The broader market looks set to continue struggling in 2019, which is why Rathbones’ David Coombs has been paying more attention to a select number of long-term themes. 
For the year ahead, Coombs (pictured) – who runs funds such as Rathbone Strategic Growth Portfolio and Rathbone Total Return Portfolio – has a preference for equities over bonds (with a focus on growth companies) and has been building up ‘safe haven’ assets, including S&P 500 put options, gold, cash and diversifiers.
“Something has been creeping into our minds over the past few years: in everything from technology, politics and risk, to the dynamics of interest rates, the models of yesterday appear to be breaking down. And that dynamic has accelerated in 2018,” he said.
“We think it’s time to throw out some outmoded ways of thinking and ensure that flexibility and open-mindedness protects you from the left-field. While our aims are the same, the structure of our portfolios today are very different to how they were three years ago.”
Performance of fund vs sector and index since launch
Source: FE Analytics
The multi-asset manager added that as central banks around the world tighten monetary policy, he expects stock markets will continue to struggle. That said, rising rates, positive economic growth and a lack of deflation should be a good environment for well-run businesses with few debts – which is where his concentrated portfolios are focused.
A number of these companies also fall under seven investment themes that Coombs thinks could come to the fore in 2019. Below, we take a closer look at them.
Life hacking
Coombs pointed out that whereas people used to worry about being burgled, the modern world has seen them become as or more concerned about their digital security and the risks created by hacking.
“Most people are fixated on the geopolitical ramifications of hackers in a digitised world. However, we are more interested in how increased cyber-risks will affect consumers and the businesses that serve them. This is the great macro risk of the coming decade, in our opinion,” he said.
“We ponder how to analyse this risk and how to invest in it. Things like cyber insurance have been talked about quite a bit, but that’s an ambulance at the bottom of the cliff rather than a fence at the top. There are other, weightier changes that will have to come soon.”
Data breaches are becoming more common and consumers are starting to demand that businesses update their systems to protect them against this. Coombs has been investing in companies that offer this service, shown through holdings such as Amazon, Adobe and Google-parent Alphabet.
5G: third time lucky?
According to Coombs, few sectors are as “hated” as telecommunications at the moment, as mobile carriers have been dismal investments despite the fact that mobile phones are ubiquitous.
“Perhaps the problem was that everyone got carried away with the unbridled potential for bundled internet and phone services, with a side of streamed television. Unfortunately, technological advances and the scramble for market share sent prices for data spiralling lower,” he said.
“As the global price of data slumped, these companies made punchy investments in whizzy new technology. Unfortunately, for monopoly-sized telcos, upgrading your whole network doesn’t come cheap – especially when the pace of progress makes your investments obsolete in less than a decade.”
Performance of indices over 5yrs
Source: FE Analytics
One positive development that the manager has seen in the space is how cheap telcos can pick up 5G spectrum. UK telcos paid £22.5bn for 3G spectrum in the early 2000s but bid one-tenth of that in 2013 at the auction of 4G spectrum; this year’s 5G auction in the UK saw the spectrum go for just £1.4bn.
5G technology is seen as “a truly revolutionary step” as it will allow a rapid expansion of the internet of things and could render home broadband irrelevant. “If the telcos can pick this new spectrum up relatively cheaply, it could prove to be much easier for them to make money in the future,” Coombs added.
China does capitalism better than capitalists
In his third theme, the multi-asset manager argued that China has reached “an interesting crossroads”, in that it is no longer an underdeveloped country scrambling towards affluence.
While parts of the country remain very poor, the country as a whole is a major global power – but appears to keep trying to avoid internationally-recognised intellectual property rules and trade laws that most nations hold as sacrosanct.
Moving away from this approach would see China increase its standing in international markets, Coombs said. “China doesn’t need to rely on corporate skulduggery or questionable practices to succeed. In fact, these old habits are now probably hindering the nation.
“We’ve been to see Baidu and the whole thing could be American. There’s a real entrepreneurial spirit in China that can be seen from youngsters working furiously to better themselves to massive businesses like Tencent and Alibaba that have risen like shooting stars above the modernised Chinese economy.”
The middle is toast
Coombs said that one theme has become increasingly clear over the recent past: if a business isn’t the cheapest or the best, then it will fail.
“This really hit home on a trip to the US in May 2018. Numerous companies were investing heavily in their bid to stay one step ahead of Amazon. Or if not Amazon, then the disruption it overwhelmingly represents,” he said.
“Amazon has been merciless in its advance on many industries, finding ways to cut costs and improve customer satisfaction. It’s not just Amazon though; Alphabet has decimated traditional media; companies like Netflix and Hulu offer much cheaper TV than cable providers, and ride-hailing/sharing apps are hurting taxis and rental firms. Many incumbent businesses took way too long to adapt to the new world and were punished for it.”
