Predictions are rife at this time of year but for Whitechurch Securities senior investment manager Simon Jaffé, forecasting in precise detail what will happen in markets or the economy is a dangerous game. A better approach, he argues, is to anticipate the bigger risks to portfolios.
“I follow John Maynard Keynes’ premise that it’s better to be roughly right than precisely wrong,” he says.
One of the big risks he sees is the danger of extrapolation. It would be easy to think US equities, led by Faang stocks, will continue to outperform as handsomely over the next decade, or that growth stocks will continue to have the upper hand over value, but Jaffé thinks investors need to keep in mind that nothing lasts forever.
Democratic Senate could challenge Faang monopolies
To illustrate this point, he recalls the consensus view held by many at the start of 2010 that the following decade would continue to be as fruitful for emerging markets as it had been for the previous 10 years. But it wasn’t and EM turned out to be one of the worst-performing asset classes during that period.
“In the noughties, EM was the strongest-performing asset class and US equities was actually the worst. And people just extrapolate so they expected emerging markets to carry on,” he says.
“Now people are still very positive on US equities so I think in the next decade, hopefully, the UK will do better and so will emerging markets.”
This view naturally leads Jaffé and the Whitechurch team to be cautious on US equities and, as such, the portfolios are slightly underweight, mainly on the belief that US valuations are very rich.
Jaffé also notes anti-trust action in the US with the Federal Trade Commission acting against Facebook over monopolisation as a warning sign that pressure on Faang stocks could ramp up as the Democrats take control of the Senate.
“You could see more action there, so some of these monopolies might be under pressure,” he says.
That said, the team believes there are some interesting opportunities to be found outside the highly popular tech names. “We like managers outside of that space that are more nuanced and you can see value in.”
One fund Jaffé highlights is Artemis US Smaller Companies, which performed strongly over the six months to 30 November, having lagged before, delivering a total return well ahead of the S&P 500.
Global vaccine rollouts will be positive for resource heavy UK
Jaffé admits to having a contrarian bent and so the team is overweight the unloved UK market. Low valuations, agreeing a trade deal and the breakthrough on a vaccine have fuelled this view, notwithstanding the latest nationwide lockdown.
“The current lockdown is hopefully just a temporary setback, but once people are vaccinated on a global basis, it will be positive for resource companies, and the UK is resource heavy,” he says.
“The economic recovery should also boost those areas hit hardest by the coronavirus pandemic, including travel, leisure and retail, as well as small and midcap stocks in general.”
One fund in this space the team stuck with through a period of underperformance is the Man GLG UK Income Fund, which has since bounced back.
When it comes to Europe, the Whitechurch team has a neutral view because while the region has “great companies” like Nestlé, they remain concerned about the “dysfunctional” single currency.
“I think there is still unfinished business there,” says Jaffé. “It’s probably a stockpicker’s market, which is a bit of a clichéd thing to say but I think it’s right.”
With Japan, the team struggles with the high volume of government intervention in the market, especially its purchase of equities through exchange-traded funds, which Jaffé terms “strange”. But the asset class’s diversification credentials, as well as its low correlation with other equity markets, means Japanese equities maintain a place in portfolios.
Jaffé considers emerging markets as most attractively valued behind the UK, although, again, he emphasises that bottom-up research is crucial. In China, Alibaba is under similar anti-trust pressures as Facebook over monopolisation, but on the whole he believes the region’s laggard status makes it attractive.
Another big risk Jaffé flags is the twin threat of inflation and deflation. In the short term, he argues the Covid pandemic had a deflationary impact due to its negative influence on economic activity, making short-term, high-quality debt attractive. Yet that was soon offset by the scale of emergency fiscal stimulus.
Index-linked bonds looking more attractive
The team deems government bonds expensive, given the low and, in some cases, negative yields. Corporate bonds have offered slightly more upside but the strategy has been to reduce the position in high yield given that, in many cases, spreads have now returned to pre-Covid levels.
Jaffé highlights the Schroder Sterling Corporate Bond Fund, managed by Jonathan Golan, which was bought about a year ago and has significantly outperformed its peer group since. “In the past six months, the fund’s total return was 11%, almost double that of other comparable corporate bond funds,” he says.
But in a world where central banks have started talking up the merits of inflation, the team predicts index-linked bonds will outperform conventional bonds, provided their breakeven rates are not too high.
“We’ve seen negative nominal bond yields in some cases, and certainly on a real basis yields are negative, so bonds look increasingly expensive,” says Jaffé. “This is why we think index-linked bonds have a role to play.”
In the final quarter of 2020, the team used the proceeds from reducing its corporate bond exposure to increase index-linked exposure by buying the CG Real Return Fund, which has 100% in index-linked bonds, predominantly through Treasury Inflation-Protected Securities.
This fund is managed by the same investment team, headed by Peter Spiller, as the CG Absolute Return Fund bought by Whitechurch early last year, which is a multi-asset long-only portfolio with about 30% in index-linked bonds. This purchase marked the first step in Whitechurch building an inflation hedge.
Property exposure is quite low at 5%. The UK market has been hit hard by Brexit and the lockdowns, causing retail to struggle, but Jaffé says there are growth sectors within property such as industrial and Whitechurch favours managers with exposure to this sector.
Infrastructure also offers diversification and breaks down into individual sub-sectors. Jaffé notes renewables as having been less affected by lockdown compared with assets such as airports.
Overall, with regard to fund selection, Jaffé and the team believe the managers who will perform best in 2021 and beyond will be those with a nuanced, possibly contrarian, approach. “It will not be enough, as it has in the past, to simply follow the trend,” he says. “Nothing lasts forever.”
