Last year, the portfolios had an unusually busy year in implementing two key policy shifts: the significant reduction in bond exposure during August and September, having profited from being overweight the asset class since 2009; and the increase in US equity exposure immediately following Trump's election victory - explanations for both being covered in previous columns.
Last month's column ('The year ahead', 13 January 2017) revisited the portfolios' investment principles and reviewed their strategy going forward. The broad sweep of that column touched on many issues. It may therefore help readers to examine in more detail the reasons for a further key policy shift as we enter 2017 - that of increasing the portfolios' UK exposure.
Sentiment and fundamentals
The UK market has had a good run partly in reaction to the pound's weakness post-Brexit and because the Remain camp's Armageddon economic forecasts should we vote to leave the EU have been proved unfounded. Indeed, apologies from major institutions, including the Bank of England and the International Monetary Fund (IMF), have followed figures suggesting the economy is actually doing very well relative to others.
However, in relative terms, over time the UK stock market has in fact been a laggard. Indeed, the MSCI index suggests the UK market is close to its lowest level relative to the rest of the world in sterling terms for nearly 40 years. This has not been a recent phenomenon, but the past five years illustrate the point well: The FTSE All-Share index has risen just 31.5 per cent compared with the FTSE All-World ex-UK index's rise of 76.6 per cent - all figures being to 31 January 2017 and total return.
Evidence elsewhere reflects the mood. Recent Merrill Lynch surveys suggest fund managers are currently at a record 'underweight' of the UK. Expectations are low. A recent survey of more than 20 investment banks and other financial service providers predicted an average 2017 year-end FTSE 100 level of 7015 - suggesting a very lacklustre year! A Sunday Times survey couldn't do much better in coming to an average of 7240. There appears to be a lot of bad news baked into prices.
With sentiment so negative, the UK market could surprise many by the extent to which it catches up in relative terms. One can understand to a certain extent why the pessimists have held sway. The FTSE 100 has an unusually heavy exposure to raw materials, courtesy of BP, Shell and the big miners, at a time that commodities have struggled. But the sector has recently been on the rise, and rightly so.
Meanwhile, despite the Remain camp's erroneous warnings about the immediate outlook for the UK economy following a Leave vote, its concerns about a 'hard' Brexit may also be casting a shadow. This group includes the large US investment houses, which feel vulnerable given their tendency to concentrate overseas staff in London. We should perhaps remember that many in this camp also predicted gloom if we did not join the euro or if we left the ERM.
It is in the EU's interest, given the balance of trade, to agree a deal. If accepted by Parliament, we leave the EU on that basis. If there is no deal or a deal is not accepted, we leave and implement the World Trade Organization (WTO)'s 'most-favoured nation status' terms and tariffs - and trade with the EU on the same basis as many other countries. Time will tell.
What we do know is that the economy is doing well relative to others, growth rates have been revised up and export orders continue to rise. We are seeing foreign internationals continuing to invest in the country. The UK's 'open' economy, rule of law, educated and skilled workforce, low tax regime and balanced labour policies, are just some of its many advantages - and investment is largely about relative advantage. Meanwhile, smaller companies are thriving.
Barclays is forecasting a near-20 per cent increase in UK earnings for 2017 - the biggest improvement of any in its peer group. It would be churlish for the market not to reward such generosity as it unfolded.
Accordingly, given the extent to which sentiment trails fundamentals, all seven of our investment trust portfolios - in both the Investors Chronicle and on the website www.johnbaronportfolios.co.uk - are implementing this policy change where appropriate.
Far Eastern clouds
By contrast, as touched upon in last month's column, markets may be underestimating geopolitical risk elsewhere. Of particular note are events relating to the Far East. China's domestic politics may prove eventful. Meanwhile, its territorial ambitions, especially in the South China Seas, while not new, have been given added poignancy given recent developments. One hopes wise heads prevail. Confrontation remains unlikely, but the risk has certainly increased.
Furthermore, following President Trump's abandoning of the Trans-Pacific Partnership (TPP), markets will certainly need to be watching the extent to which his rhetoric regarding China is translated into action. Negotiating ploy or not, the ramifications of a hardline policy could be profound. Again, while remaining unlikely, the risk of a trade war has increased.
There are always potential 'flashpoints' around the world - Iran, North Korea and the Middle East being examples - but there are also times when the risks increase. It can be the want of mankind to ignore the lessons of history, and investors should be cognisant. While few markets will be immune, those local to the source of trouble usually suffer most.
Portfolio changes
Accordingly, during January, the Growth portfolio sold entirely its holding in Fidelity China Special Situations (FCSS). While remaining positive about China over the long term, it has now become, at least for the moment, a higher risk/reward investment. The sale was made when on a smaller than average discount and presented a near 80 per cent gain since first introducing FCSS to the portfolio in May 2014. Taking profits are seldom the stepping stones to ruin.
Meanwhile, Standard Life Private Equity Trust (SLPE) was top-sliced after a very strong run and marked narrowing of the discount, in part helped by the pound's recent weakness. SLPE has been renamed – from Standard Life European Private Equity (SEP) - after a series of significant investment and dividend proposals were adopted at its recent AGM. The proceeds from both sales funded the introduction of The Merchants Trust (MRCH). Again, more information about both trusts can be found on my website.
Otherwise, there were no changes to the Income portfolio during January.
