Investors should add protection to their portfolios as further uncertainty looms in 2017, according to AJ Bell’s head of fund selection Ryan Hughes.
Hughes says investors should take action regardless of whether the value or growth style outperforms this year, with support for both investment styles in the year ahead.
Last year, value stocks outperformed growth stocks for only the third year of the past decade, returning 34.28 per cent in 2016.
However, over the long-term the quality growth sector has been the area investors would have made a better return, as the below graph shows.
Performance of indices over 10yrs
Source: FE Analytics
Hughes says current market conditions are supportive of value investing, although many outliers could force investors back into quality growth stocks.
“I’m going to caveat with the fact that I think that depending on whichever style wins out this year really depends on the direction and the health of the global economy,” said Hughes.
“If we continue where we are today [where] everything kind of looks okay and people understand there are some risks out their politically but companies are still delivering some okay profits growth, then I think the value trade continues because the jaws between value and growth opened so wide that there’s a lot of slack to still get taken up.
“On the flip side of that I think it would be very easy to see if there’s any kind of setback in the market – be that Brexit negotiations get a little bit ugly, Trump does something a little bit more stupid than we can even imagine or there is some other surprising global event – [then] we’ve got a risk-off environment.
“I would fully expect to see quality come roaring back as people hunker down and take a little bit more risk off the table.
“So I don’t know which way that trade is going to win out this year because I think there are a few variables out there.”
He explained: “The trouble is if we continue on the path we are on then quality can continue to do okay but you need to have a little bit of protection in your portfolio.
“Markets are running high, a lot of people are saying that valuations are stretched, we haven’t got a huge amount of growth in the system.
“We’ve got an uptick in inflation, and we’ve got central banks doing different policies and changing the mix of support or withdrawing that support so there are enough speedbumps out there that could derail markets, in which case I would expect quality to have a decent period.
“I think we are okay for now but you need to have some insurance there to make sure you’ve got some protection if things do get ugly.”
One big theme for the year is the return of inflation and the problems investors face when it eats into returns and erodes the real value of assets.
Source: Bank of England
Currently, inflation expectations are around 2 per cent in the UK though this could rise as high as 5 per cent in the years ahead, according to the latest data from the Bank of England.
If inflation does take hold, Hughes says quality stocks should rise to the top, says Hughes. He noted: “In the long-term, the best response to inflation is to target companies which have pricing power.
“If a firm can charge what it wants to charge it should generate high margins, consistent earnings and robust cash flow, which it can then turn into the reliable and growing dividends which provide such a large percentage of long-term total shareholder returns, especially once they are reinvested.”
Hughes suggests the £9.2bn Fundsmith Equity as the choice for those investors concerned that inflation could rise globally.
“Fundsmith Equity puts corporate quality at the heart of its strategy,” he said. “Managed by Terry Smith, the fund has a concentrated portfolio with strict investment criteria which should help investors beat inflation. It has delivered over 150 per cent return over five years, twice the level from the Global sector.”
2016 was the first year since the fund’s launch in 2010 that Fundsmith Equity underperformed the MSCI World index in a calendar year.
Performance of fund vs benchmark since launch
Source: FE Analytics
As the above graph shows, since its launch the fund has still returned superior returns to the benchmark, beating the MSCI World index by 90.15 percentage points.
The five crown-rated fund, run by FE Alpha Manager Smith, has a strong quality growth focus and currently holds 29 stocks.
Among its top 10 holdings are technology giant Microsoft and tobacco titan Philip Morris International and it has a 64 per cent weighting to the US with 34.5 per cent in the high quality consumer staples sector.
The fund has a clean ongoing charges figure of 1.08 per cent and currently yields 0.71 per cent.
Previously, FE Trustnet looked at the funds investors may wish to hold alongside Fundsmith, including Schroder Recovery, Sanlam FOUR Stable Global Equity, Rathbone Global Opportunities and First State Global Listed Infrastructure.