Model Portfolios update: a value revival, but does it have legs?

As predicted in the previous review, value-oriented strategies top the third-quarter leaderboard of our model portfolio constituents.

Fears of a global recession and Brexit uncertainty gave investors lots to fret about and posed fierce headwinds for Money Observer’s model portfolios in the third quarter.

The US-China trade war stoked fears of an imminent recession. The latest raft of tariffs – 15% tax on $112 billion ( £91 billion) of Chinese imports, including clothing and consumer electronics, from 1 September – contributed to a volatile period for stockmarkets.

Data suggests that US consumers are being hit harder than Chinese manufacturers, which can tranship via other Asian ports or shift production to other countries to dodge the tariffs.

US manufacturers are feeling it too. As exports dive amid the escalating trade war, the US purchasing managers’ index (PMI), one of the most reliable leading indicators for assessing the state of the US economy, had the lowest reading in more than 10 years in September. The Institute for Supply Management’s PMI came in at 47.8% – the lowest since June 2009 and the second consecutive monthly contraction.

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Revised data shows that the UK economy contracted by 0.2% in the second quarter as global trade concerns began to bite, while economic growth in the wider eurozone has been sluggish for the past 18 months.

For most of this year, investors have largely dismissed a deteriorating macro picture and taken comfort in the dovish pivot by most of the world’s central banks. Bad news was good news, since it made the case for more accommodative monetary policy clearer.

However, during the third quarter it became increasingly difficult for the US Federal Reserve to ‘out-dove’ market expectations and generate truly easier financial conditions, according to Rob Waldner, a macro strategist at fund manager Invesco.

A plethora of evidence suggests that investor sentiment turned more sceptical on the prospects for global growth. Sovereign and investment-grade corporate bonds rallied. An unprecedented number now offer negative yields. Searches for the term ‘recession’ on Google rose to levels not seen since the peak of the eurozone crisis in 2011.

As a result, “some of this sky-high faith in the ability of central banks to reverse a downturn came down to earth”, says Florian Ielpo, head of macroeconomic research at asset manager Unigestion. “After a year and a half of economic slowdown, the first real signs of alarming macro conditions are starting to surface,” he adds. “Worried investors now have plenty of evidence to sustain their bearishness. Yield curves are inverted or flat, industrial surveys are at low levels and even the mighty Germany has had a quarter of negative GDP.”

Heightened volatility sees several constituents nursing losses

To see a bigger version of this table, click here

Model Portfolio update Nov 2019

Notes: Table shows performance, with income reinvested, of model portfolio constituents to 1 October 2019, ranked over three months. Quartile rank is compared with Investment Association or Association of Investment Companies sector. Not all constituents have been members of portfolios over the periods in question. †Previously known as Standard Life Investments Global Smaller Companies. ††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. Source: FE Analytics 

Sharp reversal

For Ken Orchard, a fund manager at T Rowe Price, a “deep [global] slowdown or minor recession feels inevitable”. Unigestion says China and Europe are “at risk and already flashing red”, but Ielpo points to an uneven risk of recession around the world and a “limited” probability of global recession.

Nevertheless, it’s essential that the risk of recession is factored into portfolio positioning, given its bearing on investor sentiment and valuations. Markets have mostly made a positive return so far this year, but a tough third quarter for investors, particularly during August, led to largely lacklustre returns for our model portfolios, none of which managed to beat their respective FTSE UK Private Investor benchmarks or the FTSE World index.

Five out of the 12 models, all of them medium-risk portfolios with less exposure to adventurous growth-focused funds, outperformed the UK FTSE AllShare index, however. This illustrates the sharp reversal in value stocks relative to growth that took place at the start of September. Momentum stocks dropped by 10% over the course of a three-day period in early September, while value stocks climbed 7% – the largest such shift in three decades.

While growth stocks tend to trade on high price/earnings ratios and offer low dividend yields, value stocks generally trade on lower multiples and offer higher yields. This is why income funds tend to have a heavy bias towards value stocks – style is a major driver of returns in the sector – and four out of the five top-performing constituents of our models have an equity income focus.

