Particularly when choosing an investment for the long-term, it is natural to look at what a sector or fund has done in the past, but this performance will not necessarily repeat itself.
Similarly, when an idea gains common currency it is hard to disagree, meaning that market observers are slow to change their mind – this is as true for managers and advisers as it is for retail investors.
With this in mind, FE Trustnet looks at the case against three of the most popular equity sectors among investors and analysts – emerging markets, mid and small cap growth, and equity income.
Emerging markets
Despite all the doom and gloom surrounding the economies of the developed West, they have outperformed emerging markets over the past three years.
Data from FE Analytics shows that the FTSE All Share has made 34.5 per cent over that time while the MSCI Emerging Markets index has made just 18.87 per cent.
Performance of indices over 3yrs
Source: FE Analytics
Investors are used to hearing how the index has made 395.15 per cent over the past 10 years, but the vast majority of this performance came in the first five years of the decade.
The MSCI Emerging Markets index made 263.06 per cent between 4 March 2003 and 4 March 2008, and a further 38.14 per cent after that.
David Hambidge, head of multi-manager at Premier, says his portfolios have benefited over the past year from being underweight emerging markets.
"That’s where all the growth is but the stock market has been underperforming for three years or so," he said.
Gary Potter, co-manager of the Thames River Distribution fund, added: "Emerging markets as an investment destination isn’t over but they are already very developed."
"These countries have to import energy and food, so inflationary pressures will start to build. They are not any more the obvious place for capital."
While it is possible that emerging markets will rebound and start to outperform again, this is not guaranteed.
China is expected to grow much more slowly in the coming years and, as the world’s second-largest economy, it has a huge influence on the broader emerging market indices and funds.
Beyond that, higher GDP growth does not always translate into higher stock market growth, as FE Analytics data proves, suggesting that investors would be wise not to put all their eggs in one basket.
Mid caps and small caps
That mid caps outperform but with a higher volatility is something that is taken for granted, but this has not always been the case.
Over the past 10 years the FTSE 250 index has made more than double the 150.24 per cent returned by the FTSE 100 – 351.24 per cent to be exact.
This outperformance has thrust funds such as FE Alpha Manager Mark Martin’s Neptune UK Mid Cap to the top of performance tables.
However, during the 1990s the FTSE 100 substantially outperformed the FTSE 250 of mid-sized companies, growing 328.62 per cent while the 250 rose 258.35 per cent.
Performance of indices from 1990 to 2000
Source: FE Analytics
According to Hambidge, a recovery could well see this pattern repeat itself, because if a huge amount of money moves from bonds into equities it is likely to gravitate towards the larger end of the market.
"If there’s a general move back into equity it could be the mega caps which have their day in the sun," he said.
"If you go back 15 years or so that’s what happened prior to the tech boom: I saw at that point lots of fund houses setting up index-tracking funds."
While most investors may not be convinced that a genuine economic recovery is underway, the longer their investment horizon, the more relevant it is to take the possibility of economic recovery and a reversal of this trend into consideration.
Equity income
Equity income funds have become popular not just for the yield they provide but also for their defensive nature.
The highest-yielding companies tend to be located in the more defensive sectors such as tobacco, pharmaceuticals and utilities, which are less exposed to variable consumer demand.
This has worked well for investors in recent years. Over five and three years, the IMA UK Equity Income sector has returned marginally more than the IMA UK All Companies sector, according to data from FE Analytics.
Performance of sectors over 3yrs
Source: FE Analytics
However, Sebastian Lyon, manager of the hugely successful Trojan fund, warns that as the price of these stocks is increasing, the yield is decreasing, with the payout figure for the FTSE All Share at 3.3 per cent, near the bottom of its historical range of 3 to 5 per cent.
He warns that shares could be set to rise even further as investors move out of bonds, where yields have been compressed to uninviting levels.
This means that investors could be left with a low-yielding portfolio in a few months’ time if they fail to diversify their income holdings.
Potentially there could be a risk to investors getting into the sector now if this taste for defensives changes. Money could be transferred into more cyclical areas in a rush, leaving investors nursing large losses.