Stimulus packages from the likes of the Federal Reserve have helped the recent rally in developed market equities as investors have been forced out of cash and traditional fixed income securities into higher risk assets.
Performance of indices over 1yr
Source: FE Analytics
While certain managers expect the rally to continue next year, Stout – who manages the ever-popular Murray International Investment Trust – is far more bearish. As a result, the manager is maintaining a high exposure to quality and less-economically sensitive companies as he is concerned that a correction is right around the corner.
“Some considerable time has now elapsed since global financial markets focused on fundamentals,” Stout said.
“Wildly oscillating sentiment and policy induced distortions continue to exert significant influence on numerous financial assets, ranging from prices of ten year bonds, emerging market currencies and global equity markets.”
“Any return towards more fundamental based asset pricing is likely to expose the fragility of high hopes and expectations that have recently prevailed, thus great caution will continue to be exercised in the current hostile environment,” he added.
Stout has managed the £1.3bn Murray International Investment Trust since June 2004.
According to FE Analytics, the closed-ended fund has returned 305.72 per cent over that time and has beaten its composite benchmark – 40/60 split FTSE World UK and FTSE World ex UK – by more than 180 percentage points.
Performance of trust versus benchmark since June 2004
Source: FE Analytics
Though the trust has outperformed over the long run, Stout’s high weighting to emerging markets and defensive stocks has meant it has struggled against its benchmark over the past 12 months.
Nevertheless, it is still popular with investors as it is currently trading on a 7.45 per cent premium to NAV. However, that is slightly lower than its one year average discount.
The trust has a 4 per cent yield and is geared at 15 per cent. Its ongoing charges are 1 per cent, which includes a performance fee.
Mark Wynne-Jones, who manages the £22m Investec Global Special Situations fund, agrees with Stout.
He says that the huge amount of quantitative easing from the world’s central banks is creating an artificial environment and that investors should expect a “painful” correction as a result.
“The distortions created by central bank activity are another potential risk,” Wynne-Jones said.
“The ultimate outcome of policies designed to force people out of cash into increasingly riskier assets is not clear. There comes a point where risk premia across financial markets cannot be compressed any further and the correction when it comes could be all the more painful as a result.”
“Ever higher stock prices seems increasingly the only gauge of success of QE in the US, as if somehow this will lift the rest of the economy.”
“The evidence is that the impact on the real economy is minimal and only benefits the rich. Inequality in society is a real problem ad QE only serves to deepen inequality,” he added.
Wynne-Jones says this means that investors must realise that next year’s returns are likely to a lot different than they have been in 2013.
“The driver of returns of equity investors are the entry point valuation, exit point valuation and growth in underlying earnings and dividends,” he said.
“In 2013, returns were driven predominantly by re-rating activity, i.e. the change in the valuation of the market rather than by actual growth. We believe that valuations are mean-reverting, so the danger for 2014 is that valuations move in the opposite direction.”
“This danger appears the greatest in the US market where margins are particularly elevated and may not be sustainable,” Wynne-Jones added.
Wynne-Jones has managed the Investec Global Special Situations fund with Alastair Mundy since its launch in December 2007.
According to FE Analytics, it has been a top quartile performer in the IMA Global sector over that time with returns of 55.31 per cent and has beaten its benchmark – the MSCI AC World index – by 11 percentage points.
Performance of fund versus sector and index since December 2007
Source: FE Analytics
He and Mundy are currently cautious and therefore hold 16 per cent of their fund in cash. However, Wynne-Jones says that if investors do want equity exposure then they must stick with high-quality companies.
“We continue to focus on finding out-of-favour companies which are undervalued and have strong balance sheets,” he explained.
“We cannot tell in advance which kinds of stocks will appear on our investment screen but there is always some sector or area of the market which falls out of favour. We are not looking for immediate catalysts that will turn the company’s fortunes around but for relatively simple things the company can change on its own that over time will help to turn their fortunes around.”
“Even if the self-help story does not play out, we then hopefully have some downside protection as a result of the quality of the balance sheet we insist on.”
“We stick to this philosophy and methodology and try to assess each company on its own merits,” he added.
Investec Global Special Situations has an ongoing charges figure (OCF) of 1.66 per cent and requires minimum investment of £1,000.