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Surges, stock risks and supertankers: Our best stories of the week

31 July 2015

This week, the FE Trustnet team has been looking at the need to avoid giant funds, the investment vehicles scared investors should be looking at and which underperforming funds you should still hold onto.

It seems that the Greek crisis has been put on the back-burner for now as investors across the globe focus their attention on the continuing downward spiral of China’s stock market.

The Shanghai Composite index recorded its biggest one-day fall in more than eight years on Monday when it closed on an 8.2 per cent loss.

Elsewhere, investors are nervously awaiting interest rate rises from the Federal Reserve and the Bank of England, amid rumours that the Fed rate hike could occur sooner than expected.

This is just the start of what’s been going on in the world of investment news this week - FE Trustnet has been delving into debates, fund picks, research and more, as you can see from the compilation of our favourite articles below.

From everyone at the FE Trustnet headquarters, have a great weekend.

 

“Supertankers”: The reasons why you need to avoid giant funds

Fund size is an issue that we at FE Trustnet have a great interest in and will be looking at even more closely in the near future, but news editor Alex Paget explained why Association for Professional Fund Investors UK research lead Jon ‘JB’ Beckett thinks the growing number of “supertanker” funds is becoming a very real problem.

Beckett started off by explaining the obvious problem with large and growing funds – the quality of its assets under management start to deteriorate the bigger a portfolio gets. He highlighted two main problems with this.

“As a fund becomes more successful and the ever increasing sales push to sell that fund to new markets increases, you get a deterioration in terms of the investor base. Your initial tranche of investors are very well suited to the fund strategy, your second, third are perhaps less so,” Beckett said.

“The second, which should be immediately obvious, is from the fund manager’s point of view, as sometimes being thrown ever increasing amounts of cash is not always a good thing. What happens is fund managers have to try and contend with that new cash through increasing the tail of their portfolio at the risk of diluting their alpha.”

Have another read of the article to find out the other problems that Beckett believes are being created by ever-larger funds.

 

The funds DFMs are using to diversify UK equity income away from ‘bond proxies’

Senior reporter Daniel Lanyon spoke to two top discretionary fund managers – Charles Stanley’s Rob Morgan (pictured) and Saunderson House’s Ben Williams – who revealed which funds they recommend for investors looking to diversify away from the so-called ‘bond proxies’ that are extremely popular among equity income managers.

Bond proxies are equities such as consumer staples, utilities and other firms perceived as having safe, reliable returns but have become closely correlated to yields in the bond market.

Rob Morgan said: “I think this sort of diversification would be possible while staying in the UK equity income sector.”

“It [the fund recommended by Morgan] may interest investors looking for income from the UK stock market, but who would prefer well-rounded exposure that includes economically-sensitive areas as well as the usual defensives.”

Click through to discover which funds the experts highlighted.


The stocks you need to watch out for in your UK income funds

Using data from FE Analytics, reporter Lauren Mason compiled a list of the most popular dividend-paying blue-chips, or ‘bond proxies’, that are lurking in numerous UK income funds, and which investment vehicles hold the largest weightings.

GlaxoSmithKline proved to be the most popular stock in the IA UK Equity Income sector, despite dropping in popularity over the last year. The funds that hold the biggest weightings in the stock at the moment include the five FE Crown-rated Evenlode Income fund and HSBC Income.

Coming in at a close second was Royal Dutch Shell, of which Scottish Widows Multi-Manager UK Equity Income holds a hefty 26.2 per cent weighting.

The increase in bond proxy popularity comes a couple of months after Colin Morton, who manages the Franklin UK Equity Income fund, warned that the stocks could be set to cut their dividends in the near future.

“What is scary about those four companies – BP, Shell, GlaxoSmithKline and Vodafone – is when you put them together, they make up around 25 to 30 per cent of all the dividends the UK market pays,” he told FE Trustnet in March.

 

Absolute return inflows surge: Which funds should scared investors look at?

Figures from the Investment Association this week showed that absolute return was the most popular period group with private investors in June after capturing net retail inflows of £445m over the month.

We took a look at the sector’s members and identified which funds have posted the lowest maximum drawdowns and annualised volatility since the start of the financial crisis around eight years ago, as well as the products most highly rated by analysts.

Insight Absolute Insight has the lowest volatility at just 3.08 per cent; over the same time frame the FTSE All Share’s maximum drawdown was 41.09 per cent while Barclays Sterling Gilts’ was 5.98 per cent. However, as the graph below shows, the trade-off for this smooth journey was lower returns than some of its peers have achieved.

The FE Research team said: “The risk/return profile of the fund may look boring, but this is exactly what its managers are aiming for: to provide small but regular positive returns, minimise volatility and preserve investors’ capital.”


Darius McDermott’s underperforming funds you should hold onto

Following last week’s advice from Sarasin & Partners’ Lucy Walker to steer clear of top-quartile funds, Chelsea Financial Service’s Darius McDermott told FE Trustnet his favourite funds that have recently underperformed.

“We don’t subscribe to the theory of only buying into fourth-quartile funds but, on our rated panel, there are always going to be one or two of them undergoing difficult periods – I think it’s more a matter of why they have done badly and whether or not you share the manager’s view,” he said.

One fund that McDermott particularly likes is Legal and General UK Alpha which has returned just 0.55 per cent over the last year, significantly underperforming both its FTSE All Share benchmark and its sector average.

However, the fund has achieved stellar returns over the long term and has doubled its average peer’s performance since launch.

“A big chunk of this fund is in small companies. Penny either buys smaller companies with a lot of growth potential or he buys contrarian value – he has two buckets that he invests in,” McDermott explained.

“Historically, his performance generally is volatile. But, over the long term has he produced substantial returns.”

 

Kevin Murphy: The only reason you need not to invest in China

Over on Trustnet Direct, FE Alpha Manager Kevin Murphy explained that although the reasons not to invest in China at this moment in time are almost too numerous to mention, there is one statistic that stands head and shoulders above all others.

“Bloomberg analysis recently showed the average technology stock in China stood on a price/earnings ratio that was 41 per cent higher than, and a median valuation that was twice as expensive as, its US counterpart in 2000,” said Murphy, who manages the Schroder Income and Schroder Recovery funds.

“With the benefit of hindsight, people now see 2000 was a market bubble – indeed some insightful souls saw it at the time – so clearly China is horribly expensive.”

The manager added that to his continual surprise, not everyone invests on a value basis – and for these people, he offered a number of other reasons why China is “jaw-droppingly overvalued”.

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