Valuation bright spots amid the gloom

These are worrying times, but history shows that it pays to hold your nerve. Cherry Reynard canvasses wealth managers for Money Observer Rated Fund investment ideas suitable for investors of all persuasions.

These are seat-of-the-pants times for investors. When the global economic and political environment is so fragile that it imperils the pro­fitability of global titans such as Apple and Samsung, it is a time for everyone to take note. The start of 2019 may have brought more realistic stock valuations, but everything from the US/ China trade war to Brexit to the rise of global populism casts a long shadow over ­financial markets.

Last year was a bruising one, in which almost every asset class from the most risky to the most defensive lost money. This time last year, economists were cheerfully discussing a global synchronised recovery and predicting a buoyant year.

The reality proved very different. Tom Becket, chief investment officer at Psigma, says: “Rather than delivering on their promises, equity markets – wherever they were around the world – were pretty weak. In a normal year, investors might have been able to o set their losses against bonds, but these have gone from being safe investments to being riskier investments, which made life more difficult. Pretty much anywhere you invested in global bond markets, you would have also lost money in 2018.”

Many of these problems look unlikely to go away in 2019. China and the US may have negotiated a short-term truce in their trade war, but they are unlikely to resolve multi-decade problems – from the rebalancing of power from west to east to the US multibillion dollar trade de­ficit – in a few short months. Disagreements over the UK’s future relationship with the European Union look unlikely to be settled on 29 March, while the rising tide of populism did not, in fact, fade with the election of Emmanuel Macron, but is alive, kicking and wearing a yellow vest.

That said, it is not all gloom. Markets are, if nothing else, up to 20% cheaper than they were this time last year. Becket says: “All we’re currently hearing is a huge amount of noise. We are ignoring the noise and focusing on the valuations of stockmarkets. It is worth doing the opposite of what other people are telling you to do. What has been consistent in the past three years is how wrong people have been. As people are starting to get bearish, opportunities are presenting themselves.” He argues that stockmarkets are attractively priced and there will be a “great buying opportunity” sometime this year.

However, there remains a central problem for all investors. It has persisted for several years, but became particularly stark in 2018: risk parameters for different asset classes are being redrawn. In October, for example, bond and stockmarkets fell in unison. Bonds provided no protection against equity market falls. Therefore, it is increasingly difficult to say which assets are good for investors who are willing to take higher risk, and which assets are good for investors who are defensive.

Jason Broomer, head of investment at Square Mile Research, says: “With inflation running at 2-3%, the purchasing power of cash is being eroded. Investment-grade bonds yield around 3% so maintain the real value of money, but they come with the risk that ­firms don’t repay the bonds. The UK equity market dividend yield is 4.5% and if we consider that dividend yields increase no more than inflation over the long term and should do better if the economy grows, this seems attractive.

“On this basis, which is the lowest risk – a  guaranteed small loss in real terms, or investment in equities which may have volatile capital returns but generate a more reliable real return? Are cash, gilt or bond investors being recklessly conservative if they are investing over the long term? On this basis, what should a low-risk client do? ­That’s not an easy question to answer.”

­This is the difficulty for investors. ­The type of assets on which they have relied to defend their portfolios, such as government bonds, still look risky in most scenarios. ­This needs a smarter approach to portfolios in 2019.

Lower-risk suggestions

Government bonds – usually a staple in a lower-risk portfolio – have a number of problems: yields are, in many cases, extremely low. ­The UK 10-year gilt currently (mid-January) pays an annual income of around 1.25%, which doesn’t protect against inflation. At the same time, it is difficult to see how gilt investors will achieve any significant capital return unless there is a savage downturn in the economic situation. Bill Dinning, head of investment strategy at wealth manager Waverton, says: “­The Bank of England is not going to do much in terms of raising rates, but at 1.25% for the 10-year gilt, investors need to be aware that it is only going to be worthwhile to invest if the equity market does have a big drawdown [fall].” ­

That said, a major fall is not impossible. David Coombs, head of multi-asset investments at Rathbones, believes it is worth balancing stockmarket risk with more cash and short-dated government bonds, to act as ‘stabilisers’ for a portfolio. Options might include a low-cost government bond tracker such as the Vanguard UK Government Bond Index fund or the exchange traded fund (ETF) iShares £ Ultrashort Bond.

