Global equity valuations are still looking fairly full despite the January sell-off and the continuation of headwinds in the market, according to Prudential Multi Asset’s David Shairp.
Because of this, he says this year investors and managers need to be more careful than ever when it comes to stock selection and should take both economic development and valuation into account.
As such, Shairp provides his insights on which equity markets he likes and which markets he is cautious on. FE Trustnet also looks at potential funds to either counteract headwinds or to capitalise on the markets he is most positive towards.
The UK
The head of research is particularly cautious on the UK and points out that there has been a sharp decline in the return on equity (ROE) in the region, having plummeted below the global average over recent years.
“ROEs have plummeted from around 20 per cent to just under 6 per cent currently and this was driven by margins and perhaps the widening UK productivity gap,” he explained.
“The fundamentals have deteriorated here and that may reflect the exposure of the UK equity market to some of the more commodity-linked stocks and sectors that have a higher weighting in the UK.”
CF Lindsell Train UK Equity is an example of a UK fund that holds no oil & gas or commodities –sectors it currently has exposure to are food producers, telecom, media & technology, financial services, consumer products and healthcare.
The five crown-rated fund is headed up by FE Alpha Manager Nick Train and is able to invest across the market cap spectrum. It is also a high-conviction portfolio and the manager isn’t afraid to stray away from the benchmark and take bigger bets on stocks he thinks will perform well – for instance, the fund’s largest holding is currently Unilever at 10.5 per cent.
It has performed consistently well over Train’s tenure and is in the top-decile for its total returns over one, three and five years as well as over the last three and six months.
Performance of fund vs sector and benchmark under Train
Source: FE Analytics
CF Lindsell Train UK Equity has a clean ongoing charges figure (OCF) of 0.75 per cent and yields 2.01 per cent.
The US
Shairp is also cautious towards the US as he believes the economic cycle has become “long in the tooth” and says that ROEs have also fallen in the region over the last year, albeit to a lesser extent than in the UK.
“One of the reasons why you’ve not seen a sharper decline in ROE has been the build-up in leverage,” he explained.
“You’ve seen a sizeable rise in net debt-to-equity in the US corporate sector over the last few years. That’s preserved ROEs that would have fallen faster if we hadn’t had that releveraging and that is one fundamental deterioration that makes us a little more cautious on the US.”
For those that still want exposure to the region through a fund with a strong risk-adjusted return record, Peter Bourbeau and FE Alpha Manager Scott Glasser’s Legg Mason ClearBridge US Large Cap Growth could be a good option.
The four crown-rated fund holds a concentrated portfolio of 50 stocks and the managers look for companies that are dominant in their respective industries, can offer a long-term performance history and have a global scope.
Over one, three and five years, it has also achieved a top-decile risk-adjusted return, annualised volatility and maximum drawdown, which measures the most money an investor could have lost if they’d bought and sold at the worst times.
It has outperformed its average peer in the IA North America sector by 37.59 percentage points with a total return of 171.52 per cent over the managers’ tenure, although it has underperformed its Russell 1000 Growth benchmark by 12.05 per cent over the same time frame.
Performance of fund vs sector and benchmark under Bourbeau and Glasser
Source: FE Analytics
Legg Mason ClearBridge US Large Cap Growth has an ongoing charge of 1.73 per cent.
Europe
Shairp is far more positive on Europe as he believes the region is demonstrating attractive economic growth momentum overall, despite exhibiting softer headline growth.
“In terms of valuations, European equities are not super cheap but if you look at just the forward P/E ratio, you can see it’s pretty much in line with the long-term average,” he said. “The dividend yield on the market is also slightly above the longer term average.”
A fund that could appeal to investors with an eye on dividends is the four crown-rated Invesco Perpetual European Equity Income fund, which has been managed by Stephanie Butcher since 2011.
The £503m fund is currently one of the highest yielders in the IA Europe ex UK sector with a historic yield of 3.22 per cent. Since launch at the start of 2008, it has paid out just under £2,500 in income on an initial investment of £10,000.
It has also provided investors with an attractive level of growth over the longer term, having delivered a top-quartile total return of 43.57 per cent over five years and thereby outperforming its peer group composite by more than 10 percentage points.
Performance of fund vs sector over 5yrs
Source: FE Analytics
Invesco Perpetual European Equity Income has a clean OCF of 0.94 per cent and currently yields 3.23 per cent.
Japan
Japan is another area of the equity market that Shairp particularly likes because he says it has cleansed its balance sheet and offers good underlying fundamentals.
He says that Japanese companies have reduced their debt levels over a longer period of time and this has actually obscured the region’s ROE, which is currently 1 percentage point lower than the global average at 9 per cent.
“The one caveat is clearly the yen. A negative correlation between the Topix index and the dollar yen means that as the yen goes down the Topix goes up, and since the period of very unorthodox monetary policy we had in Japan, that correlation in Japan has become quite high,” he said.
“Our sense is that the Bank of Japan will continue to ease policy and we think that will keep the yen relatively soft. So for those reasons, we like Japanese equities.”
A potential pick could be JPM Japan, which has the second-highest alpha generation in the IA Japan sector over five years (the top fund is Legg Mason IF Japan Equity, but it is in the bottom-decile for all of its risk-related ratios so may only be suitable for high-risk investors).
JPM Japan is managed by Nicholas Weindling, Shoichi Mizusawa and Miyako Urabe and has four FE crowns. The managers are able to invest across the cap spectrum and aren’t afraid to stray away from the benchmark – for instance, it currently has a 19.6 per cent weighting to services, which is a 16.4 per cent overweight compared to the Topix index.
Since Weindling and Mizusawa took over the helm of the fund in 2012 (Urabe became co-manager last year), it has provided a total return of 84.79 per cent compared to its sector average’s return of 50.37 per cent and its benchmark’s return of 49.81 per cent.
Performance of fund vs sector and benchmark under Weindling and Mizusawa
Source: FE Analytics
JPM Japan has a clean OCF of 0.93 per cent.
Emerging markets
Shairp is fairly cautious on emerging markets and says that, despite increasingly attractive valuations, it is still too early to move to an overweight position in the market area because economic momentum remains weak.
“We think there are four factors when it comes to re-entering emerging markets – we think the valuations have to become not just cheap but compelling. We think the currencies have to offer compelling value, we also need to look for evidence of capitulation so that economists give up on emerging markets, and then we need some sense of cleansing of balance sheets from their high levels of debt,” he said.
“It’s attractive, it’s becoming more attractive, but it’s not yet compelling on a multi-year view.”
If investors are nonetheless looking to add exposure to the region it could be prudent to look at an emerging market fund that compensates investors through dividend payments.
A good example is FE Alpha Manager Edward Lam’s PFS Somerset Emerging Markets Dividend Growth fund, which has five crowns and seeks both growth and income through a very actively-managed portfolio.
It consists of 49 holdings spread across regions including South Korea, Turkey, the Philippines and South Africa, as well as across the UK and Europe. It currently holds a 13.09 per cent cash weighting.
In terms of performance it is in the top decile over three and five years, achieving a particularly strong performance over the latter when it made a positive total return of 24.97 per cent compared to its sector average’s loss of 8.54 per cent.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
PFS Somerset Emerging Markets Dividend Growth has a clean OCF of 1.31 per cent and yields 2.2 per cent.