In part one of our Rated Funds review, which covers the first three months of 2020, we detail how UK and global funds fared for both growth and income investors.
Plenty of column inches in financial history textbooks will in years to come be dedicated to the first quarter of 2020, a period that saw global stock markets record steep falls as a deadly disease no one had heard of until the start of this year claimed thousands of lives worldwide.
At the time of writing, in early April, a high amount of uncertainty over Covid-19 remains and the consensus view seems to be that markets are not out of the woods – despite putting in a better showing over the past couple of weeks. Trading at around 5,800 the FTSE 100 index, for example, is up 16% from its March lows.
One of the most experienced fund investors, John Chatfeild-Roberts, head of strategy for independent funds at Jupiter, cautions “what bear markets do is suck people in and then destroy their money” and argues that the market bottom has not yet been reached. Chatfeild-Roberts is preparing for further falls and adds that while he cannot predict when the market bottom will come, when it does arrive it will be when “the news looks absolutely awful”.
Ultimately, investor sentiment is unlikely to meaningfully improve until the pandemic is under control and the economic damage can be assessed. Whether this occurs in the second quarter or the second half of 2020 is anyone’s guess, but in terms of the first quarter there were painful losses across virtually every single fund sector.
In this quarterly review, we start off with the positives, detailing the funds that produced a positive return in the first quarter. We then move on to the biggest losers, before offering an analysis of each Rated Funds asset group.
Out of our Rated Funds universe of 259 funds, a total of eight produced a positive return in the first quarter. Five are passively managed, including the top performer over the quarter iShares Physical Gold ETC GBP, which returned 12.8%. Gold is widely viewed as a safe-haven investment, but over much of the market sell-off it failed to perform this role. The gold price declined around 10% from 24 February to 16 March, the period that saw the steepest falls for global markets.
Since then, gold has surged upwards following the intervention of governments and central banks to “do whatever it takes” through enormous monetary and fiscal stimulus packages. Governments and central banks cannot print more gold, as they can currencies. As a result, its value is retained. In theory, this attribute of the yellow metal will continue to be highly prized by investors, particularly in uncertain times.
The other four passives in positive territory followed the up-and-down fortunes of another safe-haven investment: government bonds: iShares Global Govt Bond ETF (up 9.3%), Vanguard UK Government Bond Index (7.4%), Vanguard Global Bond Index GBP Hedged (1.1%) and iShares Global Corp Bond ETF (0.8%).
The best-performing active fund was M&G Global Macro Bond (up 7.4%), followed by Allianz Technology Trust (3.1%) and Baillie Gifford American (1.5%), which was one of a number of equity funds that focus on technology and/or quality growth stocks (although not all) that performed well over the period.
Overall, 59 Rated Funds registered falls of less than 10%. Other equity funds with a quality focus that managed to limit losses included Lindsell Train Japanese Equity (-4.3%), Rathbone Global Opportunities (-6.9%) and Fundsmith Equity (-7.9%).
The worst performers
Bottom of the pile is a passive fund that tracks the price of a different commodity, oil. WisdomTree Brent Crude Oil 1mth GBP posted heavy losses of 57.1%. In early March, the oil price fell nearly 30% to $31, which represents the biggest single day fall since the start of the first Gulf war in 1991. It has since staged a small recovery to around $34 a barrel at the time of writing in early April. Oil tanked in response to Saudi Arabia launching the start of a price war by increasing production and drastically cutting its export prices on crude oil. The move came after OPEC members failed in March to come to an agreement with other producers (primarily Russia) to cut oil production in response to the coronavirus outbreak.
Group by group analysis
UK Equity Income: Core
We deal first with one of the most popular fund sectors with self-directed investors: UK equity income. On the whole, the nine Rated Funds in our core category either slightly outperformed or slightly underperformed the FTSE All Share index loss of -25.1% over the first quarter. Arguably a better benchmark is the UK Dividend+ index, which lost 36%, reflecting the de-rating of dividend-friendly shares as various listed companies announced plans to cut, suspend or entirely remove dividends in the short term in response to how coronavirus will impact the way they operate, and indeed their profits.
Each of the nine funds put in a better showing than the UK Dividend+ index. The top performer was Troy Income & Growth (-16.6%), owing to its defensive focus. While, at the other end of the table Royal London UK Equity Income slightly underperformed (-29.3%), yet faith should be retained in the broad-based nature of the fund, which is managed for total return. Its exposure to oil majors Royal Dutch Shell and BP, both top five positions in the fund, will have negatively impacted performances.
