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Fund tips for 2016: the results

The Big Theme

At the end of 2015 we selected four areas we believed would perform well during the year ahead - Europe, Japan, Emerging markets and Asia ex-Japan and wealth preservation. And despite the market reaction to a number of surprises including the UK's vote for Brexit and the election of Donald Trump as US president, Japanese, European and emerging market equities all surged, as instead of hitting new lows, markets rebuffed the newsflow to maintain stellar performance.

The three regional markets we selected all posted double-digit returns and performed far better on average than the FTSE 100 and FTSE All-Share. The funds we tipped also returned an average of 18.3 per cent over one year to 28 December 2016, easily beating the FTSE All-Share index's 15.4 per cent.

 

Japan

Last year Japanese equities looked as though they could continue to rise, fuelled by a weak yen and central bank easing. Although stocks did not perform as well as hoped, the funds we tipped in this area are the top performers of our selection, both posting returns above 30 per cent. Baillie Gifford Japanese (GB0006011133) is up 36.5 per cent and CF Morant Wright Nippon Yield (GB00B2R83B20) is up 34.9 per cent over one year to 28 December 2016, against 27.5 per cent for the TSE Topix and the Investment Association (IA) Japan sector average of 28.1 per cent.

In December 2015 Japan was a consensus pick among analysts and commentators, who predicted that prime minister Shinzo Abe's three 'arrows' of reform, including fiscal stimulus, monetary easing and corporate governance efforts, would create a fertile ground for market rises.

Almost four years after so-called Abenomics began, sterling investors have made 80 per cent more investing in Japan than they did during the previous four years, according to Chelsea Financial Services. Between 26 December 2008 and 2012, the Topix returned just 5.29 per cent. Between 26 December 2012 and 12 December 2016 the same index has returned 84.7 per cent. Japan's favourable exchange rate and structural changes to corporate governance have served investors well.

We chose Baillie Gifford Japanese because it is large and well-run by Sarah Whitley, who also manages IC Top 100 Fund Baillie Gifford Japan (BGFD). Ms Whitley seeks out businesses with strong balance sheets and competitive advantages, and says that there are a raft of these quality businesses in the market trading at significant discounts to their peers on the global market, where quality growth businesses often are on a high premium.

Over five years to 28 December 2016 the fund has returned 137 per cent against 97.4 per cent for its benchmark.

Its largest holdings are SoftBank (JP:99854), which accounts for 4.2 per cent of assets, and Sumitomo Mitsui Trust (JP:8309), which accounts for 4 per cent. Over the past year Ms Whitley has been focused on the growth in online retail and financial services in Japan, through holdings such as e-commerce company Rakuten (JP:4755). The fund is also exposed to robotics, which Ms Whitley feels is a growth area.

CF Morant Wright Nippon Yield aims to tap into what many perceive as the most important trend in the Japanese market - a growing dividend culture among corporates. Historically, Japanese companies hoarded cash on their balance sheets, but more recently they have been making payouts to shareholders and taking corporate governance seriously. Dividends rose by 36.7 per cent in the third quarter of 2016 alone in Japan, although that figure was inflated by a weak yen, and over 95 per cent of listed Japanese companies have an independent director compared with under 50 per cent five years ago.

CF Morant Wright Nippon Yield looks for undervalued companies and is more focused on mid- and small-cap stocks than its peers, with 41.3 per cent of its portfolio in medium-sized companies and 27.9 per cent in small-caps. It remains nimble due to its smaller than average size - £360.9m - and has paid out consistent income. It yields 2.5 per cent.

 

Europe

2016 was a year of two halves for European equities. In the first half of the year defensive, high-quality, bond-like stocks were outperforming, but following the UK's vote to leave the European Union a dramatic rotation occurred. By the end of 2016 the least loved financial and cyclical stocks had soared to the top of the pile and one of our fund tips significantly benefited.

We chose two very different funds for European equities and they performed differently to each other at different times of the year.

Schroder European Alpha Income (GB00B7FHV230) is run by James Sym and uses a business cycle investment philosophy, which attempts to shift between seven categories of stock based on which the market is favouring at a particular time. The fund has outperformed both its peer group average and benchmark, returning 23.8 per cent over one year, and also beat them over three years. At the start of the year, the fund's performance was dented by taking an early overweight position in cyclical and financial stocks, while the wider market continued to favour expensive bond-like, defensive stocks. However, following the Brexit vote, that trade came good. Cyclical stocks recovered in the latter half of 2016, with bank stocks leading the rally, and Schroder European Alpha Income benefited from that rotation.

The fund has no exposure to what it terms "archetypal bond proxies" such as Nestlé (SH:NESN), Anheuser-Busch (BE:ABI), Danone (FR:DAN) and Pernod Ricard (FR:RI), which are trading at high valuations, something that has also contributed meaningfully to performance as bond yields have risen as these stocks have derated.

Jupiter European (GB00B5STJW84) favours the kind of steady, high-quality larger companies that lagged at the end of 2016, but this fund has one of the best long-term track records of those focused on this region. The fund is a high-conviction basket of European equities, and has a bias towards larger companies with sustainable earnings streams and high barriers to entry. Those characteristics have not been in favour in recent months, but have performed strongly in recent years. Jupiter European has returned 170.2 per cent over 10 years compared with the IA Europe ex UK sector average of 73.2 per cent.

The fund is managed by industry stalwart Alex Darwall, who likes alternative finance companies including Deutsche Börse (DE:DB1X) and Provident Financial (PFG). Mr Darwall looks for companies likely to benefit from technological disruption or changing consumer habits, and during the past year invested in Continental (DE:CONX), a German car supplier and tyremaker, which he believes will benefit from disruption to the car market from electric power.

