This article was first published in the second quarter 2017 edition of Personal Finance magazine.
The year 2016 was the year that turned the world upside down. The rise of populism saw the Brexit vote in the United Kingdom in May, Donald Trump’s election in the United States in November and the resignation of Italian prime minister Matteo Renzi in December.
As a result, 2017 is infected with uncertainty too – about the impact of Brexit on UK and EU markets and, despite Trump’s policies delivering a boost to the US share market initially, about the longer-term impact of his presidency on the economy and share markets.
These two significant events, as well as others around the world, coupled with slow global growth in 2016, may have left you wondering where in the world you should be investing any offshore allocation.
But top asset managers are not without ideas and, as always, they are upbeat about periods of uncertainty, arguing that they provide opportunities for global equity managers known for their stock-picking. At times like these, the returns managers produce often diverge as managers choose to back shares with different fortunes.
Despite events, many global equity funds, in line with most global equity indices, remain overweight in the US. Tony Cadle, a fund manager at Ashburton, explains that most global equity markets reported single-digit returns last year: Britain’s FTSE 100 reported a decline of 0.2 percent in dollar terms, while both the German Dax 30 and French Cac 40 made gains of 3.3 percent and 5.7 percent. The big exception was the US equity market, where the S&P 500 reported a positive return of 12 percent, Cadle says.
Trump’s stance on taxes and infrastructure spending and his lack of interest in climate change regulation are considered pro-business and Trump has indicated his intention to reduce corporate taxes from 35 percent to 15 percent, Cadle says. In March, the US Federal Reserve increased interest rates in the US by 0.25 percent.
Arthur Kamp, an investment economist at Sanlam Investments, says it is clear that the Federal Open Market Committee (FOMC) was satisfied with the continued progress of the economy in 2016, notably firm jobs growth and a moderate medium-term GDP growth outlook. He says the FOMC continues to signal a path of gradual interest-rate hiking, but he also warns that this could be influenced by changes to US fiscal policy and potential revenue-raising measures.
Rohitesh Dhawan, the director of the Global Brexit Centre of Excellence at KPMG International, says the fact that the UK avoided an immediate economic crisis does not tell us much about the future. He says the UK economy grew two percent in 2016 and is likely to continue growing at the same rate this year. However, he says, “the pound has devalued since the Brexit vote and currently remains approximately 20 percent lower against most major currencies. Longer-term forecasts for the UK economy also vary greatly, as they depend on the nature of the future deal between the UK and EU,” he says.
Dhawan predicts that the economic impact of Brexit on the EU will be less severe than on the UK.
“The EU is a more important market to the UK than is the case vice versa. Major European economies so far have also held up strongly — with confidence in the Euro area at an 18-month high, hiring at a nine-year high and French business activity at a five-year high. But it is important to remember that there is much political uncertainty in the EU, which could affect economic prospects over the next few years.”
However, he says that “Brexit has the potential to destabilise the European financial system, and to some extent the Trans-Atlantic system because of the New York-London financial axis. This is due to the restructuring of banking, insurance, asset management and related professional and business support services and infrastructure once the UK leaves the European single market. However, the global financial system appears to be resilient enough to absorb this shock and adjust to the new normal. The regulations put in place after the 2008 financial crisis to manage risks in the financial system would have certainly helped in this regard.”
Emerging markets reported double-digit dollar returns of 11.6 percent last year based on a rebound in commodity prices and strengthening currencies, he says.
Commodity-producing emerging market economies have been under pressure due to the five-year decline in commodity prices, which bottomed in January 2016, Cadle says. Since then commodity prices have risen due to disciplined production, short-term dollar weakness and renewed fiscal stimulus in China. If current commodity prices prevail over the course of this year, he says, economic growth in emerging markets may well accelerate, underpinning equity market earnings growth.
But the asset management company Marriott is warning investors not to be fooled by the bounce-back in commodity-linked investments that made 2016 the year in which out-of-favour currencies, sectors and stocks rebounded. Over the long term, returns are sustained by earnings and dividend growth, according to
Marriott, and consumer-facing multinational companies continue to offer the best dividend growth prospects in the years ahead. The reasons for this view are:
• Rapid growth in the consumer class in the developing world;
• Improving company profit margins as a result of technology-enabled efficiencies and productivity gains; and
• Higher government spending and tax cuts in the US.
