The pandemic has polarised the markets with areas such as gold, technology, healthcare and growth storming ahead, while equity income and value have been left nursing heavy losses.
Even before the coronavirus it was the sectors that offer secular growth characteristics that were leading the way. When inflation and interest rates are low and growth scarce then it is areas like tech and healthcare that tend to flourish.
A polarised market creates challenges of its own as it is hard to know whether to modify your positions, but Ryan Hughes, head of active portfolios at AJ Bell, thinks that it is right to be prudent and is wary of chasing momentum.
“The true economic impact of the pandemic is still being seen, while some market valuations have seemingly become disconnected from reality.”
It is possible that the stock market leaders and laggards could change places as governments use fiscal policy to stimulate economic growth. This could result in the creation of a more traditional cycle with higher inflation and an upwards move in interest rates that would be beneficial for value style investments.
Adrian Lowcock, head of personal investing at Willis Owen, says that it is important to have a target asset allocation, so that when one area delivers you can rebalance by reducing your exposure and investing in those areas that have lagged behind.
“This rebalancing should be a marginal thing and not a wholesale disposal of those areas that have performed as they could continue to deliver for days, weeks, months and even years.”
One of the best performing areas of the market this year has been gold, which has benefitted from its safe haven status as investors looked to protect their portfolios against the sell-off. The precious metal recently rose above $2,000 per troy ounce for the first time in its history, although it has since fallen back slightly.
The strong performance is due to concerns about the economic recovery, as well as the weakening of the US dollar – which makes gold cheaper to buy for non US investors − and the possible return of inflation because of the monetary and fiscal stimulus being injected into the system. Low or negative real rates of interest also mean that there is no opportunity cost to holding it.
“Gold could be a long-term investment if these issues remain, although it is important to stick to your target allocation and take profits on the way up. If you don’t have gold then buying now is likely to feel like a tough decision, but it is a good diversifier so I would suggest having some, say five percent,” explains Lowcock.
He recommends Blackrock Gold & General, a gold mining fund that is managed by Evy Hambro, who looks for companies that have the best exposure to gold but without taking unnecessary risk. This means the emphasis is on larger producers with good assets and the ability to grow their production cost-effectively.
Rob Morgan, an investment analyst at Charles Stanley, says that he’s slightly nervous as he’s struggling to find anyone bearish on gold right now and that’s highly unusual.
“I can’t help think that it’s something of a crowded trade so I would be tempted to bank some profits. It’s definitely worth keeping a position for diversification, but renewed US dollar strength would be a significant headwind.”
Like Lowcock he recommends Blackrock Gold & General, which he describes as a high quality exposure with the vast majority of the portfolio invested in established producers.
Longer term the standout area of performance has been technology, a sector dominated by the US mega caps such as Facebook, Amazon, Apple, Netflix and Alphabet. The specialist funds that concentrate on this part of the market have generated some of the best returns over the last ten years with some of them up over 500% over the period.
Darius McDermott, MD of Chelsea Financial Services, says that valuations for the large US tech companies are high, but there seems to be no reason why they cannot continue to perform as technology is a secular growth story and one that will not be going away any time soon.
“The biggest risk at the moment would seem to be the US election and depending on who wins, there could be a move to break them up or limit their dominance. That said, the recent hearing that the big four CEOs attended had a more reasonable tone.”
It is also important to appreciate that many of the medium and smaller tech stocks are not on such high valuations and there are some very good technology businesses that are not based in the US.
“If you want to invest in this area we really like AXA Framlington Global Technology and T. Rowe Price Global Focused Growth Equity, which has a wider remit but currently has 35% invested in the global technology sector,” explains McDermott.
Morgan thinks that sticking with tech companies makes good sense as although they are expensive, they offer islands of structural growth in an increasingly tricky stock market and uncertain world. He believes that the best returns could come from the smaller businesses in support areas such as software and cybersecurity.
His preferred option is the Allianz Technology Investment Trust (LON: ATT) that is run by Walter Price and a team based close to the heart of the action in San Francisco. As well as the large tech companies it also targets the next wave of exciting businesses and the managers have shown themselves to be adept at finding these sorts of opportunities.
The healthcare sector has experienced a protracted period of strong performance. This is partly due to the number of successful clinical trials from emerging biotech companies and a surge in merger & acquisition activity.
It also did well during the lockdown as there was a minimal impact on drug sales and the weak performance elsewhere in the markets served to highlight the attractive growth characteristics of many healthcare companies.
Ben Yearsley, a director at Shore Financial Planning, says that he is a big fan of healthcare as a long-term investment theme.
“It should benefit from: the ageing population in developed markets, improved access to healthcare in developing markets and advances in biotech providing more specialised treatment. The main risk is a possible democrat win in the US presidential election as they want to bring in more pricing controls.”
If you want to invest in this area he suggests either the Biotech Growth Investment Trust (LON: BIOG), AXA Framlington biotechnology, or the Polar Capital Healthcare Opportunities fund.
Hughes says that healthcare is a specialist area that benefits from fund managers and analysts with genuine knowledge of the pharmaceuticals market. “The sector as a whole brings useful diversification and is an area we have dedicated exposure to in our portfolios.”
He likes having a broad based exposure and suggests that the two billion pound Worldwide Healthcare Trust (LON: WWH) is a strong option for those wanting an actively managed approach.
