None of us will forget 2020 in a hurry, but from an investment standpoint it is possible that 2021 could be just as memorable. There is a real feeling of bullishness as the markets price in a return to normality, although investors need to be watchful as the coronavirus is still wreaking havoc and the speculative excess evident in recent US IPOs could reverse without warning.
Covid will remain the key factor affecting the markets, especially in the next six months as countries rush to vaccinate to counter the more infectious new strain. Once the most vulnerable are protected we should start to see a gradual return to normality in the second half of the year.
One of the key economic indicators to look for could be inflation. Expectations are currently very low, but the amount of monetary and fiscal stimulus injected into the system could make it a medium to long-term risk, although it might not become apparent until 2022 because of the deflationary impact of the pandemic.
Governments will have to tread carefully as they will need to find ways of paying for all of the additional debt without derailing the recovery. This will probably mean tax rises in many countries alongside more support from central banks to keep the economies moving.
The best areas to invest in 2021
As investors look ahead to when things get back to normal there could be some rotation in the markets, with the areas that have worked well in the last few years not necessarily doing as well in the future. It is possible that this might help out-of-favour markets like the UK come back into fashion.
Ben Yearsley, a director at Shore Financial Planning, says that the UK has been the dog of the investing world for four years now.
“Firstly Brexit, then political instability, then latterly Covid. All three are hopefully on the way out, which would mean that the UK is well placed to prosper with cheap valuations and a government still spending.”
Another area that should do well is Asia, as a weaker US dollar is a big benefit. China should also continue to perform, especially if the change in the White House results in a thawing of relations with the US.
Ryan Hughes, head of active portfolios at AJ Bell, says that Asian markets look well positioned given their strong recovery from Covid in the second half of last year:
“With economic activity strong and the broader global economy recovering, it feels like Asia could be a big beneficiary, albeit with some degree of caution on the valuation of some of the major elements of the Chinese technology sector.”
The low bond yields and high level of issuance could make it a challenging year for government bonds, particularly at the longer dated end if the yield curve steepens. There is far more upside potential from the stock market.
“Equities should benefit in general as markets rally on the back of Quantitative Easing, fiscal stimulus and hopes for a strong rebound in economic activity as the vaccines are rolled out. Gold should also do well from this trend, which is inflationary, as well as from the weaker US dollar,” notes Adrian Lowcock, head of personal investing at Willis Owen.
Value versus growth
One of the biggest areas of debate is whether we are finally seeing the long-awaited rotation out of growth and into value. Growth stocks have massively outperformed over the last decade or so, but there are signs that this could be starting to change.
“Value stocks are not only extremely cheap, but the growth side is expensive as well, although the valuations alone are not enough to trigger the rotation. The shift to fiscal stimulus and a return to ‘normal’ economic activity both support a recovery in value, but inflation and rising interest rates are probably needed for a rotation to be material and longer lasting,” explains Lowcock.
If the yield curve continues to steepen, with longer term interest rates rising relative to shorter term rates, then that should support the move from growth to value. It is worth remembering though that there have been several short-lived rallies in value stocks over the last couple of years and they have all petered out quite quickly.
One important difference is that the hedge funds that had built up big shorts in value stocks have closed a lot of them out, which could indicate that there is more to the switch to value than was the case before.
Rob Morgan, an investment analyst at Charles Stanley, says that many investors’ portfolios are completely skewed towards growth companies and in particular the large tech companies that command such significant weightings in the major US and global indices:
“The danger is not so much that these areas suddenly plunge, more that they, as a cohort, provide uninspiring returns for a prolonged period as their valuations at this point are pretty full. In that context I would suggest it is time to revisit funds that can provide exposure to high-quality but decently valued companies that have been somewhat left behind.”
When it comes to individual funds, Lowcock recommends Man GLG Undervalued Assets, a UK value-oriented vehicle that is managed by Henry Dixon. It had a terrible 2020 because of the lockdowns and the way the value sectors struggled, but could be poised to do well.
“Dixon is a very active value manager and constantly updating the portfolio and his assessment of the investments in it. This means that he has a high turnover, taking profits as they arise and moving to alternative options to invest in, an approach that should work well even if value doesn’t take off and we only see the style recover from 2020 lows.”
Yearsley suggests Montanaro UK Income that invests in small and mid-cap stocks that offer an attractive dividend yield or the potential for dividend growth. It has a forecast yield of 3.1% and an excellent track record since the launch in 2006 despite having a difficult 2020.
Hughes prefers the Fidelity Special Values Investment Trust (LON:FSV), which focuses on out-of-favour UK companies and could do well on the resolution of Brexit and a Covid vaccine.
“Manager Alex Wright is very bullish at the moment with gearing at 15% and has big positions in Legal & General, Imperial Brands and Serco, but also invests right across the market cap spectrum with a solid allocation to smaller companies. From the start of January investors will also benefit from a reduced ongoing charges figure after the board renegotiated the management fee with Fidelity.”
