At this time of year the financial press is always littered with predictions about which areas of the market are going to produce the best returns. It can be interesting and instructive to look at the different views, but it’s important to remember that nobody is infallible and well thought-out forecasts can quickly be overtaken by an unforeseen turn of events.
Perhaps the best place to start is to look back at 2015 to see how the different sectors performed last year. According to FE Trustnet, there were only four areas where the average fund return was in double figures over the twelve months to the end of December. These were: European, Japanese and UK Smaller Companies, as well as the broader Japanese equities sector with the returns ranging from 14.8% to 19.2%.
At the other end of the spectrum there were 10 sectors that produced negative average fund returns with the worst being Global Emerging Markets, Specialist and Global Emerging Market Bond. These produced losses of between 10.2% and 5.1%.
The Smaller Companies funds tend to be more risky but can generate the strongest returns when their local markets improve, as was the case in the UK, with their counterparts in Europe and Japan benefiting from the massive programmes of Quantitative Easing (QE). Emerging Markets were the biggest casualty because of the fall in the price of raw materials due to the slowdown in China and the strength of the US dollar on the foreign exchanges.
Take profits and re-position your portfolio
The fund-of-funds team at Hawksmoor have recently rebalanced their portfolios so that they are ready for 2016. One of their new additions is the Aberdeen Asian Income Trust, which invests in high yielding shares in Asia Pacific ex Japan. This is an area that really struggled in 2015 with the sector producing an average loss of 3.3%. The fund is managed by Hugh Young, who has an excellent track record although his quality-growth style has recently fallen out of favour.
Aberdeen Asian Income’s largest exposures are to Singapore, Australia, Hong Kong and Thailand. Historically it has traded at a small premium to NAV, but with the shares down about 40% since May 2014 they have been pushed out to a 7% discount. Hawksmoor, who are contrarian investors, see this as a great buying opportunity for a long-term position and have the added comfort of a 5.4% yield.
Another interesting move was the decision to reduce their exposure to the top performing Standard Life Investments UK Equity Income Unconstrained fund, with the proceeds being reinvested in Fidelity Enhanced Income. This is basically a switch away from the UK mid-caps to the blue chips, which have lagged behind their smaller peers.
The more drastic decision was to sell their holding in Artemis Strategic Assets, despite their continued faith in the manager, William Littlewood. His fund has large short positions in Japanese government bonds and the bonds of several European countries, which could work against him given the large programmes of Quantitative Easing in these locations.
A cautious view of 2016
Darius McDermott, MD of Chelsea Financial Services, believes that it is time to baton down the hatches, as 2016 could be pretty volatile if the US and UK start to raise interest rates. The two regions he is most confident about are Europe and Japan, as both are benefiting from monetary stimulus in the form of QE.
His preferred funds in Europe are BlackRock Continental European and Threadneedle European Select, while in Japan he highlights Schroder Tokyo and Neptune Japan Opportunities.
McDermott is wary about the prospects for bond funds and expects prices to fall as a result of the increase in interest rates. Because of this he suggests going for a fund with a decent yield to give yourself a chance of making a positive total return. Potential candidates include: Invesco Perpetual Corporate Bond, Baillie Gifford High Yield and TwentyFour Dynamic Bond.
His favourite area of the market is the Targeted Absolute Return sector, whose members have the potential to produce positive returns in all market conditions while diversifying a wider portfolio. He especially likes Henderson UK Absolute Return and Smith & Williamson Enterprise, which combine long and short equity positions. Lower risk multi-asset alternatives include Church House Tenax Absolute Return Strategies and Premier Defensive Growth.
Investing for income
Eugene Philalithis, a multi-asset portfolio manager at Fidelity, expects economic growth to remain stable in 2016, although market volatility could pick up as a result of higher interest rates in the US or a slowdown in China.
Against this sort of backdrop he likes the Henderson Strategic Bond fund, which has an unconstrained approach to investing in government, investment grade and high yield debt. It has £1.4bn in assets under management and has built up an excellent track record with an attractive 4.5% yield.
Income investors willing to take on more risk might prefer the £153m JPM Global High Yield Bond fund. This has 500 different holdings based on a bottom-up stock selection approach with the managers supported by a team of 9 credit analysts. It has an impressive yield of just under 7%.
On the equity side Philalithis suggests Invesco Perpetual Global Equity Income. The fund invests in dividend-paying shares from around the world with the managers sticking to companies with good cash flow and sustainable distributions.
It is a concentrated portfolio of 54 holdings that include the likes of BT, British American Tobacco and Legal & General, with the largest geographic allocation being Continental Europe at about a third of the assets. The fund has a decent track record and is yielding 3.35%.
His other suggestion is Artemis Income, which has delivered solid long-term returns by investing in UK companies that are able to generate sufficient free cashflow. It is a large fund with £6.8bn in assets under management and has a competitive dividend yield of 3.77%.
Tom Stevenson, investment director at Fidelity International, prefers equities to bonds because of the prospect of higher interest rates. He particularly likes Rathbone Global Opportunities, which is a global growth fund with a bias towards the US market that he thinks should do well given the strength of the economy.
Stevenson also recommends the Fidelity Moneybuilder Dividend fund where the manager takes a cautious approach and looks for ‘safety of income at a reasonable price’. This is an important safeguard given that some companies may have to cut their dividends in 2016.
Another income option is the SLI Ignis UK Property Feeder fund. Stevenson thinks that commercial property will continue to offer attractive relative returns despite the strong recent performance and likes the high starting yield with the prospect of rising income over time.
His other tip is Schroder Tokyo. Stevenson has been positive about the prospects for Japan for some time and describes it as a compelling investment because of the undemanding valuations and the new focus on shareholder returns.
Contrarian ideas for the brave hearted
The investment trust team at Winterflood Securities have highlighted three contrarian ideas in areas that have been out of favour with investors. This sort of approach carries a high degree of risk, but has the potential to deliver impressive returns if the markets rebound.
Their first suggestion is Edinburgh Dragon, which invests in Asia Pacific ex Japan and is trading at more than an 11% discount to NAV, the widest it has been for five years. The fund is managed by Aberdeen Asset Management and typically invests in high quality Asian businesses, but has suffered as a result of its underweight position in China.
Another possibility is JPM Chinese, which has a decent long-term track record but has underperformed its MSCI China benchmark over the last 12 months. Nobody knows if China will bounce back in 2016 but if it does JPM Chinese should benefit, especially in view of the 15% discount to NAV and 12% gearing.
Their other contrarian idea is JPM Emerging Markets. It is run by an experienced manager who is backed up by a well-resourced team, but has underperformed in 2015 and is trading on a much wider discount than normal.
Mick Gilligan, head of fund research at the broker Killik & Co, also likes the Emerging Markets. He says that the region has suffered six consecutive years of declining GDP growth rates and that if it manages to stabilise it could signal an important turning point.
His preferred option is Lazard Emerging Markets, which uses a relative value philosophy to identify companies with good profit potential that are trading at lower valuations. This could offer an attractive source of long-term returns.
Another fund that Gilligan likes is Scottish Mortgage, which is the largest investment trust trading on the London Stock Exchange. The managers have put together a highly concentrated portfolio of companies that will benefit from transformative change in areas such as e-commerce, social media, healthcare and energy.
Scottish Mortgage has a fantastic long-term track record with a 10-year return of 250%. Its largest holdings include the likes of Amazon, Facebook and Alphabet, which have had a strong run but still offer a lot of upside potential.