Fund–of-fund (FoF) managers face the constant challenge of obtaining their preferred style, geographical, and sector biases with the comparatively “blunt” building blocks of mutual funds. This problem is particularly evident in sectors that might constitute a comprehensive exposure for other investors. The broad nature of emerging market (EM) classifications has resulted in FoFs in September 2013 using some 500 fund options to obtain their EM exposure. This reveals the difficulty FoF managers face in calibrating this particular exposure to reflect their outlook.

In September 2013 European FoFs continued to show a preference for broad-based EM funds. The 25 top fund options for September constituted nearly 40% of the €6bn that European FoFs held in global EM. A total of 11% of these assets was invested in Aberdeen funds, making Aberdeen the most popular active fund group by far in the top 25, followed by M&G and First State, which were also well represented. Investors in the EM space showed a predilection toward actively managed, broad-based funds, generally with passive options constituting the residual. Within the 25 top sellers only 8% of the overall assets for September were invested in passive products–a considerably lower percentage than for other regional classifications.

The problem of distilling specific exposure within EM was particularly evident in frontier markets. The total exposure to this subsector was only 3.1% of the overall holdings in EM. Goldman Sachs N-11 Equity Fund made an appearance at Number 14 in the popularity stakes, with 37 FoFs using it to obtain specific frontier-market exposure. Even though the number of FoFs was quite high, the average holding size was €2.3m, meaning the fund ended up with an overall investment of €73.1m–only 1.3% of the overall exposure by groups to EM. (It is one of only a handful of funds of its type in the sector.) BlackRock Frontiers Investment Trust (€17.6m) was held by 11 buyers; Schroder ISF Frontier Markets (€5.1m) also had 11 buyers. Templeton Frontier Markets (€66.1m) was the most popular fund in terms of number of holdings; the fund was held by 48 FoFs.

Passive representation in frontier markets was commensurately much lower; of the €183.0m held in frontier-market options overall for September, only €11.4m was held in the better-known frontier-market-tracker options. European FoF managers clearly were trusting active managers to better manage the liquidity and capitalization constraints faced in this area of the EM market.

This article first appeared in Citywire Global Magazine

Jake Moeller uses the Lipper Leaders scoring system to analyse the best performing funds in IMA Sterling Corporate Bond Sector.

In recent years corporate bond funds have proven very popular with investors seeking income in a low interest rate environment. Many corporate bond funds have had to deal with enormous inflows putting pressure on fund managers to fully invest their portfolios in quality assets. Recently there has been a considerable change in sentiment as investors have been prepared to take on more risk with equities investments and we have seen six months of aggregate outflows in the Corporate Bond sector.

Despite this, Sterling corporate bond funds are still offering decent returns but the sector is not homogenous. It is important that investors understand the risks that corporate bond managers have undertaken in their portfolios. At the end of November 2013 the average exposure to AAA investments (highest quality) was only 19% but the higher risk BBB exposure was 35%. Within these credit risk “buckets” there is huge dispersion – one fund for example, has 63% invested in BBB assets whilst another less than 1%

Lipper Leader ratings can help an investor assess funds on key metrics such as total return and price. However, in times of uncertainty as now, the Consistent Returns and the Preservation scores offer an invaluable tool to assess relative risk of portfolios for an investor without the time to investigate the content of a bond fund portfolio in detail. Given the diversity of portfolio composition these funds exhibit, risk-adjusted return metrics provide a useful snapshot to the investor on relative performance and volatility.

The funds in the table all score highly for Consistent Return and Preservation over a 5 year period. For investors who know highly regarded UK corporate bond fund managers like Stephen Snowden at Kames or Alix Stewart at Schroder, this will come as no surprise but all of these funds scoring so highly in key risk barometers, should offer investors some comfort should there be a large downside correction in the bond market.

This article first appeared in the January 2014 edition of Investment Life & Pensions Moneyfacts 

Highlights from the annual Artemis investment conference held on February 6, 2014, by Jake Moeller.

Over the years “An Evening With Artemis” has grown to be a notable event in the calendar of U.K. IFAs and fund researchers. As well as the usual insights from founder Mark Tyndall and income manager Adrian Frost, this year Artemis showcased four funds. This article reviews the first two:

Artemis Global Income Fund

Despite his youthful countenance, fund manager Jacob de Tusch-Lec is a highly experienced and passionate fund manager with an exceptional grasp of economics and markets. Within Artemis his expertise has been applied to a number of funds, and he has been managing the Global Income Fund since its launch in July 2010.

Global income is a fledgling sector now becoming larger as canny fund groups seek to capitalise on investor demand for yield. There are now around 30 funds in the Lipper Equity Global Income Funds sector, with a significant proportion of those being launched since 2009.

The track record of this fund is impressive. It scores a combined 14/15 in three Lipper Leader categories (Consistent Return, Total Return, and Preservation) over three years, and it has outperformed over 30% above the sector since its launch. Currently it is yielding 4.0%.

In portfolio composition the fund has been designed to avoid overlap with Artemis UK Income Fund; and Jacob eschews stocks such as Nestlé, Shell, Vodafone, and Microsoft (commonly seen in global income portfolios) in favour of less popular mid-cap names such as Silverlake and RTL Group. Overall, there is a considerable exposure (42%) to mid-cap stocks compared to its peers, which renders it the second most volatile fund in the sector over three years and susceptible to size rotation back to large-caps.

