Investors should be wary of buying into market corrections in the latter half of 2015, according to City Financial investment director Peter Toogood, who expects markets to be more unpredictable than they were in the first six months.
As you can see from the below graph below, the first six months of the year saw numerous dips for UK and global equities but these were followed by periods of recovery. Investors putting cash to work during these brief down times would have been rewarded when markets went back up.
Performance of indices during 2015’s first half
Source: FE Analytics
Toogood agrees that buying the dips was a sensible strategy for equity investors in 2015’s first half but remains unconvinced that this should be repeated over the rest of the year and even recommends trimming some equity exposure at times of market strength.
“While buying the dips in equities was a compelling strategy in the first half of the year, we are less convinced about the prospects for the second half of the year. Our sense is that we will see periods of equity strength during the third quarter and we would use any further rallies to sell holdings that are not long term in nature,” he explained.
In the years after the financial crisis, the quantitative easing programmes of the likes of the Federal Reserve and the Bank of England were responsible for pushing up equity markets after lower bond yields caused more investors to buy risk assets.
The investment director concedes that central banks will continue to drive asset prices in 2015, with the likes of the European Central Bank and the Bank of Japan committed to pouring vast sums of money into the markets over the rest of the year.
However, this does not mean that investors can ignore the threat created by the first rate hike from the Fed, which is expected to take place in September this year.
“Inevitably, the next six months will still be dominated by the extraordinary supply of liquidity provided by central banks, who collectively now own in excess of $22trn of financial assets. The marginal price-setter for asset pricing remains central bankers,” Toogood said.
“[But] the impact of a change in interest rates cannot be underestimated – the Federal Reserve last raised rates in 2006. While some profess to be relaxed about a likely change in the US monetary regime, the truth is that no-one really knows what the market response will be.”
“Unfortunately this sense of nervousness comes at a time when asset prices are, at best, described as richly priced. Indeed, fund managers remain anxious about an absence of value. The crowding into ‘bond proxy’ style equities only reinforces that sense of nervousness, as the low-yielding environment has prompted a host of different types of investors into stable, dividend-paying stocks, some of whom are unnatural holders of higher risk assets.”
In light of this “challenging backdrop”, Toogood continues to favour diversified risk strategy funds and highlights Standard Life Investments Global Absolute Return Strategies, Invesco Perpetual Global Targeted Returns and Aviva Investors Multi-Strategy Target Return.
All three funds sit in the IA Targeted Absolute Return sector and build their portfolios around a diversified selection of strategies or ideas designed to create returns uncorrelated to the movements of equities, bonds and other mainstream assets.
Standard Life Investments Global Absolute Return Strategies, also known as GARS, is the dominant fund of the three – indeed, with assets of £25.4bn, it’s the largest fund in the whole Investment Association universe.
The fund has achieved great success in its goal of making a cash plus 5 per cent return over rolling three-year periods, with less volatility than equities. Since launch in May 2008, it has outperformed the FTSE All Share with a 54.52 per cent gain but has experienced about one-third of the volatility.
Performance of fund vs indices since launch
Source: FE Analytics
The FE Research team said: “This portfolio offers investors a method of benefitting from the complexities of hedge fund-style absolute return strategies.”
“However, it is more conventional at heart than a hedge fund and seeks to derive much of its returns through dynamic asset allocation, much like a large pension fund might do. Despite the fund’s rapid growth in size, the management team has successfully maintained the same standards of returns.”
Standard Life Investment GARS has a clean ongoing charges figure (OCF) of 0.89 per cent.
The other two funds have been set up by former members of the GARS team. Invesco Perpetual Global Targeted Returns was launched by Dave Jubb, David Millar and Richard Batty in September while Aviva Investors Multi-Strategy Target Return was unveiled in July 2014 following Euan Munro becoming the chief executive of Aviva Investors.
Both have got off to a strong start and have performed broadly in line with GARS since their respective launches. They have also proven popular with investors; the Invesco Perpetual fund now has assets under management of £2bn while the Aviva offering has taken £730m.
Performance of funds over 2015
Source: FE Analytics
Over the year to date, GARS is winning with a 3.14 per cent total return; Aviva Investors Multi-Strategy Target Return has made 3.06 per cent while Invesco Perpetual Global Targeted Returns is up just 0.36 per cent.
FE Trustnet recently put the Invesco Perpetual fund’s performance under the spotlight, following its difficult start to the year. Analysts still rate the fund highly and pointed out that it tends to have more of a correlation to bonds, which had sold off over the first half.
Ben Willis, head of research at Whitechurch, told us: “I wouldn’t be panicking too much at the moment, as you’d expect these things, but I would if it drifts into a sustained period. After six months or more of poor performance you have to start questioning the managers and where they’re positioned.”
“You always have to be aware of what you’re invested in and what it’s trying to do. The bottom line is this types of funds do have periods where they are going to lose you money – there’s not going to be an absolute return every day of the year.”
Invesco Perpetual Global Targeted Returns has a 0.87 per cent clean OCF while Aviva Investors Multi-Strategy Target Return’s is 0.85 per cent.
Of course, not all commentators are expecting the second half of the year to present few opportunities for investors.
Luca Paolini, chief strategist at Pictet Asset Management, said the group is sticking with its overweight to equities as it believes “they still have further to run”.
Although Greece’s debt crisis and the expected US interest rate hike do create market uncertainty, stocks could be buoyed by economic recovery in the developed world, central bank stimulus in Europe and Japan, strong M&A activity and an improving earnings outlook.
“We recognise that the possibility of a stock market correction remains. Nevertheless, fundamentals suggest the broader stock market rally should continue over the medium term and we have not changed our overall outlook or weightings on account of events in Greece,” Paolini said.
“In our regional portfolio, we keep our preference for European and Japanese equities based on strong liquidity support and attractive valuations. In these regions, stocks also benefit from strong central bank liquidity and cheap currencies.”
“In our sector allocation, we maintain a cyclical tilt in our portfolio, with a preference for stocks that stand to benefit most from an increase in capital spending, such as industrials. Technology companies are also attractively valued and should withstand higher interest rates better than other sectors thanks to their sizeable cash reserves. Defensive sectors such as healthcare look expensive to us.”
In a coming article, FE Trustnet will look at the funds that have built up their cash reserves but are preparing to put this money to work in the event of a market correction.
