Interactive Investor

Where can fund and trust investors find value at the start of 2022?

29th December 2021 10:59

Cherry Reynard from interactive investor

Tilts towards areas of value and away from the more expensive spots may serve investors well in 2022.

It has been a bumper year for investors, with almost every asset class up over 12 months. It would be akin to a Midas touch, except the only asset investors really didn’t want to hold was gold. However, this strength has left value in short supply across financial markets as investors head into 2022, with stock markets close to, or hitting, all-time highs and bond yields near record lows.

A decade of low interest rates has inflated valuations for both shares and bonds. The S&P 500 index has (at the time of writing in mid-December) hit 50 new highs in 2021 alone. As a result, valuations have become more and expensive. The price to earnings ratio on the S&P 500 remains higher than at almost any point over the past decade.

At the same time, bond yields may have moved marginally higher from the very low levels seen in January 2020, but remain below the level seen at any point prior to that.

Omicron notwithstanding, this may be about to change. In December, the Bank of England became the first major central bank to raise interest rates, from 0.1% to 0.25%. It would not be a surprise to see one or two more rate rises in 2022. Across the pond, the Federal Reserve is paring back its quantitative easing policy and seems likely to raise rates in 2022. Rises in interest rates, albeit from historical lows, is a fundamental change that may disrupt the easy gains made by investors in recent years.

That said, while this reversal on rates should be bad news for financial markets, it is worth noting that it doesn’t affect all assets equally. This seems key to unlocking areas of good value in 2022. Low rates have disproportionately favoured those companies with high, long-term cash flows – in reality, the technology sector – while other sectors have been left behind.

Plenty of value opportunities outside US equities

James Klempster, deputy head of multi-asset at Liontrust Asset Management, says: “Global stock markets have come a long way in short order and look expensive in aggregate. However, that is really because of the US. If investors look outside the US, there is plenty of decent value and investors don’t need heroic assumptions on growth.”

Among these other markets, investors have the option between fairly priced – Europe perhaps or parts of Asia - and properly cheap – the UK and Japan. Klempster says the UK is cheap on almost all measures. It had a brief rally at the start of 2021, but its absolute and relative valuation is little changed over the year.

Bill Dinning, chief investment officer at Waverton Investment Management, is also backing the UK. He points out that the UK has lagged the MSCI World index by around 40% since the Brexit vote in 2016. He believes the pick-up in private equity interest in UK companies should support valuations. At the same time, there are signs that international investors are coming back to the UK. Strategists at JPMorgan Chase & Co recently upgraded UK stocks to “overweight,” citing the country’s “record discount” to other markets. While it has long preferred FTSE 250 vs FTSE 100, and domestic stocks over exporters, it now believes the FTSE 100 could perform better.

Which funds could be a way to take advantage? Liontrust has the Artemis Income and JOHCM UK Dynamic fund in its ‘Dynamic’ portfolios, and the BlackRock iShares MSCI UK Small Cap ETF (LSE:CUKS) and LF Lindsell Train UK Equity in its growth portfolios. The Waverton UK fund has holdings in companies such as AstraZeneca (LSE:AZN), RELX (LSE:REL)and Royal Dutch Shell (LSE:RDSB).  

Will the land of the rising sun deliver in 2021?

Japan is another area of interest. The region has been a dismal performer for much of 2020 and 2021, held back by political stasis and its ‘usual’ problems of weak demographics, high debt and a sclerotic corporate culture. However, the election of a new president, Fumio Kashida, appears to have galvanised markets once again and more recent performance from the Nikkei has been far more exciting.

Dinning says: “While we always say ‘it’s different this time’, the dynamics of some of the big companies have changed and we increasingly see Japanese companies thinking like other global companies.” He believes Japanese companies often aren’t given the benefit of the doubt by international investors, but there are plenty of opportunities.

The ii Super 60 currently has FTF Martin Currie Japan Equity and Baillie Gifford Shin Nippon (LSE:BGS) on its list.

Value stocks remain cheap

In terms of factors, ‘value’ still looks very cheap relative to history and to the rest of the market. While 2021 started out as a value year, ‘growth’ emerged as the winner again. Investors will need to decide whether some of the sectors that feature heavily in value portfolios – energy, mining, financials – have long-term structural challenges or look like a bargain. Capable value managers such as the value teams at Schroders and Jupiter, are due a moment in the sun and 2022 could be the year when it adjusts.

Ian Jensen-Humphreys, portfolio manager at Quilter Investors, says that investors may need to look beyond countries and more closely at themes in the year ahead: “The world has fundamentally changed as a result of the pandemic, from how frequently we travel, to where we spend our money, to where we go on holiday. We need to work out where the winners and losers will be in this new environment. As such, even when we look at regional allocations, we are looking at the sector composition of the index.”

The group’s ‘adventurous’ portfolio invests in the Fidelity China Consumerr fund, for example, along with a number of private equity holdings. Equally, while energy transition funds had a tougher year in 2021, it has knocked the froth off valuations and COP26 has given the sector new impetus, so this may be another area worth further examination.

Thematic opportunities aplenty

Nick Greenwood, manager of the Miton Global Opportunities Trust, agrees that there are a lot of idiosyncratic and thematic opportunities. He suggests that the further reaches of the investment trust market can be a fruitful place to explore.

Greenwood says: “It’s a difficult market to find value, but there are niches and pockets that look good. It is very stock specific. It is companies such as Strategic Equity Capital (LSE:SEC), which has a chequered long-term track record, but now has a very good manager. Georgia Capital, which no one likes because it’s in Georgia, but is interesting. The VinaCapital Vietnam Opportunities (LSE:VOF) and Geiger Counter (LSE:GCL) trusts are interesting. We can find these nuggets all over the place, even if the overall equity market is not that appealing.”

Value in bonds is in short supply

The fixed-income market is far trickier to navigate. Anthony Willis, investment manager in the multi-manager people team at BMO Global Asset Management, says: “Bonds have appeared expensive for a long time, only to consistently get even more expensive through the pandemic last year. Our view is there is little risk/reward at these levels and even if inflation does stabilise, the liquidity and monetary policy environment that has been so supportive of bonds in the past decade is unlikely to be as favourable looking into the future. Our portfolios are underweight bonds.”

Jensen-Humphreys agrees that bonds are difficult, with government bonds paying meaningfully under inflation: “If you want to generate a positive real return, you need to look at the equity market and alternative strategies.”

Klempster is marginally more positive. He says government bonds have a place as ‘the ultimate safe haven’ if everything goes wrong elsewhere. He says there are opportunities in areas such as high yield, emerging market debt and convertible debt. Liontrust allocates to these individual asset classes in-house, but investors may want to pick a capable strategic bond manager who can allocate flexibly to the right opportunities. M&G Global Macro Bond, Jupiter Strategic Bond or Royal London Global Bond Opportunities all have a broad mandate and can adapt to changing environments.

Alternatives can provide inflation protection

The final area is alternatives. Jensen-Humphreys says that the team at Quilter will look at areas such as infrastructure, which can provide some inflation protection to portfolios and a growing yield. Klempster says that there are selective opportunities, but investors need to tread carefully: “We look at areas such as government-backed social housing, healthcare and supermarkets, but we don’t want to buy areas such as offices or high street retail. Alternatives need to be a source of diversification and differentiation.”

There are plenty of risks – the Omicron variant, out-of-control inflation, political instability across many major markets. With that in mind, it is probably not a year to take significant binary bets on the direction of markets. Nevertheless, gentle tilts towards areas of value and away from the more expensive spots may serve investors well in 2022.

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