“WWH is managed by healthcare specialists OrbiMed and has a broad spread of exposure right across the healthcare spectrum. It is a little on the expensive side as it charges a performance fee, but investors will have been happy with the long-term results regardless.”
Another significant trend over the last ten years is the dominance of growth over value. Value stocks are ‘cheap’ when measured using a metric such as price to book (P/B), or price to earnings (PE), whereas growth stocks usually trade on high PEs, have above average growth and are expected to earn a lot more in the future.
Lowcock says that in a world of low growth and low-interest rates, companies that offer above-trend growth look even more attractive and are put on premium valuations.
“With interest rates set to remain low for the foreseeable future and inflation unlikely to return in the short-term, growth stocks are likely to remain attractive for now. Investors shouldn’t try and position a portfolio for one style or another as when the change comes it can be fast and dramatic; better to have a mix of growth, income and value stocks.”
For a growth-oriented exposure he recommends T Rowe Price US Large Cap. The manager uses in-house research to identify companies that have double digit earnings potential over three years as well as having defensive characteristics, which helps protect capital in market setbacks.
McDermott says that Baillie Gifford has a strong growth style and most of their funds have done superbly. He particularly likes Baillie Gifford Global Discovery, which invests in innovative smaller companies all over the world.
“Comgest is a similar story, although less well-known, with a strong investment process that is used across their range. I really like their Japan and European offerings: Comgest Growth Japan and Comgest Growth Europe ex UK.”
Value funds have had a torrid time and are lagging well behind their growth counterparts. This was the case even before the pandemic, but the lockdown provided a killer blow as the cyclical nature of their earnings worked against them.
“Returns from value-focussed funds have been terrible over the past few years and much of the uncertainty has been accentuated by the disruption caused by the spread of Covid-19,” explains Morgan.
He says that investors should maintain some value exposure in their portfolio for diversification, but they need to bear in mind that the fund managers need to negotiate an investment universe littered with value traps.
One manager he admires in this area is Henry Dixon, who runs the Man GLG Undervalued Assets Fund. A key part of his process is to avoid the structural issues and over indebtedness that can result in classic value traps, which means that the fund isn’t at the extreme end of the value spectrum.
Yearsley recommends the Schroder Global Recovery fund, which he says has an excellent team that looks for discernible value and upside.
“Value is an interesting area as there are so many cheap stocks, but what is the catalyst for those stocks going up in price? With interest rates stuck at zero for the next decade, value stocks will have to find some growth to become attractive or they could just get taken out by private equity.”
Equity income funds that invest in dividend paying stocks have had a tough time during the pandemic as company after company has suspended or reduced its distributions. It is important to remember though that even with a 50% cut to dividends, yields will still be around three percent on most funds, which is still way above cash and government bonds.
For funds that offer more certainty over their dividends McDermott suggests Montanaro UK Income. The manager expects the dividend to fall this year, but to be back to around 3.4% next year.
Another good option would be to diversify overseas where McDermott likes the Schroder Asian Income Fund because Asia’s dividends are expected to fall less than those in the UK. Alternatively there is Guinness Global Equity Income, which has a lower starting yield of around three percent, but invests in companies that can grow their dividend over time.
Hughes says that if you are relying on the investment income then it’s important to understand the structure of the fund.
“Open-ended funds have to pay out all the income they receive and haven’t been able to hold any money back in the good years to help out in the bad. This makes for a lumpier income profile and as a result, investors could see income fall by between 30-50%.”
Investment trusts are different as they can hold back income in the good years to top up the bad and this will come into its own this year and next with trusts able to deliver a more consistent income.
“One to look at would be the £1.5bn City of London Investment Trust (LON: CTY) that invests in UK equities. It has recently declared a higher dividend than last year making it 55 years in a row of increasing dividends and the board have already said they expect to pay a higher dividend again next year. At current levels, the trust yields 5.8%,” notes Hughes.
Although it is always tempting to chase the best returns, investors would be better advised to stick to a balanced portfolio that reflects their objectives and attitude to risk. Periodic re-balancing back to their target allocations would then enable them to recycle profits from the stronger performing areas to the weaker, thereby protecting against the inevitable reverses.
FUND OF THE MONTH
Rather than work out how much to allocate to each of these different areas you could delegate the decision by investing in a fund-of-funds where the manager does it for you. One such is BMO Managed Portfolio Growth (LON: BMPG) that aims to generate capital growth from a portfolio of investment trusts.
Manager Peter Hewitt believes that the case for exposure to sectors which offer secular growth characteristics remains in place. Because of this he has a high weighting in good quality investment trusts that focus on technology, healthcare and biotechnology, which he holds alongside more diversified mandates and alternatives with a more defensive nature.
It is an approach that has served him well with the fund making a small three percent loss in the first half of this year compared to a 17% loss in its FTSE All-Share benchmark. The longer term record is also good with the fund comfortably outperforming the index since it was launched in 2008.
The main downside is the double layer of management fees that result in an ongoing cost of 2.13%, which would eat into the performance. This would only be worth paying if the manager is able to add sufficient value via his asset allocation and fund selection decisions.
Name: BMO Managed Portfolio Growth (LON: BMPG)
Type: Investment Trust
Sector: Flexible investment
Total Assets: £80m
Launch Date: April 2008
Historic Yield: 0%
Ongoing Charges: 2.13% (including the charges of the underlying investments)