The extraordinary monetary policy of the post-financial crisis period along with currency and passive fund inflows have driven several long-term market trends, but investors should be prepared if one of these tailwinds is removed, according to IBOSS Asset Management’s Chris Rush. 
“In the last five years, the central bank intervention that everybody knows about – a rising tide that lifts all ships – has lifted all asset prices,” said the senior investment analyst (pictured).
“But, obviously, that has maybe got in the way of some of the longer-term tailwinds that have also helped investors make pretty decent returns – to put it mildly – over the last five years.
“And because these tailwinds are so long term, they have pushed some trends out the other side and some have taken advantage for the past decade or so.”
Below, Rush examines these tailwinds and trends in more detail.
Tailwind 1: Currency
The first tailwind highlighted by the analyst relates to currency and how the weaker pound has enhanced returns over the past few years.
For example, unhedged investors in the US equities would have almost doubled their returns over the past five years as a result of sterling’s weakness.
A sterling investor in the MSCI North America index would have made a return of 96.44 per cent over five years to 1 November, compared with a 59 per cent gain for a US dollar investor.
Performance of US dollar vs sterling over 5yrs
Source: FE Analytics
“The dollar has been strengthening relative to the pound for the past five years – ex-2017,” he said. “If you’re a sterling investor then you’ve got that currency tailwind and you’ve actually doubled the returns, which is obviously huge.”
Nevertheless, Rush was quick to note that the currency effect could be reversed should sterling begin to strengthen against the dollar.
“This has been a tailwind but that can just as easily become a headwind if sterling were to rally against the dollar,” he said. “If things were to switch around you would get the complete opposite of this scenario.”
Tailwind 2: Passive flows
The second long-term tailwind is passive inflows, which have surged in the past decade as the equity bull market has continued apace and investors have increasingly focused on fund fees.
“We think this is generally positive because, first off, we get more tools to work with so we can get easy exposure or broad-based market exposure from different indices.
“Another positive is the active fund houses have been forced to reduce their fees. Where you used to get a global equity fund anywhere between 0.9 to above 1 per cent, these days you pay 0.6 to 0.8 per cent, which is great for everybody.”
However, Rush said the inflows into passive strategies has had an impact given the sheer volume of money now being invested directly into markets.
“Because the indices are built on market capitalisation structure, whereby the largest firms make up the largest portion of the index, these flows are going to the larger areas,” the analyst explained.
“For example, in the MSCI World you have around 60 per cent US equities so there’s more money going into the growth and technology stocks which [already] dominate those markets.”
And this, said Rush, has led to another long-term trend.
Long-term trend 1: Quality-growth style
In recent years, funds and managers that specialise in the quality-growth style have been among the best performers as investors have increasingly sought out the stocks with stable cash flows that they have been able to reinvest for further growth.
“With central bank policy and these tailwinds, it really has risen all asset prices from a relative point of view, those growth managers have absolutely crushed value managers,” said Rush.
Yet, more recently, there are signs that the strong outperformance of growth stocks may not be as strongly supported as many believe.
Performance of indices over 1yr
Source: FE Analytics
“If we look at the one-year data, and you can see why you would potentially want the two things [value and growth] at once,” he said.
“[In] the long term we can see growth outperforming value, but you can see that in Q4 last year – when central bankers stepped away from markets and they had to trade on their own two feet – one of the tailwinds was basically pulled away and you can see that growth, on a relative basis, underperformed value.”
Long-term trend 2: Technology & the US
The removal of one of the tailwinds also had a similar impact on the fast-growing technology sector, which has led markets higher over the past decade with stocks such as Facebook, Apple and Alphabet becoming ubiquitous in portfolios.
During the fourth quarter of the year, the MSCI World/Information Technology sub-sector index fell by 15.73 per cent – in sterling terms – compared with an 11.35 per cent decline for the broad MSCI World benchmark.
And this was seen too in the US, where once support was removed by the Federal Reserve the market began to underperform.
“North America has outperformed significantly over five years and that has obviously increased the amount of pressure on fund managers and asset allocators to allocate there and become more specific in their holdings,” said the IBOSS analyst.
“It essentially means that you have been punished for being more diverse in your geographical allocation and you’ve been rewarded for being more specific with your allocation.”
Performance of indices over Q4 2018
Source: FE Analytics
As such, investors have been crowding into more of the stocks that have many of the same features as the quality-growth favourites.
“So, where we are today is that we’re back to the Nifty 50,” he explained. “The Nifty 50s in the 1960s and 1970s were a lot of US blue-chip companies that were essentially seen as infallible.
“You put your money into them and no matter what the valuation, the earnings will pay for themselves. If that sounds familiar that’s because that’s exactly where we are today.”
However, Rush said while there have been increasingly polarised views on how the markets are likely to perform going forward, it still makes sense for investors to remain diversified.
“Diversification isn’t dead, it is just sleeping,” he explained, arguing that there are risks for backing one style over the other.
“There are risks on both sides and actually you want to be somewhere in the middle whereby you are blending these things together,” the IBOSS analyst concluded. “You just need to be aware that there are dangers on both sides.”