Fund tips for 2020

The narrative of recent years has not changed significantly. US equities, and stock markets more generally, have continued to storm ahead even though investors have been worried about a downturn. Large tech companies and other quality growth names led these rises, and remain supported by an environment in which central banks appear reluctant to aggressively raise interest rates. A potential easing of the US/China trade war could also push markets ahead, although it is unlikely that the stellar returns of 2019 will be repeated.

“In 2020, investors can expect a world in which growth is slowing but central banks are accommodative in terms of keeping interest rates low,” notes Rob Morgan, pensions and investments analyst at Charles Stanley. "Markets are anticipating a so-called phase one trade deal between the US and China, which will see the rollback of some existing tariffs on US imports from China. Much of the optimism on next year’s growth and corporate earnings outlook rests on this, but fundamental differences on technology transfer and intellectual property rights may remain unresolved. Markets also seem to be extrapolating the recent slight improvement in growth indicators into a much more robust global growth picture for next year, which creates some downside risk."

The cost of making the wrong decision on big asset allocation calls is high. Avoiding equities in 2019, for example, would have meant missing out on enormous returns. But the gains of the last decade mean that equities and other investments now have a long way to fall if markets run into trouble. 

So, as always, diversification is pertinent. It makes sense to have a good allocation to equity markets offset with diversifying assets, although the balance will depend on factors such as your investment needs and risk appetite. But within this there are short- and long-term trends that you may be able to exploit in the coming year.

UK equities

Having been deeply out of favour with investors because of Brexit-induced uncertainty, UK equities could be on a firmer footing. Prime minister Boris Johnson secured a good parliamentary majority in December’s general election, putting him in a stronger position to take the UK out of the European Union (EU). And the sheer unpopularity of UK equities means that any clarity on this process could greatly boost prices and returns.

“If not totally lifted, then the cloud of uncertainty that overshadowed the UK equity market has diminished markedly following the large Conservative majority in the UK election,” says Rory McPherson, head of investment strategy at Psigma  Investment Management. “Global asset allocators might finally wake up to the fact that the UK equity market is cheaper than its international peers, the fundamentals are improving and it is no longer a market that can be ignored. The very fact that the two biggest stocks in MSCI World index – Microsoft (US:MSFT) and Apple (US:AAPL) – account for [a similar proportion of it as] UK equities highlight just how easy it has been for international asset allocators to ignore this market. So there’s now a compelling case for the re-emergence of interest [in UK equities].”

We suggested buying UK equity funds last year, an asset that has performed well and could have further to go. For example, sectors in which some companies might have been nationalised if there had been a Labour government, such as utilities, have performed well following the election result. 

But Brexit uncertainty and the prospect of market volatility has not gone away. Both sterling and UK equities performed very strongly in the days immediately after the election, but by 17 December these gains fell back when the government indicated that there could still be a no-deal Brexit. The UK’s departure from the EU and conditions beyond this could be rocky and unpredictable.

But if you have a long-term investment horizon and can weather some volatility in the pursuit of good returns, small- and mid-cap companies could be a good choice. These tend to have more domestic exposure than the larger businesses found in the FTSE 100 index, so are sensitive to changes in investor sentiment towards the UK and shifts in the underlying economy. This means that they could benefit from any improvements in the current situation.

For getting exposure to these, James Calder, research director at City Asset Management, favours Merian UK Dynamic Equity (IE00BLP59769), managed by Luke Kerr. This mid-cap biased fund's returns are ahead of the FTSE 250 index and the Investment Association (IA) UK All Companies and UK Smaller Companies fund sector averages over one, three and five years. Merian UK Dynamic can take short positions on equities – bet on their price falling – although its activity on this front was fairly limited at the end of October.

If you want a more straightforward approach a fund we suggested last year, Merian UK Mid Cap (GB00B1XG9482), remains a good option. These two funds have some similarities: six of Merian UK Dynamic’s top 10 holdings were also in Merian UK Mid Cap’s top 10 holdings at the end of October, and the funds have similar sector allocations.

But Merian UK Dynamic may be more nimble because it can take short positions and is a much smaller fund. It levies a performance fee under certain conditions, although it has still delivered better returns after charges than Merian UK Mid Cap.

