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Funds Focus: Trump hits Woodford, Train & Smith
A turnaround in markets, accelerated by Donald Trump's election, has put star fund managers on the back foot.
Neil Woodford, Terry Smith and Nick Train are among the star fund managers who have found themselves on the back foot after the shock election of Donald Trump as US president accelerated a sharp turnaround in markets.
Trump's election, on a platform of tax cuts and heavy spending, accelerated the market's move from 'defensive' sectors to 'cyclical' stocks more sensitive to the economic backdrop, as investors anticipated a boost to US growth.
But while the move was given added impetus from Trump's shock victory, its roots can be traced back to the summer of last year, as US economic growth gathered strength.
'Defensive' stocks, prized for their reliable earnings and dividends, enjoyed what turned out to be their last hurrah – for 2016 at least – with the Brexit vote.
That prompted a flight towards the relative safe havens of gold and bonds, while those investors braving the stock market plumped for the perceived security of consumer staples and utilities companies.
But since then, the tables have turned. While the Bank of England reacted to the Brexit vote by launching more quantitative easing and cutting interest rates, in the US all the talk in the second half of last year was of when the Federal Reserve would raise rates, after an upsurge of economic growth in the third quarter.
The Fed finally delivered in December, indicating it would hike rates three times this year. Last week's robust jobs figures from the US meanwhile had some commentators predicting the US central bank could move as early as March.
Investors have been quick to respond, dumping defensive stocks in favour of more cyclical sectors, such as banks, industrial companies, oil stocks and miners.
That has ended a long period in the sun for defensive names, which shone in 2014 and 2015 particularly against a backdrop of anaemic economic growth and ultra-low interest rates. With little in the way of yield to be found on the bond markets, investors turned to these dividend-paying shares in their search for income.
Blow to 'defensives'
But the prospect of an upsurge in growth – in the US at least – has dealt a double blow to these stocks. Stronger economic growth has made the 'cyclical' stocks more geared to this expansion more attractive, while the higher inflation and interest rates that are likely to result will cut into the value of their dividends and make their typically higher levels of debt more expensive.
Then there is the valuation argument. With stock markets in both the US and UK trading at all-time highs, investors have been betting that cyclical stocks, which until last summer had endured two years of derating, are more likely to lead the next leg of the rally than defensive sectors, driven to ever-more expensive levels which even the last six months has not reversed.
The turnaround in global markets can be seen clearly by looking at the FTSE All-World Cylical and Defensive indices, which group together global stocks from both camps. While defensive stocks continued to lead the way in the first half of 2016, as they had in 2014 and 2015, the last six months of the year saw the Cyclical index rise 22.1% in pound terms, while the Defensive index was up just 2.7%.
In the UK, the swing has been even more pronounced. The FTSE UK Cyclical index, made up of FTSE 100 and 250 stocks, was up 26.7% in the last six months of 2016, versus a 2.9% fall for the Defensive index.
All of which has led to a similar about-turn in the funds world. Managers who have ridden high at the top of their sectors have found themselves at the bottom over the last six months, while among those propelled to the top since last summer are managers who emerging from a tough few years.
Trickier times for Woodford
A look at the Investment Association's UK Equity Income sector bears this out. Citywire AA-rated Neil Woodford topped the sector in his first two years running the Woodford Equity Income fund, but his record since July last year places him towards the bottom with a 6.4% return.
Woodford is a heavy backer of defensive stocks like pharmaceutical and tobacco companies, and has long shunned the banks, meaning he has lost out on their recent rally on the prospect of higher interest rates that will boost their net margins. Nor does he own oil stocks, resurgent after the Opec cartel of oil producing nations' agreement to curtail supply, or miners, the best FTSE 100 performing stocks of last year.
Top of the sector since July is UBS UK Equity Income, a little-known £3.9 million fund slanted towards banks and oil majors and away from consumer staples like drinks and tobacco companies.
That positioning has helped manager Steve Magill deliver 24.3% since July, having lost 1% from the beginning of 2014 until last summer, when defensive companies consolidated their position as market leaders.
Their fund, overweight banks and industrial companies but owning no consumer goods companies and little in the way of pharmaceuticals, has jumped 20.3% since July. In the two-and-a-half years before that, they had lost 2.4%, placing the fund towards the bottom of the sector.
Sticky patch for Global leaders
In the Global sector, it's the same story. Citywire AAA-rated Terry Smith tops the sector over five years, with a 158% return. Yet he has found the going a bit trickier over recent months. Since July, his Fundsmith Equity fund has returned just 6.8%, placing him towards the bottom of the sector, with much of that performance due to the pound's continued slump against the dollar.
Smith's fund is dominated by consumer staples and healthcare companies, and he is no stranger to answering critics who have argued this strategy could come unstuck.
A year ago, he wrote that while commentators had been warning of trouble ahead for defensive shares 'these stocks and our fund have continued to outperform the market significantly'.
And while recent months have seen his most sustained underperformance of the market since the fund's launch, it has done little to dent his long-term lead over rivals.
Citywire AA-rated Nick Train, often likened to Smith for his high-conviction approach and liking for drinks companies, had a similarly difficult second half of 2016.
Like Fundsmith Equity, the Lindsell Train Global Equity fund he manages with Citywire AA-rated Michael Lindsell has beaten nearly all-comers in the Global sector over five years, with a 138% return. But since July, the fund has returned just 6.6%, placing it 200 out of 213 funds in the sector over that period.
Recovery funds recover
Meanwhile, 'value', 'recovery' and 'special situations' funds, which target out-of-favour stocks trading on low valuations, have surged to the top of the sector since last summer.
These funds share an investment style that had itself fallen out of favour in recent years, as the consistent rerating of defensive stocks to ever-higher valuations confounded those searching among beaten-up stocks for returns.
Witness the Investec Global Special Situations fund, which returned 30.5% since July, double the return it had managed in the previous 30 months, with heavy overweights to banks and industrial companies. Or River and Mercantile World Recovery , which returned just 3.5% from the beginning of 2014 to last summer, before rallying 27.4%.
For investors the crucial question now will be whether cyclical stocks manage to maintain the impressive momentum they have built up. For those who believe in 'mean reversion', it's worth pointing out they have further to go if they are to make up the ground lost to defensive stocks over the last three years. Given the leg-up cyclicals enjoyed from Trump's victory, much too will depend on whether Trump delivers on the promises made during his election campaign.
While some will see the market rotation of the last six months as the sign of more to come, others will be wary of a market that has exuberantly priced in the impact of policies from a US president who has yet to even enter office.
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- CF Woodford Equity Income A Sterling Acc
- UBS UK Equity Income A Acc Net
- JOHCM UK Equity Income A Acc
- Lindsell Train Global Equity B
- Investec Global Special Situations A Acc Net GBP
- River and Mercantile World Recovery B Inc
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by Jack Gilbert on Apr 27, 2017 at 10:33