Funds to hold alongside Fundsmith Equity and Scottish Mortgage

You are probably more than familiar with the selling points behind some of the most popular global funds. Fundsmith Equity (GB00B41YBW71), Scottish Mortgage Investment Trust (SMT), Lindsell Train Global Equity (IE00BJSPMJ28) and Rathbone Global Opportunities (GB00BH0P2M97) have made extremely strong returns over the past decade, explaining the frequency with which they appear in portfolios.

There are plenty of important differences between the four. Scottish Mortgage has the biggest focus on Chinese stocks (see 'The China dilemma', IC 24.09.21) and may have a higher risk/reward level than the likes of Fundsmith Equity. Lindsell Train Global Equity's managers, meanwhile, have a greater focus on Japan and little interest in the tech space – something that has hurt performance this year (see 'Explaining Lindsell Train's underperformance', IC, 20.08.21).

Yet very broadly speaking, these are funds with a heavy bias to quality and growth stocks, often with a reliance on certain leading sectors. So you might want to consider whether you can diversify your equity exposure using other funds.

Going global

Some global funds take a notably different approach to the most popular names and could complement the funds mentioned above. The differentiation they offer can take a variety of forms.

One obvious complementary holding would be a value fund. While these portfolios have had a rough decade, they might act as a safeguard if cyclical assets have a sustained comeback. As the chart shows, recent performance has been strong but the picture looks somewhat bleaker over five years.

Rob Morgan, chief analyst at Charles Stanley, highlights Ninety One Global Special Situations (GB00B29KP10). He describes it as "a classic value fund looking for businesses with earnings recovery or rerating potential, trading at a significant discount to their estimate of intrinsic value”.

The fund is relatively concentrated with 41 holdings at the end of September and around a quarter of its assets in financials. Around half of the fund was in US equities at the time, with roughly a quarter in the UK, 17.6 per cent in Europe and 10.3 per cent in emerging markets.

It is important to check that value funds have not succumbed to so-called “style drift” – when their managers adopt a different investment approach to limit underperformance (see 'Mind the market shift by paying attention to style drift', IC, 22.11.19). As part of this due diligence, it can also be useful to see which value funds have benefited from the recent cyclical rally and Ninety One Global Special Situations has done well in this respect. As of 21 October, it was the top generalist global equity fund by one-year performance, with a sterling total return of 48 per cent. Another value fund, Schroder Global Recovery (GB00BYRJXP30), was close behind.

Morgan also highlights AVI Global Trust (AGT), another strong performer from the past year that takes a distinct approach from its peers. This trust focuses on picking up “mispriced assets” via stakes in family-controlled holding companies and certain other closed-ended funds. The fund has a big focus on Japan which made up more than a quarter of its assets at the end of August, with a “Japanese special situations” basket of 16 stocks making up 16.7 per cent of its assets.

The trust is likely to have investments not found in other funds so provides an element of differentiation. It can also hold closed-ended funds that private investors may find difficult to access. These include Oakley Capital Investments (OCI), a top 10 holding at the end of August which is listed on the Specialist Fund Segment.

The most popular global funds tend to focus on large companies and aim for total returns. So one way to diversify could be an income fund such as M&G Global Dividend (GB00B39R2P18). It takes a relatively practical approach, favouring companies with the potential to grow dividends over the long term rather than simply backing high-yielding names. The fund diversifies across sectors though has a relatively limited number of stocks.

M&G Global Dividend has a relatively modest 12-month yield of about 2.76 per cent, probably because of its focus on dividend growth and chunky allocation to the US – a common feature of many global equity income funds. But this should not detract from its merits as a complementary addition to the most widely held global funds.

A global smaller companies fund could also help to diversify a holding in a better-known, large-cap oriented global equities fund. Adrian Lowcock, an independent investment specialist, makes the case for ASI Global Smaller Companies (GB00BBX46522). “The team are very experienced and run a well-established and disciplined approach considering growth, momentum, quality and valuation factors to identify ideas,” he says. “They look for proven, sustainable business models and recurring revenues.”

Regional benefits

It doesn’t necessarily require another global fund to diversify away from the most established names. And pairing up too many global funds might risk an element of overlap – even if the funds in question take broadly different investment approaches to each other.

Instead, you could add regional funds. For a value investment approach, Lowcock suggests Man GLG Undervalued Assets (GB00BFH3NC99), a popular UK equity name run by Henry Dixon and Jack Barrat. They look for companies whose profits are not fully appreciated. Lowcock says that they are a disciplined team with a good approach for pulling out of so-called value traps – important features when investing in this type of fund.

UK funds may again stand out if you wish to diversify with equity income portfolios. There is a broad range of UK equity income funds on offer but Lowcock favours Threadneedle UK Equity Income (GB00BDZYJV10). He rates its manager Richard Colwell's flexible approach, which involves holding both income and growth stories, while also backing a mixture of high-quality businesses and unloved companies with potential for higher dividends in the longer term.

Alex Brandreth, chief investment officer at Luna Investment Management, remains a fan of the value trade as bond yields move up and interest rate rises appear more likely. He also believes that the UK continues to look attractively priced. So he favours Aberdeen Standard Equity Income Trust (ASEI), a name that has seen its share price discount to net asset value (NAV) widen in recent weeks. It also had a tempting dividend yield of close to 6 per cent on 21 October.

Regional value plays are not restricted to the UK. Lowcock suggests Lazard Emerging Markets (GB00B24F1G74) whose investment team seeks companies with above-average earnings but which trade at below-average share prices. This approach has led to the fund being underweight in Chinese equities which detracted from its performance until fairly recently.

Europe has also tended to be a good hunting ground for value investors given its heavy exposure to sectors such as banking. One well-regarded fund focused on this area is LF Lightman European (GB00BGPFJN79) which has racked up huge gains in the past year.