With equity and bond markets “still defying gravity”, McDermott has identified three equity and three fixed income market asset classes which he believes could continue to fare well next year.
Equities
Despite having performed well this year, McDermott believes many areas within emerging markets are attractively valued relative to many of their developed market counterparts.
“We think James Donald, who heads up the Lazard Emerging Markets Fund, is particularly adept at seeking individual opportunities within such a broad area of the market,” he said. “For those who want to tap into the growing dividend opportunities Charlemagne Magna Emerging Market Dividend is also worth a look.”
Away from emerging markets, another region McDermott tips to have a good 2018 is Europe.
He said: “Improving economic growth, increased political stability and falling unemployment levels have bolstered sentiment in Europe, with M&A activity in the region picking up and IPOs continuing to come to market. That said, there are still pockets of value which can be captured by selecting the right managers.”
David Walton’s Marlborough European Multi-Cap fund is one European fund he particularly likes.
“While it is overweight smaller companies relative to the broader index, it has a highly diversified portfolio of stocks in a bid to minimise volatility,” he said. “Mirabaud Equities Europe ex UK Small & Mid is another option.”
Lastly, while Japan’s Nikkei 225 has indeed performed well this year, McDermott noted it is still about 40% below its long-term peak.
“Japanese equities have remained unpopular among UK investors in particular, who have been told one too many times that ‘this time it is different’,” he said. “However, fresh from a landslide election victory, Japanese prime minister Shinzo Abe can continue with his business-friendly reforms.”
Two funds he picked out as being “worth a look” are Baillie Gifford Japanese and T Rowe Price Japanese Equity.
Fixed income
Given that central bank tapering appears to be on the cards in some regions, McDermott said investors would do well to exercise caution within the fixed income space and minimise interest rate risk.
One possible attractive option in this environment, he said, are short-duration bond funds.
“We particularly like AXA Sterling Short Duration Bond, which will only invest in high-quality corporates with maturities of less than five years,” he said. “Manager Nicholas Trindade also structures the portfolio so that it is well diversified and that around 20% of the holdings mature each year.”
Meanwhile even with its “superior ability to generate income”, McDermott said in today’s low-yield environment emerging market debt looks particularly attractive.
“Within this space, Claudia Calich’s M&G Emerging Markets Bond fund, which is able to invest in both hard and local currencies as well as a combination of both government and corporate bonds, is a newly rated fund which currently yields 4.9%,” he said. “We also like Aberdeen Emerging Markets Bond with its 5.2% yield.”
The final area within fixed income McDermott said investors may look to next year are floating rate notes. These are bonds which have a variable coupon; this is determined by adding the bond’s spread to its reference rate, for instance Libor or the Consumer Price Index (CPI).
“A fixed income fund we like which uses floating rate notes is Ariel Bezalel’s Jupiter Strategic Bond Fund, which currently has a 12.3% weighting to the asset class,” he said.
“Likewise, GAM Star Credit Opportunities managers Anthony Smouha and Grégoire Mivelaz have long been fans of floating rate notes. They have 43.3% in ‘fixed-to-floater bonds’ which provide a fixed interest for a specified period and then float at a spread over a specified benchmark, which is regularly re-set and can move in line with interest rates.”
