Fund Management Monthly Commentary Covering the month of September 2018 September Market Update Margetts monthly diary summarises major economic and market developments that occur over the month. It is written by the Fund Management team and supplements the weekly diary that is written in part by Capital Economics. September s EU summit in Salzburg highlighted how both sides in the Brexit negotiations are still far apart, and the chances of a no deal Brexit increased, which caused the largest one-day fall in Sterling against the Dollar in nearly 12 months. During the month, the UK government published its latest round of no deal Brexit planning documents, which conveyed how it could cause chaos. In addition, the Labour party conference members voted for a second Brexit referendum if parliament rejects the deal brought to them by the government, and if Labour cannot get a general election. The ballot paper may even include the option to remain in the EU. In the UK, CPI (Consumer Price Index) inflation surprised markets on the upside, and came in at 2.7%, up from 2.5% the month before. This was pushed up by higher costs of package holidays and new-season autumn clothing introduced by high street retailers. UK GDP growth was confirmed to be 0.4% in the second quarter of 2018, with service sector growth being stronger at 0.6%. Some commentators state that this is still below the long-term average and business investment data is weakening, whilst households are spending more than they are earning, and our trade deficit is worsening. We feel that Brexit is clearly a drag on consumer confidence, and whilst spending is growing faster than earnings there has been recent evidence of earnings beginning to rise more strongly especially with public sector pay caps being removed. During the month, the Brent Crude Oil price surpassed $81 a barrel for the first time since 2014. This was mostly driven by concerns that US sanctions on Iran could reduce global oil supply. The rising cost of oil acts as a tax on economies which are net importers of energy whilst providing a boost to exporters. China, the US, the EU, Japan and India are the largest net oil importers whilst Russia and Saudi Arabia are the largest net exporters together with the other OPEC countries. At the end of the month, equities fell after the Italian government announced that it would increase public spending, even though it already has very high national debt to GDP ratio of 131%, which is the second highest ratio in the Eurozone, behind only Greece. In early September, Amazon became the second ever company, after Apple, to reach a market cap of US$1 trillion. Amazon is a company which has changed many aspects of people s shopping habits and disrupted many industries. Whilst some stocks continued rising, other technology growth stocks have struggled. For example, since Facebook fell by nearly 20% in a single day in July, it has continued to fall, and ended September c. 24% below its peak value. In August, Elon Musk of Tesla published a tweet stating he had secured funding to take the company private at a valuation higher than its trading price, which sent the stock soaring. At the end of September,
the SEC filed a lawsuit accusing Elon Musk of committing securities fraud, and aimed to ban him from acting as a director of a publicly traded company. This sent the stock tumbling over 10% the next day, and by the end of September it was down c. 30% since its peak in 2017. Elon Musk later reached a deal with the SEC and agreed to pay a fine and step down as the chairman in return for keeping the CEO position. On 1 st October the stock has recovered following the announcement of the deal. We have mentioned Tesla in previous commentaries, as it is an example of a volatile growth stock with negative cash flows and a high market valuation, which could have benefited from the era of loose monetary policy and the availability of capital. The Federal Reserve continued to tighten monetary policy, and raised its base rate by 0.25% to the range of 2.00% to 2.25% in September, the highest level relative to other developed markets in many years. At the start of 2018, the markets were pricing in only a 20% probability that the Fed would have raised rates three times by now, however this probability crept up over the month. In September, bond markets have fallen, with IA UK Gilts returning -1.4% as yields rose. Corporate bonds performed slightly better, with the IA Sterling Corporate Bond sector delivering -0.6%. Many absolute return funds have continued to struggle, and the IA Targeted Absolute Return sector has returned close to 0% over the 12 months to the end of September, with many large funds having delivered negative returns over that period. Margetts continue to avoid these types of funds due to the inconsistency of their returns and performance profiles. The IA Japan sector was the strongest performing equity region over the month, rising by 2.4%. This was likely due to the Yen weakening against the US dollar, and assets flowing into Japanese equities as investors stayed away from the UK and the EU. This was mainly due to Brexit risks, worries over Italy s politics and investing less in Emerging Markets and North America due to trade wars. Meanwhile, IA UK Equity Income and IA UK All Companies returned -0.3% and -0.5%, respectively, and IA North America returned -0.2%. Weaker returns came from IA Europe ex UK which delivered -1.4%, IA Global Emerging Markets, returning -0.9%, and IA Asia Pacific ex Japan, which had the lowest return of - 1.6%.
