Below we assess which Rated Funds have subsequently made the most of the carnage wrought in the first quarter, and which have not. In the first of three articles we look at global and mixed asset groups
Markets around the world have recovered from the pandemic-inspired falls of late February and March.
Leading indices in the US, Japan, Europe and emerging markets gained between 17% and 21% in the second quarter of the year, when expressed in sterling terms. The FTSE World index gained 20%, but the UK continues to lag, with the FTSE All-Share recovering by only 10%.
Below we assess which Rated Funds have subsequently made the most of the carnage wrought in the first quarter, and which have not. Now that the dust has settled somewhat, we have had a better opportunity to assess which Rated Funds need to be put under review and where performance needs to be closely monitored.
In the first of three articles we look at global and mixed asset groups.
To check what constitutes a ‘yellow flag’, see the bottom of the article.
Global equity income
Growth-focused trusts that pay comparatively low but progressive dividends topped the performance tables over the quarter, with Scottish American and Bankers returning 18.9% and 17.4%. The more value-focused Scottish and Murray International trusts were not far behind, with both returning 17.2%. JPMorgan Global Growth & Income trust, which funds its 4% yield partially from capital, and Henderson International Income, which avoids the UK, filled the next two spots.
Although Artemis Global Income’s return of 14.6% over the quarter was a little better than that of the Vanguard FTSE All World High Dividend Yield ETF, it is well behind this yardstick over one, three and five years. The Artemis fund has a strong tilt to value and cyclical areas of the market, but even a recent switch towards quality growth stocks has done little to improve relative performance. Our analysis shows that poor stock selection has also contributed to poor relative returns in the short to medium term. We are looking for clear signs for this decline to be arrested and in the meantime we are placing the fund under formal review.
A strong preference for value-focused holdings has also dented the performance of Schroder Global Equity Income, which props up the performance table over the quarter and the year to 30 June. Unlike the aforementioned Artemis fund, Schroder Global Equity Income does not have any emerging markets exposure but also has a high weighting to the UK, which has also hurt relative performance compared with more internationally diversified peers. Given this strong geographical tilt and the poor outlook for UK dividend payers we feel it would be appropriate to put the fund on performance watch, and hope for signs of improvement elsewhere in the portfolio, if not the UK-based holdings.
In the meantime, we are adding Morgan Stanley Global Equity Income – the first new addition since the launch of the Super 60. In the course of rigorous quantitative analysis, the £49 million fund showed exceptional qualities in terms of investment process, performance and capital protection, income generation, strength of the team, transparency, and value for money. All this helped us to build conviction during our due diligence process. The Morgan Stanley fund returned 14% over the second quarter, but is well ahead of the sector average over all longer timeframes.
As would be expected after a strong bounce-back, seven of our adventurous global growth selections snaffled the second-quarter top spots, with three of the top five managed by Edinburgh partnership Bailie Gifford. Smaller company specialist Edinburgh Worldwide returned 44.8%, a shade ahead of its larger stablemate Scottish Mortgage, up 43.3%. The more diversified Monks came fifth, returning a highly respectable 30.1%.
Sandwiched between these were ASI Global Smaller Companies, returning 31.9% and T. Rowe Price Global Focused Growth Equity, up 30.7%. Although ASI Global Smaller Companies has seen a manager change, with Alan Rowsell departing and being replaced by veteran former co-manager Harry Nimmo, the latter's high calibre and close previous involvement with the fund mean we don’t plan to place the fund under review. However, we will watch its progress carefully.
Vanguard Global Small-Cap Index ETF (+24.6%) and Fidelity Global Focus (+24.5%) make up the top-performing adventurous funds, with BMO Responsible Global Equity not far behind in ninth place with a 22.6% return, closely followed in 10th place by F&C IT, up 20.4%.
In this large grouping of 30 funds, the best-performing core offering was Rathbone Global Opportunities, in eighth place with a 24.2% return.
On a one-year view only a few selections have failed to make a positive return: Vanguard Global Small Cap Index fund (-2.8%), F&C trust (-0.9%), Artemis Global Growth (-3.2%), Witan IT (-11.6) and Brunner IT (-6.2%).
It is the last three mentioned that we want to place under review. Starting with Brunner, longstanding manager Lucy Macdonald has stepped down, which is a yellow flag event for us, so the trust goes under review. She is replaced by Matthew Tillett, who has worked closely with Macdonald for several years. Neverthless, we want to see how he gets on before potentially reconfirming Brunner’s Rated Fund status.
Witan’s high UK focus has been a drag on recent performance, while chief executive Andrew Bell has also recently made a number of changes to manage the outsourced regional and global portions of Witan’s £1,5 billion portfolio. Hopefully this will go some way to addressing the negative return of -1.3% over the past three years, which compares very unfavourably with global generalist trusts such as F&C, which is up 22.5%. We feel the trust’s performance and management switches warrant placing the trust under review.
