Watch the professionals to work out your best next move

Recent history has demonstrated the edge specialists can possess. For example, discretionary fund managers who are multi-asset investment specialists tended to get out of open-ended property funds before the mass gatings of summer 2016, having noticed earlier warning signs that may have eluded investors with fewer resources and time. The majority of discretionary fund managers had also abandoned LF Woodford Equity Income Fund (GB00BLRZQ620) some time before it was suspended from trading in June 2019.

So assessing the current mindset of professional investors can offer clues, but remember that while this can feed into your ideas and provide an indication of broader sentiment, these investors can also make mistakes.

The chart below shows how a combination of multi-asset teams and chief investment officers at a dozen different fund providers are feeling towards some of the main asset classes as we enter 2020.

With more than a decade of growth behind us and a variety of economic challenges, the mixed views on equities are not difficult to understand. But there is an expectation among many that with monetary policy remaining loose equities could continue to muddle on for another year. This, and progress in the US/China trade war, suggest that some equity regions may be worth sticking with or even returning to after a bout of underperformance.

Asset managers, albeit reluctantly, are tending to stick with the US, the dominant equity market of the past two calendar years. Some 40 per cent of the companies in our sample were positive or overweight US equities, with the same proportion taking a neutral position.

This is partly due to the fundamental attraction of this economy. US consumers account for a large part of it and could feel more positive on the back of a recent easing in the trade war with China, while monetary policy is set to remain loose. US companies also tend to stand out versus their rivals around the world in terms of their earnings, which could help to drive markets higher.

The opportunity cost of not backing US stocks also remains high, given the strong returns of recent years and the fact that large tech companies listed on this market have performed extremely well. So think carefully before turning your back on the US or being very underweight this region.

But there are a number of problems associated with this market. The US/China trade war is likely to be a protracted process that could cause further problems for both the US economy and equities. Indices such as the S&P 500 also look vulnerable to any future shocks because prices are so high – this market has already hit a new record high since the start of the year. JPMorgan Asset Management’s multi-asset team has remained positive on the US because of large-cap equities' strong fundamentals, but they acknowledge that high price/earnings ratios are a challenge.

There are also expectations that the US dollar could weaken against other currencies this year. If it weakened versus sterling it could diminish the value of US-based earnings and returns for a UK investor. But it is also notable that, with the US losing some of its lustre, specialists are now looking at other areas that could outperform.

On the rise

The standout equity region in terms of positive sentiment is Japan. Although the Topix, one of its main indices, delivered strong sterling returns in 2019, both Japan’s economy and markets have encountered recent challenges. A new consumption tax triggered a deceleration in the economy late last year, while factors including trade war noises and a strong yen hurt the sterling returns from Japanese equities. As a result, Japan was among the cheapest markets in 2019, suggesting that it might be a good time to get exposure to it, even if this only accounts for a small part of your portfolio. Importantly, there are factors that could drive better performance.

Kristina Hooper, chief global market strategist at asset manager Invesco, argues that the economy could stabilise from the effects of the consumption tax in early 2020 and “modestly reaccelerate” later on.

“The increased tax burden should slow consumption demand, although the impact should be much smaller than what we saw with the 2014 consumption tax increase,” she says. “The Japanese government is likely to initiate accommodative fiscal policy to help counter tax-related headwinds, and we also believe that the Tokyo Olympic Games will increase tourism and help boost economic growth.”

She adds that any significant strengthening in the yen – a drawback for sterling investors – would be likely to prompt Japan’s central bank to take action.

It is also notable how many asset managers are bullish on the prospects for emerging market equities. Any weakness in the dollar tends to provide a boost for emerging markets and the expectation that global economic growth should be steadier this year, and the possibility of a scaling back of US/China tensions, could translate into better times for developing economies. In the longer term, the argument that emerging markets should benefit from a large working population and a growing middle class remains.

However, emerging markets have often been tipped as an outperformer, only to lag other regions. Many analysts expected them to deliver exceptional returns in 2019, only for them to disappoint versus other markets.

European equities, meanwhile, are still deeply out of favour among investors. With Brexit posing a challenge and the European economy looking sluggish, it is difficult to make an optimistic case for the region. But contrarian investors might be drawn here, and there are European equity funds that have made consistent strong returns.

Bonds

In the fixed income space, asset managers are turning sour on higher-quality bonds normally prized for their defensive qualities and are instead turning to riskier but higher-yielding debt.

Nearly two-thirds of the companies in our sample were negative on government bonds, and none of them had a positive view on investment grade debt. This reiterates a dilemma of last year: higher-quality bonds look expensive and yield little, but offer some defence in times of market volatility. It also seems unlikely that central banks will aggressively raise interest rates, suggesting that higher-quality bonds may have a smooth ride for the time being.

So, if you are seeking income and have a higher risk appetite, it is worth considering the riskier ends of the bond market. Emerging market debt in particular performed strongly last year amid strong demand for income. This demand is unlikely to go away, and any improvement in emerging markets economies could boost the appeal of this asset class.

Funds to tap into these views

If you don't want to avoid US equities and believe that this market will continue to benefit from the conditions of recent years, a fund that has capitalised well on prevailing trends, including the success of the large tech names, is Baillie Gifford American (GB0006061963). This is a relatively concentrated fund and its largest holdings include Amazon (US:AMZN), Netflix (US:NFLX), Alphabet (US:GOOGL) and Facebook (US:FB), and it has outperformed all the funds in its Investment Association (IA) North America sector over three and five years. However, this fund could face tough times ahead because the big tech companies could run into regulatory issues and its growth investment style could struggle after such a successful decade. So if you hold this fund consider having alongside it exposure to different investment styles, companies and markets.

A simpler approach is to use an S&P 500 tracker such as Fidelity Index US (GB00BJS8SH10). This is cheaper and offers a broader approach, but also has hefty exposure to tech and growth names.

A Japan equities fund that continues to stand out is Legg Mason IF Japan Equity (GB00B8JYLC77). The fund is one of the best performers in the IA Japan sector over various time periods – for example, over 10 years it has returned 720 per cent, while the next best performer is far behind, with a return of 241 per cent.

The fund’s manager, Hideo Shiozumi, focuses on stocks with extremely high growth potential, often lower down the market cap scale. Although the fund's returns have been extremely impressive, it is not for the faint-hearted. The fund can be highly volatile, and over shorter-term periods may endure big falls.

A less racy alternative that offers less phenomenal returns, but gives investors a smoother ride is JPM Japan (GB00B235RG08). 

For emerging market equities exposure it is a good idea to pick a fund with a proven track record in a difficult asset class. BlackRock Emerging Markets (GB00B4R9F681) has been among the best performers in its sector over one, three and five years. The fund should be relatively nimble with assets of just £353m, and it has a stake in some of the region's leading companies and markets. At the end of December, its 10 largest holdings included leading emerging market companies such as Alibaba (US:BABA), but the fund also deviated from its benchmark, MSCI Emerging Markets Index, with an overweight position in mid-cap stocks. 

A good way to access Europe's promising companies without being too exposed to external factors is to invest in a fund where the managers select holdings according to their own merits – rather than according to geographic or sector considerations. Funds that take this approach and have outperformed include Miton European Opportunities (GB00BZ2K2M84).

For fixed income, investors with a higher risk tolerance and a desire for yield could consider M&G Emerging Markets Bond (GB00B4TL2D89). The fund looks attractive in terms of both its yield and total returns, and takes a flexible approach that should continue to work well with an unpredictable asset class. The fund can invest in both emerging market debt issued in the local currency and emerging market debt issued in an established currency such as the US dollar.