Along similar lines Morgan recommends the Aberforth Smaller Companies Investment Trust (LON:ASL), which invests in smaller, more domestically-oriented businesses:
“The management team has a value-based investment philosophy that aims to unearth cheap companies whose longer-term potential has been misunderstood or underestimated by the market as a whole. Combined with meeting company management and understanding the industry environment, their process seeks to uncover less fashionable businesses priced below what they consider to be their intrinsic or sum-of-the-parts value.”
Turning to Asia, both Lowcock and Yearsley like the FSSA Asia Focus B fund that is managed by the highly experienced Martin Lau. It is skewed in favour of tech stocks and financials that each account for around 20% of the portfolio, with the main country weightings being China (24%) and India (19%).
“Lau invests in Asia by taking a long-term approach and combining stock selection with an understanding of the prevailing social and economic conditions. There is a focus on capital preservation, which has been the foundation for long-term performance,” explains Lowcock.
Yearsley also recommends the Matthews China Smaller Companies fund, which he describes as the standout performer in 2020. In the last twelve months its portfolio of dynamic small-cap Chinese stocks was up 67%, but he says that he will stick with it as the Chinese consumer comes roaring back.
Hughes suggests Jupiter Japan Income, which has a yield of 2.4% that should increase strongly in the years to come. Japan isn’t normally associated with income producing stocks, yet many companies have evolved to become highly profitable and have significant amounts of cash on their balance sheets.
“This is translating into income with company management showing more understanding of the importance of dividends to overseas investors. The fund actively seeks out those high quality companies that are generating profits and have a willingness to return that to shareholders as dividends.”
Darius McDermott, MD of FundCalibre, says that he has a preference for Asia and the emerging markets over the developed markets, as they will benefit from a weaker dollar and better economic growth.
“Murray International (LON:MYI) ticks all of the right boxes. It’s a global equity income investment trust, but the manager currently favours emerging market equities and bonds. Its yield is also above 4%.”
For those who are primarily interested in capital growth he suggests Federated Hermes Emerging Markets SMID Equity and Fidelity Asia Pacific Opportunities.
In terms of global funds, Lowcock recommends the Mid Wynd International Investment Trust (LON:MWY) that has been managed by Simon Edelsten since May 2014. It has around 20% invested in technology and a similar amount in healthcare, with just over half of the assets in the US.
“Edelsten invests in the picks and shovels of global growth. This means the trust has lagged some of the recent growth seen in markets, but it also means that it is not invested in the more expensive names. As valuations get stretched investors are likely to seek reasonable growth at more attractive prices, which will help to deliver positive returns while protecting investors from the volatility and risks of expensive valuations.”
Last year was a tough environment for income seekers with companies having to cut or postpone dividends because of the pandemic, but with the vaccines being rolled out and a return to normal life on the horizon there is greater visibility on earnings and many businesses are looking to reinstate their distributions.
With this in mind Morgan suggests M&G Global Dividend where manager Stuart Rhodes focuses on the ability of companies to grow their earnings.
“Since the launch of the fund in 2008 his philosophy of backing companies that grow their dividends, while avoiding high yielders whose dividends don’t grow, has been largely successful. The fund has been able to healthily increase its pay-outs to investors, including a modest increase in 2020.”
Those more interested in capital growth who are willing to consider a specialist area might prefer the BlackRock World Mining Investment Trust (LON:BRWM). There could be big opportunities for the mining sector as the transition to cleaner sources of energy is heavily reliant on certain metals and minerals, while many of the businesses involved in this industry are taking important steps towards becoming more sustainable themselves.
“The mining sector, unlike lots of others, could also provide a decent inflation hedge, so long as supply is relatively tight and demand keeps going. Inflation is not considered to be a significant risk so even a small shift in expectations could have a big impact on markets,” explains Morgan.
Hopefully we will soon start to see a return to normality as the vaccines are rolled out and this should enable economies and markets to carry on their recovery. Out-of-favour areas like the UK could come back into fashion, while regions like Asia that were able to deal with the pandemic without racking up huge debts should continue to prosper.
FUND OF THE MONTH
The UK has been out-of-favour for years and looks cheap relative to many of the other major markets. With the vaccine rollout underway and the worst of the Brexit uncertainty behind us there is a good chance that once the lockdown eases there will be more international interest, which could push share prices higher throughout the year.
With a potential rebound in UK equities on the cards, Hughes says that gaining exposure to some of the fastest growing companies in the domestic market could be a potential winner. With this in mind he recommends the Standard Life UK Smaller Companies Investment Trust (LON:SLS).
“The smaller companies team at Aberdeen Standard that is led by the highly experienced Harry Nimmo is very strong and the trust has also recently appointed Abby Glennie as co-manager. It is a nice size at £600m, has a high active share and an outstanding track record and is a great example of the benefit of genuinely active management.”
SLS has a concentrated portfolio of around 50 holdings representing the manager’s highest conviction ideas. It has an excellent long-term record with a NAV return of just over 250% in the last ten years, which is well ahead of the smaller companies sector return of 172%.