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Colin McLean: prospects are good, but fear complacency

Colin McLean: prospects are good, but fear complacency

Investors do not start each year with a clean slate; each experience shapes future behaviour.

Most enter 2018 more confident, having learned over the last 12 months that taking risk pays off. Many investors felt like winners in 2017; interest rate rises did little to stem the tide of global liquidity, lifting all assets.

Even those who underperformed benchmarks typically had enough absolute performance to make a good story to tell clients. And, many of those stories will be about stockpicking, with companies as diverse as HSBC, Sophos, Kaz Minerals and Fevertree Drinks boosting returns. 

Dodging bullets also mattered, but bad stocks may not feature in the client reports. Profit warnings triggered share price collapses in some big companies – from Provident Financial to Petrofac and Dixons Carphone. Globally, it paid to back emerging markets, and the more frontier the better. There were many opportunities for managers to beat their benchmarks. 

Most of the best performances came after mid-year, with the market rotation into some big inflation-driven value stocks. Overall, portfolio gains were sufficiently strong and focused for investors to consider themselves quite clever. 

What does this augur for the year ahead?

A world awash with dollars

Complacency is certainly a risk. But investors have latched on to the political need around the world to deliver real per capita wage growth, and increasingly hope that the monetary tightening of central banks may prove an illusion. The US president has just sanctioned a $1.5 trillion (£1.1 trillion) rise in US debt, via tax reform, setting in motion a new scenario for 2018. Markets may face a world awash with dollars. 

As the US dollar hits a three-year low against the euro, borrowing in dollars is becoming easier. Companies and governments in emerging economies may have no fear of repaying dollar debt, even as interest rates rise.

The consequent strengthening of commodity prices will do some of the work of central banks in squeezing consumers. Overall, global activity is likely to remain strong, and emerging markets will benefit in particular.

For active managers, it could again pay to be on the right side of major secular trends. The first is continuing disruption in many sectors. To see this as being purely technology-driven is to miss the major consumer trends that are emerging in Western economies. 

These have brought a focus on experiences rather than goods, and show little respect for longstanding brands. Many retailers do not yet seem to get this, and the impact on banks and the finance sector may be just starting.

There will eventually be some winners in these sectors, but many active investors will conclude that portfolios should be tilted away from some of these incumbents. It is a bet against complacent business strategies.

And, a bias against the largest stocks may also help, with many clients deciding that passive investing can cover that at low cost. Eventually, as Mifid II cuts research, more opportunities for active funds may emerge. But, it is becoming much harder to market the concept of alpha in the very biggest companies. 

Growth and inflation

The more problematic decision for 2018 is on growth versus value. Growth has enjoyed an unusually long-winning streak, just as the lengthy economic cycle has confounded history.

But, a major rotation back into value will depend on inflation breaking out. In the UK, inflation is actually likely to fall this year. The risk is that many growth stocks have long duration bond-like characteristics and could be sold to fund investment in value if inflation takes off globally. 

Investors could be helped in 2018 by maintaining biases to mid cap and growth, and remaining alert for disruption. Clients should look out for overconfidence in managers. 

One sign is when, after strong performance, individual positions outgrow a portfolio.

Last year was exceptional and, by itself, that tells us less about manager skill. Thoughtful investors will be those who monitor unconventional information sources and are vigilant for change in the world economy.

Getting the year ‘right’ is less a matter of January forecasts than of keeping an open mind and incorporating new information as the year unfolds. 

Disclosure: SVM holds positions in HSBC, Sophos, Fevertree Drinks and Petrofac.

Colin McLean is founder and director of SVM Asset Management. His UK Growth fund, which he runs alongside Citywire A-rated Margaret Lawson, has returned 42.9% over three years versus a peer average of 30.7%.

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