A significant feature of this fund is its low relative weighting to the U.K. compared to its peers (12% compared to the peer average of 16%). It is also considerably overweighted to Europe (+17%) and underweighted to the U.S. (-23%). Jacob notes that the median price/earnings ratio for the S&P 500 Dividend Aristocrats is at 23x, which makes chasing dividends in the U.S. currently an expensive proposition.

Despite recent strong performance, Jacob remains sanguine about the outlook for equities generally, noting the normalisation of bond/equity correlations and further support from bond fund net outflows. He believes the equities beta play is over, and in this “alpha market” he is positioning himself more cyclically and looking for an increase in M&A activity and Capex.

SmartGARP–Artemis Capital Fund, European Growth Fund, and Global Growth Fund

For the romantically disposed investor Artemis’s SmartGARP range offers very little. This is a purely mechanical investment process that was started by Phillip Wolstencroft from his days at Merrill Lynch and subsequently was developed by both him and Peter Saacke.

Put simply, SmartGARP is driven by measuring quantitative value and growth metrics (e.g., ROE, price-to-book ratio, etc.) in conjunction with revisions (changes to earnings-per-share estimates) momentum and an accounting metric. This screen then scores the stocks, with the best scorers going into the portfolio. For the Global Growth Fund the asset allocation is automated also, with the countries weighted according to their proportional SmartGARP stock output.

“SmartGARP Works!” was the claim of this presentation, and the figures presented herewith appear to validate this for the funds since inception:

 However, as with many automated strategies SmartGARP faltered in 2008. To be fair to Artemis, the fund managers have addressed this up front and are quite candid about what went wrong and why. Since 2008 the value metric has been adjusted and is now a flexible input. The fund naturally has a value bias, and the managers have been increasing the value factor over the last 12 months.

SmartGARP is currently rating stocks such as Lloyds Bank, easyJet, BP, and BT; underweighting the U.S.; and overweighting emerging markets with particular emphasis on China.

Regardless of your view on automated fund management styles—where the calibration of the inputs is at the fund managers’ discretion, a human and possibly fallible element is introduced to the process. One unintended consequence of SmartGARP is that it is definitely good for the environment–the managers do not undertake any company visits, thereby keeping their carbon footprint to a minimum.

Highlights from the annual Artemis investment conference held on February 6, 2014, by Jake Moeller.

This article concludes the highlights with a review of the remaining two funds that were showcased at “An Evening With Artemis.”

Artemis Strategic Bond Fund

James Foster and Alex Ralph have formed a very credible partnership at Artemis. James ostensibly concentrates on the investment-grade component and Alex on the high-yield, but they both work on duration and are clearly comfortable offering each other counsel and ideas.

Although a highly flexible fund, the Strategic Bond Fund historically has had substantial exposure to the financial sector and high-yield investments, causing traumatic results in 2008. The team managed this situation prudently, however, and were able to benefit from the credit rally that subsequently occurred throughout 2010.

The portfolio has performed strongly in both its sector and against its benchmark. It scores a combined 15/15 in three Lipper Leader categories (Consistent Return, Total Return, and Preservation) over five years, maintaining a first-quartile ranking since its launch.

Throughout 2013 the managers successfully reduced duration in the fund, reversing this position when U.S. Treasury yields hit 3%. Maintaining a key exposure to financials and hybrids bonds (mainly utilities & telecommunication) and an overweighted high-yield component, while remaining underweighted in CCC, also proved fruitful. They are comfortable with their banks position, stating that ongoing deleveraging and capital buffers make these bonds safer. James stated that extra yield is still above noncorporate, suggesting that ongoing “rehabilitation” in the sector will further narrow spreads.

Both James and Alex were “excited by the prospect of a dull year” for bonds in 2014, believing that interest rates won’t go up until possibly 2016 (because of tougher bank capital restrictions and policy preference for tweaking the funding-for-lending scheme). They are confident that “tapering” will occur cautiously.

Alex’s outlook for high-yield was sanguine (particularly in Europe), with global default rates remaining low and with a market resilient to emerging markets rumblings. She was cautious on increased M&A and threats from private equity in 2014, but she was looking to cherry pick in the B and BB space, watching leverage carefully to monitor overheating.

Investment-grade liquidity was highlighted as a potential concern in a selloff. Concentration of holdings within large “mega-funds” within Europe and the U.K. is substantial. In the U.K. the three top funds manage over 40% of the assets. This concentration is not as prevalent in funds in the strategic bond sector.

Artemis UK Growth Fund

There is something reassuring about Tim Steer’s background as a chartered accountant, given his natural flamboyance and willingness to wear his stocks on his sleeve. Certainly as a GARP-type manager, his ability to speak fluent “balance sheet” complements his more esoteric art of correctly picking top-down themes that might drive share performance. His now infamous shorting of Autonomy in 2011 notwithstanding, he is able to sift through the myriad accounting tricks companies employ and to generally identify potential mischief hidden in the statements.

His fund has undergone a sea change in the last 18 months, with a shift in emphasis from U.K. stocks that have exposure to offshore earnings—notably the U.S.—to stocks that are more U.K.-domestic focussed. This shift to what he describes as “U.K. survivors” drove the fund’s considerable outperformance for 2013. This Darwinian notion is that companies have been “shocked” after the credit crisis into becoming fitter, deleveraging and adapting to a low-growth environment. This, combined with a shift to a more favourable macro environment (Tim thinks 3% GDP growth is sustainable) justifies his continuing shift in portfolio composition to U.K. earnings.

