As we sprint down the home straight of this current year and get ready to collapse over the fast-approaching finish line, making predictions for next year seems unusually complicated.

The economic and market outlook has gone from being relatively easy to prophesy a few years ago to now being as unpredictable as I have known it in nearly two decades of investing. If we think back to late 2015 and early 2016, it was obvious that most investors and economic commentators had it wrong and that the market outlook was nowhere near as bad as the consensus suggested. It was a great opportunity to be “on risk” with your investment strategy. 2017 similarly was a year to ignore the political nonsense over the election of Mr Trump and Brexit and recognise that there were still abundant opportunities on offer in an era of low volatility in markets. Our view subsequently changed and became more cautious the end of at the end of 2017, as everyone seemed to be very positive and all the talk of a “synchronised global expansion” intoxicated investors. From the very start of 2018, it became obvious to all that it was instead a time for defence and protecting the downside experienced across nearly all asset markets.

The year just finishing now has been extraordinary, even in the context of a rollercoaster of a decade just concluding, as the global economy and financial markets clambered off of the canvas in 2009. If in advent of 2019, investors had known that the global economic engine would splutter to the lowest rate of growth since the financial crisis of a decade ago, that the US and China’s relationship would deteriorate further and that global corporate earnings would shrink, then most would have expected asset markets to labour again as they did in 2018. Of course, thanks to the massaging and manipulating efforts of central bankers and the associated surge in the associated investors’ animal spirits, we have seen a fantastically strong year for nearly every asset class around the world. It is clear from the soothing tones of central bankers that this dynamic is not going away at any time soon. But does this mean that markets can continue to defy the economic gloom and political uncertainty and scale new heights next year?

In a sense, economic and corporate fundamentals have been rendered almost irrelevant in this era of excess liquidity. That makes the outlook, in our view, extremely perilous. Whilst we do not think that next year will be very exciting from an economic or corporate perspective (it is unfashionable but perfectly sensible to say that things will be “boring” or “average”), we feel strongly that financial markets themselves are vulnerable to shifts in sentiment and any hint that the financial masters on the universe, or at least that’s how central bankers appear to see themselves, might shift their policies.

So, what are we doing with our clients’ portfolios? In very simple terms, we are steadfastly focussing on where we can find “value” in a world where “Black Friday bargains” are all too rare. But as we will detail, if investors are willing to do the “hard yards” and make some uncomfortable decisions, then we can find adequate compensation for the macroeconomic and market risks that exist.

Fund for the Parochial Investor – Royal London UK Equity Income

Following the 12th December election result, it seems the UK may finally be released from purgatory and international investors might lose their excuse to ignore the UK equity market. If that is the case, then there is no reason why UK equities can’t close the valuation gap on their international peers. The fundamentals of the UK are nowhere near as bad as many suggest, even if the future of the domestic economy is one of low growth. This fund offers investors a balanced and diversified approach to the UK market, with the manager’s speciality in the mid-cap arena, where we believe the prospects for further takeovers by international predators remain high.

Fund for the Paranoid Investor – Allianz Strategic Bond

There is a chance that it all goes wrong for investors next year. Market valuations are stretched; the global economy is not firing on all cylinders and downside risks are obvious; there is a chance that the “Chimerica” relationship fractures further; global corporate profits growth will likely be anaemic, and headline political risks are unlikely to recede. How can investors navigate those troubled waters and make a return out of high risk and low return traditional fixed interest markets? Whilst we are sceptical of the dubious merits of strategic bond funds, the manager we trust most in this space is Mike Riddell, who has been able to read the vagaries of the economic and market tales of the last few years and position his fund appropriately. The fund is different from other strategic bond funds in the sense that its first responsibility is to protect and it focuses on making money when times are less tough. That strategy makes perfect sense as a diversifier in portfolios.

Fund for the Contrarian Investor – Semper Strategic Focus

One of the “weird” things to happen this year is the extreme bifurcation between investments that investors are embracing warmly and those that are currently being shunned. Within “high yield” bond markets the contrast is most stark. The higher rated bonds are yielding close to the lowest they ever have in history, with little additional compensation over government bonds presently on offer. Why? Because investors have been forced by central bankers to find an income. On the flip side, lower-rated or more illiquid bonds have been left out in the cold, because they are considered “risky”. We understand this, but like every other investment, there should be a return you are willing to accept to take a risk. We think we are there in lower-rated and higher-yielding corporate bonds. Even if a price recovery does not immediately appear, a yield in excess of 12% from this fund is sensible and the potential for a catch-up to other investments, where complacency is extremely high, is obvious.

Fund for the Long-Term Investor – RWC Nissay Japan Focus

It must have been a good year for markets, as even Japanese equities have made gains! Maybe that’s unfair, but it remains noteworthy how unloved and underappreciated Japanese equities are. We think we are fully justified in our overweight stance on Japanese equities. Our research suggests that Japanese equities are cheap and that both macroeconomic fundamentals and corporate reform should be supportive of Japanese equity outperformance in the coming quarters (and in the case of corporate governance reform) years. That most investors still ignore Japan gives us confidence that the positive view we have held since 2011 can continue to deliver good returns for our clients in the years ahead, although I am very much of the view now that Japanese equities will be an alpha rather than a beta play, with the “winners” rewarded and the “losers” drifting in to obscurity through both operational and share price underperformance. The most efficient way to exploit the opportunity and “corporate change” theme in Japan is the RWC Nissay Japan Focus fund, where the manager focuses on a small number of companies where the potential for improvement is high. A stellar performer in the last few years, there is no reason why the success of this strategy can’t be repeated.

Fund for the Yield Hungry Investor – TwentyFour Asset Backed Income

In similar fashion to the experience in high yield corporate credit markets, it has been a “tale of two markets” in every fixed interest market segment. In less well-known markets such as collateralised loan obligations (not swear words despite the experience of 2008), there has been a reticence shown by investors to take risk, despite the runaway performance of equity markets, leaving yields and valuations on offer “out of sync” with other asset market opportunities. Certainly, investors need to ensure that there is both a liquidity and a complexity premium on offer before they invest in such assets, but with the relevant valuations of collateralised loan obligations (CLO) at extremes by comparison to nearly every other asset class, we feel convinced a long term opportunity is on offer. Certainly, it could be that such markets are correctly priced for a deterioration in global economic conditions next year, but that would make CLOs less exposed than equities and traditional corporate bonds to any economic setback, given those other markets are “priced for perfection”. The TwentyFour Asset Backed Income fund has been a six year long friend to our portfolios and we currently view the opportunity this fund offers as extremely attractive, with a yield of around 7% and the fund diversified across a range of high-quality loans in Europe and the UK.

Conclusion

In an attempt to simplify an increasingly complicated picture, we see the outlook as being “boring” in terms of economic growth, “below par” for the prospects of corporate earnings growth and “bumpy” in terms of financial markets; from an investment strategy point of view we firmly believe investors are best served in backing very specific investment opportunities in the year ahead. Hopefully, the opportunities outlined here today can help portfolios to a happy new year and positive decade starting in 2020!

Thomas Becket
Chief Investment Officer