The worst performer of this group was BMO Capital & Income trust (-32.9%), which had close to 40% in financials during the meltdown. Its sustainably focused sister fund performed better: BMO Responsible UK Income lost -24.5%.
UK Equity Income: Adventurous
On a more positive note, all but three Rated Funds held up better than the UK Dividend+ index: the underperformers were Lowland Investment Company (-37.1%), Chelverton UK Equity Income (-38.6%) and worst of all Temple Bar (-47.3%).
The notable outperformance by Trojan Ethical Income was helped by virtue of having a large slug of assets overseas, which is why it is listed in the Investment Association’s (IA) ‘unclassified' sector. Funds listed in IA UK equity income sectors cannot hold more than 20% in overseas equities, whereas Trojan Ethical Income has its own policy of holding up to 30%.
In the case of Franklin UK Rising Dividends, the fund’s ethos of focusing on lower yielding but dependable dividend payers paid off in the first quarter. For example, consumer goods giant Unilever, which has a modest yield of 3.8%, is the fund’s top holding.
In terms of the losers over the first quarter, the underperformance of Chelverton UK Equity Income is understandable given its small-cap focus. This part of the UK market was hit hardest during the sell-off, as investors moved to reduce risk.
Lowland, which invests across the UK market, looks in a good position to maintain its dividend. Analysis by Investec Securities found that Lowland, along with 16 other UK equity income trusts it reviewed, has sufficient reserves to endure a 30% fall in dividend income from their underlying holdings over the next year, and still pay a progressive dividend (it modelled a 3% rise). The 30% figure was used because this is the dividend decline that is being priced in by the futures market.
However, the value focus of Temple Bar, which has been forced by its board to de-risk (by neutralising gearing in a fire sale of assets) means investors will need plenty of patience to wait for a value-based recovery. At the start of 2020, Temple Bar was fully invested, as well as being 8% geared. Numis, the investment trust analyst, says: “We can understand the urge to reduce risk through a reduction of gearing, but we expect it may have been difficult for a contrarian manager to sell holdings after a market fall. Significantly, whilst gearing has been reduced the fund maintains its contrarian approach with a heavy focus on value and a recovery in UK domestics, having sold the least cyclical positions.”
UK Growth: Core
Moving to UK growth-oriented funds and dealing first with the core Rated Fund choices, all funds bar one beat the FTSE 100 (-23.8%) and FTSE All-Share (-25.1%) indices. Royal London Sustainable Leaders (-15%), which adopts an environmental, social and governance (ESG) investment policy, was the best performer.
A big driver behind its outperformance, alongside other ESG-focused funds that on the whole managed to outperform during the sell-off, can be explained by what it was not holding – oil stocks. As Adrian Lowcock, head of personal investing at Willis Owen, notes: “Any funds which avoid oil – and many ESG funds will be either underweight it or exclude the sector entirely – are likely to have outperformed.”
Value-focused fund R&M UK Recovery was the worst performer of this group (-33.9%). Although the fund is highly diversified, its focus on recovery situations and its 40% position in financials and basic materials, as well as 14% in industrials, weighed on performance.
UK Growth: Adventurous
Just four of the 16 funds in this group managed to beat the FTSE All-Share index.
The standout performer was the Ardevora UK Equity fund, which lost just -6.6%. Its 150/50 strategy, which enables its fund managers to make money when certain share prices fall, has clearly been of huge benefit in a falling market.
The two next-best funds that beat the index are managed by Nick Train: Finsbury Growth & Income Trust (-15.6%) and Lindsell Train UK Equity (-15.9%). Marlborough UK Multi-Cap Growth (-22.3%) also outperformed.
Value-focused funds and those favouring mid-caps underperformed, with Fidelity Special Values providing the worst return (-38.5%). Other funds that lagged included Schroder Recovery (-33.9%), Man GLG Undervalued Assets (-34.5%), Miton UK Value Opportunities (-34.6%) and Franklin UK Mid Cap (-34.7%).
UK Smaller Companies
Our UK smaller companies’ selections have on the whole marginally outperformed small cap and mid-cap indices. But the difference between the top and bottom performer was stark; Slater Growth was down (-25.3%), while Aberforth Smaller Companies Trust racked up a loss of (-45.7%).