The portfolio has performed strongly in both its sector and against its benchmark. It scores a combined 14/15 in three Lipper Leader categories (Consistent Return, Total Return, and Preservation) over five years, maintaining a first-quartile ranking since its launch.

 Tim actively engages companies, colleagues, broker research, and financial statements. This information is distilled into Artemis’s “MARKET” screen, ranking stocks according to valuation, financial strength, and EPS revisions. Of the 30 top stocks from this model in 2010, 6 were U.K. earners. In 2013 that was 15 stocks. Tim puts considerable faith in this model, saying it “works 90%” of the time and has most recently proven itself by reducing exposure to miners and other foreign earners and into stocks such as Sports Direct, easyJet, William Hill, and Howdens. Tim stressed that the screen remains an adjunct to his skill set as an active manager – this is very much an active fund and should not be confused with the SmartGARP process.

Jake Moeller, Head of Lipper UK and Ireland Research, examines how European fund of fund managers are getting their exposure to Asia and Japan.

Asia and Japan proved to be considerably important sectors for asset allocators during 2013. For YTD October 2013 the Lipper Global Equity Asia ex-Japan sector returned 5.5% (with the top fund returning 33% and the bottom fund -17%). Lipper Global Equity Japan returned 27.4% (with the top fund returning 110% and the bottom fund returning -9%). Comparing these sectors against the Lipper Global Equity US sector, which returned 26.3%, considerable rewards were on offer for those with an overweighting to Japan and for the astute fund selector.

In October 2013 European funds of funds (FoFs) showed a preference for well-known names and broadly based Asia ex-Japan funds, with the 25 top fund options (by asset size) constituting 62% of the total €4.3bn written in the sector. First State, Aberdeen, Fidelity, Schroder, Newton, and Templeton were all well represented, with First State Asia Pacific Leaders – with over 100 FoF investors in October – taking the first two spots. Aberdeen’s Asia Pacific Equity, with 30 FoF investors, appeared in third place. The first passive option came in at Number 7; iShares MSCI AC Far East ex-Japan UCITS exchange-traded fund was written by 21 FoFs. The least popular funds with buyers in the month were at the specialist end of the spectrum; infrastructure and Asian dividend income appeared with only a handful of investors.

Japan showed a similar concentration pattern to Asia; 56% of the total €3.6bn of assets was held by the 25 top fund options (by asset size GLG, Jupiter, and Aberdeen all get honourable mentions). However, despite the potential outperformance available in the sector, fund selectors appeared less enamoured with active fund managers.

Passive options in Japan proved most popular for FoFs, with the ten top options by FoF popularity consisting of seven passive options (MSCI Japan being the most popular benchmark). Given that Japan generally constitutes a relatively small exposure within most FoFs’ equity allocation, this might not come as a surprise. Interestingly,  of the three previously mentioned active funds represented in the FoF top ten, only GLG Japan Core Alpha managed to beat the Lipper Global Equity Japan index (and then only by 79 basis points).

This article first appeared in Citywire Global Magazine

The following report is based on the unique fund flows information delivered through Lipper FundFile, our leading global fund flows database. The charts and tables in this report reflect only the tip of the iceberg in terms of the depth and breadth available from Lipper within FundFile. The report offers a high-level overview of European fund flows activity in 2013.

Lipper FundFile allows deep fund flows analysis of all key geographical markets covering: Asia Pacific, Latin America, the Middle East and Africa, and the U.S., and delivers a truly global fund flows solution.

By gradually building the international reach of global sales data, the high quality and ease of use that have made FundFile the unparalleled source of data and analysis–compiling information on more than 100,000 funds over the past ten years–have been maintained.

The cross-border dimension of the European funds industry–the “international” fund market–can only truly be assessed with Lipper SalesWatch, a unique cooperative, confidential benchmarking service that allows leading fund groups to track their cross-border sales and assets against their competitors’ by country, distribution channel, institutional versus retail activity, and both gross and net sales. This service now counts 50 of the leading asset managers among its members. Some sample data taken from the tool can be seen on pages 17 and 18 of the current report.

Over the course of the year 2013 the European fund industry enjoyed net sales of €183.5bn into mutual funds. These consisted of sales of €96bn into bond funds, €92bn into equity funds and €85bn into mixed-asset funds. The highest outflows were seen in money market funds (-€93bn) and commodity funds (-€8bn). This year stands in considerable contrast to 2012 which saw the complete domination of sales into bond funds. Whilst there is no substantial evidence that the bond bubble is bursting, 2013 has been characterised by a considerable uptake in investor risk appetite which has been reflected by more robust flows into equity funds. Equity sales have increased in all major countries (with the notable exception of Germany with outflows of -€6bn). For 2013 Global and European equities were ranked third and fourth respectively with around €26bn of net sales.

There was a marked inflection point in May and June 2013 with the first mentioning of “tapering” which spooked the market and resulted in large adjustments in fixed income composition. Interestingly, investors didn’t cash in their chips with bonds, but rather de-risked within the sector – moving out of EM debt and local currency bonds into better rated global currency and western high yield bonds. Indeed, global currency debt came in at number two on the sales hit parade at €27bn and more nimble flexible bond funds taking nearly €24bn.

In what is clearly a volatile asset allocation environment, there has been considerable growth into Mixed Asset funds (€85bn) which have proven particularly popular in Italy (€18bn) the UK (€12bn) and Germany (€10bn). The bulk of these mixed flows have come in via the cross border funds (€37bn) showing that the trend may be geographically wider than mere regional sales suggest. Certainly, sophisticated products like Standard Life Gars (€4.2bn) have continued to raise the profile of the sector.

