Recent market volatility, though long overdue, has understandably rattled many investors’ nerves. Sentiment is cautious at best. At such times, it is important to remember tried-and-tested investment principles. When deciding our portfolios’ strategy, little attention is paid to short-term market ‘noise’. The portfolios contain a blend of strategies and preferences, but the overarching objective is to hold companies that create wealth and add value. The focus remains on the longer term when assessing sentiment and fundamentals, and volatility is therefore seen as an opportunity.
As regular readers know, the portfolios remain invested and seek to add value over time – and, while never complacent, their performance suggests a reasonable record in achieving this. Time spent in the market is considered more important than market timing. This also allows the full harvesting of dividends, which become an increasingly important contributor to total return. This approach continues to guide the eight real investment trust portfolios on the website www.johnbaronportfolios.co.uk – including the two covered by this column.
Last month’s column suggested three investment opportunities – UK smaller companies, Japan and commercial property. This column suggests two more. Again, they have different attributes, but they share one characteristic: sentiment trails fundamentals, so investors tend to be underweight. Such is the opportunity for those willing to see through the short-term volatility.
Commodities
It has been a torrid few years for commodities. An uncertain economic backdrop has seen businesses cut back investment and capacity to reduce debt levels and shore up balance sheets. Yet history suggests commodities in general usually do well when economies globally are entering a period of synchronised growth, particularly after a prolonged downturn – and there is little to suggest this time will be any different. After some high-profile dividend cuts, increases are now back on the table.
Meanwhile, certain elements of the sector are seeing shades of a geopolitical risk premium return. Uncertainty about events in Saudi Arabia, tensions in the Korean peninsula and the threat of new sanctions against Iran, to name but a few, have reminded investors that the sector has distinct qualities. Meanwhile, an output cut agreement between the Organization of the Petroleum Exporting Countries (Opec) and a bellicose Russia, each desperate to raise prices in order to help fund domestic policies, has defied the sceptics – with oil inventories recently hitting a three-year low.
Of course, not all commodities will do well. There will be nuances to consider, including the advent of the electric car and advances in renewable energy. However, the sector should start to pick itself up, especially as growth moves forward and inflation continues to rise. Meanwhile, fund managers – particularly those seeking income – tend to be underweight the sector, despite the outlook for dividends being more positive than it has been for at least five years.
Emerging markets
The consensus view is that emerging markets are ‘riskier’ than most, and there can be little doubt of the many challenges facing a number of countries and some regions. However, investors are tending to underestimate the change in the composition of the markets. A historical reliance on commodities is giving way to the rise of domestic demand, courtesy of urbanisation and a growing middle class.
For example, two of the largest sectors in the MSCI Emerging Markets index are now information technology and financials – both individually larger in size than the energy, materials and industrials sectors combined. This improvement in both diversification and quality of earnings is significant, and yet one which is still not fully recognised by investors. Those investors who have are profitably focusing on the growth of the consumer.
Meanwhile, the many advantages of emerging markets are becoming more apparent. Faster economic growth rates do not always equate to better performing markets, but they usually provide a richer pool from which good fund managers can profitably fish. And emerging markets are attractively rated relative to others. When comparing price/earnings (PE) ratios, whether cyclically-adjusted or not, these markets look cheap historically. Valuations will continue to revert to mean.
Portfolio changes
During February, the portfolios in general selectively increased their equity exposure, courtesy of some realisations and cash reserves. The Growth portfolio top-sliced its holdings in TR Property (TRY) and Chelverton Small Companies Dividend Trust (SDV) and, with the proceeds, introduced Atlantis Japan Growth Fund (AJG) and added to European Assets Trust (EAT).
TRY and SDV have performed well recently and this builds on their impressive longer-term record. The outlook for these sectors remains positive, given they are attractively rated relative to prospects, while offering opportunities to those seeking income. However, both companies were looking a tad expensive relative to recent ranges, which left little room for disappointment in the short term. Furthermore, monies were needed elsewhere.
AJG’s focus is on smaller companies courtesy of a ‘bottom-up’ stock selection approach that embraces propriety research. There has been a noticeable pick-up in performance since Taeko Setaishi took over as lead manager in May 2016, having already established a good reputation in running an open-ended fund, with a similar mandate, over a longer period. Speaking with Taeko in Tokyo recently, she is positive about the outlook for Japanese equities for many of the reasons highlighted in last month’s column.
EAT has been a core holding for some time and has performed well over this period. The company invests in smaller companies on the continent and therefore should particularly benefit if the long overdue economic recovery proves sustainable. It pays a dividend equivalent to 6 per cent of its net asset value as at the end of the preceding year, from both income and capital as necessary. The management believes stock selection should largely be driven by the ability of a business to create value and the entry price paid when acquiring the equity.
Meanwhile, the Income portfolio added to its holding in Aberdeen Smaller Companies Income (ASCI). ASCI seeks to provide a reasonable and growing dividend together with capital growth from a portfolio invested principally in smaller companies, with around 10 per cent of the portfolio invested in UK fixed-income securities – the company’s yield at purchase being 2.7 per cent. Speaking with Jonathan Allison, who took over as lead manager at the beginning of 2016, the equity focus is on good quality companies with sound balance sheets and progressive dividend policies. An 18 per cent discount was harsh given the company’s improving performance.
