“I’m happy to report so far in 2016 we’ve seen some embryonic signs of businesses start to turn around,” Stuart Rhodes, manager of the M&G Global Dividend fund, told investors last week. 
The fund has been under pressure since the second half of 2014, having previously outperformed in five consecutive years from 2009.
“We’ve been running this fund since July 2008 and we’ve got a reasonable track record now in terms of length and it did get off to an incredibly good start,” Rhodes (pictured) said.
“The first six years were very good, performance was exceptional in the very different market environments but since the second half of 2014 and 2015 we’ve had much more difficulty.”
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
As the above graph shows, since launch the fund has beaten its sector and benchmark by 25.3 and 53.91 percentage points respectively, however this outperformance was more pronounced before the second half of 2014, when the fund began to slip back.
Indeed, in 2014 and 2015 the fund was in the bottom quartile among its peers, returning 3.11 and - 6.83 per cent respectively against the sector averages 7.09 and 2.77 per cent.
This has led to outflows from the fund. According to FE data, it has been the most sold IA Global fund over the past 12 months with £1.5bn having been redeemed over that time. Taking into share price performance of the fund’s underlying companies, M&G Global Dividend’s AUM has shrunk by 36 per cent in November 2014.
Having stood at £9.5bn in size at that time, the fund now weighs in at £6bn.
Rhodes says his recent lacklustre returns have been due to the high level of cyclical stocks within the portfolio, which have performed particularly poorly over the last few years.
“We continued to buy more at the second half of 2015 and early 2016 because we think the opportunities we were getting was once in a generation,” he said.
“If you think about assets as an investment style they’re very much exposed to that valuation – value is a big driver of performance.”
As the below graph shows, value has underperformed growth by 34.30 percentage points over the last eight years.
Performance of indices over 8yrs
Source: FE Analytics
A number of factors have contributed to this including weak investor sentiment following the financial crisis, a generally low-growth world and (possibly most influentially) central bank policies globally.
Low interest rates, large quantitative easing programs and low inflation has meant savers and traditional fixed income investors have been pushed into higher-risk investments, with defensive large-cap dividend companies the main beneficiaries of this trend.
“During that entire period going back to 2008 growth has outperformed value on a global basis so value as an investment strategy has been an awful place to be for a decade and that gap between growth and value in terms of the valuation difference now is at extraordinary levels,” Rhodes said.
“So I would ask you to think if that will continue over the next 10 years and the fact that we’re getting so stretched makes it quite unlikely.”
He adds that while growth, and particularly ‘quality’, have outperformed over the period, valuations have now widened to levels which are unsustainable, making these types of stocks difficult to own for the long term investor.
“It is getting a bit harder [to hold], the valuations of these names have definitely shifted up,” he said.
Five years ago, he says, the fund had around a 25 per cent weighting to consumer staples, one of the bellwether sectors for growth, but that is down to just 10 per cent today, with most of that in the large tobacco companies.
“So one of the big pillars of quality is getting harder to justify and that’s consumer staples,” he said.
The other, which he says is now beginning to pique his interest, is healthcare, where “the gap between healthcare and consumer staples is starting to widen out again”.
As the below graph shows, healthcare has outperformed consumer staples over the last five years by 41.91 percentage points.
Performance of indices over 5yrs
Source: FE Analytics
Despite this, valuations suggest the large pharmaceutical companies are on earnings multiples in the mid to high teens, compared to the consumer staples, which are typically on P/E ratios in the low to mid-twenties.
This has been predominantly due to the US election, where both Donald Trump and Hilary Clinton are viewed as negative for the healthcare market.
“Thanks to these two fine individuals, this year has not been a good year for healthcare and they have been underperforming pretty significantly,” Rhodes said.
In some cases, he says, healthcare companies have been undervalued by 10 per cent or above compared to other more traditional defensive sectors.
“And actually healthcare grows quicker than all of these other sectors so actually despite exhibiting better operational performance and better dividend growth share prices have come under – in some cases – a lot of pressure this year and we’re starting to see a valuation point that is starting to become acceptable,” he said.
“So the one area within quality that I think is going to be interesting in 2016 as we move towards the election is we might get some interesting entry points in the sector.”
This position (reducing expensive defensives in search of cheaper, more cyclical stocks), has begun to bear fruit this year, with the fund in the top quartile among its peers, returning 25.63 per cent.
However, Rhodes warns that “I don’t want to leave you with the message that it’s all over as I said I think we’re in the very early stages of that recovery.”
What he says is important is the track record the M&G Global Dividend fund has in terms of income distributions, as Rhodes has been able to grow the dividend in each year since inception.
M&G Global Dividend’s income track record since launch
Source: FE Analytics *based on an initial investment of £10,000
“We’re very pleased with how the fund has performed on the dividend side,” Rhodes said.
“We started at 3.56p we’re now paying well over 5p next year will be a much bigger figure than this year. We’re very pleased that track record is intact and the growth is coming through and our long term returns are still a long way ahead of the market.”
The £5.98bn fund currently yields 2.93 per cent and has an ongoing charges figure of 0.91 per cent.