In terms of group success, BlackRock has maintained its number one ranking with €32bn of European sales however, given that this figure includes a substantial book of passive business, JP Morgan should be considered the top active house with flows of €21bn. The most notable omission in the league table is PIMCO. In light of the bond tapering scare, recent poor performance of their flagship fund and the departure of CIO/CEO Mohamed El-Erian, they have slipped from number one in 2012 (€35bn) to outside of the top 25 for 2013.

The report is available for free download here

Highlights from presentation by Leon Howard-Spink, March 4, 2014.

There are three certainties in life – death, taxes and fund manager under-performance. The third is neither to be feared nor seen as an indictment against active funds management. It is during periods of under-performance that a fund manager shows steel or “courage under fire” as I refer to it.  Leon Howard-Spink does not shrink from his recent difficulties at Schroder. He explains his attribution calmly and with an assurance that suggests his central stock picking tenets remain intact. To his credit, not only does he understand and thoroughly articulate his portfolio positioning, he has recognised there may be a structural problem with his fund. He has therefore initiated remedial actions that although they don’t dilute his stock picking process, appear to address the concerns he has identified.

Mr Howard-Spink has a strong European stock picking pedigree. Since his time at Schroder (November 2005) his track record has been characterised by consistent out-performance against the Lipper Global Equity Europe ex UK Index. Last year proved to be a difficult one for him with the fund losing over 8% from March to September 2013 relative to the sector benchmark.

This came about as a decreasingly risk averse market gained momentum penalising the “quality core” component of his portfolio. Furthermore, the emerging market exposure his stocks contained was similarly penalised in the general “tapering” sell off that afflicted the market from May 2013. Stocks Mr Howard-Spink sees as “value destroying” – such as utilities – were rewarded whilst a key sector underweighting in financials and positions in technology also detracted from performance.

This fund has now broken the £1-billion mark and Mr Howard-Spink intimated that although capacity isn’t a direct concern, the decline in market volumes in major indices in recent years has reduced liquidity markedly in large-cap stocks.

Source: Schroders

He stated that traditionally his fund was low beta with a natural hedge of smaller capitalised stocks and that in 2013 this hedge was missing. Hence to overcome the liquidity issue, he has initiated a three stock position (5% of the portfolio) to small-cap stocks. He reserves the right to increase this – potentially up to 10% of the portfolio. He has also undertaken to increase the “conviction” of his active stock positions. He noted that where he had got stock bets right in 2013, they simply were not material enough to influence overall performance. He has eschewed some big names such as Nestlé in order to “concentrate his firepower” in stocks such as Henkel and Svenska Cellulosa.

The latest five year Lipper Leader scores for Schroder European Alpha Fund are reflected in the recent numbers:

History suggests that Mr Howard-Spink will prevail. Already there has been an improvement in recent numbers and other periods of under-performance in 2007 and 2009 were similarly made good. He has formulated a credible response after a poor year and refined his process without compromising the core values which brought him success in the past.

Lipper’s Jake Moeller presents highlights of Threadneedle’s U.S. equities capabilities following a presentation by Leigh Harrison, Head of Equities, and Neil Robson, Fund Manager, February 12, 2014.

REUTERS/Lucas Jackson

It feels strange to see Leigh Harrison, one of the most highly respected U.K. equity income fund managers, fronting up a U.S. equity fund presentation. But in his role as head of equities at Threadneedle, he has been called upon to do just that. The well-publicised resignation of Cormac Weldon and Stephen Moore is as much a remarkable coup for Artemis as it is a loss for Threadneedle. Mr. Harrison was generous in his praise for Mr. Weldon and those departing. If there is any consternation at the disruption these departures cause Threadneedle, he didn’t show it, and he appeared to be genuine in wishing them all the best.

Magnanimity, while admirable, doesn’t pay the rent, and the task to maintain the goodwill in this franchise is considerable. The U.S. market is a notoriously difficult region in which to succeed, and only a handful of U.K.-based managers have managed to forge a credible reputation. Consider the recent experience of Investec, which since insourcing its U.S. equities from Thornburg, has seen Alastair Mundy step down as co-manager of that fund.

Threadneedle’s Diane Sorbin has been appointed head of U.S. equities; she and Neil Robson, who has three years of experience on Threadneedle Global Extended Alpha, come across as two strong pairs of hands to keep the tiller steady and given that 64% of stocks in the Global portfolio are shared in the U.S. one, their experience is extremely portable. Furthermore, Mr. Robson’s recent track record is strong:

Figure 1. Cumulative Performance of Threadneedle Global Extended Alpha, February 28, 2011-February 28, 2014

Source: Lipper, a Thomson Reuters company

While many investors perceive Threadneedle to be a boutique fund company, the considerable resources it can draw upon from its sister company, Colombia Management, should put paid to that misconception. There are 28 additional senior specialists and other professionals at hand to provide input into Threadneedle’s global and U.S. equities businesses.

That notwithstanding, the key to the future success of this franchise will depend on the new appointees. Threadneedle has gone to market, and at the time of this writing has stated that it is in the final interview stages for candidates to replace the departing team. A steady hand on the tiller is well and good, but new appointments have to hit the ground running. There is much to lose. For example, Mr. Weldon has presided over Threadneedle American Select Fund, which has consistently remained in the top quartile of its peers:

Figure 2. Cumulative Performance of Threadneedle American Select Fund, December 28, 2008-February 28, 2014

Source: Lipper, a Thomson Reuters company

Mr. Harrison as head of equities will know the team dynamic at Threadneedle better than anybody, and although he is a U.K. specialist he has considerable equities gravitas. Threadneedle has stated the interview process is a collegiate affair, and having met a number of the team, I’ve no doubt this is the case. That Mr. Harrison is effectively “chairman of selectors” over a group that still retains plenty of U.S.-based intellectual capital augers well for Threadneedle as it makes a new transition in a very competitive space.