Murray International, the global equity income investment trust whose performance (though not its rising dividend record) had been giving us some concern, shoots up the rankings to third-best performing constituent with a 5.2% gain. That followed a 0.6% loss in the previous quarter.

UK-oriented funds and trusts, particularly those that focus on smaller companies, a fiercely unloved area of the stockmarket amid Brexit storm clouds, also fared well. Mercantile and Miton UK Value Opportunities, which sit in the UK all companies sectors in their respective investment trust and open-ended fund peer groups, have a bias towards the small and medium-sized companies that led the market lower last year. Both feature in the top 10 performers this quarter with gains of around 3.4%.

Conversely, staunch growth-oriented trust Scottish Mortgage is one of the bottom performers, having shed 5.1%. It favours high-growth, momentum-driven technology stocks, including some of the FAANG (Facebook, Apple, Amazon, Netflix and Google) stocks that have supercharged stockmarket gains since the end of the financial crisis.

Portfolios mixed in a volatile quarter

  Total return (income
to 1 October 2019 after:
  3 mths 6 mths 1 year 3 yrs 5 yrs Since
  % % % % % %
Alpha: Short Term Growth, Medium Risk  2.5 8.9 9.8 37.4 73.0 108.3
Bravo: Medium Term Growth, Medium Risk 1.9 7.8 6.2 40.2 80.4 137.4
Charlie: Longer Term Growth, Medium Risk  1.7 6.1 3.1 25.4 52.9 110.9
Delta: Short Term Growth, Higher Risk  1.3 5.5 4.2 29.0 62.8 115.7
Echo: Medium Term Growth, Higher Risk  0.5 8.0 4.0 33.4 47.2 93.9
Foxtrot: Longer Term Growth, Higher Risk  0.9 4.9 -1.4 33.7 55.5 124.7
Golf: Immediate Income, Medium Risk  -0.1 2.7 2.5 16.6 25.6 76.7
Hotel: Balanced Income, Medium Risk  1.9 5.5 2.8 18.0 36.0 90.7
India: Growing Income, Medium Risk  1.6 6.0 2.8 28.3 55.7 135.1
Juliet: Immediate Income, Higher Risk  -0.3 3.2 -0.5 16.4 33.4 94.1
Kilo: Balanced Income, Higher Risk  0.6 2.2 -4.1 12.6 33.8 105.1
Lima: Growing Income, Higher Risk  -1.2 5.6 2.2 29.5 58.1 155.9
How index benchmarks compare            
FTSE UK Private Investor Balanced  2.4 6.1 6.3 23.7 48.7 92.9
FTSE UK Private Investor Growth  2.6 7.0 6.4 28.2 55.1 107.1
FTSE UK Private Investor Income  2.3 5.6 6.4 19.5 42.3 76.0
FTSE All Share TR in GB 1.5 4.8 2.9 22.0 39.2 89.6
FTSE World GTR in GB 3.8 10.6 7.9 42.2 88.1 174.0

Notes: Inception date of our model portfolios is 1 January 2012. Source: FE Analytics, as at 1 October 2019

Foot in all camps

What has sparked this aggressive style rotation, and will it last? Architas, the multi-manager, says expectations globally that economic stimuli will move from monetary to fiscal policy – from changing interest rates and influencing money supply to the use of government spending and tax policies – has increased investors’ appetite for value.

Lower interest rates make it cheaper for companies to borrow money for share buybacks or business expansions. Growth stocks get a bigger boost from easier monetary policy than value stocks, as these companies are more likely to use leverage to expand.

“Growth is also sputtering, due to slower global growth rates, slowing corporate profits, and expectations of litigation and regulation for global tech companies that again would impact corporate profits,” says Nathan Sweeney, a senior investment manager at Architas.

However, he expects the transition to be slow; “I wouldn’t pin all my hopes on value,” he says. The US Federal Reserve and other central banks are likely to keep monetary policy easy for the foreseeable future, and politically led decisions generally take more time than those made by central banks.

Ben Yearsley, a director at Shore Financial Planning, urges investors to be measured in their positioning – something our models aim to achieve by giving exposure to a range of assets and investment styles. “‘Go-go’ growth stocks have come off the boil slightly, but we are in a rate-cutting environment hinting at slowing growth, so more value-orientated cyclicals are faring no better,” he says. “It’s a time for a foot in all camps!”

