As a year like no other ends, investors are questioning how events in 2020 will influence the next 12 months. Are we set for a recovery and a return to ‘pre-Covid’ conditions or have things changed for good?
We believe markets are probably correct to assume the development of several vaccines represents ‘the beginning of the end’ of the pandemic. The latest leg-up in the stock-market rally reflects this optimism and has seen some of the laggards play catch-up on hopes the link between free mobility and the spread of Covid will be broken.
However, with global corporate profits likely to end this year about 20% lower than in 2019 – and world economic output recouping just two-thirds of that lost in the crisis at best – it is likely to be 2022 before we return to pre-pandemic levels of activity and earnings (and somewhat longer for the UK). Moreover, there will be many sectors – notably retail, travel, leisure and hospitality – where the damage is permanent. This means, more broadly, there may be ‘scarring’ across the economy, resulting in lower future growth and employment.
Against this sobering background, it is important to consider whether markets have run too far ahead of themselves. Certainly, equity valuations are elevated. Earnings multiples are at their highest level since the height of the dot-com boom. Yet financial markets have become a key policy tool in managing the economy. By buying bonds out of the reserves they themselves create, central banks inject liquidity into the financial system. This action also drives up the price of bonds, lowering their yields as well as the cost of borrowing for governments, corporates and households. A widespread ‘easing’ of financial conditions.
With more money circulating in the financial system – and bonds now much more expensive – equities begin to look relatively more attractive to investors. Not only do low-bond yields make other assets look relatively cheap, they create a low ‘discount rate’ when forecasting future equity earnings. This has the effect of boosting equity valuations. Certainly, investors have increasingly bought into the notion that central banks have, for the time being at least, put a safety net under the market.
So, the outlook for next year rests as much on the shoulders of central bankers as it does on the lingering effects of the pandemic. Given the risks to the global economy of an early tightening of monetary policy, we expect interest rates to hover at low levels for the foreseeable future. This will provide a modest tailwind for equities, which we expect to deliver mid-to-high single-digit returns in 2021. Elsewhere, whilst government deficits have ballooned this year, low bond yields should help ensure that public finances are sustainable.
Furthermore, and whatever the Brexit outcome, we feel that the poor relative performance of the UK equity market is unlikely to be repeated next year. On balance, better economic growth and more favourable corporate earnings delivery should be a modest tailwind for many of this year’s economically-sensitive laggards.
However, investors need to keep an eye out for any sustained pick-up in inflation. If higher real prices translate into higher bond yields, it could spell trouble both for the equity market and the ability of governments to provide the necessary additional fiscal support for the global economy. Another key risk is disappointment in relation to the effectiveness or pace of rollout of the Covid-19 vaccines, either of which could mean activity is curtailed for longer and more businesses struggle to make ends meet.
With this backdrop in mind here is a selection of funds our Collectives Research Team believe could do relatively well in their respective areas over 2021 and beyond. They offer varying levels of risk, which are noted. 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.
Aberforth Smaller Companies Trust (Adventurous)
We feel ‘value’ investing is still relevant and seeking out long-suffering value managers with a decent pedigree may be a worthwhile strategy in 2021 as the world recovers from the pandemic. In addition, investors continue to view the UK stock market with scepticism. Uncertainty surrounding Brexit fallout persists, weighing on share prices, most notably in respect of smaller, more domestically orientated companies. It means there is value to be found for experienced stock pickers that can add additional value through picking out the best of the opportunities and avoid the traps. Certain areas are likely to see structural decline, parts of the energy and retail sectors for instance, which means value investing may best be undertaken in a selective rather than a comprehensive fashion.
One option to take advantage of these trends is Aberforth Smaller Companies Investment Trust. It’s investing style has been horribly at odds with the market action for the past couple of years but its still a high quality investment that follows a defined and disciplined process. The managers aim to unearth cheap companies whose longer-term potential they believe has been misunderstood or underestimated by the market as a whole. Combined with meeting company management and understanding the industry environment, their process aims to uncover less fashionable businesses priced below what they consider to be their ‘intrinsic’ or sum-of-the-parts value.
Baillie Gifford Positive Change (Very Adventurous)
It’s been striking how rapidly socially responsible and sustainable investing has taken hold during 2020. Rather than slow it down the pandemic seems to have sped up the adoption as it provided a wake-up call that financial markets don’t exist in isolation, rather they are part of the fabric of society. As a consequence investors are paying greater attention to issues of sustainability and governance.
We have backed Baillie Gifford Positive Change Fund since 2018 in the belief it was a differentiated and adventurous option, and a refreshing change to some of the more turgid exclusion-based ethically-driven funds. The fund aims to contribute toward a more sustainable and inclusive world while generating strong returns by investing in four ‘impact themes’: Social inclusion and education, environment and resource needs, healthcare and quality of life and ‘base of the pyramid’ (companies addressing the basic needs of the global poorest). Although we were convinced the fund had the potential to generate strong performance, the level of return has been extraordinary and it should be remembered that past performance is not a guide to the future.
Returns have been driven by the very strong returns in the technology and healthcare sectors, notably by individual stocks flying high including Tesla and Moderna with it breakthrough Covid vaccine. These stellar performances are unlikely to be repeated to the same extent, but its testament to the Baillie Gifford process that they are able to find companies that are helping address environmental and social problems while generating strong returns for investors.