Income seekers could turn to Royal London UK Equity Income (GB00B3M9JJ78), run by Martin Cholwill. This fund has beaten the IA UK Equity Income sector average over one, three and five years, and offers a historic yield of 4.4 per cent. And, importantly, it should offer a diversified approach to the UK market – a good position in volatile times – while also giving investors exposure to mid caps.

“This fund offers investors a balanced and diversified approach to the UK market via the manager’s [expertise] in mid caps where we believe the prospects for further takeovers by international predators remain high,” says Mr McPherson.

Fiscal stimulus

Economic growth currently looks unlikely to take off rapidly and central banks seem unlikely to aggressively raise interest rates from their low levels. In this environment, bonds and quality growth stocks have performed well. But one factor that could change this is fiscal stimulus and should be considered when you choose funds.

With central banks looking as if they have run out of tools with which to boost economic activity, governments around the world including those in continental Europe, the UK and US, have grown increasingly open to the idea of carrying out public spending programmes. And a fiscal stimulus, if successful, could trigger economic growth and inflation. An inflationary surge could see classic value stocks such as banks and energy companies make a comeback. Although this part of the market has had many false dawns in a decade where growth-style investing has done better, you may still wish to include some value exposure in your portfolio. But be aware that equity funds in your portfolio may already have dipped a toe into the value part of the market during the past year. As we recently discussed, it is worth assessing how your current holdings are positioned in terms of sector exposure and investment style before adding anything new.

“One thing investors may not be giving enough thought to is what will happen if inflation returns, even in a modest way,” explains Simon Evan-Cook, senior multi-asset investment manager at Premier Miton Investors. “With fiscal stimulus back on the cards after a decade on the sidelines, this isn’t a risk that should be dismissed lightly.”

Given how beaten up the market has been, he thinks UK equities funds with a value-style investment approach may be a good way to play this. His favoured picks include Teviot UK Smaller Companies (GB00BF6X2124) and Man GLG Undervalued Assets (GB00BFH3NC99), which has a broader exposure to the market by company size.

So-called real assets such as commodities could be another way to capitalise on a round of fiscal stimulus. Mr Evan-Cook suggests RobecoSAM Smart Materials (LU0869110436).

“Commodities are typically an asset that has fared well when inflation is on the rise, and this fund is correlated with natural resources prices,” he says. “This is because the manager is seeking out companies that are providing more efficient substitutes for natural resources, and as the prices of those resources rise, so should demand for their substitutes.”

Infrastructure is another area that could benefit from fiscal stimulus and, as well as providing strong income and total returns, it can be less correlated to equity markets. One way to access it is Legg Mason RARE Global Infrastructure Income (GB00BZ01WV25), which has exposure to utility companies that could benefit from enhanced spending. This open-ended fund is less expensive than many infrastructure investment trusts whose shares trade on hefty premiums to the value of their underlying assets. But it invests in the shares of companies involved with infrastructure rather than the projects themselves, so could have a higher correlation with equity markets.

Sustainability

Although once viewed as a gimmick by many investors, funds with a focus on issues such as sustainability, governance and environmental issues are now in vogue. Mr Calder believes that because of this shift even mainstream funds without an explicit emphasis on these issues will start to focus on such metrics.

“Environmental, social and governance (ESG) is here to stay,” he says. “I thought it would take five years [before] the majority of funds become ‘ESGable’ but, for example, Schroders recently stated that all their funds would be assessed and [made] compliant [with ESG criteria]. So instead of buying ESG funds the ones we currently [hold] will move in this direction.”

Unlike a few decades ago, ESG approaches and other processes aligned with investor beliefs are no longer viewed as a drag on returns. And with investors increasingly favouring companies that operate in a more sustainable manner, funds that have long focused on these areas could stand to benefit from an uplift in performance.

Mr Morgan says that WHEB Sustainability (GB00B8HPRW47) would interest investors who long for a greener world. The fund looks to identify companies with long-term solutions to sustainability challenges such as the transition to a low-carbon economy. He also believes it can provide access to a new, growing part of the economy, and provide diversification from businesses in the “old economy”.

“The fund is likely to perform best in an environment where trade frictions ratchet down rather than up, thereby paving the way for industrial change and international co-operation on important environmental and social issues, meaning less disruption to global supply chains,” he says.