Growth portfolios

Medium riskAlpha, Bravo and Charlie, which target short-, medium- and longer-term growth, comfortably beat the FTSE AllShare index’s 1.5% return in the period under review, with gains of 2.5%, 1.9% and 1.7% respectively.

LF Lindsell Train UK Equity and Capital Gearing Trust are among the standout performers across these medium-risk portfolios. Their quest for absolute returns means they have avoided the ‘momentum massacre’.

Nick Train, the seasoned UK equity manager behind Lindsell Train, cares more about maintaining or growing the real value of investors’ capital and income over time than about outperforming a stockmarket index. He looks for inefficiencies in the valuation of exceptional quoted companies and backs 20-35 of these big brands when they are trading at below their intrinsic worth.

Peter Spiller, who has run Capital Gearing since its launch in 1982, prioritises capital preservation and has most of the trust’s assets in bonds – 60% in index-linked and conventional gilts, corporate bonds and preference shares (which work like bonds in that they pay fixed dividends), and just 16% in equities.

MEDIUM RISK          
Alpha - Short Term Growth % Bravo - Medium Term Growth % Charlie - Longer Term Growth %
Capital Gearing IT 13.8 Artemis Global Growth 12.7 Capital Gearing IT 12.2
Fundsmith Equity 16.6 Capital Gearing IT 10.1 F&C IT 20.4
Jupiter Strategic Bond 13.3 CFP SDL UK Buffettology 16.4 Fidelity Emerging Markets 10.1
LF Lindsell Train UK Equity 18.3 F&C IT 17.2 LF Lindsell Train UK Equity 10.0
Mid Wynd International IT 10.6 Fidelity Global Dividend 10.4 Mercantile IT 12.9
Quilter Inv Cirilium Conservative Port 10.8 Fundsmith Equity 23.7 Merian Global Equity 18.8
Royal London Sustainable Diversified 16.6 Jupiter Strategic Bond 9.5 Schroder Asian Total Return IT 15.6

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


Higher risk: Foxtrot, the riskiest of our growth models, owns this quarter’s top performer – private equity trust Pantheon International (+8.7%). Investment research house Hardman & Co points to economic sentiment being material to its performance – the trust’s net asset value rose every year in the early 1990s recession. However, Foxtrot also owns Scottish Mortgage and Baillie Gifford Shin Nippon (-0.1%), which were hurt by their growth bias – giving this model a quarterly gain of 0.9%.

Echo (+0.5%), our higher-risk medium-term growth portfolio, was the weakest growth model. Strong performances for Miton UK Value Opportunities and Ardevora Global Equity (+2%), which seeks ‘safe’ growth companies globally, were held back by punchier growth propositions Monks (-1.6%) and JPMorgan Emerging Markets (-1.4%).

Royal London Sustainable Diversified Trust (+3.8%), a mixed asset trust that considers environmental, social and governance factors – increasingly believed to build robustness into investment processes – is the top performer for Delta (+1.3%). The bottom constituents are Schroder Asian Total Return (-1.5%), which failed to deliver on its capital preservation mandate, and Schroder Recovery (-0.5%), which missed the value rally.

HIGHER RISK          
Delta - Short Term Growth % Echo - Medium Term Growth % Foxtrot - Longer Term Growth %
Capital Gearing IT 10.2 Ardevora Global Equity 16.9 Baillie Gifford Shin Nippon IT 9.8
Fundsmith Equity 20.5 CFP SDL UK Buffettology 12.8 Henderson Smaller Companies IT 18.1
Rathbone Income 14.2 LF Miton UK Value Opportunities 9.9 Hermes Global Emerging Mkts 13.4
Royal London Sustainable Diversified 12.0 Monks IT 15.7 Pantheon International IT 15.0
Schroder Asian Total Return IT 16.4 Seneca Global Income & Growth IT 16.3 Scottish Mortgage IT 15.7
Schroder Recovery 10.4 ASI Global Smaller Companies 17.0 Seneca Global Income & Growth IT 10.3
Witan IT 16.2 JPMorgan Emerging Markets IT 11.4 ASI Global Smaller Companies 17.6

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

Income Portfolios

Medium risk: Hotel and India, which focus on balanced and growing income respectively for medium-risk investors, are the cream of the income crop this quarter by a decent margin, having returned 1.9% and 1.6%.

