Investors should expect another volatile year from equity markets in 2016, according to Rathbone’s David Coombs, who says investors should largely focus on funds which hold companies with pricing power and stable revenues to make sure their portfolios are protected. 
It’s been a choppy year for investors with macroeconomic headwinds such as China’s slowing growth, plummeting commodity prices, the Greek debt negotiations and the prospect of higher interest rates in the US all weighing on sentiment.
David Coombs, head of multi asset investing at the group, (who recently told FE Trustnet about the trends that will dominate investors’ portfolios in 2016) says that the year ahead is likely to be just as volatile.
“Stock market valuations corrected substantially over the summer, but the cushion for disappointment remains thin, with investors ready to dump companies that fail to hit their numbers or cannot offer earnings’ certainty,” Coombs (pictured) said.
He added: “We believe businesses with pricing power and more stable revenues offer the best protection in the current low-growth world.”
With that in mind, he highlights five equity funds from around the world he is currently backing in his fund of funds range that he believe will protect his investors best over the year ahead.
In the US – Brown Advisory US Smaller Companies
The US is Coombs favourite region heading into 2016, which is a very different view to many of his peers who feel the North American market is in for a period of underperformance given it has posted gains in every calendar year since the financial crisis.
However, the manager says the genuine economic recovery in the US will continue to buoy the market.
“Low inflation and a strong dollar should continue to push valuations higher. Couple this with a feel-good consumer, and solid gains are still there for the right companies. We like businesses that are able to eke out revenue gains despite tough conditions and consolidate their market leaderships.”
Coombs uses individual stocks for this large-cap exposure (such as Coca-Cola, Visa and Alphabet) but, given he is bullish on the region, his favourite fund focuses on the lower end of the market-cap spectrum.
“We like the Brown Advisory US Smaller Companies fund, which has a strong track record in picking stocks that fall beneath most analysts’ radars. The fund has a hefty weighting to IT companies and industrials, which are benefiting from the strong domestic recovery,” he said.
The $188m fund, which sits in the offshore universe, has been managed by Christopher A Berrier since its launch in November 2007.
Performance of fund versus index since launch
Source: FE Analytics
According to FE Analytics, it has returned 147.27 per cent over that time meaning it is ahead of its Russell 2000 benchmark by 10 percentage points. It is also outperforming over one, three and five years.
The fund has an ongoing charges figure (OCF) of 0.96 per cent.
In the UK – CF Miton Multi Cap Income
Coombs isn’t overly bullish on the UK.
While the managers says the UK economy is growing strongly and the UK consumer is starting to see better wage growth, the international aspect of the FTSE 100 index and its exposure to macroeconomic headwinds along with heightened political risk (in the form of a EU referendum) means he is underweight the asset class.
Like in the US, Coombs uses direct equities for his exposure to the UK such as Reckitt Benckiser and Lloyds but for his fund exposure he is using the more domestically-orientated five crown-rated CF Miton UK Multi Cap Income fund.
“Industry veteran Gervais Williams runs the Miton UK Multi-Cap Income Fund, which we also like. The fund is predominantly in mid and small-caps, with a hefty 34 per cent in AIM stocks. Mr Williams has a strong track record in this space, and the fund complements our direct UK holdings nicely,” he said.
Williams launched the £558m fund with Martin Turner in October 2011 over which time CF Miton UK Multi Cap Income has been the best performing portfolio in the IA UK Equity Income sector with returns of 115.34 per cent.
As a point of comparison, the FTSE All Share has gained 40.93 per cent over that time.
The fund has also beaten the sector and index in each calendar year since launch including 2014 when most small-cap orientated funds lost money thanks to a rotation, among investors, away from high multiple growth stocks and into ‘safer’ large-caps.
The fund, which has a quality growth bias, yields 3.75 per cent and has an OCF of 0.81 per cent.
In Europe – Baring German Growth Trust
Despite the ECB’s quantitative easing programme, signs of an economic recovery and the market’s decent gains this year, Europe continues to be one of Coombs largest underweights – which is, again, very anti-consensual.
