Equities are a better option than corporate or government bonds to generate real returns against the current market backdrop, according to Brooks Macdonald chief investment officer Edward Park.
There is a huge amount of cash on the side-lines in US money market funds and when that money is looking for a home, Park said the options are “fairly stark”.
“Should investors move back into risk assets, equities offer an earnings yield premium. In the case of the US market, the equity earnings yield currently stands at over 4 per cent,” he said.
“This is more than double the yield available on investment grade corporate debt at just under 2 per cent and is more than four times greater than the close to 1 per cent yield on offer from 10-year government bonds.”
The yield on equities is “not particularly exciting” compared to history and is similar to levels seen in the 2000s, Park noted. But the alternative in the 2000s was to buy US 10-year treasuries on a yield of around 6.5 per cent.
The chief investment officer contrasted this to today, where the 10-year US Treasury now trades at around 1 per cent.
Earnings versus yield gap
Source: Brooks Macdonald
Brooks Macdonald had a large gilt position coming out of the pandemic, however due to the five-, six- and seven-year duration gilts showing a negative yield to maturity, it has sold out and moved to investment grade instead.
“Do you want to buy Treasuries on 1 per cent or do you want to buy US investment grade bonds at 1.8 per cent?” Park asked. “Both are below 10-year expected inflation.
“If you want to get a real return, equity markets are one of the few available areas.”
This is one of the main reasons Brooks Macdonald’s portfolios are overweight equities and will maintain this position going into 2021.
“In 2020 we had more of a growth bias,” Park revealed. “But we did do a few changes, one of which was to add sustainability as a major theme. Sustainability is an area where we're particularly positive. There will be flows into the area as more money goes into the space.”
Indeed, last year proved that sustainable investments not only held up well during the market turmoil of the year, but delivered strong performance despite the pandemic.
This was largely due to many sustainable funds having little or no exposure to sectors such as oil, travel, hospitality and leisure, which suffered dramatically due to the coronavirus crisis.
Last year saw sustainable investment themes being propelled into the mainstream as more investors took interest.
Given this, Park highlighted three of his preferred active funds in the international equity space for sustainability.
His first pick is the £490m Ninety One Global Environment fund, which is managed by Deidre Cooper and Graeme Baker.
The fund aims to invest in companies enabling decarbonation which in the managers’ view “will enjoy a multi-year tailwind from global efforts to reduce emissions”.
Ninety One Global Environment takes a high conviction approach with a concentrated portfolio of 25 stocks. Some of its largest positions include Danish wind turbine manufacturer Vestas Wind Systems, American-listed Waste Management, and North American clean energy firm Nextera Energy, which all together make up almost 20 per cent of the portfolio.
Performance of fund
Source: FE Analytics
Since launch in December 2019, it has delivered a total return of 57.96 per cent, compared to 20.48 per cent from the IA Global sector and 18.22 per cent from its MSCI ACWI benchmark.
Ninety One Global Environment has an OCF of 1.15 per cent.
The second fund Park highlighted is the £790m FP WHEB Sustainability fund.
Managed by Ted Franks and Ty Lee, the fund is focused around nine sustainable investment themes; five environmental themes (cleaner energy, environmental services, resource efficiency, sustainable transport and water management) and four social themes (education, health, safety and wellbeing).
It takes a quality-growth approach and holds 48 stocks, with large positions in firms that include European nursing home Orpea, Japanese automation sensor and measurement manufacturer Keyence, and British listed testing and certification services provider Intertek.
Performance of fund
Source: FE Analytics
Since launch in 2009, it has delivered a total return of 195.39 per cent, compared to 263.66 per cent from the IA Global sector and 323.41 per cent from the MSCI World benchmark. FP WHEB Sustainability has an ongoing charges figure (OCF) of 1.05 per cent.
The third Park highlighted is the £1.2bn Impax Environmental Markets investment trust.
Managed by Bruce Jenkyn-Jones and Jon Forster, the trust aims to benefit from growth in the markets for cleaner or more efficient delivery of basic services of energy, water and waste.
The portfolio is invested small- and mid-cap companies that have more than half of their underlying revenue generated by sales of environmental products or services in the energy efficiency, renewable energy, water, waste and sustainable food and agriculture markets.
The trust has 63 holdings, including one unlisted company.
Performance of fund
Source: FE Analytics
Since launch in 2002, it has delivered a total return of 404.67 per cent, compared to 145.06 per cent from the IT Environmental sector and 346.47 per cent from the MSCI ACWI benchmark.
Impax Environmental Markets has an ongoing charge of 1.02 per cent, trades at a 2.9 per cent premium to net asset value (NAV), and currently yields a dividend yield of 0.7 per cent, according to the Association of Investment Companies (AIC).
However, despite being broadly optimistic for equities, Park said investors should also consider what could be the biggest risk equity markets face in 2021.
“If either the vaccine are rolled out slower than the market is currently pricing in and hoping for, or if the virus mutates where the current vaccines being rolled out are not effective against it, I think both of those would be a game changer in terms of risk appetite,” the chief investment officer said.
“Clearly we see a large number of variants of the virus already, expectations are that the vaccine will be address all those as well, but if that narrative changes, I think that will be the big risk to 2021.”
Park said that markets are trying to look through the current restrictions which are in place towards “the greener pastures of a vaccinated world”.
“Anything that makes that timescale elongated or calls into question its entirety through a mutation will definitely challenge the valuation of risk assets,” he finished.