One of the major frustrations investors can face is holding on to a fund for too long, watching their once high returns erode away without solidifying any gains.
With that in mind, and with the outlook for a lot of asset classes, regions and sectors looking decidedly more mixed than 18 months ago, we ask the experts which previously top performing areas they think investors should start trimming their positions in.
High yield bonds
Richard Scott, manager of the PFS Hawskmoor Distribution and Vanbrugh funds, says that investors should be severely reducing their exposure to high yield bonds. He warns with yields at such low levels after a period of significant outperformance, the chances of increased volatility are very high.
“One area where we see asymmetric risk very much to the downside is in traditional high yield fixed interest,” Scott (pictured) said. “I think that given the humongous amount of money that has flown into the asset class, it is very important to highlight the risks around it.” “I don’t want to seem too alarmist, as I think inflation will remain subdued and interest rates aren’t going to be going up quickly, but when you have areas such as European high yield below 4 per cent, you’ve got to question how much upside is really left.”
According to FE Analytics, the average fund in the IMA Sterling High Bond sector has returned 76.84 per cent over the last five years. As the graph below shows, those returns are similar to global equities, but with significantly less volatility.
Performance of sector vs index over 5yrs
Source: FE Analytics
There are funds within the sector that have delivered significantly higher returns than that however, with the likes of Invesco Perpetual High Yield and Baillie Gifford High Yield Bond both making more than 100 per cent over that time.
The high yield sector itself is the obvious starting place, but our data shows that there are several funds in the IMA Sterling Strategic Bond sector that have benefited from the high yield tailwind.
Royal London Sterling Extra High Yield Bond, Jupiter Strategic Bond and Artemis Strategic Bond have all delivered top decile returns over recent years and there is little doubt that their chunky weighting to lower-rated areas of the fixed income market have contributed significantly.
Like Hermes’ Fraser Lundie, Scott is also concerned about the deteriorating quality of covenants in the high yield market, which is skewing risk-reward far more in favour of the issuer and not the bond-holder.
All things combined, Scott says investors should sell their high yield bonds sooner, rather than later.
He added: “In terms of more anecdotal evidence on why we think we are right to be concerned about high yield is the news that the Fed is considering putting exit fees on bond funds. There is a growing realisation that there could be an awful lot of “flighty” money in the asset class.”
UK smaller companies
“Another area we have been scaling back our exposure to is smaller companies,” Scott said.
“They did so well, so fast, that we now think, as they are at the moment, vulnerable to a pull back. They were trading at around a 30 per cent discount to wider market a few years ago, but are pretty much on parity to a premium.”
“They have sold off recently, but I think there is a little bit further to go.”
UK Smaller Companies have been one of the prime beneficiaries of the recent positive environment as investors have felt more comfortable a higher degree of risk.
Our data shows that the likes of R&M UK Equity Smaller Companies, Unicorn UK Smaller Companies and CF Miton UK Smaller Companies all returned more than 50 per cent in 2013. As the graph below shows, the returns from the wider UK market were far more subdued.
Performance of funds vs sector and index in 2013
Source: FE Analytics
The sector has lost money this year and has underperformed against large-caps in the process, but Scott is still concerned about valuations in the small-cap space.
There are signs of this as data from the AIC shows that 10 out of the 12 trusts in the IT Smaller Companies sector are trading below their three year average discount. They include Aberforth Smaller Companies, Throgmorton and Henderson UK Smaller Companies.
Simon Evan-Cook, manager of the five-crown rated Premier Multi Asset Distribution fund, agrees that investors should be taking profits from the sector.
While he doesn’t think the asset class is about to crash, he thinks returns will be hard to come by over the coming year due to current valuations and growing uncertainty across the wider market.
“Some of these funds have come off 10 per cent since March, but a lot of the stocks they hold still look quite expensive,” he said. “We had already taken profits from our UK smaller companies funds and we won’t be looking to add back to our exposure for some time to come,” Evan-Cook said.
European equities
Evan-Cook (pictured) has also been trimming his exposure to funds within the IMA Europe ex UK sector.
“We still think Europe looks relatively cheap compared with the US and I’m not suggesting there is any imminent danger on the horizon, but we have scaled back our exposure because we think the risk-reward ratio has come back in,” he said. According to FE Analytics, the average fund the European sector has returned more than 50 per cent since ECB chairman Mario Draghi alerted the market he would do “whatever it takes” to save the eurozone back in the summer of 2012.
Investors have felt comfortable taking risk and funds such as Schroder European Alpha Income, Invesco Perpetual European Opportunities and Neptune European Opportunities have all rallied hard recently on the back of overweight position in the indebted peripheral economies and highly cyclical sectors.
Performance of funds vs sector over 1yr
Source: FE Analytics
As a recent FE Trustnet article highlighted, the ECB announced that it would implement negative interest rates and provide cheap loans to banks to stimulate lending growth; both with a view to create economic growth and fight the increasing threat of deflation.
The majority of experts have taken this a real positive for the region, as the added stimulus should prop up the equity market. Sceptics, on the other hand, say the measures aren’t enough to stimulate growth and therefore investors would be wrong to use them as a reason to build up exposure.
Evan-Cook is far more neutral, but says investors should err on the side of caution.
“It all comes down to valuation really,” he explained.
“European equities looked like an absolute bargain a few years ago and we were telling people that they should fill their boots. We don’t know what is going to happen with the economy and we can see valid points in both the bull and bear arguments.”
“Because of that, we fall back to valuations and European equities simply aren’t as cheap as they were a few years ago or this time last year.”
