Sectors that usually make up minor allocations in investors’ portfolios have had a strong start to 2015, according to FE Analytics, with funds in the Japan, China and smaller companies peer groups performing especially well.
The first six months of the year have presented investors with a turbulent ride, with notable events including the FTSE 100 passing the psychologically important 7,000 mark as global indices pushed into new record highs. But concerns over Greece and US interest rates have led to setbacks in recent weeks.
Bond markets, meanwhile, hit a rough patch of their own after worries about liquidity, rate rises and better than expected economic growth prompted a strong sell-off. Holders of some supposedly safe government bonds took significant losses in a pushback against their yields turning negative.
Against this backdrop, equity funds performed well over the six months – especially those in regions where central bank policy remains loose.
Performance of sectors over 2015
Source: FE Analytics
Japanese equities have had a strong performance since Shinzo Abe was re-elected as prime minister on 26 December 2012 and ushered in a series of bold reforms designed to bolster the flagging economy, which is the third largest in the world.
These policies – which are commonly known as ‘Abenomics’ – are based around three arrows of more aggressive monetary easing from the Bank of Japan (BoJ), massive fiscal stimulus and structural reform to boost Japan's competitiveness.
Performance of indices over Abe’s tenure
Source: FE Analytics
As part of this the BoJ is currently buying securities and bonds at a rate of ¥80trn a year in an attempt to double Japan's money supply, while the country’s businesses are being encouraged to become more shareholder-friendly through measures such as better corporate governance standards.
In a recent note, analysts at Bank of America Merrill Lynch reaffirmed their ‘buy’ recommendation for Japanese equities and said: “The dream combo for equity investors in recent years has been QE and buybacks; the US now has only buybacks, Europe has just QE, EM [emerging markets] has neither. But Japan has both buybacks and QE.”
The Nikkei 225 is now trading at levels last seen around 15 years ago after being buoyed in 2015 by a weak yen and improving investor sentiment. The country’s stock market is viewed as being one of the few still at attractive valuations, leading to more than £230m of retail money going into the IA Japan sector in the past three months.
Looking ahead, Bank of America Merrill Lynch says positives for the asset class include the expected end of deflation, record-high corporate profits, a weaker yen and government pension money set to be allocated to equities.
Meanwhile, research from Standard Life Investments suggests that the value of the Japanese stock market could rise by 15 to 30 per cent from the impact of improving corporate governance alone, as it makes the country more attractive to foreign investors.
Govinda Finn, senior Japan analyst at Standard Life Investments, said: “Many global investors have moved heavy or overweight in Japanese equity markets since the Abe government gained power. Yet Japan faces a growth conundrum. With a declining population and high levels of economic development, the prospect of future growth led by capital accumulation is low.”
“To ensure that global investment in Japan becomes a longer term phenomenon, rather than a short-term tactical trade, efforts to improve the capital efficiency of Japanese companies, and raise the return on equity for shareholders, have become ever more important.”
Looking at other sectors that have performed well over 2015 so far and those focusing on smaller companies are well represented with the IA European Smaller Companies, IA UK Smaller Companies and IA Japanese Smaller Companies peer groups sitting comfortably in the top 10.
Europe and Japan are viewed as two of the main pockets of value in global stock markets, helping to increase inflows from investors looking for less pricey equities than the US and UK.
Both regions have also witnessed signs of improving economic growth, although in recent days the good news around Europe has been overshadowed by Greek debt crisis and the growing risk that it could have to leave the eurozone.
While IA Japanese Smaller Companies is by far the smaller sector in the Investment Association universe and has the inflows to match, IA European Smaller Companies is becoming increasingly popular with UK retail investors.
The sector captured a net £124m in retail sales in May, making it the fifth most popular of the month. After spending most of 2014 being hit by outflows, the peer group has taken more than £100m in each of the past three months.
Top three performing IA European Smaller Companies funds in 2015
Source: FE Analytics
Following poor performance in 2014 on the back of profit-taking and weaker sentiment, IA UK Smaller Companies has had a much stronger start to this year.
Last week, FE Trustnet looked at the UK small-cap funds that have benefitted from a strong past few months after the cheaper valuations on offer in the space created an attractive entry point.
Neil Shillito, investment director of SG Wealth Management, said investors should not ignore this part of the market, despite its tendency to be more volatile than large and mega-caps.
“As we’ve just experienced, [small-caps] are affected by macro views, so clearly a lot of the underperformance prior to the election was to do with political uncertainty,” he said.
“To ignore the small-cap market from the point of view that it has had its day, we don’t view it that way. Yes, it might underperform for a while but it’s got nothing to do with the fundamentals and everything to do with the sentiment.”
IA China/Greater China is another sector that has soared in the opening six months of the year.
Chinese equities have rallied since the second half of 2014 after authorities moved to liberalise the market through measures such as the Shanghai-Hong Kong Stock Connect programme, which allows private investors and fund managers in mainland China to trade in Hong Kong-listed stocks and vice versa.
Sentiment has also been bolstered by easing from the People’s Bank of China. Over the past six months, the central bank has cut interest rates three times in a bid to stabilise growth in the world’s second biggest economy.
Performance of indices since mid-2014
Source: FE Analytics
However, some commentators warned recently that Chinese equities looked as though they could be entering bubble territory following a sharp rise in margin debt – or money that is borrowed to buy equities. Indeed, as the graph above shows, there has been a strong downturn in recent weeks.
Andrew Herberts, head of private investment management (UK) at Thomas Miller Investment, said: “China’s stock market resemblance to that of Western markets in 1999 is partly the result of the vast growth in Chinese domestic investors, who seem to be fuelling a speculative bubble in Chinese equities,” he said.
“Inexperienced individual investors are investing in companies which they do not understand but are still making money. The situation is being compounded by the rise in amounts of risky retail margin trading, whereby investors borrow money from dealers rather than invest their own capital.”
FE Trustnet will highlight the individual funds and investment trusts that have performed best so far this year in two articles tomorrow.