Looking Ahead With regard to Brexit, Margetts believe that there is a high likelihood of a deal being agreed nearer to the end as both sides stand to lose out both economically and politically from a no-deal event. Our lower risk portfolios have a bias towards UK and Sterling assets, and are likely to outperform in the event of a Brexit deal being struck, which is also the outcome predicted by Capital Economics who we engage with. We expect there to be some volatility in markets as Brexit negotiations continue, the Fed maintains it quarterly interest rate increases and political risk remains high especially in relation to the US and trade wars which present both upside and downside market risk. The divergence of US equities against the rest of the world has been more significant than we expected and the risk of reversal is significant. The Margetts portfolios should benefit from this reversal of divergence which is related to three factors. Firstly the Fed increasing US interest rates, secondly trade wars causing a move towards repatriation of dollar assets and finally, the current level of earnings growth for US companies which is considered unsustainable given that the effects from tax cuts and spending are likely to be only temporary, while longer term levels of growth are expected to be similar to other global markets. In western developed countries, employment markets are tightening, inflationary pressures are rising and this fits in with our long term view that we are in a rising interest rate environment. Therefore, our overweight to short dated credit stance remains appropriate and has added to the relative performance over the past 12 months, as short dated corporate bonds have retuned c. 0.7%, whilst the IA Sterling Corporate Bond sector returned a lower c. 0.1%, and exhibited higher volatility and drawdowns over that period. Trade wars have benefitted US assets in terms of round 1, however a longer protracted position is likely to damage both sides and the Chinese economy is better positioned to see through a long term cold war from a trading perspective. The Chinese holdings in US Treasury bonds provide a clear reservoir of ammunition for the Chinese to deploy during a long term stand-off.
Margetts Risk Rated Funds The fund s current allocations are shown against the long term strategic allocation below. This reflects the short term views of the investment committee in relation to our longer term views. The strategic allocations for each of the funds can be found in the Appendix. Providence Cash Bonds UK Asia Pacific ex Japan -8-6 -4-2 0 2 4 6 8 The portfolio s general bias towards short dated bonds remains in place, and over the month this marginally added to the relative performance of the bond allocation as longer dated bonds have underperformed. The weakest bond holding over the month was Royal London Global Index Linked due to its longer dated positioning, but this fund acts as a diversifier in the portfolio and benefits from rising inflation. The weakest performing fund was Threadneedle UK Equity Income, however this fund experienced much better performance in previous months, and the long term track record is strong, so we currently have no concerns. Meanwhile, the Man GLG UK Income fund was the strongest performing fund in the UK equities allocation. It is positive to see that Premier Income has outperformed over the month, following weaker returns in previous months. The L&G Asian Income fund outperformed the IA Asia Pacific ex Japan sector, mostly due to its value bias and overweight to Australian equities. This fund continues to have a c. 4% dividend yield and is an effective diversifier to the portfolio.
Select Cash Bonds UK Europe ex UK North America Japan Asia Pacific ex Japan Emerging Markets -4-2 0 2 4 6 8 10 The portfolio s general bias towards short dated bonds remains in place, and over the month this has marginally added to the relative performance of the bond allocation as longer dated bonds have underperformed. Within the European allocation, the F&C European Growth & Income fund exhibited poor performance, however this fund had a very strong period earlier in the year, so we are not currently concerned. In addition, the Invesco Perpetual European Equity Income fund has partly offset this, as it outperformed its IA sector over the month. The BlackRock Asia fund struggled over the period, partly due to its growth bias. Meanwhile, Schroder Asian Income offset this and tends to outperform at a different time due to its income and value bias.
International Cash UK Europe ex UK North America Japan Asia Pacific ex Japan Emerging Markets -20-15 -10-5 0 5 10 The portfolio s overweight towards Asia Pacific ex Japan and Emerging Market equities detracted from returns. Baillie Gifford Pacific and Threadneedle Global Emerging Markets Equity both performed poorly, mostly due to their growth style. We are not currently concerned about these funds. The strongest performance in the portfolio came from the Japanese allocation. The GBP hedged holding of the Schroder Tokyo fund returned c. 5%, which was much higher than the return on the IA Japan sector of c. 3% as the Yen weakened against the Sterling over the month. Within the North American allocation, the only active fund is JPM US Select, which had a strong month and outperformed its IA sector by c. 1%.
Venture Cash UK Europe ex UK North America Global Japan Asia Pacific ex Japan Emerging Markets -12-10 -8-6 -4-2 0 2 4 6 Venture s bias towards Asia Pacific ex Japan and Emerging Markets detracted from its returns, as these equities lagged behind developed markets. However, the fund selection in these areas was mostly strong over the month, especially JPM Emerging Markets Income, which was c. 3% ahead of its IA sector. The F&C European Growth & Income fund exhibited poor performance, however this fund had a very strong period earlier in the year, so we are not currently concerned. M&G Global Dividend had a strong month against its IA sector, as commodity prices rose over the period.
Appendix Strategic Asset Allocations Providence Asset Strategic Allocation Cash 10% Bonds 40% UK 50% Asia Pacific ex Japan 0% Select Asset Strategic Allocation Cash 4% Bonds 20% UK 47% Europe ex UK 6% North America 13% Japan 3% Asia Pacific ex Japan 4% Emerging Markets 3% International Asset Strategic Allocation Cash 4% UK 12% Europe ex UK 17% North America 50% Japan 10% Asia Pacific ex Japan 4% Emerging Markets 3% Venture Asset Strategic Allocation Cash 4% UK 4% Europe ex UK 7% North America 17% Global 0% Japan 3% Asia Pacific ex Japan 33% Emerging Markets 32%
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 0121 236 2380 or at 1 Sovereign Court, Graham Street, Birmingham B1 3JR You can e-mail us at admin@margetts.com