In the wake of voters returning a hung parliament in the UK general election and geopolitical uncertainty broadly expected to continue for the year ahead, FE, the leading UK investment ratings and research agency, has collated investment views from the 2017 winning FE Alpha Managers. The managers comment on the challenges and opportunities they foresee in delivering alpha in the next 12 months, how bullishly or bearishly they are positioning their portfolios and prospects for their respective asset class or sector.
Many of the winning FE Alpha Managers agree that unpredictable macroeconomic shocks will be the biggest risk to alpha generation. FE Alpha Manager of the Year, Alex Wright of Fidelity suggests that: “2016 should serve as a reminder to us all that proper diversification is the only defence against the unexpected.” However, as Ben Leyland of J O Hambro Capital Management remarks: “active managers will find it far easier to deliver relative performance when market volatility picks up, valuations fall, and dispersion of valuations across the market rises.”
Oliver Clarke-Williams, portfolio analyst, FE Fund Research said: “It has been an eventful 12 months both politically and economically, yet the effects of these events have yet to be felt as markets remain at record highs and stock market volatility is at 20 year lows. The prediction of market routs after the Brexit referendum, a Trump Presidency and a hung parliament in the UK have not come close to realisation. Will voters’ chickens finally come home to roost over the next 12 months?
“We believe markets will continue to be extremely difficult to predict and are therefore looking for managers who are prepared to have the courage of their convictions and will not be spooked by short term market events - those who are constantly reacting to every Trump Tweet or Theresa May speech will likely do more harm than good.”
A mixture of Bulls and Bears
Ben Leyland, J O Hambro Capital Management (BEST GLOBAL EQUITIES FE ALPHA MANAGER): “We have been fairly cautious for some time and our trepidation has increased over the past twelve months. We see a market full of stretched valuations and high levels of corporate leverage. These are two key warning signs, as is the level of complacency in markets, as illustrated by the VIX index. In that context we think it is prudent to run lower than average position sizes and maintain a cash balance in the fund, to protect capital and take advantage of a future pick up in volatility.”
James Salter, Polar Capital (BEST FE ALPHA MANAGER IN A BULL MARKET): “While the portfolio still has a positive slant (especially in financials) our overweight in Japanese exporters, especially tech related areas, is much lower than in previous years. Given a likely slowdown in auto demand in the two biggest end markets and stretched valuations in technology names we are now underweight these areas.
Richard Woolnough, M&G (BEST STRATEGIC BOND FE ALPHA MANAGER): “In my view, we are entering a period of normalisation: growth and inflation are back and central banks are adjusting their policies accordingly. We have been positioning the fund for this: short duration, and cautious on market segments that have been distorted by central bank intervention. I am still positive on credit risk, and increased the fund’s spread duration to 6.4 years in May – investment grade credit exposure currently stands just short of 60%.”
Gary Greenberg, Hermes Investment Management (BEST EMERGING MARKETS FE ALPHA MANAGER): “We are moderately bullish; emerging markets are performing well and we don't see severe problems arising in the short term.”
Alex Wright, Fidelity (FE APLHA MANAGER OF THE YEAR): “Although in general, there is still a large gap in valuations between cyclical and defensive stocks, the picture is more nuanced than it was 12 months ago, and stockpicking opportunities have become available in some classically defensive sectors, such as healthcare, telecoms and even tobacco. However, the defensive companies I am finding attractive have esoteric features which has led to them becoming unloved in the market and therefore trading at inexpensive valuations. I welcome this opportunity to give my portfolios a more balanced exposure.”
Steven Andrew, M&G (BEST MULTI ASSET FE ALPHA MANAGER): “Rather than considering our portfolios as bullish or bearish, I would rather say my outlook is broadly pro-growth. We are experiencing a synchronised improvement in economic growth around the world, as supported by a whole range of economic and corporate data, such as GDP numbers, purchasing managers’ surveys and upward earnings revisions.”
Michael Della Vedova, T. Rowe Price (BEST FIXED INCOME FE ALPHA MANAGER): “The high yield market is credit based. Both the greatest risks and long term gains are derived from idiosyncratic credit performance. Tactical positioning or a short-term focus of bullish or bearish positioning can distract from a portfolio built to capture mid to long term strategic value based on fundamental bottom up analysis. This basis of our investment approach not only refers to identifying the credit performers, but also avoiding the losers.”
Macro and geopolitical risks and valuations among biggest challenges to delivering alpha
Richard Woolnough, M&G: I expect US and UK politics to remain key in 2017, while Europe’s heavy political calendar is also continuing to influence markets. The biggest danger is President Trump’s unpredictability – something that markets are still getting used to. Trump’s planned tax reforms and policies to encourage corporate repatriation of funds should prove supportive for US corporate bond markets. However, as we have seen in recent weeks, the so-called ‘Trump trade’ has been losing momentum, while risky assets have been supported by the newer ‘Macron trade’.”
Michael Della Vedova, T. Rowe Price: “The biggest risks largely lie outside the market and are macro and geopolitical in nature (Trump, China, Korean peninsula to name a few). Moreover, the ECB remains supportive and growth in Europe although low is positive without adverse inflationary pressures. Specific to credit, we are not seeing aggressive financial engineering or leveraging activity in the market. It is easy to be distracted by the short-term focus or trends that can be reactionary and this is why we believe a commitment to a proven fundamental process is key to meet this challenge.”
Ben Leyland, J O Hambro Capital Management: “The biggest challenge to delivering absolute performance, on a medium-term view, is starting valuations. The biggest challenge to delivering relative performance in the next 12 months is that markets continue to be driven upwards by inflows to passive vehicles. By definition these are price-insensitive, indiscriminate buyers, and their dominance has made it very difficult for disciplined active managers to distinguish themselves. Active managers have to decide whether to keep chasing a rising market or step away and wait for better opportunities to present themselves.”
