the dividend register as well as companies that regularly distribute cash, whether that be through dividends or share buybacks.’
While the past decade has been a miserable one for value investors, Artemis Global Income has managed to buck the wider trend. On a five year view the fund has returned 115 per cent, comfortably ahead of the IA global equity income sector average return of 73.2 per cent.
On a three- and one-year timespan the fund is also ahead of the average global equity income fund. ‘We’ve been investing against the tide now for around three years, but thankfully stock-picking has carried us through,’ he says. ‘Defensive growth-style funds are where the appetite remains, but we hope to be the contrarian play for value investors who want to profit from the different set of winners that will emerge when interest rates rise. We are 20 per cent cheaper than the wider global market (MSCI AC World) when using various valuation measures, so I think we are well-positioned.’
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