How combining fund styles can give investors a smoother ride

Year-to-date, the US market has dominated the minds of investors and market commentators, but Japan has also been posting strong returns (in sterling terms) and to the end of April stood just 30 basis points behind the US market with growth of 7.52% (MSCI Japan NR index versus S&P 500 NR index).

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The strength of the equity market in Japan has been driven by a number of factors including artificial intelligence (AI), a positive signal on interest rates, the weaker yen and the corporate reform that has been driven by pressure from the Tokyo Stock Exchange for companies to disclose initiatives to improve capital efficiency.

Market leadership has been concentrated in the inevitable AI-related names but also mega-cap value stocks, and, as a result, value as an investment style has outperformed growth.

A fund to profit from this trend

The ii Super 60 includes a fund that has been in the sweet spot of this trend, the Man GLG Japan CoreAlpha fund. Jeff Atherton took over as lead manager in January 2021 following the retirement of the fund’s long-standing manager. However, Atherton is well versed in the fund’s investment philosophy and process having worked on the team since 2011.

Atherton adopts a distinct value and contrarian bottom-up investment approach, which means he tends to buy stocks when they are unloved and then remains patient until the value is realised. There have been some refinements to the investment process, but we view these positively and expect them to lead to a slightly higher-quality portfolio without sacrificing the contrarian-value nature of the investment philosophy.

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The fund’s value bias will clearly influence returns and over the year to the end of April it returned 9.92%, outperforming the MSCI Japan index and many other funds on the Super 60 list.

Value approach can give investors a bumpy ride

However, looking further back into the relative performance of the Japanese market, we can see that value-style investing is not always a winning approach. In years such as 2020 the style as measured by MSCI indices underperformed by over 13 percentage points, severely denting returns.  

So, how can investors protect themselves from these market-related fluctuations?

Various studies have highlighted the difficulties of timing such market shifts and most professional investors do not attempt to do this in a meaningful way, instead preferring to stay invested and relying on portfolio diversification to produce returns across different market environments.

One option to improve diversification within equity regions is to allocate across funds with different investment styles.

Style is a broad way to identify managers who focus on particular types of stocks, and by selecting those with different styles we can create efficient portfolios through combining funds that produce excess returns with low or negative correlations.

In theory, as one fund’s style falls out of favour, the style of another manager should come into favour to offset any weakness in relative returns.

A quality growth fund to mix and match with value style

As an example of what you can achieve with actively managed funds, we can go back to the Man GLG Japan Core Alpha fund on the ii Super 60 list.

A simple way to balance the low-valuation stocks held in this fund is to look for a manager who has been successful in buying stocks with higher-growth profiles and higher valuations, such as Nicholas Weindling who manages the JPM Japan fund.

Weindling is viewed as a talented manager who benefits from the support of a well-resourced and experienced Japanese equity team that has been very stable over the years. The time-tested investment approach, with its focus on quality-growth firms, results in a portfolio that shows higher-than-benchmark growth characteristics, return on equity and valuations, and therefore provides a good foil for the Man GLG fund.

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If we want to take this assessment a little further, we can look at the detail of these portfolios and compare the underlying holdings. As expected, we see minimal overlap, with just three common holdings from the 47-48 total number of stocks in each fund.

We would therefore hope that combining these high-quality funds would produce an attractive outcome, and this has been shown to be the case. Buying both these Japan equity funds with a 50:50 weighting would have produced a portfolio that has shown almost two percentage points per annum of outperformance versus the MSCI Japan index over the past 10 years.

Importantly this performance has shown much more consistency than that available from the individual funds. On a calendar year basis, the largest level of underperformance seen from this portfolio was 126 basis points in 2018, which compares very favourably to the maximum underperformance of the Man GLG fund of 2494 basis points in 2020 and the 1999 basis points of underperformance shown by the JPM fund in 2022 (as of 31 May 2024).

Combining active managers can therefore provide both outperformance and fewer sleepless nights!  

Simon Dorricott,is director of manager research, manager selection services, at Morningstar.