Concentrated funds focusing on quality growth will outperform for the foreseeable future as markets are due for a pause, according to Tilney managing director Jason Hollands. 
Therefore, funds that focus on companies with strong brand loyalty, asset-light businesses and those that can produce high returns on capital are more likely to succeed moving forward, he said.
Last year saw the return to fashion of value stocks, but the style has struggled again this year, underperforming global growth stocks by 7.72 percentage points.
Performance of indices YTD
Source: FE Analytics
“There is quite a debate going on in the asset management world of people asking is now a good time to buy value because you’ll get some sort of late cycle revaluation,” Hollands (pictured) said.
“There was some brief evidence last year of a bounce in what would be classically called value stocks but that has subsided and actually more recently it has been the quality growth companies that have kept going through the economic cycle that have outperformed again.”
He said this is symptomatic of markets, which are uncertain at the moment with bond markets starting to expect a change in monetary policy leading to an end to the easy returns of the last decade.
“The environment in recent years of very loose money has lifted all boats with the tide so it has definitely benefited bonds but also shares generally,” he said.
“If we’re edging towards a different type of policy environment then arguably you need to be a lot more selective on the companies you are holding and really focus on enduring quality businesses.
“Our view is that in the second half of this year we don’t expect the sort of returns that you had in the first half because there are some pause factors in the global economy going on one of which is the effects of China’s credit stimulus fading.
“There are mixed signals in the global economy – for example UK facing a tough patch as inflation bites into consumer spending power – and we think we’re going to go through a period where perhaps there is a pause in the returns you’ve seen from markets,” Hollands added.
“So you want to be funds invested in companies that are very resilient and can create their own growth and are not just plays on economic sensitivity.”
In this article, FE Trustnet looks at the three funds the managing director recommends for investors looking to maximise returns during this difficult period.
The first is Evenlode Income, run by FE Alpha Manager Hugh Yarrow and Ben Peters, which he said focuses on companies that are asset-light and therefore have less outgoings on the balance sheet.
“[Yarrow] essentially looks for companies that he describes as cash compounders. These business that generate a very visible stream of cashflow and he also likes businesses that are capital light,” Hollands said.
“In other words he doesn’t like investing in businesses in areas that involve a lot of plants and machinery because capital intensive businesses like that have a wear and tear drag on the capital of maintaining and servicing lots of physical assets.
“Sage Group for example which is the number three holding is a leading international provider of accounting and payroll software.
“That would be a good example of a capital light business – you don’t need lots of factories to produce software but you do need lots of bright people.”
However, the fund benefits from a global approach despite being a UK equity income fund, with 13.2 per cent invested in US businesses and 2.7 per cent in European companies.
“Although the portfolio is a UK equity portfolio it does make use of the limited freedom it has to invest partially outside of the UK,” Hollands said.
The five crown-rated fund also focuses on businesses that generate most of their returns from overseas, giving the fund a more international feel.
“Even though Evenlode Income is a UK equity fund actually if you look at where the underlying revenues in the portfolio generally they are very international in flavour,” the managing director said.
The £1.4bn fund, which is in the IA UK All Companies sector but benchmarked against the IA UK Equity Income sector, has outperformed both since launch, as the below shows.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
The other key area for the fund is that it is invested in brands, with Marmite and Dove owner Unilever and drinks giant Diageo its two largest holdings.
“That is one thing I would say about this fund – a major theme is consumer brands with about 28 per cent in the consumer goods sector,” Hollands added.
This is a trait the fund shares with the five crown-rated Lindsell Train Global Equity fund, Holland’s second fund for investors looking to outperform potentially stagnant markets.
“Quality businesses tend to have intrinsic characteristics that are very difficult for competitors to replicate. They command brand loyalty.
“If you are a Guinness drinker for example it doesn’t matter whether the economy is up or down over the next six months, you’re probably still going to have your pint of Guinness on a Friday night.
“Unilever will be another one. It owns both Marmite and Bovril. If you want that on your toast in the morning and you like it you probably are going to keep spreading it irrespective of Brexit or anything else.
“These businesses tend to be quite resilient and have the ability to create their own growth irrespective of the overall economic climate.”
Unilever is also Lindsell Train Global Equity’s largest holding while Diageo is in its top three holdings, while other companies with strong brands include Heineken and Nintendo.
“This sort of stuff is very cash generative and strong underlying brands are a feature of that portfolio. You’ve got a very high ratio to consumer staples and also technology is a big theme in this portfolio,” Hollands said.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Since its launch, the fund, has been the fifth best performer in the IA Global sector, returning 183.41 per cent, as the above shows.
The £2.7bn fund has been run by Michael Lindsell since launch with James Bullock and FE Alpha Manager Nick Train joining in 2015.
The third fund he suggested is the £11.4bn, five crown-rated Fundsmith Equity run by FE Alpha Manager Terry Smith.
While he does own companies with strong brands such as Intercontinental Hotels or Dr Pepper Snapple, the main area he focuses on is those businesses with a high return on capital, regardless of the valuation.
“He’s very blunt guy and his view is that people who try and second guess the macroeconomic outlook and invest on the back of that usually get it wrong,” Hollands explained.
“It’s easy to get caught up on price-to-earnings valuations but what you really want to look at is what there track record is on delivering a high return on capital and have they got healthy free cashflow generation to keep doing that.
“He believes it is better to pay a fair price for a good company rather than a good price for a fair company.”
The fund has been the best performer in the IA Global sector since launch, returning 238.69 per cent as the below shows.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Overall, Hollands said there are a lot of similarities between the three funds as they are all benchmark unconstrained and focus on these high-quality growth companies with some level of brand appeal.
As well as this, they are all employ a buy-and-hold strategy, meaning they are not trying to second guess the overall market climate, but focus on the individual stocks.
However, Hollands – who owns all three funds – said they are not identical funds in any sense as there would be no point in buying three funds that do the exact same sort of thing.
The easiest way to differentiate the three funds – other than the different focuses on brands, return on capital and focus on asset-light businesses mentioned above – is through geography.
“There is clearly some overlap and some features in common but Evenlode is much more weighted to UK listed companies albeit they are generally companies with very overseas earnings, Fundsmith has a much higher weighting to the US and Lindsell Train sits somewhere in between and has for example almost 24 portfolio in Japanese companies,” Hollands said.
“Terry Smith’s fund is much more a US, UK and European fund,” he added, while noting that Lindsell Train Global Equity “have managed to find some attractive companies in Japan”.