It is difficult to make predictions, especially about the future, so the quip goes. Forecasting 2024 is especially challenging due to the uncertain economic and geopolitical backdrop, as well as the various courses that inflation and interest rates might take.
As it stands markets will enter the year with a reasonable one behind them. 2023 has hardly been a classic, but considering the fractious political climate, the disappointment in Chinese recovery and the worries about inflation, the outcome wasn’t too bad. It certainly beat 2022 hands down, a period when both equity and bond markets endured a brutal sell-off as inflation and interest rates expectations took off. There also have been some real highlights with strong performance from the technology-laden Nasdaq Composite index in the US, and the broader S&P 500 thanks to the technology giants’ weights in that too.
Meanwhile, bond yields climbed for much of the year, meaning prices fell, owing to a mixture of higher-than-expected inflation and better-than-expected growth data, especially in the US, before falling away sharply on hopes that we have seen the last of recent interest rate rises. This sentiment was underscored last week by the US Federal Reserve, which held interest rates steady but indicated that members of the rate-setting committee now predict three quarter-point cuts next year. A traditional ‘Santa Claus’ rally across both bond and share markets ensued.
A happy new year for investors?
Looking ahead investors have reason for some festive cheer. Inflation is coming down and each subsequent data print seems to reinforce that. Cash, which has been such an attraction in recent months with returns not seen for 15 years, could start to lose its gloss as headline rates gradually subside and the fixed or rising yields on other assets start to have greater appeal. Overall, it a return to a more ‘normal’ environment is likely as a period that has been dominated by inflation risk and monetary tightening draws to a close.
Traditionally, bonds perform well as inflation peaks and rolls over, and if inflation and rates subside more quickly than expected then bonds should provide diversification from share markets that might be buffeted by the headwind of an economic downturn constraining earnings. However, given recent market moves there is a risk that much of the good news on inflation is already priced in, meaning the upside is more limited. Nonetheless, if do rates stay higher for longer owing to stickier inflation, locking into yields at this juncture could still provide an adequate medium-term return from the asset class.
The repercussions of higher interest rate are going to be felt for a while, which stands to put some pressure on company profits if the developed market economies continue to teeter along the edge of recession while accommodating higher borrowing costs. We only have to look to household bills and higher mortgage payments as an indicator of the elevated running costs and debt payments that businesses large and small are enduring.
It is therefore still an environment where resilience of earnings along with a strong balance sheet, ideally with net cash, provides reassurance. In both share and bond markets, this warrants a focus on quality and strength, as well as a need to harness enduring structural growth themes. As always, diversification by sector, geography and type of asset is wise to help reduce risk and ensure you are not overly reliant on one area or on certain circumstances.
With this backdrop in mind here is a selection of funds we believe could do relatively well in their respective areas over 2024 and beyond – they should all be considered long term investments meaning five years plus. They are provided for your information but are not a guide to how you should invest. Before investing in any fund please read the relevant Key Investor Information Document or Key Information Document, and Prospectus to ensure they fit with your objectives, risk appetite and wider portfolio. The very broad risk category is indicated.
Four funds for 2024
1. Vanguard Global Credit Bond (medium-low risk)
In 2024 refinancing needs will pick up for many businesses, which has consequences for both bond and share investors. Given the gap between the amount corporates pay on existing debt and what they must pay on new debt, this could be expensive, potentially impacting business spending. The situation is likely to be more problematic for smaller and more indebted companies, which in fixed interest markets supports our preference for good quality investment grade debt over high yield. Here returns could also benefit more from higher interest rate sensitivity if government bond yields start to fall.
There are a wide variety of options for investors wishing to invest in bonds, and there are many different types of funds available: government, corporate, strategic, emerging markets and high yield. However, for those seeking broad, ‘core’ exposure to the asset class we believe Vanguard Global Credit Bond Fund is worth considering. It seeks to provide a moderate level of income through investing in a diversified portfolio of corporate bonds on a global basis. The focus is predominantly on developed markets and on relatively secure investment grade bonds, but with some scope to buy high yield and investment grade emerging market bonds too.
Investors’ bond exposure is often dominated by UK corporate bond funds, but the UK is only around 5% of the global fixed-income market. The active, global approach taken by this fund provides a much greater opportunity set and is sufficiently selective to add value but diversified enough to mitigate stock-specific risks. Overseas currency exposure is hedged in order to remove the additional volatility associated with foreign exchange markets. The very wide portfolio of predominantly high-quality bonds should have more limited default risk during a recession, and the yield could provide investors with a solid income return with the added potential kicker of some capital growth if interest rates expectations subside further.