Emerging market debt (EMD) has been gaining headlines for considerable time following the high profile sell off in May and June 2013 after the “tapering” discussions by the Federal Reserve. More recently poor national account data and fiscal issues in emerging markets has similarly resulted in further volatility in the asset class.

REUTERS/Navesh Chitrakar

The Lipper Global Bond – Emerging Markets Global sector was down nearly -11% for the 12 months to December 2013 with the top fund returning 4% over that period and the bottom fund -30%. Considering that the Lipper Global Bond sector is down only -4% (and had tracked the EMD index fairly closely until May 2013) by comparison, European fund of fund managers (FoFs) have faced considerable challenges in both allocation to, and stock selection within, this sector.

Table 1. Performance of EMD Bonds v Global Bonds

Source: Lipper, a Thomson Reuters company.

European FoFs have shown a preference for well known names and active funds in this sector. In December 2013 the 25 top fund options (by popularity) constituted 36% of the total €3.5bn written in the sector overall. This is a lower concentration than we have seen in other sectors. Active managers have taken the lion share of space in the hit parade with only 5 tracker options appearing in the top 25 fund options.

The most popular fund by holdings is Saxo Invest Global Evolution Frontier Markets with 23 FoF purchasers. Julius Baer, Pictet, Morgan Stanley, Goldman Sachs, JPM and Aberdeen are all well represented. Interestingly, despite high profile outflows and the recent departure of its CEO Mohamed El-Erian, PIMCO GIS Emerging Local Bond Inst USD comes in at number 10 in the order of FoF manager popularity. This sector doesn’t contain many small boutiques and the less popular funds consist mainly of well known names the residual share classes of larger funds.

Table 2. Emerging Market Debt Funds by Popularity.

Source: Lipper, a Thomson Reuters company.

This is clearly a sector where FoFs prefer active fund management – across the entire sector for both hard and local currency funds there are only a handful of passive options appearing. iShares J.P. Morgan $ Emer Mkts Bd UCITS ETF proving the most popular tracker in December 2013.

A version of this article first appeared in Citywire Global magazine in January 2014.

Lipper’s Jake Moeller provides highlights of a presentation by Andrew Rose on March 11, 2014.

REUTERS/Yuriko Nakao

The ongoing travails faced by Japan have proven a considerable burden for many asset allocators. Some have chosen to eschew the region altogether or to maintain a nominal benchmark position. Compounding the complexity of populating allocated exposure, active managers have exhibited a huge dispersion of returns (for the three years to December 2013, the best performing fund returned 47.6% and the worst 2.6%). Only in the last year has a handful of managers started to take material positions in the region:

Figure 1. Historical Exposure to Japan in the IMA Mixed 40%-85% Sector, 2005-2013

Source: Lipper, a Thomson Reuters company.

However, investors could have done much worse than chose to invest in Schroder Tokyo. In the last ten years the fund has consistently remained in the first or second quartiles of the IMA Japan sector and has a considerably lower volatility profile than many comparable funds.

Lead manager Andrew Rose has an impressive CV, having spent his entire working career within the region since joining Shroders in 1981. He brings passion and knowledge to explaining not only the company opportunities in Japan but to deciphering the policy machinations and their potential implications for markets as well.

Mr. Rose believes Japan is being disproportionately influenced by macro factors. As foreign investors were responsible for 65% of all trading in the market (in February 2014), combined with the high number of noncommercial short-yen futures positions driving the currency down, Mr. Rose believes a more significant correction is occurring than perceived in 2014. However, he is broadly positive on the economic policies of Prime Minister Abe, seeing small signs such as the shortage of labour in the market as allowing the potential for wage increases in the upcoming “Spring Wage Offensive.” Along with modest improvements in  corporate spending on fixed investment, this is evidence that some of the “Abenomics” arrows are hitting their mark.

Figure 2. Growth of Schroder Tokyo Within IMA Japan Sector, 2003-2014

Source: Lipper, a Thomson Reuters Company.

However, there are a few concerns he sees in the environment. Despite the weakening yen, there has not been a commensurate recovery in export volumes. He is uncertain as to the possible effects of an imminent increase in the consumption tax, and only a “muted” rebalancing of assets has occured under the Abenomics policies. Japanese banks, while desperate to lend, have no demand and therefore have sold bonds and placed the proceeds on deposit. Households similarly remain highly invested in cash.

The “third arrow” of Abenomics–structual reform–has appeared to be less effective. There has been no progress with electoral reform or immigration, and there is uncertainty as to whether the corporate tax rate will come down from 35% to 30% in June. However, Mr. Rose argues that investor expectations here are too high and that reforms will be incremental if not enduring.

At a corporate level Mr. Rose is encouraged by improving profit momentum and at 13x P/E doesn’t believe the market is overvalued. He has adopted a procyclical bias in his portfolio–holding few defensive stocks, and he is now slightly overweighted in financials “for the first time in some time” (although this is via insurers–he remains  underweighted in banks). His overall portfolio has a value tilt, and he has been adding to manufacturing “yen laggards,” such as Canon, Honda, and Hitachi. He believes his mid-cap exposure will be further rewarded as smaller companies begin to benefit from the weaker yen.

