Developed equity markets have been on an upward trend over the past five years, buoyed by low starting valuations, gradually improving economic conditions and huge and unconventional central bank intervention.
Performance of indices over 5yrs
Source: FE Analytics
However, while a huge proportion of equity managers are confident that the rally will continue, Becket is reducing risk within his clients' portfolios, claiming too many investors are getting carried away.
“We are pretty diversified, that is the starting point,” he said.
“I am really surprised by how optimistic people are given the high returns we have seen in 2012 and 2013. I think one of the major risks this year is excessive optimism in equities. If there is any disappointment, be it economic or other, company share prices will be punished.”
“I wouldn’t be surprised to see a correction of 15 per cent over the coming year,” he added.
Becket is quick to point out that equities are by far his favoured asset class, but says investors need to be realistic.
He points to the fact that the eurozone crisis apart, equity investors have seen fairly uninterrupted gains since the financial crisis, so it would be naïve to think that markets can continue their stellar run at the current pace.
The bears say the rally is unsustainable because it is built on shaky fundamentals – money printing and mediocre economic growth – and the majority of returns have come from re-ratings, not growth in company earnings.
Becket says that the latter point, the divergence between share prices and the companies' underlying earnings growth, is the major reason why investors should expect a market pull-back.
“If you think about the S&P’s 27 per cent return last year, 20 per cent of that [so 75 per cent] was driven by multiple expansion. We are not going to see that again,” he said.
“Do I think we will see the last five years’ returns over the next five years? Absolutely not.”
“My concern is that there are a lot of people who think the equity bull market can continue at its current rate – they are misguided. There is the argument that it can because inflation is tame and interest rates are set to remain low, but that isn’t something we adhere to.”
“Investors will now have to be much more selective as companies will need to be judged on their own merit,” he added.
Becket, like FE Alpha Managers David Coombs and Toby Ricketts, says that markets look expensive. This means investors who want equity exposure should look to active managers who have a proven stockpicking ability and who are willing to take off-benchmark positions.
He says this is important because although equities will likely be the best-performing asset class, investors can no longer rely on all markets to maintain their recent good run.
“They [equities] are the best of a bad bunch but we are going a lot more active this year, if that makes sense. We want managers who can outperform via alpha instead of beta. Whatever asset class you are invested in, you need to be extremely selective.”
For his UK exposure, for instance, he is taking a non-consensual view.
Performance of indices over 1yr
Source: FE Analytics
The FTSE 250 and FTSE Small Cap, which are largely dominated by cyclical and domestic facing companies, have led the recent rally in UK equities while large cap international earners have lagged behind.
Becket says that with volatility expected over the coming 12 months, investors would be wise to look at funds with a decent exposure to the larger end of the FTSE 100.
“We favour mega cap equities, particularly some of the large pharmaceuticals, instead of cyclicals and domestic stocks,” Becket explained.
Artemis Income, which is headed up by the FE Alpha Manager duo of Adrian Frost and Adrian Gosden, is one of Becket’s favoured funds and one he uses in his portfolios.
The £6.2bn fund has 84.6 per cent of AUM in large caps. Healthcare is its largest sector weighting and pharmaceutical giant GlaxoSmithKline is its third-largest individual holding.
According to FE Analytics, the fund is a top-quartile performer in the IMA UK Equity Income sector with returns of 155.95 per cent over 10 years, beating the FTSE All Share by more than 25 percentage points.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
Its performance has tailed off recently compared with the sector and as a result, Artemis Income sits in the third quartile over five years.
However, given the managers’ preference for large cap – often defensive – equities, the fund has shielded its investors' money more adequately during times of volatility than its peers.
This is demonstrated in the fact it was a top-quartile performer in 2008 and made money in 2011 while the average fund in the sector lost close to 3 per cent.
Artemis Income has a yield of 3.8 per cent, an ongoing charges figure (OCF) of 1.54 per cent and requires a minimum investment of £1,000.
Becket is also using Jamie Hooper’s AXA Framlington UK Growth fund.
Hooper’s largest holding is GlaxoSmithKline and he has recently bought shares in AstraZeneca. Like Frost and Gosden, Hooper also predominantly invests in large caps, with three quarters of his fund's assets in the FTSE 100.
Hooper took over the £240m fund from FE Alpha Manager Nigel Thomas in November 2006.
Over that time, AXA Framlington UK Growth has returned 59.72 per cent, compared with 48.94 per cent and 45.93 per cent from the IMA UK All Companies sector and its FTSE All Share benchmark, respectively.
The fund requires a minimum investment of £1,000 and has an OCF of 1.59 per cent.
