Many economies are on the cusp of either tipping into a reflationary environment or a deflationary one so investors should position themselves accordingly, according to Premier’s Simon Evan-Cook (pictured). 
The senior investment manager says this is one of the biggest challenges facing investors at the moment, as it plays a key role in whether value or growth stocks will outperform.
“If you look back on the whole year focusing on market movements and the way funds have behaved, we’re on a potential inflection point between types of investments. Broadly you can categorise them as ‘deflationary winners’ or ‘reflationary winners’ and that seems to be dictating whether a lot of funds are winning or losing versus their benchmarks or peer group,” he said.
“Over the last few years it’s been deflationary funds that have outperformed which, in the equity world, you consider to be the quality growth funds out there. However, they’ve been struggling a little bit, particularly since the furore around Brexit died down at the start of July.
“That seems to be what’s dictating things. In terms of what we’re doing, we aren’t trying to call whether either one of those is the winner. We’re essentially trying to get the best of both because we don’t know whether deflation is going to be the winner or whether we’re going to end up with reflation and higher fiscal spending.”
In the below article, Evan-Cook lists his favourite ‘reflationary’ and ‘deflationary’ winners across three regions, all of which are currently held by Premier.
The UK
Deflationary: Evenlode Income
The senior investment manager says Hugh Yarrow’s five crown-rated Evenlode Income fund is a good option for those worried about the impact of lower inflation, given its focus on quality growth stocks.
“[Yarrow] is looking for those companies that are all-weather winners, so companies that are going to grow regardless of whether the economy is stagnating, shrinking slightly or even rising, they’re going to keep performing at a stable rate,” Evan-Cook said.
“If everything is going amazingly well those companies might be left behind but, if the environment becomes deflationary, they’ll do fairly well.”
The £1bn fund invests across the market cap spectrum, although its largest holdings include blue-chips such as Diageo, Unilever and AstraZeneca. That said, it currently has a 32.4 per cent weighting in mid-caps and 2 per cent in small-caps.
The manager is also able to invest up to 20 per cent of the fund in overseas companies and has a 14.9 per cent US weighting.
Over five years, the fund has comfortably doubled the returns of its average peer in the IA UK All Companies sector and has almost doubled its IA UK Equity Income sector average benchmark with a total return of 114.34 per cent.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
If an investors had put £1,000 into the fund five years ago, they would have received £251.59 in income.
Evenlode Income has a clean ongoing charges figure (OCF) of 0.95 per cent and yields 3.4 per cent.
Reflationary: Man GLG Undervalued Assets
For those who believe inflation could rise, Evan-Cook says FE Alpha Manager Henry Dixon and Jack Barrat’s Man GLG Undervalued Assets fund could be appealing.
The £487m fund aims to achieve long-term capital growth through stocks deemed to be undervalued by markets and trading below the managers’ estimations of its value based on its returns on invested capital.
The fund will hold significant weightings in small and medium-sized companies as well as large-caps.
“The managers are looking for companies that are simply on a good valuation,” Evan-Cook explained.
“They do the work needed to make sure companies are financially sound and aren’t about to go bust, but they’re much more interested in finding companies that are just under-appreciated rather than trying to find exceptional companies.”
Because of its value bias, the fund is in the third quartile for its maximum drawdown (which measures the loss if bought and sold at the worst possible times) and annualised volatility since its launch at the end of 2013.
However, it has outperformed its sector average and benchmark by 5.36 and 4.35 percentage points respectively over the same time frame, with a total return of 21.8 per cent.
Man GLG Undervalued Assets has a clean OCF of 0.9 per cent and yields 2.07 per cent.
Europe
Deflationary: Baillie Gifford European
The four crown-rated Baillie Gifford European fund is £186.6m in size and is headed up by Thomas Coutts, Stephen Paice, Moritz Sitte and Tom Walsh.
It aims to achieve long-term growth by investing across any sector in continental Europe. It will hold between 40 and 80 stocks at any one time and aims to keep its annual portfolio turnover below 20 per cent.