On the whole, open-ended funds outperformed investment trusts in this sector. In some cases this was down to discounts widening, but this does not paint the full picture as investment trust discounts to net asset value have not ballooned out to significant levels. In fact, they are modest, with Aberforth Smaller Companies Trust, for example, trading close to par. Elsewhere, two trusts that have over the past year typically traded on a small premium - BlackRock Smaller Companies (which declined -34.6%) investment trust and Henderson Smaller Companies investment trust (-36.4%) – both slipped to small discounts at the end of March, but are far from being at bargain basement levels.
Instead, the likely reason behind the relatively large losses incurred by some investment trusts during the market sell-off, including those in this group, is as a result of their ability to borrow (known as gearing). Gearing in a rising market magnifies gains for shareholders; but if the market falls, investors in a geared trust will suffer larger losses.
In the months ahead, prolonged economic weakness could see investment trust discounts widen more notably. Under this scenario investment trust investors should be prepared for any net asset value (NAV) growth to not be fully reflected in share price total returns.
On the plus side, investment trusts would be expected to bounce back better when sentiment does improve, owing to the structure of having a fixed pool of assets and the ability to gear.
A notable open-ended fund laggard was Unicorn UK Growth, which lost -37.1%. Its highly focused portfolio has been hit hard, which has lead the fund’s management team to a “reassessment of the fundamentals of all holdings in the portfolio”. It adds: “Action has been taken to reduce exposure to companies perceived to be at most risk from falling demand and/or weak balance sheets.” As a result, its cash position has been raised and now stands at 17%.
Global Equity Income
Given that global fund managers, whether they are income or growth focused, have the flexibility to invest wherever they see fit, such funds should have held up better than those constrained to investing in a single region. For the global equity income Rated Fund choices, this played out, with losses in most cases less severe than our UK equity income picks. Five funds managed to keep losses below 15%, with the top three performers being Fidelity Global Dividend (-10.3%), Fidelity Global Enhanced Income (-10.3%) and Guinness Global Equity Income (-13.1%).
A focus on quality stocks helped Fidelity Global Dividend, but proved a hinderance to Murray International (-30.6%), which was the worst performer, hampered by its Asia and emerging market exposure, which accounts for 60% of the portfolio versus 40% for developed markets.
As longstanding shareholders of Murray International can testify, performance ebbs and flows, but over the long term its performance has brought home the bacon. Between 30 June 2004 (when manager Bruce Stout took over) to 31 December 2019, Murray International produced a share price total return of 510% versus its composite benchmark return of 202%. Added to that, its secure and growing income means that it continues to serve its purpose. Its yield has increased to 6.3%.
Global Growth: Core
Most global growth funds in our core category managed to keep a better lid on losses compared to funds investing in a sole region. In addition, most funds managed to beat the MSCI World index loss of-15.7%.
Quality-focused funds held up best of all, with the standout performers being Rathbone Global Opportunities (-6.9%), Fundsmith Equity (-7.9%), Trojan Global Equity (-8.4%) and Mid Wynd International investment trust (-8.4%).
The three worst performers were Brunner investment trust (-22.4%), F&C investment trust (-25.2%) and Witan investment trust (-29.4%). Brunner and Witan suffered due to their relatively high UK equity content. Widened discounts did not help either trust, and the same rings true with F&C investment trust, which moved from trading close to par at the start of 2020 to a 9% discount.
Another culprit behind the relatively poor performance, however, was gearing. All three had gearing of around 10% during the period, with Witan’s net asset value taking a further hit when the board opted to exercise a break clause and repay some its more expensive borrowings early. Witan ended the period with gearing of 4%. At a net asset value level, F&C was just a few percentage points behind the 16.1% loss from its FTSE All World index benchmark.
Global Growth: Adventurous
It is pleasing to report the majority of global growth funds in our adventurous category put in a better showing than the MSCI World index. A focus on quality was again evident among the second and third best performers: Investec Global Franchise (-6.9%) and Fundsmith Sustainable Equity (-7.8%). The top performer was Scottish Mortgage, which focuses its sights on fast growing ‘disruptors’. Its shareholders had a rollercoaster ride during the market sell-off, but at the end of the first quarter its losses were just 1%.
Only Artemis Global Growth (-20.2%) proved relatively disappointing in this category. The proprietary SmartGARP (growth at a reasonable price) process employed by manager Peter Saacke aims to identify shares that offer value, a process that has worked very well in the past, but has now left this well-diversified fund lagging peers over periods of up to three years. The fund has a hefty 24% weighting to emerging markets, where the manager has found compelling investment opportunities that may yet come good.