The Rathbone Multi-Asset Portfolio range invests in several companies that either “do the punishing” or appear resilient to it. Examples include chemicals company Ecolab, which sells cleaning agent for substantially more than rivals but its efficiency helps customers save money overall compared with lesser brands, and US Bancorp, which has invested in its branches to serve more of its customers directly.
More political meddling
In the UK, the public appears to become increasingly comfortable with interventionism, shown through the popularity of price caps on utility bills and railway fares. Even nationalisation of key services is back on the political agenda.
“Part of the reason for this is that many people feel they’ve had a raw deal over the past decade. Pay has gone virtually nowhere, yet monopoly services rise inexorably in price each year. Some of these increases are warranted, some aren’t; some of the public anger is warranted, some not,” Coombs said.
“The UK rail network – and most of the franchises that run trains along it – is badly run, expensive and terrible at customer service. But state-run rail wasn’t much better.
“As for utilities, energy costs have increased dramatically and that’s been exacerbated by a large devaluation of sterling, too. In the main, these companies make reasonable profits, but regulators ensure their margins are pretty thin. They have to pass on higher costs because otherwise they’ll go out of business.”
The manager expects political meddling to become more extreme, with sectors in the firing line likely to be those that makes its pricing opaque (car insurance) or has a whiff of hurting the vulnerable (power companies and gambling companies). But he added that while intervention might be popular, history has shown that it tends to cause problems further down the road.
“All over the world there’s increasing support for protectionism, which is virtually the same thing as interventionism. While we think nations will be better off coming to terms over trade rather than continuing tit-for-tat tariff battles, it could be some time before they agree,” he continued.
“To protect ourselves against this market ruckus, as well as any tariff-induced consumer price rises, we are holding a good slug of commodities, from gold and pork bellies to steel, grains and coffee.”
Shaping up for a backlash
In his sixth theme, Coombs considers the advances that have been witnessed in many parts of life but wonders if consumers will start to turn away from some of them
He pointed out that over the past couple of decades, people have generally got larger and lived longer than their parents. In more recent years, super-fast internet allowed more people to work from and have goods delivered directly to them, cabs can be easily caught anywhere and modern medicine can stave off the effects of bad lifestyle choices for years.
“Something has changed, however,” said Coombs. “In many advanced nations life expectancies have started falling again. This has led to some interesting backlashes. Suddenly no-one is celebrating how advances in food technology, such as genetic modification and preservatives, have made food cheaper and cut down on waste. People have rebelled by craving local, organic and less uniformly shaped fruit and vegetables.
“At the same time, people are striving for a very uniform shape for themselves: slim and toned. The number of gym-goers has skyrocketed, especially among the cash-strapped younger generations. In the hunt for health, we think companies like Abbott Laboratories should prosper. Not only does it own a leading diabetes monitoring test (unfortunately, demand is soaring worldwide), but it also produces scores of nutritional supplements, from baby formula to vitamins.”
Likewise, Coombs and his team has been pondering if social media is also due a similar backlash. While social media became increasingly popular with younger generations, its darker side has emerged through vitriolic political arguments, fake news and “creepy social experiments playing with people’s moods”; platforms such as Facebook are now the domain of middle-aged parents rather than their children.
“What if Generation Z goes analogue? It’s certainly on our mental radar,” the manager said.
A 90s argument
The seventh and final theme that the manager thinks is worth watching is a challenge to commonly-held view that people in emerging markets are desperate to buy western consumer brands.
“We feel this is a very dated argument. And an arrogant one, imagining people in developing countries aspire only to our most humdrum consumer products. We think most people in emerging markets think about shopping the same way we think about shopping. They care about value, and similar to the west, they see little reason to buy a branded detergent at three times the price of a local product that does the same job,” Coombs said.
“Twenty years ago, it would be fair to say local consumer products were ropey, inconsistent and scandal-ridden. Now, in many cases, these factories are on a level playing field with those that churn out the western brands. In some industries, they may even be the same factories.”
He believes that as emerging market middle classes continue to expand, so will be importance of local tastes. Everything from the scent preference of cleaning products and the taste of toothpaste to how a firm’s marketing attracts customers can be completely different depending on the nation. This means western consumer companies can no longer run their operations from London or New York with a global culture strategy; instead they need to draw on the expertise of local managers who know what their particular market wants.
One area where western companies might have an advantage is in luxury branks. The developing world is creating vast numbers of millionaires and they want goods that signal of their status and cannot be sourced locally, such as French wine, Swiss watches and Italian cars; Coombs funds own premium perfumery and make-up company Estee Lauder and LVMH, a holding company for a range of ultra-high-end luxuries that spans many industries.
“We believe consumer brands are too slow to realise that they aren’t luxuries and too far removed from emerging markets to avoid getting outflanked by more adaptable local rivals,” he concluded. “But as middle classes and the number of millionaires swell in developing markets, we think the demand for true luxuries should rise noticeably. As long as they can keep control of their brand, that is.”