In this environment, John Ventre – head of multi asset at Old Mutual Global Investors – says investors need to be active within their portfolios to make sure they are prepared for the year ahead.
With that in mind, in his investment outlook for 2015 Ventre (pictured) tells FE Trustnet which parts of the investable market he would recommend buying, holding and exiting from the point of their starting valuations and market background.
Emerging market debt funds – BUY
Ventre says emerging market debt, as an asset class, looks attractive on a valuation basis.
Funds within the IMA Global Emerging Markets Bond sector have had a tough couple of years as the prospect of tighter monetary policy in the US, which in turn has led to significant outflows, has hurt the asset class.
Our data shows the average fund in the sector is down 9 per cent over the last two years and only two portfolios out of the 25 within the sector – M&G Emerging Markets Bond and Standard Life Emerging Market Debt – have delivered a positive return over that time.
Performance of sector over 2yrs
Source: FE Analytics
However, Ventre says the worst could well be over for the asset class and suggests investors can pick up some attractive yields.
“In particular, we favour Brazilian fixed income government bonds. Brazil has an inflationary past – the period 1980 to 1994 saw three to four-digit annual inflation rates that coincided with a period of economic crisis and political turmoil,” Ventre said.
“Today, the rate stands at just 6.4 per cent. What puzzles us is that the local currency five-year government bonds trade at over a 12 per cent yield, almost 6 per cent above the current inflation rate. Investors are being more than compensated for the degree of risk they’re taking.”
China funds – BUY
Ventre has become increasingly bullish on Chinese equities over the last year or so as poor investor sentiment has driven down valuations.
Though concerns about the country’s slowing economic growth, banking system and real estate markets persist, Chinese equities have been on the up over the last few months. While those gains are less than the MSCI AC World index, the MSCI China index is up against the wider MSCI Emerging Markets index year to date.
Performance of indices in 2014
Source: FE Analytics
However, Ventre says the market is still very cheap and can continue to rise significantly from here.
“Historically, Chinese equities have traded on a price/earnings multiple of as high as 30 times. That compares to 7.5 times earnings currently against over 17 times earnings for US equities,” Ventre said.
“There are certainly pitfalls, for example government confiscation of assets, but those risks have always been present. Today, with reform top of the Chinese fourth plenum’s agenda, visibility is arguably higher.”
“It would appear that investing in Chinese equities is a risk that investors are over compensated for.”
Ventre has used a tracker for his China recently as it gives him access to very lowly-valued banks, but some of the top-rated active funds in the IMA China/Greater China sector include Invesco Perpetual
Hong Kong & China, Threadneedle China Opportunities and Jupiter China.
High yield bond funds – HOLD
Though more and more experts have warned about the outlook for high yield bonds, given declining market liquidity and as their historically low yields have given them a much higher sensitivity to interest rate movements, Ventre says investors can afford to hold onto their exposure.
He says that as spreads are now at or below their long-term averages, returns aren’t likely to be as high as they have been over recent years but the income available is still attractive.
Performance of sector over 5yrs
Source: FE Analytics
“There won’t be the bumper crop of the last few years of double-digit returns – that much is obvious. But investors should still be able to harvest a yield of 5 per cent,” Ventre said.
“The economic cycle shows little sign of ending, default rates have been low and corporate balance sheets have been strong. Importantly, while there has been quite a lot of issuance, proceeds have been used to refinance existing debt or are sitting in cash. This lack of capex isn’t great for the economy but it’s pretty good for bondholders.”
“The asset looks a little expensive, but it is that way for a reason. The risk has reduced in the asset class, at least in the short to medium term, making it attractive to hold on to in a world where returns don’t grow on trees.”
Defensive equity funds – SELL
While Ventre says developed market equity markets do face risks, he warns that investors may be in danger of over-paying for safety.
He says defensive equities, such as utilities, healthcare and consumer staples, are likely to be affected by rising bond yields. He therefore recommends switching to funds which offer exposure to more economically sensitive stocks as they are cheaper and are likely to benefit from higher interest rates.
“It’s difficult to argue that those companies that produce solid, dependable earnings, irrespective of what stage of the economic cycle they are in will be able to increase their profits much further,” he said.
“The current rate at which these types of companies discount back their future earnings – typically the 10-year long bond rate – is unlikely to fall any further given that the next move in interest rates, however small, is likely to be upwards. “
“Better, therefore, to be in those companies whose earnings are tied to the economic cycle and where the scope for improving profitability is greater. At the same time, it may also be that the global leaders – large cap quality blue chips – have had their run and it’s time to invest elsewhere.”
Funds from the IMA UK All Companies sector which have a cyclical bias include FE Alpha Manager Alex Wright’s Fidelity Special Situations fund, the Schroder Recovery fund and CF Miton UK Value Opportunities.
India – SELL
Indian equities have had a barnstorming year so far in 2014, as Narendra Modi’s election victory in the spring and his reformist agenda has meant the MSCI India is up more than 25 per cent year to date.
Performance of indices in 2014
Source: FE Analytics
However, while the likes of Brewin Dolphin’s Ben Gutteridge and Neptune’s Robin Geffen are expecting more of the same next year, Ventre is not convinced.
“In terms of stock market return, India’s S&P BSE Sensex has been one of the best performing equity markets in 2014 – up over 35 per cent in local currency terms at the time of writing, buoyed by the belief that prime minister Modi will make good some of his election pledges in terms of political and economic reform.”
“In the short term, the market has also been buoyed by the lower oil price.”
“However, India has no oil of her own and now that Modi has done away with the diesel subsidy for consumers, the Indian economy and market could be vulnerable to a bounce-back in the oil price, which, in our view, looks oversold.”
Ventre therefore thinks that investors aren’t really being compensated for the risk they are taking in India given the market’s current valuation.
“On a price/book ratio of nearly three times – compared with 2.7 times for the US market and under 1.4 times for the MSCI AC Asia ex Japan Index – we believe the stock market is not cheap, even when considering India’s growth potential.”