They are largely populated with equity income and strategic bond funds, which have benefited, respectively, from the revival of value stocks and their ability to take advantage of the best investment opportunities in bond markets. Recession fears have driven a similar push into fixed-income markets – investors are once again hiding out in boring bonds.

Hotel’s top performers are Sarasin Global Higher Dividend (+4.5%), Baillie Gifford Strategic Bond (+3.1%) and Man GLG Strategic Bond (+2.6%), while Troy Income & Growth Trust (+5.3%) is India’s shining light. Golf, the immediate income portfolio, has the biggest allocation to fixed income out of all our models, at 46%. Its top constituents this quarter are Baillie Gifford Strategic Bond and Jupiter Strategic Bond (+2.4%), but it trod water overall due to holding our poorest-performing constituent. Picton Property Income shed 9.7% to almost reverse an 11.6% gain in the second quarter.

MEDIUM RISK          
Golf - Immediate Income % Hotel - Balanced Income % India - Growing Income %
Artemis High Income 15.6 Artemis Global Income 15.5 Artemis Global Income 16.9
Baillie Gifford Strategic Bond 14.8 Baillie Gifford Strategic Bond 17.5 Bankers IT 19.2
City of London IT 18.5 City of London IT 14.4 Guinness Asian Equity Income 13.2
Fidelity Multi-Asset Income 15.9 Kames Diversified Monthly Income 10.1 Henderson International Income IT 15.0
Jupiter Strategic Bond 11.6 Man GLG UK Income 13.3 Man GLG UK Income 10.7
Picton Property Income IT 10.8 Sanlam (Man GLG) Strategic Bond 13.7 Royal London Sterling Extra Yield 12.5
Schroder Income Maximiser 12.5 Sarasin Global Higher Dividend 15.5 Troy Income & Growth IT 12.5
Weighted yield 4.7 Weighted yield 4.1 Weighted yield 3.9

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


Higher risk: Picton Property also hampered Juliet (-0.3%). The real estate investment trust’s volatile performance record and loss of recognition by the Association of Investment Companies puts it on our radar for potential replacement in the immediate income portfolios.

However, it is Lima (-1.2%) that is our worst portfolio, due to poor performances from the income shares of JPMorgan European (-5.1%) and Lowland (-4.9%). The latter, a UK equity income investment trust, missed the wider rally for unloved UK equities; it also dragged down Kilo (+0.6%). Co-manager Laura Foll attributes Lowland’s performance to an underweight position in consumer staples, which outperformed, and an overweight position in financials, which struggled alongside other value-oriented cyclical sectors. Stock-specific issues have also hurt, among them a profits warning from Shoe Zone.

Foll concedes that a resolution to Brexit and greater confidence in the domestic economy is necessary for a large chunk of the portfolio to re-rate. In the meantime, the trust has raised its dividend by 10% for the past seven years and currently yields close to 5%. It has a year’s worth of dividend reserves in the coffers.

HIGHER RISK          
Juliet - Immediate Income % Kilo - Balanced Income % Lima - Growing Income %
Artemis Global Income 14.8 Artemis Global Income 15.9 Baillie Gifford Strategic Bond 13.1
Axa Framlington Monthly Income 19.0 Baillie Gifford Strategic Bond 12.7 JP Morgan European IT - Income 15.3
Picton Property Income IT 11.5 Lowland IT 14.3 Lowland IT 8.1
Royal London Global Bond Opps 10.3 Murray International IT 13.5 Temple Bar IT 11.4
Sanlam (Man GLG) Strategic Bond 17.1 Sanlam (Man GLG) Strategic Bond 12.7 Schroder Oriental Income IT 17.0
Schroder Income Maximiser 10.1 Schroder Income 14.9 Fundsmith Equity 18.8
TB Wise Multi-Asset Income 17.2 TB Wise Multi-Asset Income 16.0 Utilico Emerging Markets IT 16.3
Weighted yield 4.9 Weighted yield 4.3 Weighted yield 3.3

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


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