However, for overall fixed income exposure, the M&G Global Macro Bond fund would be another option. It is run as a go-anywhere bond fund run with an eye to the prevailing macroeconomic environment. It made money in last year’s tough climate.

Dinning believes that investors need to look away from the conventional equity, bond, property and cash mix. ­This means thinking about the world of alternatives. He highlights real assets such as infrastructure. Rated Fund options here include Renewables Infrastructure IT and the SPDR Morningstar Multi-Asset Infrastructure ETF, while some mixed asset funds also have a dollop of exposure to real assets.

Lower-risk investors should not neglect equities, says Broomer: “Investors may be frightened to put money into falling stockmarkets. If we measure value by the price/earnings (p/e) ratio, over 2018 the FTSE All Share price fell 9.5% (the p) and UK earnings climbed by 8-9% (the e). Markets have therefore become almost 20% cheaper. When fashion shops have a New Year’s sale with a 20% discount, do you feel like spending more or less money? Does the discount put you off?” However, it is worth taking a lower-risk approach, using Fidelity Global Dividend or, for UK-listed shares, Royal London UK Equity Income.

Medium-risk opportunities

For medium-risk investors, many of the same rules apply. While it is important to retain some equity weighting, a conventional 60/40 equity/bond portfolio probably isn’t going to be the answer. Some exposure to alternative assets could help. However, the big question for this group of investors may be whether to look at corporate bonds or property.

After a tough year where the average fund in the Investment Association’s sterling corporate bond sector dipped 2.2%, corporate bonds draw differing views. Becket sees a mixed picture. He says that markets have been worried, perhaps excessively, about economic weakness and rising corporate defaults. However, he believes the real opportunities lie in high yield or asset-backed securities. The Royal London Sterling Extra Yield fund is focused largely on high yield bonds of this type.

Coombs has no property exposure: “We believe we are not adequately compensated for the risk we see to these assets from Brexit because, as we saw in 2016, the asset class tends to find itself in the crosshairs of souring Brexit sentiment.” However, Chase de Vere is still supporting a 10% allocation in its medium and low-risk portfolios. After all, the inflation-adjusted income that property provides has its merits.

Higher-risk allocations

Within equities, Dinning favours emerging markets for higher-risk clients: “Emerging markets could be quite interesting this year,” he says. “They have outperformed the US market since October. At the moment, the market is worried about a global recession, but to my mind, the data is more consistent with a shorter-term rotation than a cataclysmic bear market.” Fidelity Emerging Markets fund and the investment trust JP Morgan Emerging Markets are generalist funds that are decent core choices to consider.

The biggest risk is China, which is suffering as the US administration ‘puts America first’. The Chinese government may be taking tentative action to support the economy, but it is not yet clear whether this will be enough. Dinning adds: “We always worry about China, not least because it is difficult to get a handle on what is happening.”

Allocation to the US and big tech is another key question for higher-growth investors. Over the past few years, investors could hold a handful of large tech stocks and make good returns, but it has been a very difficult area in recent months. Becket points out that the US really does have some of the best companies in the world, but they look expensive. He is currently underweight the US market for that reason.

The North American Income Trust, run by Aberdeen Standard, invests in the US markets, but not technology stocks (they don’t pay an income). Equally, Artemis US Smaller Companies and Miton US Opportunities are a more nuanced way to approach the US markets. Becket, however, prefers Europe and Japan for higher-risk investors.

How wealth managers see the investing world in 2019

How three wealth managers see the investing world in 2019


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