Compared to last year, the investment landscape for this year therefore appears more positive for growth assets such as equities, with the expectation of a year-on-year acceleration in global economic growth and a switch in economic policy, led by the US, away from monetary to fiscal policy stimulus.
Here are some of the conditions the top-performing global equity funds have to navigate and this is how they have chosen to do it.
Allan Gray-Orbis Global Equity Feeder Fund
Ranked first in the global equity general sub-category over 10 years to the end of December 2016, with an annual return of 13.25 percent a year, according to ProfileData
The Allan Gray-Orbis Global Equity Feeder Fund is linked to the Orbis Global Equity Fund managed by Allan Gray’s sister company Orbis, whose founder is also the man who gave his name to the South African investment house.
Tamryn Lamb, the head of Orbis client servicing in South Africa, says Orbis has what is known as a bottom-up approach to investing: choosing shares that are trading below the manager’s assessment of their value, based on research into various factors assessed over a long term.
Orbis also considers the risk of each share losing further value. With many shares in offshore markets currently trading at prices that reflect their full value, Orbis is even more careful to consider the risk of a share losing value, Lamb says. But she adds that “we are also encouraged by the relative attractiveness of the individual opportunities we can uncover”.
The Orbis analysts are finding more opportunities in selected emerging markets and fewer in developed markets, such as the US, she says. The fund has just under 30 percent of the portfolio in emerging market shares, with the exposure to Asia, excluding Japan, comprising about 20 percent.
Examples of the opportunities the fund has found include Sberbank, a leading bank in Russia, Netease, JD.Com and Baidu, all internet-related stocks in China, and KB Financial Group, a domestic financial services business in Korea. In part because of the negative sentiment around the “riskiness” of emerging markets, these shares are trading at attractive valuations that do not reflect their long-term growth potential, Lamb says.
By contrast, in the US valuations (prices relative to earnings or profits) and earnings are high, which does not bode well for future returns, Lamb says. Nevertheless, the Orbis Global Equity Fund still has about a 49-percent exposure to the US, as it is an extremely large market. This is significantly underweight relative to the benchmark US weighting of 60 percent.
The US shares Orbis has chosen include Motorola Solutions and Amazon, media companies such as Charter Communications and Healthcare companies such as Abbvie, Anthem and Aetnam, which are out of favour for various “idiosyncratic reasons”, Lamb says. Abbvie, one of the world’s largest bio-pharmaceutical companies, has a four percent dividend yield (the dividends paid as a percentage of the share price), and a price-to-earnings ratio in the low teens indicating that it is relatively cheap. This despite the potential for high teens growth in earnings, she says.
Absa Global Value Feeder Fund
Ranked fifth in the global equity general sub-category over 20 years to the end of December 2016 with an annual return for this period of 8.59 percent
The Absa Global Value Feeder Fund feeds into the Schroders International Selection Fund Global Recovery Fund.
Andrew Lyddon, the co-portfolio manager for the Schroders Global Recovery Fund, say the US and Europe account for about 80 percent of the world’s capital markets, and Schroders has a significant exposure to these regions.
However, Schroders’ regional exposure is very different to the benchmark, because it has a higher exposure in Europe, where it is finding some of the cheapest businesses in the world. The European banking sector is particularly attractive, and the fund has taken positions in Italian banks Intesa Sanpaolo and Unicredit, and UK bank RBS, Lyddon says.
The UK’s Brexit vote resulted in a 20 percent sell off in the banking sector, with the Italian bank shares being among the weakest performers, Lyddon says. Intesa Sanpaolo’s share price fell too, despite it being better capitalised than its peers, Lyddon says. However, the fee income from its significant asset management operation continues to offset the pressure on its banking unit’s net interest margins. It is profitable, capital generative and its robust balance sheet provides a “margin of safety” against any further shocks, he says.
Schroders has also been active in the basic materials sector and started building a position in Anglo American’s offshore listing in the first quarter of 2015. As the share price fell throughout the year, Schroders bought more shares, decreasing the average price at which the manager purchased the stock. In the
second half of 2015, Anglo’s share price fell 67 percent and resulted in it trading at a book value it hadn’t reached in any recession over the past 40 years.
