Many markets have rallied this year but investors can still find good value opportunities even when everything seems to be getting more expensive, according to experts.
Looking at historic cyclically-adjusted price-to-earnings (CAPE) ratios, the US stands at the highest it has been since the tech bubble of 2000, with a CAPE of 39.1x as at the end of September.
In the UK, the FTSE 100 has broken records this year and the CAPE of the wider market has risen above 17 for the first time in three years. There is a similar phenomenon elsewhere, with Europe trading at the upper end of its five-year range and some emerging market countries (such as India) also trading at large ratios.
Away from stocks, gold rose above $4,000 per ounce last month as investors piled in, while cryptocurrencies have also enjoyed a strong year.
With everything looking expensive, below fund selectors pair up strategies that are still undervalued, including bonds and quality growth equities, Japan and Europe, and the US and UK.
Nedgroup: Japan and Europe
Louis Hutchings, multi-asset portfolio manager at Nedgroup Investments, favoured a combination of Waverton European Capital Growth and Lazard Japanese Strategic Equity.
These two strategies pair well because they offer very distinct tailwinds and markets, meaning they have relatively little exposure to similar assets or risks, he said.
For example, the Waverton Portfolio is benefiting from the currently strong macro situation in Europe, Hutchings explained. Valuations remain “reasonable” even after recent strong performance and there are “no major signs of economic stress” with many companies having strong corporate balance sheets.
Waverton’s Chris Garsten and Charles Glasse are accomplished active managers who use supply and demand dynamics to identify underappreciated companies with changes in earnings growth earlier than many of their peers, he added.
By contrast, the Lazard Japanese Strategic fund is benefiting from the wave of corporate reforms in Japan, such as more independent boards. This has led to increased corporate activity and capital discipline, resulting in renewed interest in the market, according to Hutchings.
Managers Matthew Bills and June-Yon Kim are based in Tokyo and are “familiar with the language and culture”, allowing them to directly meet companies and giving them an insight into the opportunities other investors may lack.
Hutchings also noted that the managers maintain a boutique mindset, aiming to remain very flexible to take advantage of fast-moving opportunities in their markets, which he expects will pay off over the long term.
Mirabaud: US and UK
Meanwhile, Jonathan Unwin, head of portfolio management at Mirabaud Wealth Management, combined US value (through the Dodge and Cox US Stock fund) and the UK (Invesco UK Equity income fund).
The Dodge and Cox US strategy stood out due to the “true sector diversification” it offers compared to the wider market. The strategy is underweight information technology by more than 25 percentage points compared to the S&P 500 and holds an overweight in sectors such as healthcare, financials and industrials.
Pairing it with Invesco UK Equity Income would help investors further diversify their portfolio away from tech, allowing an investor to do well “whatever way the tech/momentum trade wind blows in the short term”.
The UK market looks particularly compelling because it remains “relatively cheap” even after the good run it’s had so far this year. As a result, investors can still access defensive high-yielding companies at very low costs, which can prove “attractive as rates fall”, he explained.
“When multiple markets and assets are rising as one momentum trade, it is a matter of striking a balance between being invested but avoiding the most extremely valued areas,” Unwin concluded.
Chelsea Financial Services: Bonds and Global Equities
Lastly, Darius McDermott, managing director at Chelsea Financial Services, suggested pairing the Artemis Short-Duration Strategic Bond fund with a quality-growth fund such as Evenlode Global Equity.
Artemis Short-Duration Strategic Bond targets a three-year rolling return above the Markit iBoxx 1-5 year £ Collateralised & Corporates index, with an average duration of four years.
To help manage risk, the fund’s ‘core’ allocation is in investment-grade bonds but it will hold some assets in lower-rated bonds if they are downgraded after the initial purchase.
Short-duration bonds look compelling compared to longer counterparts because they are less exposed to interest rate risk and their yield can serve as a “cushion” if inflation proves sticky, McDermott explained.
Meanwhile, Chris Elliott and James Knoedler’s Evenlode fund stands out for its “disciplined, quality-driven approach”.
The fund targets companies that can deliver sustainable growth over time while needing minimal capital investment, using internal data software to help screen for those businesses.
It has a very different composition than the wider MSCI World, with just 3.1% in information technology compared to 27.4% in the index, which brings diversification to portfolios.
While these quality-growth businesses have underperformed due to the dominance of tech, the strong balance sheets and dependable earnings could cause them to “make a comeback” in the event of a sustained wobble in global equity markets, McDermott explained.
This combination of funds means portfolios can still benefit from rallies while also holding up in more challenging periods. “The aim is always to balance growth and defence. The bond fund brings stability and income; the equity fund adds long-term capital growth.”
Source: FE Analytics