“The managers are trying to find companies that are long-term structural winners regardless of whether we have deflation or inflation. They’re looking for companies that are going to be big in 10 years’ time because they’re on the right side of history,” Evan-Cook explained.
“They’re more likely to be the ‘disrupters’ than the ‘disruptees’. Those kinds of companies will do well even if there is a deflationary environment because they’re rare companies that are able to grow through regardless.”
Over five years, the fund has returned 109.03 per cent, outperforming its sector average and MSCI Europe ex UK benchmark by 28.73 and 36.78 percentage points respectively.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
It has a top-quartile maximum drawdown and Sharpe ratio (which measures risk-adjusted returns) over the same time frame.
Baillie Gifford European has a clean OCF of 0.7 per cent and yields 1.34 per cent.
Reflationary: Edinburgh Partners European Opportunities
While this fund isn’t widely available to retail investors, Edinburgh Partners European Opportunities is held by Premier for manager Craig Armour’s value approach to stock selection.
“The team isn’t trying to find exceptionally good companies or companies that are growing at a fast rate. It’s simply trying to find financially sound companies that are disliked by the market,” Evan-Cook explained.
“Its stocks have been discarded or de-rated because they’re not the kinds of companies that people are looking for at the moment, but they’ve got to the point where they’re so cheap that, providing the world economy just muddles through and survives, everything will be fine.
“Also, if everything reflates and all boats are lifted then these stocks have even further to run. They’ve had a particularly good month as some of the weaker companies in Europe have started to re-rate.”
Over five years, the €119.3m fund – which is domiciled in Ireland – has returned 57.38 per cent compared to its average peer’s return of 68.13 per cent and its benchmark’s return of 79.75 per cent. This could be to do with the fact value investing has been out of favour.
Over the last decade, however, it has comfortably outperformed both its sector and benchmark.
Edinburgh Partners European Opportunities has a clean OCF of 1.38 per cent.
Emerging markets
Deflationary: Fidelity FAST Emerging Markets
Fidelity FAST Emerging Markets fund has been held by the team at Premier for some time.
While it was soft-closed to new investors last month, existing investors are still able to increase their exposure to the fund. It previously soft-closed in 2013 and was re-opened two years later, although this was for less than four weeks due to high levels of interest.
“Fidelity FAST Global Emerging Markets which is run by Nick Price, who is looking for the very best companies,” Evan-Cook said.
“Stocks in the portfolio are solid growers which investors are willing to pay a premium for if deflation happens, because these companies will continue to grow at an acceptable rate while everything else is declining. It tends to do quite well in a deflationary environment.”
The offshore fund, which is domiciled in Luxembourg, is $1.8bn in size and has been awarded five FE Crowns.
Price and his team mostly aim to buy long positions in ‘structural winners’ but are also able to short some stocks to capitalise on weaker companies.
Since launch, it has returned 69.63 per cent, more than doubling both its sector average and benchmark. Over the same period, it has a top-quartile annualised volatility, maximum drawdown and Sharpe ratio.
Fidelity FAST Emerging Markets has a clean OCF of 1.5 per cent.
Reflationary: M&G Global Emerging Markets
Managed by Matthew Vaight since its launch in 2009, the £1.7bn M&G Global Emerging Markets fund aims to achieve both income and capital growth over a minimum period of five years.
It does so through a portfolio of between 50 and 70 stocks which are chosen based on their high level of quality as well as whether they have been hastily discredited by markets due to short-term noise.
“The managers care about how good the companies are and they care about their balance sheets being sound, but they really are looking for out-of-favour holdings so they are more driven by valuation,” Evan-Cook explained.
“In a situation where it looks like emerging markets are going to be okay, even reasonably good, those sorts of companies will come back into favour as people re-rate their chances of survival.”
Over five years, the fund has outperformed its sector average and benchmark by a respective 6.82 and 6.88 percentage points. However, it also has a bottom-quartile annualised volatility and maximum drawdown over the same time frame.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics