Fund Management Diary

Transcription

1 Fund Management Diary Meeting held on 12 th March 2019 Earnings to weigh on emerging market equities A slowdown in both the United States and Chinese economies will weigh heavily on export growth in the emerging markets, leading to slower earnings growth. The fall in earnings growth is expected to be greater in emerging countries closely linked to the Chinese economy. Valuations and commodities prices will add further downward pressure on emerging market equities. The slowdown in emerging markets export growth will weigh on earnings The earnings of firms in the Morgan Stanley and Capital Group International (MSCI) emerging market index generally tend to track trends in the exports of its largest constituent countries. An implicit assumption behind a lot of analysis of the earnings of listed companies is that they grow at a fairly similar rate to the domestic economy. However, for the MSCI emerging market index as a whole, and some of the largest countries within that index, earnings tend to have a closer relationship with exports instead. This index is dominated by large firms, many of which are either major exporters themselves or key parts of the supply chains of China s exports in particular. Weaker growth in both the United States and in China will affect global demand and the largest emerging markets exports. In the United States, the fading fiscal boost and the effects of tighter monetary policy are expected to weigh on the economy in In China, the economy is likely to slow further as the effect of previous policy tightening and the associated weakness of credit growth take their toll. While both monetary and fiscal policy are set to be loosened in China, the scale of stimulus will be smaller than in previous cycles. Overall, the slowdown is likely to affect demand for exports from the rest of Asia. There are already signs of export weakness in the emerging world. According to December s data, aggregate emerging markets exports expanded by just 2.7 per cent year-on-year, their slowest pace in about two years. The slowdown in export growth, especially in China, will weigh on earnings growth. China, and its exports, matter a lot for the MSCI emerging market index as it is by far the largest country in the index by market capitalisation. Moreover, the next two largest countries in the index, Korea and Taiwan, are particularly integrated into the supply chains of China s exports to the United States. Those three countries equities together account for around 60 per cent of the overall index. Although China s exports to the United States account for just under ten per cent of the total exports of the ten largest countries in the MSCI emerging market index, an escalation of United States protectionism would likely harm emerging markets earnings growth. That said, this escalation seems unlikely as recent media reports suggest that the United States and China are close to agreeing a trade deal which would eliminate the threat of further tariffs on Chinese goods, with the potential removal of existing tariffs. The outlook for earnings growth is expected to vary among different emerging economies A first group of emerging markets will feel the slowdown in the Chinese economy. In China, all the other Asian countries in the top ten of the MSCI emerging market index (India, Korea, Malaysia, Taiwan and Thailand), and Russia, earnings growth tends to follow a similar pattern. This can be explained by the close links between China s economy and those of most of the rest of the countries in this group. Therefore, as

2 China s economy loses more momentum and as Chinese exports growth slows, drivers of earnings growth in other countries of the group are likely to be weaker. These drivers include nominal gross domestic product growth in Malaysia, exports growth in Thailand and industrial metals prices in general. This would lead to a slowdown in earnings growth in all of the countries in this first group. The outlook for a second group of emerging countries looks less pessimistic. In Mexico, Brazil and South Africa, the correlations between earnings growth with the countries of the first group are low. Earnings growth is hardly correlated within the second group either. This could be explained by some common features of the countries in this second group, such as the greater distance from China s economic orbit or the presence of a few large companies dominating the equity markets earnings. Overall, this suggests that this second group of countries might be less exposed to the anticipated China-driven slowdown in earnings growth. However, that does not mean that the near-term prospects are especially bright. According to Capital Economics, earnings growth in Mexico is expected to pick up but probably not by as much as analysts estimates compiled by Bloomberg suggest. This is because the anticipated weakening of the United States economy, Mexico s largest trading partner, in 2019 would limit the strength of Mexico s export growth, and therefore earnings growth too. That said, while the weaker connections of the countries in the second group to China are unlikely to help in the short term, they might prove beneficial in the longer term. Other factors may also influence emerging market equities Although the impact tends to be small, lower prices of industrial metals can weigh on earnings growth and the MSCI emerging markets index. Firms in the materials sector make up roughly seven per cent of the index. Slower global growth, and in China in particular, will reduce energy and metals prices, hitting emerging markets commodity producers. Supply-side developments in metals markets are also expected to weigh on industrial metals prices in Therefore, a fall in industrial metal prices will likely add to the downward pressure on earnings growth. Lower energy prices are not expected to be an additional threat. Oil prices have been rising recently, reflecting concerns about a supply shortfall, but Capital Economics expects that subdued growth in demand in the coming months coupled with persistently strong United States output will cause prices to fall back. However, while lower energy prices may weigh on the earnings of firms in the energy sector, they are also likely to drive down input costs for firms that account for the remaining 90 per cent of the index. Moreover, energy firms now account for only about half as much of the MSCI emerging market index as they did during their heyday in the late 2000s. Overall, this suggest that energy prices are not likely to add further downward pressure on earnings growth. That said, Russia remains an exception as, according to Capital Economics regression model, energy price growth is a significant driver for the country s earnings growth. This contrast with what observed in other countries and can be explained by the heavy Russian reliance on oil and gas exports. Valuations will weigh on emerging market equities. The price of the MSCI emerging market index in 2018 was driven primarily by a drop in the price that investors were willing to pay for earnings, as measured by the price-earnings ratio. The past fall in valuations alone is not enough to ensure that emerging market equities will perform well this year as valuations usually take time to bounce back. Moreover, fluctuations in valuations tend to be outweighed by what happens to earnings over longer time horizons. In addition, as the United States stock market is expected to slump again in 2019, the price-earnings ratio of the MSCI emerging market index is likely to struggle too, as it tends to decline whenever the United States stock market falls sharply. Trade war talks are unlikely to prevent emerging market equities from falling. Admittedly, increasing optimism about the United States-China trade talks has supported the rally in emerging markets equities observed since around the turn of the year. A future comprehensive US-China trade deal now appears largely priced in to markets. However, although a comprehensive deal might provide a short-term boost

3 to the global economy, it would not be enough to prevent the global economy from slowing further over the year. Indeed, it is unlikely that a trade agreement would significantly alter the near-term outlook for the United States and Chinese economies. All this points to emerging market equities struggling over the year as a whole. Capital Economics expects the MSCI emerging market index to decrease from 1,051 at the end of 2018 to 840 at the end of this year. *This diary has been written in conjunction with Capital Economics. Strategy While Capital Economics are concerned about the effect the global economic slowdown could have on Emerging Markets in 2019, we remain relatively positive on the long-term prospects of these countries. Our higher risk portfolios currently have a tilt towards Asia and Emerging Markets and we are planning to retain these positions. Our choice of funds in Asia and Emerging Markets provide good diversification across both regions and we focus on quality-oriented strategies which tend to behave more defensively compared to many of their peers.

4 Fund Comments The below charts show the current positions of the funds, the tactical (short term) targets, and the strategic (long term) allocations of the funds. We aim to keep the current positions in line with the tactical targets from week to week. The differences between the tactical and strategic weightings reflect the views and convictions of the Margetts Investment Committee. Providence 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Bonds Cash UK Europe ex UK North American Asia Pacific ex Japan Emerging Markets Japanese Global Current Position Tactical Targets Strategic Targets Asset Allocation: The above chart, as of 12/03/2019, demonstrates the fund s current asset allocation and the tactical targets set by the committee. No changes are being made to the tactical targets or current allocations this week. Fund Selection: The fund continued to outperform and is now ahead of the IA Mixed Investment 20-60% Shares sector by c.2.3 percentage points over 3 months. The Providence fund has benefited from a recovery in equities, a stronger relative performance of the UK equity market and the recent appreciation of Sterling. Both allocation and selection effects are now positive over 12 weeks. There was a slight improvement in valuations of underlying short-duration bond funds, however these are still behind their long-duration counterparts over 12 weeks. In equities, the more mid-cap oriented Premier and Man GLG lagged the IA UK Equity Income sector over 1 week, but remain the strongest performers over 12 weeks. The Threadneedle and Aviva funds had a more positive week following a period of weaker relative performance during a number of previous months. No fund changes are being considered at this time.

