Maintaining a regionally diversified portfolio is one of the most efficient ways for investors to protect themselves in today’s challenging market conditions, according to Henderson’s Paul O’Connor.
The head of multi-asset, who took over from Bill McQuaker after his departure from the firm earlier this year, adopts a top-down focus when it comes to choosing investments and, given the high number of macro and geopolitical headwinds on the horizon, has ensured his equity portfolio is spread across a broad number of regions.
“If I looked at our equity portfolios, they’re probably more regionally diversified than they’ve been since I’ve come onto the desk and in terms of style, they’re more diversified and have less of a factor tilt than they have since I’ve been on the desk given that monetary policy has become a little more fatigued globally,” he said.
As such, the manager gives his top-down thoughts on five main investing regions and gives examples of the funds he is using to play them in the below article:
The UK
The manager is underweight UK domestic stocks and believes that the area currently plays host to value traps.
However, he did buy into the FTSE 100 index shortly after the shock EU referendum result was announced.
“Obviously weaker sterling is a part of the FTSE 100’s strong performance, but we like the structure of the index as well,” he said.
“If you compare the FTSE 100 to other global indices it’s broadly speaking overweight in quite defensive sectors and it’s overweight in global resources. It’s also relatively light on global financials.”
O’Connor adds that many global investors are currently underweight UK stocks, which acts as further encouragement to hold equities in the region.
Not only does he hold futures in the index, he also holds a small number of UK value funds despite the fact that his portfolios generally have a tilt towards quality.
One of these is the four crown-rated Majedie UK Income fund, which has been headed up by FE Alpha Manager Chris Reid since 2011 and aims to provide attractive levels of income while also outperforming the FTSE All Share index over the long term.
The manager likes companies that are unloved by the market and are undergoing positive transformations – his largest weightings currently include Legal & General, Aviva and Pearson.
Since Reid launched the fund, it has returned 90.66 per cent, outperforming its sector average and benchmark by 27.29 and 35.51 percentage points respectively.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
While the fund boasts a top-quartile risk-adjusted return (as measured by its Sharpe ratio) over this time frame, it is also in the bottom quartile for its annualised volatility and maximum drawdown (which measures the most potential money lost if bought and sold at the worst possible times).
The fund yields 4.78 per cent and has a clean ongoing charges figure (OCF) of 0.77 per cent. While it is soft-closed, it is still available on some retail platforms.
Emerging markets
Aside from adopting a significant underweight in UK domestic stocks, the other major repositioning that O’Connor has done is to feed back into emerging market equities.
“We look at EM equity and think that this is an environment in which emerging markets can do quite well in this combination of decent, albeit moderate, growth but very abundant liquidity, and lower bond yields is great for EM,” he explained.
“What we have begun to see over the last quarter or so is the hunt for yield has actually started to move progressively into EM and that has helped to stabilise the broader area – at the same time we’ve seen some macro stabilisation in the market area as well.”
An example of a fund that O’Connor is using to gain exposure to the market area is Schroder Asian Income, which has four FE crowns and has been headed up by Richard Sennitt since 2001.
The £923m fund aims to provide both growth and income through companies that offer attractive yields and are able to grow their dividends. Currently, more than 74 per cent of the fund is invested in companies in the Pacific Basin, 20.29 per cent is in Australasia and 1.61 per cent is in the UK.
Among these, the fund’s largest holdings include Taiwan Semiconductor Manufacturing, China Mobile, HSBC and Bank of China (Hong Kong).
The fund has outperformed its benchmark and sector over one, three, five and 10 years, having returned 203.2 per cent over the last decade compared to its benchmark’s return of 150.53 per cent and its sector average’s return of 153.15 per cent.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
In terms of its risk metrics, the fund is in the top quartile for its annualised volatility and maximum drawdown over one, three, five and 10 years.
Schroder Asian Income has a clean OCF of 0.93 per cent and yields 3.75 per cent.
Japan
O’Connor says that Japan has become a very tricky market given a general loss in confidence in Abenomics, the three-arrow approach to revamping the country’s economy that was initiated by prime minister Shinzo Abe when he came into power in December 2012.
The manager says that sentiment has been hit due to a loss of macro momentum in the Japanese economy – over the last few quarters, growth forecasts have been trending lower and inflation is far lower than the Bank of Japan’s official target.
“Markets are now in a position where they’ve lost confidence in their ability to predict what the Bank of Japan will do and they’re looking very keenly on the next meeting on the 29th of this month to see if they come up with something there,” he said.
“A bull story for Japan would be that we’re going to see some decisive intervention from the Bank of Japan and that will be the bridge to the fiscal easing. That could be a positive and something that resuscitates the economy and brings back macro momentum to Japan.”
While the manager is not prepared to take a significant bet on this, he has nevertheless reduced his underweight to the region. One of the Japanese funds he holds is the four crown-rated CF Morant Wright Nippon Yield fund, which is managed using a whole team approach and has been awarded four FE crowns.
The £297m fund has an absolute return mandate and will invest in Japanese companies the team deems to be undervalued and that have strong balance sheets, attractive yields and a sound franchise.
It has a portfolio of 65 holdings, the largest of which include Fuji Media Holdings, Honda Motor and Sumitomo Mitsui Trust.
Since its launch in 2008, the fund has comfortably doubled the performance of its sector average and benchmark with a total return of 239.26 per cent. While it does have a higher-than-average annualised volatility over this time frame, it boasts a far higher Sharpe ratio and a lower maximum drawdown than both its sector average and benchmark.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
CF Morant Wright Nippon Yield has a clean OCF of 1.2 per cent and yields 2.19 per cent.
Europe
O’Connor says that Europe is a similar market to Japan in that it was one of the darlings of the equity space last year but has since fallen in popularity as many investors have lost faith in its central bank’s ability to continue implementing loose monetary policy.
“With Japan and Europe, you’ve seen policymakers introducing negative rates, which they thought was a good idea for the economy and you’ve seen investors focusing on the fact that these negative rates have really intensified the hunt for yield. That’s pushed bond yields lower and bond yields going lower has raised some real questions about the sustainability of some of the business models in the financial sector,” he said.
“We’ve seen a loss in macro momentum, we’ve seen some doubts begin to emerge about the efficacy and the potency of monetary policy and we’ve seen a wash-out in both markets.”
“However, we look at the European economy and we think it’s in decent shape, we feel that the concerns in the banking sector are pretty well factored into markets.”
One fund that O’Connor is playing the market through is Stephanie Butcher’s Invesco Perpetual European Equity Income fund, which is £526m in size and has four FE crowns.
The fund aims to hold stocks that are attractively valued and have the potential to pay and grow their dividends as well as deliver capital appreciation – its largest holdings include Novartis, Roche and Royal Dutch Shell.
Over Butcher’s five-year tenure, the fund (which isn’t benchmarked against an index) has outperformed its sector average by 17.78 percentage points with a total return of 63.8 per cent. However, it is in the third quartile for its maximum drawdown and annualised volatility over the same time frame.
Performance of fund vs sector under Butcher
Source:FE Analytics
Invesco Perpetual European Equity Income has a clean OCF of 0.94 per cent and yields 3.31 per cent.
