Fund tips 2017 review: one-year's progress

But while good performance over a year is pleasing, funds focused on risk assets such as equities and bonds should be held for at least five years to ride out volatility and allow their assets time to grow.

Japan in the lead

The fund that enjoyed the strongest return was Baillie Gifford Shin Nippon (BGS), which made 54.6 per cent – more than double the return of MSCI Japan Small Cap index over that period. The trust also has a very good long-term record and is well ahead of this index over three and five years, although this is not all attributable to its current manager, as he was appointed relatively recently.

Praveen Kumar became lead manager of this trust and Baillie Gifford Japanese Smaller Companies Fund (GB0006014921) in December 2015. After slightly lagging MSCI Japan Small Cap index in 2016, albeit with double-digit net asset value (NAV) and share price returns of 22.4 per cent and 24.5 per cent, respectively, the trust is well ahead over 2017.

This is partly because Mr Kumar is not new to what he does: after joining Baillie Gifford in 2008 he became part of the Japanese equities team as an investment manager in 2011. Baillie Gifford also emphasises that its funds are run via a team approach and its Japan team has delivered some excellent returns over the years.

These include the second-best performing fund in our tips for 2017 selection – Baillie Gifford Japan Trust (BGFD) – which over the past year has made a return of nearly 44 per cent. Both it and Baillie Gifford Shin Nippon have benefited from a positive economic and market backdrop with the fiscal stimulus, quantitative easing and structural reform that Japan's Prime Minister, Shinzo Abe, initiated in 2013 really starting to bear fruit. And Mr Abe's election win last October should allow him to continue these policies.

Markets also did well as companies benefited from record-low interest rates and high cash balances, with an increasing number of them choosing to return this as capital to shareholders through dividends and share buybacks, as policies to improve corporate culture take hold. These are some of the reasons why Japan funds are also among our tips for 2018.

But Baillie Gifford Japan Trust and Baillie Gifford Shin Nippon's returns were also driven by their managers' stock selection and gearing – the ability to take on debt. Both trusts were well ahead of their sector peers and benchmarks in terms of their NAV returns.

However, the future for Baillie Gifford Japan Trust is less certain as in October its board announced that its manager, Sarah Whitley, who has run it since 1991, is to retire at the end of April. The trust has made very strong returns while she has been lead manager: between 30 September 1991 and 31 August 2017 Baillie Gifford Japan Trust's NAV increased 545 per cent compared to the Topix index's return in sterling terms of 156 per cent, according to the trust's board.

>Funds focused on risk assets such as equities and bonds should be held for at least five years to ride out volatility and allow their assets time to grow

Baillie Gifford has appointed Matthew Brett as lead manager of Baillie Gifford Japan Trust and Mr Kumar as deputy manager from the end of April. The trust's board says that Ms Whitley will work with Mr Brett and Mr Kumar up until she leaves to ensure a smooth transition.

Mr Brett is fairly experienced: he joined Baillie Gifford in 2003 and since June 2008 he has been co-manager of Baillie Gifford Japanese Fund (GB0006011133) alongside Ms Whitley, as well as attending the trust's board meetings. He is also co-manager of Baillie Gifford Japanese Income Growth (GB00BYZJQG71) and part of the investment team that runs Baillie Gifford Global Select (GB00BYNK7G95).

Research company FE Trustnet says that Mr Brett has overall performed better than his peer group composite and that "over a long track record, the manager has outperformed the peer group more often than not. Good stockpicking has had a material positive impact on results, which have tended to be similar in rising and falling markets". He is well ahead of his peer group composite over one, three, five and seven years.

Views are mixed on whether Baillie Gifford Japan Trust can continue to do well, though. Analysts at Winterflood say the trust's investment "approach has undoubtedly been team-based, with investment ideas generated from a number of sources including other areas of the firm. We rate Matthew Brett and Baillie Gifford's wider Japan team highly and would not expect the investment approach to change materially as a result of Sarah Whitley's retirement".

And analysts at Numis say: "Sarah Whitley's track record during her 37 years at Baillie Gifford is impressive, but investors should not be concerned by her retirement. There is an emphasis on a team-based approach to idea generation, and crucially there will be no change in approach. We believe the trust remains an attractive core holding for exposure to Japan. Reflecting the strong long-term performance record the trust has typically traded on a premium in recent years. However, there could be some pressure on the size of this premium following the announcement [of Ms Whitley's retirement]."

Baillie Gifford Japan Trust is trading on a premium to NAV of around 6 per cent.

But Anthony Stern, analyst at Stifel, says: "While the change is being managed carefully, there is clearly the risk that the trust's future performance will not match its strong track record under the departing manager, and there is also the possibility that long-term backers of Sarah Whitley may seek to exit the trust. The trust could be exposed to a discount de-rating should this materialise. Sarah Whitley has been a key portfolio manager in the team for many years and her experience as well as decision making is a significant loss."

>Markets also did well as companies benefited from record-low interest rates and high cash balances

While Baillie Gifford's team seems to have a good process and so far the transition to a new manager at Baillie Gifford Shin Nippon has been successful, it will be important to monitor both these trusts – especially after the end of April next year in the case of Baillie Gifford Japan – looking at details including performance, premium/discount to NAV and portfolio composition. Baillie Gifford Japan Trust is one of our IC Top 100 Funds so we will provide regular updates on it.

US in the rear

The funds that did least well over the past year were our two US selections, Schroder US Mid-Cap (GB00B7LDLV43) and iShares S&P SmallCap 600 UCITS ETF (ISP6), but over three and five years they have made much stronger returns. 

iShares S&P SmallCap 600 UCITS ETF has not beaten the index it tracks over one, three or five years, but exchange traded funds (ETFs) do not necessarily outperform the indices they look to replicate. Even if they track them closely their costs, albeit low, can mean they return less than the index.

Schroder US Mid-Cap has underperformed its benchmark, the Russell 2500 index, in part because stock selection in the third quarter of 2017 detracted, with producer durables, healthcare and consumer discretionary the largest laggards. Much of the underperformance in producer durables was due to its holdings in the aerospace and air transport industries. And its healthcare holdings lagged because the fund was underweight biotechnology, which surged over 13 per cent in the third quarter. Schroder US Mid-Cap's average cash position of 7.5 per cent also detracted from returns.

But over longer periods such as three and five years Schroder US Mid-Cap has beaten its benchmark. And, as with all our fund suggestions, although we label them as tips for a given year, if you put your money into them you should hold them for the long term – five years plus. This is especially the case with higher risk and volatile areas such as smaller and mid-cap companies.

Smaller companies can be less liquid than larger companies, so funds focused on the former may experience greater price swings than funds focused on larger companies. Schroder US Mid-Cap's returns have varied quite drastically from calendar year to calendar year, although this still stacks up to outperformance over the long term and in most years its returns are positive.

Performance of 2017 fund tips of the year