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Where NOT to invest in 2015

17 December 2014

FE Trustnet asks the experts which areas of the market they are avoiding like the plague going into next year.

By Alex Paget,

Senior Reporter, FE Trustnet

At this time of year, it is commonplace for fund houses to dish out their investment outlook for the coming 12 months and most of the time they are talking up areas of the market they think will do well.

However, in this article we turn the issue on its head by asking the experts which sectors, asset classes and regions they think are best left alone in 2015.

Unfortunately, in a similar article last year most of our experts’ forecasts were way off. However, it is clear that most market commentators have been caught out by the surprise performance of bonds and the losses from UK equities so far in 2014.

Only time will tell if these predictions will come true, but here are four parts of the market some of our regular contacts think investors should be avoiding at all costs for next year.

 
Government bonds

Though 2014 was proclaimed as the year that the multi-decade rally in fixed income would come to an end, bond yields have fallen across the board over the past 12 months.

Ten-year gilt yields started the year at around 3 per cent and, at the time of writing, currently stand at just 1.77 per cent, while the Barclays Sterling Gilts Index is up close to 14 per cent year to date.

Performance of indices in 2014


   
Source: FE Analytics

Ben Willis, head of research at Whitechurch, was among a number of our regular contacts who was bearish on fixed income going into this year and, like the majority of them, is still very underweight government bonds.

Concerns over weak economic growth, lacklustre inflation figures and geo-political tensions have all contributed to the rally and though Willis understands why investors may still turn to them for protection, he says the risks now far outweigh the potential rewards.

“Clearly, being underweight bonds has not helped us this year but we are sticking to our guns. Yes, it’s a moveable goal post to a certain extent, but the time when interest rates go up is only getting closer,” Willis (pictured) said.

“I can see why a lot of people think they may do OK next year, but we think the downside risk is much greater than any potential upside these markets can give you.”

“I know that the central banks are going to be pretty vocal about the plans for future interest rates, but you can be sure that even when the first rate happens, it’s going to have significant impact on the gilt market.”

In a recent FE Trustnet article, JPM’s Bill Eigen warned that there would be “devastation” in government bonds next year when the US Federal Reserve raises rates as the market is not priced correctly. 
 


Fixed income ETFs

Following on from that theme, Richard Scott – co-manager of the PFS Hawksmoor Distribution and Vanbrugh funds – says investors should not follow the herd into fixed income focused exchange traded funds (ETF), particularly in the high yield and leveraged loan arenas.

ETFs have grown in popularity as they offer instant, and most importantly cheap, access to the market while high yield bonds and leveraged loans have been in favour due to their income and capital appreciation potential compared to other asset classes.

Though high yield bonds and leveraged loans have delivered strong returns over recent years, Scott says the fact that ETFs offer such instant exposure to markets with sparse liquidity could become a major issue if yields do begin to rise next year.

“People have been piling into them, I think next year will be the year investors will regret buying ETFs,” Scott said.

“2014 might not have been the best year for active managers, but I think the liquidity issues with the ETF market will become increasingly apparent in 2015. Default levels have been extremely low but surely the knock-on effects of what has happened in commodity market will start to feed through given the significant representation of energy companies within the high yield and leveraged loan markets.”

“It could therefore mean that 2015 is an opportunity for good active managers in high yield to prove their worth. We would particularly rate the managers at Baillie Gifford, Kames and Royal London.”

Scott’s major problem with high yield ETFs is that he doesn’t think corporate bonds are designed to be priced by the second, like ETFs are as listed-vehicles. If volatility does pick up in the market, he warns that it could have very negative implications for shareholders as ETF providers could struggle to deal with significant outflows.

“It hasn’t really mattered yet as money has been generally pouring in, prices have been rising and the ETF market has been growing. However, if conditions continue to be volatile, I don’t think they will be the panacea that some investors think they are.”
 

US equities

Equities have, in general, had a tough time of it this year but one market which has bucked the trend is the US. The S&P 500 has broken through its historic high water mark on a number of occasions this year and is currently up 15 per cent in sterling terms.

Performance of indices in 2014



Source: FE Analytics

According to FE Analytics, the IMA North America sector has been the best performing equity sector year to date with returns of 13 per cent, beating its nearest competitor – the IMA Asia Pacific ex Japan sector – by 6 percentage points.

A number of experts, such as Neptune’s Robin Geffen, are backing the US to continue to lead the way next year due to the country’s robust economic growth. However, Premier’s Simon Evan-Cook says the starting valuation means he is largely avoiding North American equities in his portfolios.

“US equities have been a perennial underweight for us, but even more so after their rebound after the October sell-off,” Evan-Cook (pictured) said.

“It seems that a lot of investors have felt ‘why should we invest anywhere else? The economy is doing well unlike a lot of other places’. While I get that, the problem is always the price you have to pay. The S&P 500 is trading on a CAPE [cyclically-adjusted price to earnings ratio] of 26/27 times and it has only previously been that high in 1999 and 1929 – and we all know what happened after that.”

“I do understand the economic argument, but the price is simply too high. I’m sure that managers can find good value opportunities at a stock level, but if you are buying an index the US is a particularly bad choice at the moment.”

His thoughts are echoed by FE Alpha Manager Marcus Brookes, who recently warned that US equities are due a very difficult period as huge amounts of investor complacency has crept into the market. 
 


Gold

Ben Willis also says investors should steer well clear of physical gold in 2015.

Having been the star holding for asset allocators in the period before and immediately after the financial crisis, the price of gold has steadily fallen over recent years. There are certainly fewer gold bulls than prior to 2011, but a number of investors keep hold of the precious metal as a hedge against possible inflation and for potential doomsday scenarios.

On top of that, data from FE Analytics shows the gold spot price is up 6 per cent year to date, though it has generally traded downwards since its peak in March.

Performance of gold in 2014



Source: FE Analytics

The gold price currently stands at $1,211 but Willis says investors shouldn’t expect it to roar back next year.

“It’s actually given you a positive return this year, but we just don’t like it. People have traditionally used gold as a dollar-hedge and as a hedge against inflation. However, inflation is not an issue and the dollar is expected to strengthen plus it doesn’t yield anything,” Willis said.

He added: “I’d rather hold cash to be honest.”

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