The manager believes that while Europe has performed well this year, it hasn’t delivered the gains he would have hoped for given the added stimulus and huge weakening of the Euro. On top of that, he thinks those gains have masked unresolved structural issues and further political risk.
“We remain underweight Europe for these reasons, but Germany continues to be in a strong position due to its relatively robust economy, which benefits from ultra-low borrowing costs,” Coombs said.
“This, along with the devalued euro, gives German exporters a huge leg up. A drop in Chinese demand will put a dampener on this; exactly by how much is yet to be seen. Broadly speaking, as an investor, it is difficult to get good, ‘pure’ exposure to Europe through a fund or investment trust.”
He added: “But we do like the Baring German Growth Trust, which offers us specific exposure to the heart of the eurozone.”
Despite its name, the Baring German Growth Trust is an open-ended fund. It is £417m in size and is headed-up by FE Alpha Manager Robert Smith.
FE data shows that since Smith took charge of the fund (which sits in the IA Specialist sector) in November 2008, it has returned 168.41 per cent beating its HDAX benchmark by 56 percentage points in the process.
Performance of fund versus index under Smith
Source: FE Analytics
Baring German Growth, which is biased towards the large-cap end of the market, has beaten the index in four out of the last six calendar years and is outperforming again in 2015. Its OCF is 0.82 per cent.
In Japan – JP Morgan Japanese Investment Trust
Coombs is bullish on Japan, however, as he believes in the country’s corporate resurgence even though it fell into recession once again this year.
“Most Japanese giants are simply listed in Tokyo, with most of their factories offshore and their main markets spread around the globe,” he said.
“Japanese companies are opening themselves up to external directors, and shareholder returns are already improving noticeably. The fundamental backdrop to this change in attitude is positive, as excess corporate cashflows in Japan are close to an all-time high.”
“Increasingly, this is being returned to shareholders, with a greater proportion coming from dividends as opposed to buybacks.”
While Coombs is eyeing up the soon-to-be launched Coupland Cardiff Japan Income & Growth investment trust, one of his long standing holdings is the JP Morgan Japanese Investment Trust which is managed by Nicholas Weindling and Shoichi Mizusawa.
FE data shows the trust, which is biased towards structural growth companies, has significantly outperformed its Topix benchmark over one, three and five years have beaten the index in five out of the last six calendar year. It is also up relative to the index in 2015 with gains of 22.39 per cent.
According to the AIC, the trust is currently trading on an 8.97 per cent discount to NAV which is the widest in its peer groups. That discount is narrower than its one and three year average, though, reflecting the increased popularity of Japanese equities.
It is geared at 10 per cent and has ongoing charges of 0.78 per cent.
In the emerging markets – Oppenheimer Developing Markets
Like most market commentators, Coombs is nervous in his outlook for emerging market equities as while they have performed poorly for a number of years now he sees plenty of clear and dangerous headwinds.
These include slowing Chinese growth and the exuberance of the country’s emerging middle class which created the market’s bubble earlier in the year.
While he holds a number of country specific portfolios for his Asia ex Japan exposure (such as China AMC China Opportunities and JP Morgan Indian) he uses the Oppenheimer Developing Markets fund for more broad-base positioning.
“In terms of emerging markets, we are less negative on greater emerging Asia but wary of commodity-producing nations such as Brazil and Russia. For broader emerging markets exposure we like the Oppenheimer Developing Markets Fund, a quality-biased index-agnostic fund, that is overweight the burgeoning consumer theme. It steers clear of natural resources,” he said.
The $600m fund is managed by Justin Levernz and since it launched into the FCA offshore recognised universe in January 2013 it has lost 6.92 per cent.
Performance of fund versus sector and index since launch
Source: FE Analytics
As the graph above shows, it had been well-ahead of its MSCI Emerging Markets benchmark up until this year. Nevertheless, despite its losses, it is still outperforming the index and the average fund in the IA Global Emerging Markets sector since launch.
The fund is currently overweight consumer discretionary, consumer staples and healthcare stocks. Its OCF is 1.38 per cent.