The election of Joe Biden in the US promises a decarbonising Green New Deal, and the prospect of the world’s largest economy joining other major nations in the objective of “net zero”. We therefore believe there remains significant mileage in the trend towards clean and renewable energy businesses, as well as increased digitalisation which is beneficial for a number of the fund’s technology related holdings. The fund will be volatile though. It should be noted that the significant holding in electric car pioneer Tesla will likely be instrumental to performance and influential on the short term ups and downs.
BNY Mellon Sustainable Real Return Fund (Cautious)
For investors looking for a ‘plodder’ rather than a ‘leaper’ in their portfolio BNY Mellon Sustainable Real Return is an option worth considering. It invests in a diverse portfolio of assets, aiming to beat the return on cash by 4% a year (before charges) while limiting the scope for losses.
The fund comprises a ‘core’ of assets chosen to generate attractive long-term returns, which are offset by stabilising, lower-risk assets and hedging positions to dampen volatility and to provide downside protection. The core is currently invested in shares of high-quality companies with predictable and stable cash flows, alongside bonds which the managers believe offer value. Among the offsetting positions are typically gold and US Treasuries, while the tactical use of ‘put options’ can serve to protect the portfolio against a significant fall in the market.
The managers use a thematic approach to investment decision making, which focuses on identifying long-term structural changes impacting the global economy. This includes demographic shifts, growing demand for healthcare and environmental change. This analysis provides the basis for the views taken on asset classes, sector positioning, stock selection and risk. The fund benefits from a strong team who make full use of the wider resources across BNY Mellon, and it may appeal to investors looking for modest long-term growth while aiming to control volatility.
The fund also restricts investments to companies that positively manage the material impacts of their operations and products on the environment and society.
M&G Global Dividend (Income / Moderately Adventurous)
2020 has been a tough environment for income seekers in equities with the pandemic creating a perfect storm. Companies cut or postponed dividends in expectation of a tougher trading environment or increased regulatory pressure. The latest Janus Henderson Global Dividend Monitor estimates that global dividends will fall between 17.5% and 20.2% in 2020. Yet with vaccines being rolled out and a return to normal life on the horizon there is greater visibility on earnings and companies are seeking to build back or reinstate dividends.
In addition to an improving dividend picture, at a time when inflation may be re-emerging equity income funds investing in yielding shares may offers some protection as well as offering exposure to areas that have lagged over the course of 2020.
It will be important to be selective, though. The outlook has fundamentally changed for many companies. Shares and sectors that have been badly damaged by the absence of customers during lockdowns and the shortage of turnover can be expected to bounce if as they return to better earnings, cashflow and profitability. But some businesses will be forever scarred by smaller volumes or a weaker balance sheet, notably those that have burnt through cash reserves and issued equity or debt. Other companies that have weathered the storm have has opportunities to grow market share and could be in a good position to increase their pay outs going forward.
A selective approach could favour active managers who are focussed on the ability of companies to grow earnings, and one fund that stands out in this regard is M&G Global Dividend. Since the launch of the fund in 2008 manager Stuart Rhodes’ 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 over the longer term. Impressively, it looks on course to do so this year, albeit modestly, despite the adverse conditions posed by the pandemic.
Given the fund’s well-rounded approach, Rhodes has been able to perform in a variety of market conditions – although it has tended to struggle during periods when very high quality, lower yielding companies have outperformed. We believe it is an attractive proposition for those seeking a rising income from global companies in a challenging environment.
RIT Capital Partners Trust (Balanced)
For investors looking for a broad spread of assets in a single investment, as well as the potential for outperformance through asset allocation and specialist active management, RIT Capital Partners may be of interest. It’s an investment trust with a flexible and unconstrained approach and an overall aim to beat inflation while limiting the ups and downs usually associated with investing in the stock market – a goal that resonates with many investors.
Shares make up the core, represented by managed funds and some individual stocks, and this is supplemented by bonds, absolute return funds, investments in private companies and the ability to add downside protection through derivatives. 2020 has not been a sparkling year for the Trust in comparison with its fine longer term record but we continue to believe the Trust maintains an edge with its access to specialist managers and private equity deals.
Schroder Asian Total Return Trust (Adventurous)
While the UK, Europe, the US and Latin America have struggled to contain Covid-19, hampering economic recovery, China is expected to have grown around 2-3% in 2020, the only major economy forecast to expand. Elsewhere in the region the impact has been less severe too, with Taiwan, Singapore, Hong Kong and South Korea also faring relatively well.
Our expectation is that Asian recovery will be quicker than in the western hemisphere. That’s significant as the region already accounts for half of the world’s economic activity, a proportion that looks likely to grow further over the next few years, aided by a pronounced demographic advantage, rising wealth and hard working populations. However, with such strong returns from Asian indices – led by China – over 2020 it seems markets may already be expecting a lot of company earnings.
One option for exposure to the region is Schroder Asian Total Return investment trust, which aims to achieve market-beating performance while offering a degree of capital preservation through tactical use of derivatives. This approach offers the managers the opportunity to go some way to protect capital in weak markets while still harnessing long term returns from the region. Having greater exposure when markets are cheap and gradually reducing and focussing on relative performance as markets get expensive makes sense – although the timing can be difficult to achieve.
Co-manager, Robin Parbrook, is currently circumspect, in particular about what he sees as ‘bubble’ like valuations in the electric vehicle, biotech and internet sectors as well as new companies coming to market of “dubious quality”. He still sees opportunities in the region but believes investors must tread carefully. The managers’ preference is for high-quality but resilient businesses, and they can draw on a large and impressive research team in the region in their such for the best ideas.
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