5 Select 50.0% 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Bonds Cash UK Europe ex UK North American Asia Pacific ex Japan Emerging Markets Japanese Global Current Position Tactical Targets Strategic Targets Asset Allocation: The above chart, as of 12/03/2019, demonstrates the fund s current asset allocation and the tactical targets set by the committee. No changes are being made to the tactical targets or current allocations this week. Fund Selection: Select was ahead of the IA Mixed Investment 40-85% Shares sector over one week and outperformed by c.1.4 percentage points over 3 months. Similar to the Providence portfolio, Select continues to benefit from an overweight equity allocation and a bias to the UK. Among underlying equity funds, only 3 have lagged their respective sectors over 1 week. Performance profiles of the SVM UK Growth and SLI UK Equity Income Unconstrained funds improved dramatically over 12 weeks, and along with the BlackRock Income strategy, they were the best performing holdings in the portfolio, with absolute returns of c.6% - 6.5% over 12 weeks. The Committee are pleased with the short-term improvement in the performance of the Henderson Emerging Markets Opportunities strategy. This fund has a more defensive risk profile compared to many other Emerging Markets strategies, hence it lagged the IA Global Emerging Markets sector since the start of The BlackRock Asia fund s performance remained strong, while the Schroder Asian Income fund was behind the sector over 1 and 4 weeks. Compared to the Schroder strategy, the BlackRock fund has a higher exposure to China and tends to outperform during periods of positive markets. The Committee discussed the relatively weak 12-weeks performance of the Jupiter UK Special Situations fund. While there was no decisive action taken at this stage, the Committee will monitor the performance of the Jupiter fund closely going forward. No fund changes are being considered at this time.

6 International 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Bonds Cash UK Europe ex UK North American Asia Pacific ex Japan Emerging Markets Japanese Global Current Position Tactical Targets Strategic Targets Asset Allocation: The above chart, as of 12/03/2019, demonstrates the fund s current asset allocation and the tactical targets set by the committee. No changes are being made to the tactical targets or current allocations this week. Fund Selection: International outperformed the IA Global sector over 1 and 12 weeks. Over 12 weeks, the portfolio s overweight allocation to Emerging Markets and the UK has been the main driver of stronger relative performance, as both regions outperformed North America, which the fund is currently underweight to. In Asia, both underlying funds outperformed the IA Asia Pacific ex Japan sector over 1 week. The Baillie Gifford Pacific strategy also outperformed over 12 weeks, driven by a higher allocation to China. The L&G fund has a higher exposure to Australia and has had mixed success since the start of Both Emerging Markets strategies lagged the IA Global Emerging Markets sector over 1 week but outperformed over 12 weeks. The Committee have no immediate concerns about these holdings and are pleased with the performance of the Threadneedle Global Emerging Markets Equity fund over the year to date. The fund selection in Europe was mixed, as the BlackRock Continental European fund outperformed the sector, while the JPM Europe Dynamic underperformed. The Committee are generally neutral/negative on Europe, and given that both funds were ahead of the sector over 12 weeks, there was no immediate concern. No fund changes are being considered at this time.

7 Venture 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Bonds Cash UK Europe ex UK North American Asia Pacific ex Japan Emerging Markets Japanese Global Current Position Tactical Targets Strategic Targets Asset Allocation: The above chart, as of 12/03/2019, demonstrates the fund s current asset allocation and the tactical targets set by the committee. No changes are being made to the tactical targets or current allocations this week. Fund Selection: The Venture fund outperformed the IA Flexible sector over 1 and 12 weeks. Over 12 weeks the fund has benefited from overweight allocations to Asia, Emerging Markets and underweight to North America, as the latter underperformed the former. The Committee are pleased with improving performance of the more defensively oriented Asia and Emerging Markets funds, such as Stewart Investors Asia Pacific Leaders and Henderson Emerging Markets Opportunities. Over one and two weeks, some more aggressive funds have underperformed, but most of them remain ahead of their respective sectors over 12 weeks. The relative performance of the BMO Select European fund was mostly flat over 1 week. Over 12 weeks this fund is ahead of the IA Europe ex UK sector by c.1.8 percentage points. Despite this recovery from a previous period of losses, the Committee are not confident in the future performance profile of this fund and continue to discuss other options. No other fund changes are being considered at this time.

8 Important Information Please note that the contents are based on the author s opinion and are not intended as investment advice. This information is aimed at professional advisers and should not be relied upon by any other persons. Any research is for information only, does not constitute financial advice or necessarily reflect the views of the author and is subject to change. It remains the responsibility of the financial adviser to verify the accuracy of the information and assess whether the fund is suitable and appropriate for their customer. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested. Important information about the funds can be found in the Supplementary Information Document and NURS-KII Document which are available on our website or on request. Issued by Margetts Fund Management Ltd Margetts Fund Management Limited is authorised and regulated by the Financial Conduct Authority For any information about the company or for a copy of the company's Terms of Business, please contact the company on or at 1 Sovereign Court, Graham Street, Birmingham B1 3JR You can us at admin@margetts.com