To the end of December 2013 Schroder Tokyo scored 15 of the possible 20 in four combined Lipper Leader categories (Total Return, Preservation, Expense, and Consistent Return) in the five-year category.

Jake Moeller uses the Lipper Leaders scoring system to analyse the best performing funds in IMA Europe ex UK Sector.

REUTERS/Jon Nazca

Most investors will be familiar with the headlines that have emanated from Europe in recent times. Despite the macro headwinds which have dominated the news, many fund groups have been able to generate some good returns with the commotion providing active stock pickers with unique opportunities.

These opportunities should not be overlooked – Europe offers the investors a wide range of stocks and industries which are not well represented in the UK. The range of performance outcomes in this sector is broad. In 12 months to December 2013 the sector returned 26% with the top fund returning 42% and the bottom fund 4%.

 Table 1. Quartile Spread of the IMA Europe ex UK Sector – 12m to 31 December 2013.

Source: Lipper, a Thomson Reuters company.

The funds included in the table are those with the best 3 year total returns in this sector. Including the Lipper Leaders ratings reveals that these funds have also delivered excellent Consistent Returns (risk-adjusted performance relative to their peers) over the last 5 years – this shows that they are able to add value of a longer period of time.

 Table 2. Top Performing Funds in the IMA European ex U.K. Sector (over 3 years)

Interestingly, the funds across the table have varied processes and portfolio composition. Schroder European (managed by Martin Skanber) has invested in PIIGs countries and is positioned for European recovery. Henderson European Focus (managed by John Bennett) is heavily weighted to pharmaceutical and consumer stocks. Threadneedle European Select (managed by David Dudding) likes basic materials whilst Invesco Perpetual European Opportunities (managed by Adrian Bignell has exposure to financials and industrials. Despite these differences, all of these funds share a good score across the Lipper Leader categories, proving that a comparable risk adjusted performance track record can be generated across differing fund manager styles.

It is worth mentioning that the Expense and Preservation scores are comparatively lower– active fund management tends to be more expensive and product structures can matter (Scottish Widows HIFML Euro Strategic is in a life wrapper for example). As fully invested equities funds, they can exhibit considerable volatility which accounts for the lower Preservation scores. A long term investor horizon and a good Consistent Return score should compensate the investor for these.

A version of this article first appeared in the January 2014 edition of Moneyfacts magazine.

Lipper’s Jake Moeller examines how European fund of fund managers are gaining their exposure to Japanese equities.

There has been considerable on-going focus on Japan, generated by the strong regional performance in 2013 (the Lipper Global Equity Japan classification returned 27.4% for the year) and the continued debate about the potential effectiveness of the “Three Arrows” of “Abenomics.” The third arrow–structural reform to boost potential growth–has been particularly highly discussed.

REUTERS/ Stringer

Given the large dispersion of fund performance in the sector, which returned 15.7% over one year to January 2014 (the best performing fund–Legg Mason Japan–returned 50.3%, while the worst performer–JPM Japan Market Neutral–returned minus 9.5%), choosing the right fund in the sector has been as important if not more so than the asset allocation decision.

In January 2014 European funds of funds (FoFs) showed a remarkable preference to eschew the stock selection side of the portfolio construction process in obtaining their Japan exposure. This was despite the positive skew in the distribution of one-year returns to January. By buyer popularity, only two active funds appeared in the ten top options–Polar Capital Japan, which was popular with 20 buyers, followed by Aberdeen Global Japanese Equity–popular with 17 buyers.

Source: Lipper, a Thomson Reuters Company.

Topping the overall list for January was iShares MSCI Japan Monthly EUR Hedged, which was popular with 41 buyers. Amundi ETF Japan Topix Eur Hedged Daily UCITS ETF came in second with 39 buyers, while iShares MSCI Japan UCITS ETF picked up the bronze medal with 28 buyers. Overall, in the ten most popular options by buyer, 85% were invested in passive options. However, in the top 25 the incidence of active fund purchases increased, with only 47% of investors buying passive options.Of the €3.8b invested in Japan by FoFs in January 2014, the ten top-ranked options by buyer popularity constituted roughly 20% of overall assets under management. When ranked by total net assets the ten top fund options comprised 32% of all assets; here passive funds were much less represented. GLG Japan CoreAlpha Professional collected €161m, with Morant Wright and Nomura in hot pursuit.

To further show the buyer concentration of the sector, there were some 240 individual fund options that fund buyers used for Japan exposure in January. The 25 top options by total net assets constituted nearly 60% of all assets. While a considerable number of FoF managers seemed to be happy simply to obtain beta to the market, the average asset-holding size per buyer was lower to passive funds than to active. The larger groups were actively seeking alpha in this region. There likely were of course plenty of portfolio constructors using both active and passive funds together. Unfortunately, that was impossible to discern from the data.

A variation of this article first appeared in CityWire Global magazine in January 2014.

Jake Moeller uses the Lipper Leaders scoring system to analyse the best performing funds in IMA North America sector.

REUTERS/Jo Yong-Hak

The importance of the U.S. market simply cannot be overlooked by a U.K. investor. Traditionally the U.S. has composed around 50% of the MSCI world index by weight and the fortunes of other world markets are invariably beholden to events there. North America is a heavily analysed market and obtaining an information advantage as an active fund manager is a particularly challenging undertaking. An institutional fund investor will have the resources to examine the detailed characteristics of a U.S. fund – style bias, portfolio composition, sector tilts etc and then interview the fund manager. A retail investor is unlikely to be able to undertake this level of due diligence and is thus faced with a difficult choice.