“Buying the shares was a very lonely place to be,” says Lyddon, but Schroders thought the market was overly concerned about Anglo’s debt when the gearing was only 60 percent. In the five weeks to the end of February, there was a significant 117-percent share-price rally, with the only explanation being a correction of the previous market panic, Lyddon says. Anglo was the best performing holding in the portfolio in 2016, up some 290 percent.
He says history suggests there is a significant opportunity for deep-value investors today.
“Value has been out of favour for the past decade, but as an investment style, value has displayed a consistent pattern of mean reversion over more than 100 years. Its potential recovery is the most attractive investment opportunity for patient investors in today’s equity markets,” Lyddon says.
Coronation Global Opportunities Feeder Fund
Ranked third in the global equity general sub-category over 10 years to the end of December 2016 with an annual return of 10.61 percent for this period
The Coronation Global Opportunities Feeder Fund invests in Coronation’s Global Opportunities Equity Fund of Funds which is domiciled in Ireland. The Global Opportunities Equity Fund of Funds is a multi-manager fund that invests in a number of funds and portfolios managed by top global managers who follow different strategies. These managers have their highest exposure to shares in developed markets, such as Europe, the United States and Japan.
Coronation “rigorously” researches each manager it chooses, to ensure it has a sound investment philosophy and a long-term track record of outperforming the market.
If the underlying shares of the different managers are analysed, the fund-of-funds is 64 percent exposed to the US and 14.5 percent to the UK and Europe, 6.4 percent to Japan and 11.5 percent to emerging markets.
Fund manager Tony Gibson says the global economy and markets started 2017 in a considerably better position than they were in at the same time last year. The outlook for developed economies has improved, with growth momentum picking up and risk assets rallying since the US presidential election.
Markets are indicating that the new US leadership should have a fundamentally positive impact on the economy and a faster-growing US economy will be good for the global economy, although it will be some time before its impact is felt outside of their country, Gibson says.
However, there is a risk that Trump’s views on globalisation and any strong action in this regard will contribute to global stress.
In Europe, 2017 will see important elections in Germany and France, and these, plus the long-awaited Brexit negotiations, cannot be discounted, he says. Emerging markets face near-term challenges as the stronger US dollar leads to capital outflows and rising interest rates.
Gibson says stocks with low levels of volatility have gained favour recently, outperforming more cyclical counters. Often, this was due to their bond-like qualities, rather than their fundamental attributes, and it made these stocks expensive. Such valuations are likely to prove unsustainable, and are already starting to reverse.
Furthermore, anticipated fiscal stimulus in the US under the Trump administration will support those parts of the market that have lagged “safe haven” assets. In particular, the banks should continue to perform well. Being better capitalised now than they were in the wake of the financial crisis, these entities have also generally reduced the volatility of their earnings streams, despite operating under heightened regulation and in an environment of exceptionally low interest rates, Gibson says.
The sharp drop in commodity prices from mid-2014 into early 2016 weighed heavily on global equity indices, capital investment, and the economies and currencies of commodity-sensitive countries, he says. Due to the lag between investment and production for most non-agricultural commodities, it takes time for lower prices to reduce supply, or for a price rebound to increase production.
Energy inventories remain high, and the scope of pledged 2017 oil production cutbacks remains uncertain, he says. However, the supply headwinds created by the sharp drop in energy sector capital investment from 2014 through 2016 will more than offset the near-term impact of a modest 2017 rebound in drilling and spending, Gibson says. Increasing recognition of this reality fuelled the sharp year-on-year rise in oil and natural gas prices in 2016 and modest rebounds in other raw materials .
Investec Worldwide Equity Feeder Fund
Ranked second over 20 years and third over 15 years in the global equity general sub-category. The fund achieved returns of 11.06 percent and 7.76 percent a year over these periods.
The Investec Worldwide Equity Feeder Fund feeds into the Investec Worldwide Equity fund. The fund is managed according to Investec’s “4Factor” process, which screens companies according to: high quality, attractively valued, improving their operating performance and receiving increasing investor attention.
