Recovery since the financial crisis of 2007 has been anything but textbook. Persistently low interest rates have given rise to persistently low global government bond yields, hindering the ability of investors to accurately assess where we are in the business cycle.
Whilst fixed income investors have struggled to forecast the return on bonds, equity investors have been able to ride a clear winner over this period. Growth investing has been one particular factor (or investment style) that has steadily outperformed its value investing sibling.
Using the MSCI World Value and Growth indices as proxies, the outperformance since 2007 has been around 53 per cent in US dollar, total return terms.
Performance of indices since 2007
Source: FE Analytics
Fast forward to 2018 and the majority of long-only investors have seen strong performance from their equity portfolios.
Indeed, last year even saw some active managers outperform their passive rivals. If low interest rates had been keeping equity markets buoyant in the immediate aftermath of the crisis, stronger, and synchronised, global economic growth has taken over as the key driver.
Growth investing as a style hugely outperformed value in 2017, and there were particular sectors and companies more aligned to the growth style which contributed heavily.
Take the case of the US equity market, the S&P 500, which generated a total return of 21.3 per cent in 2017. IT as a sector within this index contributed around 40 per cent of these returns, despite only having an index weight of 21 per cent at the start of the year.
Whilst IT should not be considered as the only example of a growth industry, its proliferation across the globe should not be ignored.
As developed equity markets produced strong returns in 2017, the pick-up in global trade and wider economic growth also propelled emerging and Asian equity markets materially higher last year. Yet a closer look at the sector breakdown in those markets reveals that both indices (as measured by MSCI Emerging Markets and MSCI Asia Pacific ex Japan) have a high weighting to IT of around 30 per cent.
The concentration of equity returns in this part of the world are even greater, where only three companies – Baidu, AliBaba and Tencent (known as BAT) have driven performance in the sector.
As a result, multi-asset portfolios that have generated returns from equity markets in those regions of the world will need to carefully consider how they position portfolios in 2018.
Prudent investors would typically aim to rebalance away from the high performers towards the pockets of relative value opportunities. This doesn’t mean trying to time the business cycle, far from it.
With valuations running at multi-year highs across all asset classes, the prudent investor is far more interested in protecting his portfolio’s downside deviation. Value as an equity investing style presents one such opportunity. Industries that are more cyclical in nature could be considered to have a value tilt – these include the financial, industrial and energy sectors.
Of course value has had a more recent renaissance, only to fizzle out after one quarter. Famously, this was in the fourth quarter of 2016 following Donald Trump’s election as US president.
With promises of higher spending in the US, cyclically sensitive industries enjoyed a temporary boost in sentiment while government bond yields and inflation expectations moved higher as the reflation trade kicked in. The traction could not be maintained into 2017.
Government bond yields were more volatile but finished the year broadly where they started while inflation remains the dog that hasn’t barked. The rest, as they say, is history.
We believe multi-asset portfolios should always be managed with a healthy dose of prudence. This year that means looking for opportunities to switch some equity growth exposure into a more value orientated option. As defensively minded investors, we do see an opportunity to take some profit from a style that has performed well and rotate
In the US equity market, one such fund that we find attractive is the JP Morgan US Equity Income fund managed by Clare Hart. With an income orientated approach, the fund is overweight financials, industrials and energy sectors. Whilst not deliberate, the fund’s investment approach results in a portfolio that generates strong downside protection. When blended with the slightly more growth-like S&P 500 index, investors can construct an equity portfolio that should be more resilient in 2018.
Jordan Sriharan is head of fund research at Thomas Miller Investment. All views are his own and should not be taken as investment advice.