Table 1. 12 month spread of funds in the IMA North America sector to end of February 2014.

Source: Lipper, a Thomson Reuters company.

The funds included in the table are those with the best 3 year total returns in this sector. Including the Lipper Leaders ratings reveals that these funds have also delivered excellent Consistent Returns (risk-adjusted performance relative to their peers) over the last 5 years – this shows that they are able to add value of a longer period of time.

Table 2. Top Lipper Leader Rated Funds in the IMA North America sector

Source: Lipper, a Thomson Reuters company.

In this list you see a broad group of styles – Ian Heslop’s Old Mutual fund is a quantitative strategy with an inherent value bias. Peter Bye and Dan Neuger manage the UBS U.S. Growth Fund with a growth tilt. Threadneedle American Extended Alpha is a 130/30 type fund which allows shorting of stocks and JPM U.S. Equity Income aims to achieve an attractive yield from its portfolio. Despite these varied approaches, the important translation to out-performance is reflected in the strong Lipper Leader scores.

It is important to note that Lipper Leaders are calculated solely on quantitative inputs. Recently, Stephen Moore left Threadneedle with Neil Robson and Ashish Kochar now lead managers on the Threadneedle American Extended Alpha fund. A change in fund manager is a critical event that needs some qualitative evaluation by an investor. Any style changes that new managers bring to a fund need to roll through into longer term performance data before the Lipper Leader scores apply entirely to them.

A version of this article first appeared in MoneyFacts magazine.

Lipper’s Jake Moeller presents highlights of a presentation by Sam Morse, manager of the Fidelity European fund,  April 30 2014.

“Bull Markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.”

REUTERS/Kai Pfaffenbach

Opening with this cautionary quote by Sir John Templeton, Mr. Morse, although not entirely bearish on the outlook for European equities, intimates that investors consider there will be a lukewarm—if not a cold—shower on the asset class.

Looking back at the market since May 2012, he notes that the best performing European companies have been either dependent on high leverage, based in peripheral Europe, or simply floating on the “rising tide” of momentum. He points out that, while European rerating has risen over 30% since March 2012, earnings contributions have actually been negative over the same period. In comparison, the U.S.A.—with a similar return—has had over 10% increase in contributions. Mr. Morse, with his considerable experience managing U.K. investment trusts, is also concerned that historically low discounts to NAV (now around 5%) are compelling evidence that the European market generally may be too euphoric.

It is clear that the recent market environment has not been conducive to Mr. Morse’s portfolio construction process. The Fidelity European Fund underperformed its benchmark by some 9 percentage points for 2013:

 Table 1. Performance Summary – Fidelity European Fund 

Source: Lipper, a Thomson Reuters company.

Mr. Morse is an ardent picker of dividend growth stocks, and it is the inherent quality bias in his portfolio that has detracted from its overall performance. For 2013 only 30% of his portfolio beat the market, with many consistent “dividend growers” such as Novo-Nordisk, Nestle, and Sanofi failing to keep pace.

To Mr. Morse’s credit he also accepts that there has been some adverse stock selection. For example, he defended Turkiye Garanti Bankasi, stating that Turkish banks are very well capitalised and are strictly regulated. He continues to prefer his largest active position, Nestle, over Unilever and Danone because of its strong product range, improvements in sales, margins, and a “refocusing” of the business on return on capital.

Far from being a harbinger of doom, Mr. Morse’s message is delivered with balance. He suggests European valuations are expensive but not historically so (the 12-month forward median P/E of the  FTSE Eurofirst 300 Pan Europe index is currently 15.5x and has been considerably higher than its long-term average of 14x). He also recognises that macro considerations may yet drive the exuberance further. But, with a portfolio well diversified across the capitalisation spectrum, he is happy to await a rotation back to quality.

Since taking over the fund from Tim McCarron in December 2009, Mr. Morse has had three strong years and—despite a poor 2013—still remains in the second quartile:

Table 2. Performance of Fidelity European Fund within IMA Classification.

Source: Lipper, a Thomson Reuters company.

Sam Morse has a considerable pedigree in dividend investing and despite the recent bout of under-performance is totally confident that market conditions will again turn in favour of his style. His overall track record suggests he may well be right and that a lukewarm shower on Europe is forthcoming.

Global Bonds remain a popular discussion point among investors and pose a particular problem because of the lack of homogeneity in the sector. The risks of making a wrong call in a portfolio’s bond allocation are amplified by the on-going abnormal interest-rate environment. The Lipper fund flows data in February 2014, shows that fund buyers are seeking a more dynamic solution through flexible bond funds with broader income-based mandates at the expense of U.S. dollar-, Asian-, and emerging market-specific exposure.

Thomson Reuters

For the 12 months to February 2014 the Lipper Global–Bond Global sector returned minus 8.11%, with the best performing fund (Invesco Perpetual Global Financial Cap) returning 14.5% and the worst performing fund (Axis Renta Fija Cobertura A) returning minus 30.5%. The most popular fund for European fund buyers for February was M&G Optimal Income, which appeared three times in the ten most popular funds (175 buyers combined).

The sector was reasonably concentrated: 24% of the total €5bn that flowed into the sector for February was in the ten most popular options (by purchaser). The 25 most popular options by purchaser represented 37% of the total net inflows for the month.