The fund’s fact sheet shows that, to the end of December last year, regional allocation was weighted towards the US (53.6 percent at the end of December), followed by Europe and the UK. But the fund does not tactically manage the regional allocations; instead fund manager James Hand selects individual stocks according to the 4Factor process, so there are no big country calls.
Investec says the fund’s exposure to the US is its largest underweight position relative to the benchmark, the MSCI All Country World Index. Nevertheless, exposure to the US is high, because the US constitutes over half of the benchmark, Hand says.
In considering the future performance of the fund, Investec says three market trends are worth highlighting. First, since the middle of last year, the degree to which global share prices move in the same direction has moderated and they are now moving more independently of one another.
“This is normally a more conducive environment for bottom-up investors, as stocks tend to be driven more by company fundamentals and less by geopolitical or macro-economic events,” Hand says.
Second, Investec’s four factors are less correlated with one another. Early 2016 proved to be a difficult period for multi-factor investors, because the value factor sharply reversed its long-term downtrend, yet Investec’s other three factors were closely correlated and underperformed in unison, Hand says. Now that the factor correlations have eased over the past six months, Hand says he is seeing more diversification within the 4Factor process, with shares that score well across multiple factors performing best, he says.
Finally, the earnings factor has rotated from being expensive relative to the market and history, to appearing somewhat undervalued. “This isn’t to say that these particular stocks have come down in price. Rather, where previously it was high quality, defensive and largely expensive stocks that were seeing the lion’s share of the sell-side upgrades, and therefore dominating the factor’s top quartile, our earnings high scorers have now rotated into cheaper, more cyclical sectors,” he says.
Nedgroup Investments Global Equity Feeder Fund
Ranked eighth over 10 years in the global equity general sub-category with a return of 9.22 percent a year and fourth over 15 years with a return of 7.1 percent a year
The Nedgroup Investments Global Equity Feeder Fund feeds into the Nedgroup Investments Global Equity Fund – a dollar-denominated fund domiciled in Ireland – and the management of this fund is outsourced to London manager Veritas Asset Management.
The manager has a deep, fundamental research process to identify quality and cheapness and is benchmark agnostic.
The fund is modelled on Veritas’s Global Focus Strategy Fund and its portfolio is concentrated in 25 to 40 quality stocks with an emphasis on capital preservation.
Andrew Headley, a co-fund manager with Charles Richardson, says the impact of Brexit and Trump could be both significant and long-lasting, but the biggest issue is the uncertainty they bring.
“We do not know what Brexit will mean and what the terms of trade will be for Britain, nor do we know what Trump will introduce by way of new policies: trade, taxation, immigration, infrastructure, and so on. This uncertainty has not stopped many billions (or perhaps even trillions) of dollars being invested. Sterling, infrastructure companies, US Treasury stocks, the dollar, US banks, metal and mining companies and healthcare stocks, for example, have experienced substantial price moves. These investments are being made on the basis of speculation, and some of the speculators will make money, while others will lose it,” Headley says.
Veritas prefers to identify companies with strong long-term competitive advantages and buy them when they are attractively valued, he says. While individual companies may well see a disproportionate impact (positive or negative) from Brexit or Trump in the short term, over the long term the strength and sustainability of their competitive advantage will make them winners in the corporate world.
One such company is the pharmaceutical company, Allergan. Veritas has invested in the business because of its strong position in niche therapeutic areas, its branded cosmetic treatment presence, the growth potential in the company’s pipeline and its attractive valuation, Headley says.
Allergan’s best-known treatment is Botox, traditionally a cosmetic treatment. However, Allergan realised the potential of Botox in a range of medical conditions and the medical revenue for this product now exceeds the cosmetic revenue, he says.
The fund’s biggest holding, 6.5 percent, is in Charter Communications, a provider of cable services offering various entertainment, information and communications solutions, including video, internet, and advertising to residential and commercial customers.
The second biggest holding, 6.3 percent, is in the Comcast Corporation, a media and technology company with two primary businesses, Comcast Cable and NBC-Universal. The company’s businesses include cable communications, cable networks, broadcast television (NBC and Telemundo), filmed entertainment, and theme parks in Orlando and Hollywood.
UnitedHealth, the US-based health insurance company, is also among the fund’s 10 largest holdings.