At Artemis Global Growth there has been a recovery over the last quarter, but the 15.7% return continues to lag the MSCI All Country World index, which returned 19.6% over the quarter. The fund’s poor performance over the past 18 months or so means it is bottom-quartile in all periods out to five years. It has recently been positioned for economic recovery, mainly via financials. Analysis shows that stock selection within sectors has been relatively strong, but the fund has been highly exposed to underperforming sectors. Rather than put the fund under formal review, we are instead opting to place the fund on performance watch for now.
We have been disappointed by the performance of a number of our Rated Funds in this group and are taking action to address this and approach managers for explanations.
Templeton EM Smaller Companies has performed best over the quarter, returning 28.9%. However charges are quite high and it has not delivered over the longer term, remaining in fourth quartile over one, three and five years, and not adding value compared with its benchmark index. Therefore we are placing the fund under review.
We have been monitoring the disappointing performance of Blackrock Frontiers trust for several months. The trust has a high yield of more than 6% and returned 18.4% over the quarter, but longer-term returns are comparably poor in the sector. Although the trust’s benchmark was changed a few years ago to take in smaller emerging markets alongside frontiers, the trust has not outperformed the new benchmark, and we feel stock selection has been the main cause of this. We are placing the trust under review and will make a decision on its Rated Fund status well before January 2021, when investors have the opportunity to tender their shares at the underlying net asset value (less costs). The current discount on the trust is an estimated 6%.
The weakest returns in the group came from Utilico Emerging Markets trust, which gained 11.4% over the quarter, and currently yields 4.3%. The trust was selected for its defensive qualities, but these were lacking during the worst of the market falls in February and March. Its holdings in ports, airports and other transport infrastructure holdings have undeniably been hit hard by the coronavirus pandemic, as has its very high weighting to Brazil. Although the trust has committed to pay quarterly dividends at the same level in this financial year as last, we are concerned about the low revenue reserves and whether the trust will need to dip into capital to fulfil this promise. Therefore, we are placing the trust under formal review until there is clarification of how dividends will be funded and the general outlook for investments in the portfolio.
High weightings to India, which has also been hard hit by the pandemic, weighed on the recent performance of Fundsmith Emerging Equities Trust and Stewart Investors Global Emerging Markets Sustainability, but they remain among the top performers in the year to date and over one year.
Like other Artemis-managed global equity funds (see global equity income review), Artemis Global Emerging Markets fund has suffered a poor run recently. Its yield has risen from 2.6% at the start of the year to a current historic yield of 3.8%. Its diverse portfolio – it has more than 100 holdings – may help to eliminate the risks that can hurt other more concentrated funds in periods of market stress, but that has not proved to be the case this year, as it is among the worst-performing funds. Therefore, we are placing the fund on performance watch and will be looking for clear signs of a turnaround in its fortunes in the near future.
M&G Emerging Markets Bond was the top-performing Rated Fund, gaining 16%. Despite the uptick in capital performance this fund still yields an attractive 6.4%. Other high-yielding funds also gained strongly – TwentyFour Select Monthly Income and Royal London Global Bond Opportunities both gained 12.2%.
Funds with a higher exposure to equities led the performance tables, with two funds returning in excess of 20%. Baillie Gifford Managed came top, with 24.8% return over the quarter, but a notable performance was made by Shires Income, which returned 22.8%. The trust is a member of the AIC’s UK equity income sector, but we classify it as a mixed asset fund due to its high exposure to bond-like preference shares.
Funds we are watching closely for signs of an improving performance profile are predominantly those with a high weighting to the UK. They include TB Wise Multi Asset Income and Seneca Global Income & Growth IT. Both have recovered in the last quarter but poor choices over the past year to 18 months have hit longer-term returns quite hard as well, particularly at Wise, which is down 20% over three years.
We think these funds deserve to be put on performance watch, along with two monthly distribution funds that have been weaker than we would like. They are Artemis Monthly Distribution and Axa Ethical Distribution. The Artemis fund’s 3.8% yield has helped prop up returns over the past three years, but they have slipped into negative territory with income reinvested. The five-year record, however, remains good. The yield on the Axa fund is less than 1.5%, which is not ideal for a mixed asset fund with a ‘distribution’ label.
We will also be keeping a close eye on Kames Diversified Monthly Income over the next quarter, where recent performance has also been comparatively weak although the longer-term numbers are still holding up reasonably well.
The yellow flags we look for
Manager change: Some funds are managed using a team approach, whereas others have a lead manager at the helm. When a Rated Fund manager departs, our default position (unless an established co-manager is taking over) is that we put the fund under review.
Fund too big: Some fund management firms ‘soft-close’ a fund when it hits a certain size, often by imposing an initial charge to deter new investors from investing. When Rated Funds are soft-closed, we place them under review.
Performance down: On a quarterly basis we keep tabs on how all our active funds are performing versus both peers and their benchmarks. Where we have concerns over performance, we will place a fund under review or on performance watch.
Discount monitoring: We also keep an eye on investment trusts that see a notable change in their ratings over a short period of time. High investment trust premiums are a potential yellow flag that investors should keep an eye out for, while a rapidly widening discount can be an indication of trouble in the underlying portfolio. We may put Rated trusts under ‘premium watch’ if we deem the premium or discount to net asset value to be excessive.
This article was originally published in our sister magazine Money Observer, which ceased publication in August 2020.
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