Gary Greenberg, Hermes: “Global investors jumping on the GEM bandwagon could take valuations beyond sustainable levels. Emerging chaos in US politics could spark contagion globally.”
James Salter, Polar Capital: “The biggest challenge for us as bottom up stock pickers will likely be a return to a period where investors are willing to pay up substantially for the yield and perceived safety of bond proxies. Another key issue could be any unpredictable macroeconomic shocks that causes the Yen to strengthen materially. In the short term a volatile Yen exchange rate drowns out strong longer term company fundamentals as investors focus too much on the currency impact to short term earnings guidance. This usually creates great opportunities for longer term investments.”
Steven Andrew, M&G: “As always, the biggest challenge would be if the valuation signals I have identified become outweighed by investors’ emotional reactions to, for example, political events or newsflow. While this could be challenging, this sort of circumstance can be part of the territory when your investment approach depends on identifying when prices have moved in an irrational manner.
Opportunities for delivering alpha in the year ahead
Michael Della Vedova, T.Rowe Price: “We view the market as relatively stable. The largest threats are macro and geopolitical, and will cause spikes in volatility but the exact trigger is unknown. Remaining focused on fundamentals during this time is crucial, and this approach will allow the strategy to take advantage of volatility – buying credits we favour at cheaper levels. Some investors focus only on technical outputs of the market such as duration while not placing enough emphasis on the coupon. The yield cushion can help buffer against volatility and is often the overlooked element of high yield securities that will deliver the returns for 2017.”
Richard Woolnough, M&G: “In financials, I am particularly finding opportunities further down the capital structure in the Lower Tier 2 and subordinated debt space. I have been selectively adding exposure in recent months, particularly from the US and Europe. French financials in particular have been attractive so far this year, having been impacted by uncertainty in the run-up to presidential elections.”
Ben Leyland, J O Hambro Capital Management: Active managers will find it far easier to deliver relative performance when market volatility picks up, valuations fall, and in particular, dispersion of valuations across the market rises. These will provide opportunities for patient, selective, benchmark-agnostic stock-pickers to thrive. Whether this happens in the next twelve months is unclear.”
Gary Greenberg, Hermes: “Taiwanese optoelectronics, Brazilian pulp and paper, Indian cyclicals, Russian consumer plays”.
Steven Andrew, M&G: “At the moment, my assessment of the relative valuations of different asset classes leads me to favour equities over bonds. The areas of the equity market that offer a combination of robust growth characteristics and attractive valuations include US banks and technology stocks, as well as the markets of Korea, Taiwan, Europe and the UK. However, I also have meaningful exposure to government bonds in peripheral Europe and emerging markets, where the yields on offer are more attractive than those provided by, for example, German government bonds.”
James Salter, Polar Capital: “The biggest opportunity for us is likely presented by our large underweight in more expensive areas of the market including tech, healthcare and consumer staples. A shift towards value, especially within smaller companies, will be favourable for our portfolio.”
Asset class and sector prospects for the year ahead
On the main drivers of the bond market this year, Michael Della Vedova, T.Rowe Price, comments: “Volatility has been relatively low across markets with a higher degree of complacency, particularly given outstanding global geopolitical and policy risks. The US is implementing a tightening policy, albeit slow and deliberate, while the ECB is still market supportive. This complex macro backdrop combined with fixed income markets that have enjoyed a multi-year run make credit research critical.”
Commenting on the regions likely to drive returns in the year ahead, Ben Leyland, J O Hambro Capital Management, said: “Equity markets are currently dominated by top-down perspectives expressed through passive vehicles, which is why perceptions of macro-level political risk are the most important factor driving most share prices. We think it is far better for medium-term investors to measure risk with reference to economic exposure rather than listing venue. It has become fashionable to argue that US equities are significantly more expensive than elsewhere, but we see little evidence of this when looking at comparable stocks listed in different parts of the world. Unfortunately, the rally in European and emerging markets equities year to date leaves them looking just as expensive as their US counterparts.”
Commenting on whether the rally in emerging markets reached its high, Gary Greenberg, Hermes, said: “Not yet. Valuations remain reasonable, interest rates are not rising, earnings estimates are turning positive. The rally has further to go.”
On whether Indian equities can make further gains, Greenberg commented: “Yes, if earnings estimates reverse course and begin to rise, which we expect to start later in the year.”
Commenting on the regions which are ringing alarm bells this year, Greenberg remarked: “The future of essential reforms in Brazil has suddenly become very uncertain. Turkey and South Africa also suffer from discouraging economic and civil conditions. China's slowing growth, along with expected Central Bank moves to reverse QE, may put pressure on the materials sector over the coming twelve months.”
Commenting on the growth backdrop for Japan, James Salter, Polar Capital, said: “Thanks to robust consumption and exports Japan is experiencing the longest run of growth in more than a decade. First quarter annualised growth came in at 2.2%, well above the 1.7% expected by the market and also above the long run growth potential of 0.7%. Japan is expected to grow above the long run growth rate for at least the next two years. In a global context this growth is modest but it definitely creates the type of environment required to drive domestic inflation higher and restore corporate and consumer confidence in the domestic economy.”
NOTES TO EDITORS
About the 2017 FE Alpha Manager of the Year Awards
The 2017 FE Alpha Managers of the Year are the very best active managers in the industry – those who have combined consistent performance throughout their career with phenomenal outperformance over the past year.
The winners are selected from the 2017 list of FE Alpha-rated managers – those able to create risk-adjusted alpha, outperformance in both rising and falling markets, and those who consistently beat their sector peers.