Jupiter European has been volatile due to its high concentration in a small number of stocks, just 38 currently, and Mr Darwall has an unconstrained mandate and veers far from his benchmark. However, this has earned him solid results over the long term.

 

Emerging markets and Asian equities

We predicted that emerging markets would experience a reversal in fortune last year due to the depth of gloom surrounding them in 2015, and we were right. Emerging markets were the turnaround story of the year, propelled to the top of the pile on a wave of political change, a hunt for yield and an uptick in commodity prices - among other factors. Over the year to 28 December 2016 MSCI Emerging Markets index rose 32.9 per cent in sterling terms.

Newton Global Emerging Markets (GB00BVRZK937) is one of the more cautious emerging markets equity funds and takes less risky bets on high-risk areas such as financials. Those areas surged in 2016 and, as a result, the fund has slightly lagged the benchmark over one year, returning 21.2 per cent. Chinese banks rallied last year, but Newton Global Emerging Market's manager, Rob Marshall-Lee, steers clear of these because he thinks they are vulnerable to a correction due to the size of China's debt.

He also chose not to invest in Brazil, which was among the top-performing markets in 2016 following the impeachment of former president Dilma Rousseff, preferring to invest in companies that demonstrate a good return on capital and sustainable growth.

Mr Marshall-Lee uses macroeconomic themes to determine which stocks to invest in, together with a rigorous bottom-up analysis in order to buy quality stocks at good valuations. He is currently most overweight consumer discretionary and healthcare stocks, while 30.3 per cent of the fund's assets are invested in India.

Over three and five years he has easily beaten both his peer group average and MSCI Emerging Markets index.

Asia Pacific equities were also stellar performers throughout the year and our tip, Pacific Assets Trust (PAC), outperformed its benchmark. Over one year to 28 December 2016 MSCI AC Asia ex Japan index is up 26.4 per cent, the Association of Investment Companies Asia Pacific ex Japan sector average is up 25.5 per cent and Pacific Assets Trust is up 27.2 per cent.

That is impressive considering that the trust's managers were cautious during the year and the trust did not take part in the more aggressive parts of the rally across Asia Pacific equities. Instead of opting for cheaper, unloved shares its managers paid premiums for stocks they believed were quality businesses. Like Mr Marshall-Lee, Pacific Assets' managers are confident in the outlook for Indian stocks and their holdings include pharmaceutical company Dr Reddy's Laboratories (DDRREDDY:NSI).

Pacific Assets invests in companies based in Asia Pacific and the Indian subcontinent, excluding Japan, Australia and New Zealand.

 

Downside mitigation

We predicted in December 2015 that the new year would be volatile and suggested that a good way to mitigate those uncertainties would be to invest in funds designed to protect your capital. In fact markets have soared, but the popularity of capital preservation funds was undeniable - targeted-return funds were the most popular funds in 70 per cent of the months of 2016, according to wealth manager Tilney Bestinvest.

We tipped Henderson UK Absolute Return (GB00B5KKCX12) and Standard Life Investment GARS (GB00B7K3T226).

Henderson UK Absolute Return aims to deliver positive returns over a rolling 12-month period in all market conditions and has returned 1.5 per cent over one year. The fund takes both long and short positions in stocks to take a market-agnostic view on individual stock outcomes. Two-thirds of the fund's portfolio is in shorter-term tactical ideas where its managers believe the market has underrated stocks with potential earnings upside, while the rest of the portfolio is invested in long-term core holdings.

Standard Life Investment GARS performed less well, losing 3 per cent over the year to 28 December 2016. Recent issues for performance include the outperformance of small-cap US equities against large ones, the impact of rising bond yields on the fund's position in relation to Australian interest rates, and its bets on UK and German rate rises.

 

Performance and ongoing charges of 2016 fund tips

JAPAN 1-year total return (%) 3-year cumulative total return (%) 5-year cumulative total return (%)  10-year cumulative total return (%)  Ongoing charge (%)
CF Morant Wright Nippon Yield 34.970.5123.01.2
Baillie Gifford Japanese 36.552.1137.0133.00.7
IA Japan sector average 28.147.896.368.9
TSE Topix index27.551.897.480.2
EUROPE1-year total return (%)3-year cumulative total return (%)5-year cumulative total return (%)10-year cumulative total return (%)Ongoing charge (%)
Schroder European Alpha Income23.839.31.68
Jupiter European 5.432.4107.5170.21.78
IA Europe Ex UK sector average16.625.289.473.2
FTSE World Europe ex UK index3.621.181.731.8
EMERGING MARKETS1-year total return (%)3-year cumulative total return (%)5-year cumulative total return (%) 10-year cumulative total return (%) Ongoing charge (%)
Newton Global Emerging Markets 21.231.966.71.03
IA Global Emerging Markets sector average29.120.731.374.5
MSCI Emerging Markets index32.923.833.590.4
ASIA PACIFIC 1-year share price return (%)3-year cumulative share-price return (%)5-year cumulative share-price return (%) 10-year cumulative share-price return (%) Ongoing charge (%)
Pacific Assets 27.261.4133.4200.21.33
AIC Asia Pacific ex Japan sector average26.431.768.1189.3
MSCI AC Asia ex Japan index25.533.558.0128.0
TARGETED ABSOLUTE RETURN1-year total return (%)3-year cumulative total return (%)5-year cumulative total return (%) 10-year cumulative total return (%) Ongoing charge (%)
Henderson UK Absolute Return 1.513.337.11.69
SLI Global Absolute Return Strategies -3.05.321.21.31
IA Targeted Absolute Return sector average0.15.816.038.2
Libor GBP 6 Months 0.72.03.820.4

Source: FE Analytics, as at 28.12.16

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By Kate Beioley ,
05 January 2017

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