2. M&G Global Dividend (medium-high risk)
Dividends, the pay out of profits a company makes to its shareholders, are an important feature of investing in share markets. Yet they are frequently overlooked. Not only do they form an integral part of overall return, but the process of providing income to investors them instils capital discipline. Companies whose earnings and dividends can repeatedly withstand the travails of a changing economic environment will likely have strongly performing share prices. In contrast, those that disappoint investors with static or lower dividends often see their share prices punished.
Identifying companies with growing dividends is the goal of ‘equity income’ fund managers and these investments can help form an important part of an income-seeking portfolio. But it’s not just yield hunters that should take notice. Any investor wanting to focus on quality and income with a view to maximising overall returns should consider funds that focus on dividend payers. In particular, these funds can blend well with more growth-orientated holdings, perhaps dominated by the low-yielding parts of the technology sector, for diversification.
One fund that offers a pragmatic, well-rounded approach to dividend investing is M&G Global Dividend Fund, which invests globally in businesses that have the potential to grow dividends significantly over time. Often this means manager Stuart Rhodes accepting a lower starting yield in exchange for probable future growth in payments. Conversely, companies that are only able to maintain their dividends or, even worse, forced to cut them, are actively avoided, though inevitably this is difficult to achieve across a broad portfolio. Any business can fall victim to changing industry dynamics or misfortune.
Mr Rhodes balances wide a variety of companies: Disciplined firms with reliable growth strategies that can usually thrive no matter what is going on in wider economy, including more defensive areas such as pharmaceuticals and food producers; More economically sensitive businesses whose earnings are less consistent but should still trend higher over time, energy or commodities companies for instance; And faster-growing companies whose pace of expansion and dividend growth has the potential to surge thanks to rapid expansion in a new market or product line.
3. Aberforth Smaller Companies Trust (high risk)
Sentiment surrounding UK shares, smaller companies in particular, has been depressed for several years now. Smaller businesses are often more sensitive to both economic activity and borrowing costs compared with larger, more established ones. In addition, they tend to be more orientated towards the UK’s domestic economy where there are currently concerns of an extended slowdown.
However, as evidenced by recent bid approaches, trade buyers are eyeing value in the market and brave investors do stand to be rewarded for their patience. Presently, investors can benefit from a ‘double discount’; cheap valuations across the spectrum of UK companies and the discount to net asset values of investment trusts targeting the sector.
Aberforth Smaller Companies investment trust is one option and is trading on a 10% discount to NAV presently. It has a strong value bias to its investment approach, typically buying stocks when they are unloved, which means the portfolio is even less expensive than an already cheap broader market.
The managers place valuation, dividend yield and balance sheet strength at the forefront of their thinking, so the trust doesn’t capture the more expensive but potentially faster-growing parts of the smaller company universe. However, if this is a concern it could be blended with a more growth-orientated fund or trust.
The focus on valuation combined with balance sheet strength has historically meant that several holdings within the portfolio become the target of merger and acquisition activity, a factor that usually provides an uplift to share prices and could continue to help generate superior performance in the current environment.
4. Schroder Energy Transition (high risk)
In 2021 clean energy and related stocks attracted huge interest from investors as low interest rates and a compelling narrative around the scale of changes required to meet net zero carbon emissions targets created something of a frenzy. There were some parallels to the tech boom and bust in 2000. After a spectacular re-rating of valuations in expectation of strong future earnings growth, pressures from tightening financial conditions and slower-than-hoped demand caused a collapse in sentiment over the course of 2022 and 2023.
It’s fair to say that a number of companies simply haven’t delivered, especially in the renewables space, as a result of poor capital allocation decisions or supply chain problems. But there is also evidence some technical factors are at play as well, with disillusioned investors withdrawing from previously popular sustainable energy ETFs and creating selling pressure across the board.
Yet the political and social will to decarbonise and electrify the world hasn’t gone away. Just as valuations of companies got ahead of themselves, there now could be too much gloom. Spend in this space will still need to accelerate meaning structural demand for energy transition technologies will once again come through as consumers and businesses gradually adjust to higher interest rates while technology costs continue to fall. The long-term opportunities for future earnings and cash flow growth as the world transitions to a cleaner and more sustainable economy are therefore still alive, though significant risks do remain in this capital-intensive area.
Mark Lacey, the manager of Schroder Energy Transition Fund, takes a selective and disciplined approach to investing in the theme, which has helped limit losses over the past couple of years, and having moved from a high weighting in cash – close to the limit of 10% – the portfolio is now more fully invested and ready to benefit from any subsequent upturn. We believe the approach adopted is well placed to identify longer term beneficiaries of this important structural trend and there may be decent recovery potential if sentiment picks up in this highly specialist and riskier space.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
Four funds for 2024
Read this next
From avoiding cash to exploring equities: six tips on how to preserve your moneySee more Insights