More economically sensitive areas of the market have driven the recent equity market as investors have largely been rewarded for taking a higher degree of risk.
However Anness says that the recovery phase has all but ended as he doesn’t expect developed world equity markets to re-rate any further from here. Because of that, he is focusing on high quality companies that can keep growing their earnings as they are the ones which are being rewarded by the market. “Broadly speaking, company earnings results have been quite mixed with the market seemingly being much more punishing of those that miss expectations than it was in 2013,” Anness explained.
“This, we believe, is consistent with the sharp re-rating equities have seen in the past few years. The emphasis is now on stocks to deliver the earnings growth expected of them.”
“At this stage in the market cycle, we want to invest where we believe earnings growth is persistent. We believe that future performance will be generated from earnings delivery rather than continued belief in the ‘recovery story.’”
“As such we are happy to ‘pay up’ a moderate amount for genuine growth that can be compounded over the long term.”
A number of fund managers – such as FE Alpha Manager Jeremy Podger – have warned that without earnings equities will be unable to continue their stellar run.
According to FE Analytics, the FTSE All Share and the S&P 500 have both delivered a return in excess of 100 per cent over five years while the wider MSCI World index has returned 90 per cent. Those returns have also been almost interrupted, with the only falling market being 2011.
Performance of indices over 5yrs
Source: FE Analytics
Anness says that the major driver of those gains have been the more-cyclical sectors, as investors have felt more comfortable moving out of classic defensive areas of the market into higher risk, often out of favour sectors and stocks, and have been rewarded as a result.
“Over the last few years since the global financial crisis, we have seen a strong recovery in lower quality and more economically sensitive stocks as investors have become more enthused over the global economic recovery,” he said.
“Alongside this we have seen a relative de-rating in some of the higher quality stocks which have the robust compounding characteristics that we like, but which have suffered as they have lacked the gearing into economic recovery that the market has desired.”
Our data shows, for instance, that the S&P 500 Automobiles, S&P 500 Financials and S&P 500 Industrials indices have all outperformed the wider US equity markets over cumulative 12 and 24 month periods. However, those returns have waned during recent months.
Performance of indices in 2014
Source: FE Analytics
Anness attributes that underperformance to their punchy valuations. He says the valuation premium between higher and lower quality stocks is nearing its most compressed level in more than 10 years.
The manager says this is another reason why investors should be turning to defensives.
“Over time we would expect higher quality companies [with characteristics such as high returns on capital, strong cash flow and good organic growth] to sustain a valuation premium to those companies with poorer characteristics,” Anness said.
“However, the premium the market is willing to pay can vary significantly over time. Since 2012 this “quality premium” has fallen from 10 percentage points to 7 percentage points.”
“Looking back over the last 14 years the lowest spread was circa 6 percentage points, immediately prior to the global financial crises.”
“Increasingly our trading screens are highlighting more companies in this high-quality arena and our fundamental analysis is beginning to drive the portfolio in this direction,” he added.
Anness took over his five crown rated Invesco Perpetual Global Opportunities in December 2012, having previously managed the group’s highly rated UK Aggressive fund.
According to FE Analytics, his £154m Global Opps fund has been the sixth best performing portfolio in the IMA Global sector since he took over with returns of 40.18 per cent, nearly doubling the returns of the sector average in the process. It has, however, fallen further than the sector so far this year.
Performance of fund versus sector since Dec 2012
Source: FE Analytics
His bullish outlook for defensive companies which can deliver high returns on capital, strong cash flow and good organic growth is represented in the make-up of his portfolio.
For instance, he holds close to 30 per cent in consumer products companies and counts notable defensive names such as SAP, Roche and Novartis as top 10 holdings.
The Invesco Perpetual Global Opportunities fund’s clean share class has an ongoing charges figure (OCF) of 1.2 per cent.
In an article yesterday, FE Alpha Manager Iain Stewart also told FE Trustnet that investors should be focusing on defensive, rather than cyclical, stocks at this point in the cycle.