Table 1 – Global Bond Funds by Buyer Popularity – February 2014.

Source: Lipper, a Thomson Reuters Company.

Looking at popularity by total net assets, M&G featured predominately again. For February M&G Global Macro Bond A Inc, with a total of €431m, topped the charts. This constituted 9% of the total net inflows for the month. M&G Optimal Income, with 215 individual buyers, appeared in three different share classes, and M&G options overall represented 30% of the total net inflows to the sector for February. PIMCO GIS Diversified Income, HSBC ISF MultiAlpha Global Aggregate Bond, Liontrust GF Glo Strat Bond, and Jupiter JGF Dynamic Bond all got honourable mentions.

In what appeared to be one of the best-kept secrets of the sector, Aviva Investors Alpha Yield was used by only four European fund-of-fund buyers. That was despite its having the second best performance in the entire Bond Global sector for the 12 months to February (+13.31%).

A version of this article first appeared in CityWire Global magazine. 

Lipper’s Jake Moeller presents highlights of a presentation by James Harries, manager of the Newton Global Higher Income Fund,  March 27, 2014. 

Newton has been something of a leader in developing a comprehensive equity income fund suite. Newton Global Higher Income was among only a handful of comparable funds when it was launched in 2005. Then, Lipper’s Global Equity Income sector didn’t yet exist. Today, there are 29 funds in that sector, of which only four were in existence at the time of the Newton launch.

Thomson Reuters

Apart from a brief stint at Veritas Asset Management, James Harries has been at Newton for his entire financial services career and is well embedded into the Newton investment infrastructure, sitting within the global equity and real return teams. In addition to his duties on the Global Income fund he is also lead manager of the euro Global Real Return Fund and co-manager of U.K. based Real Return Fund.

Far from being a distraction to the management of the Global Higher Income Fund, his additional duties (he also sits on various internal committees) appear to considerably complement the Newton thematic approach that underpins this portfolio. His knowledge of currency hedging, derivatives, and fixed income is much more prominent than one would expect from a specialist equity manager. Mr. Harries is clearly passionate about equity investing and provides a refreshing, if somewhat cautionary, perspective on current global equity markets.

Table 1. Performance of Newton Global Higher Income, 2009 to April 30, 2014

Source: Lipper for Investment Management.

Mr. Harries likens the current market to the “call of the Sirens” and urges investors to “cover their ears” to the seductive overtones of central bank stimulus and the fallacy of deleveraging (companies have been writing down assets rather than paying off debt). He warns that not only are earnings expectations over-inflated and earnings growth flat, but cheap finance is resulting in a plethora of one-off share buybacks, which although further seducing investors, is actually being used to fund options issues and is not supported by cash flow growth.

Mr. Harries is worried about history repeating itself and is wary of the “we are all okay” complacency that is now afflicting investors. This caution is the basis of his justification for his 2013 relative underperformance: defensive positioning. As the market got ahead of itself on the back of quantitative easing, cash flows and sales had in reality started stalling in the middle of 2012–a signal that many investors appeared to have missed. He is highly critical of consensus estimates for 2014 EPS growth at 14x, when negative preannouncements on the S&P 500 constituents have far exceeded positive ones for the same period (see table 2).

Table 2. S&P 500 Negative & Positive Preannouncements: 5 Year

Source: 3B Corp, Facset Business insider 2013. Reproduced with permission of BNY Mellon.

Mr. Harries is still bracing for a realignment of earnings and growth and a slowing of re-ratings, which in turn will create an environment more conducive to his current portfolio positioning.  He is currently overweight in telecoms and healthcare and is a seller of mining stocks. He remains positive on the U.S. and European regions but is underweighted in Asian markets, with a zero exposure to Japan. He has reduced his exposure to emerging markets down to 6% of the portfolio (it has been as high as 28% in the past) but may increase this if he initiates a more procyclical tilt to his portfolio. His currently favoured stocks include H&M, Adecco, Microsoft, and Dr Pepper.

Table 3. Performance of Newton Global Higher Income in Sector Classification Quartile Bands

Source: Lipper for Investment Management.

It would be remiss of me not to mention the staff movements that have occurred in the team since the departure of Tineke Frikkee in 2013. However, it is reasonable to assume Mr. Harries has been well quarantined from these disruptions. His track record and pedigree is strong and despite the underperformance of 2013, there has been a recent turnaround. His Lipper Leader scores are good across all categories (see Table 4) and a current yield of 3.89% should sate the income appetite of most equity investors.

Table 4. Lipper Leader Scores for Newton Global Higher Income Fund

Source: Lipper for Investment Management.

Lipper’s Jake Moeller examines changes in the credit composition of the Lipper – Bond EUR Corporates Sector.

Reuters/Thomas Peter

Flows into European corporate bond funds have remained buoyant into 2014 with over €800 million net flowing into the sector for the year 2014 to the end of April.

Throughout the course of the last 12 months (to the end of May 2014), there has been a slight increase in aggregate credit risk. The combined bucket of AAA, AA, and A rated instruments across funds in the sector has fallen 4.8% while the combined BBB, BB and B bucket has increased 2.65%.  The BBB bucket with a 43% average exposure – is the most popular, followed by A with 29% and “Unrated” – with 9%.

The dispersion among individual fund credit buckets, though is marked. Pimco GIS Euro Credit E Eur Acc for example, has reduced its AAA bucket 28% and has increased exposure to AA, A and BBB 18%, 6.5%, and 5.5% respectively. Only three funds in the sector have increased their AAA exposure more than 5% with Aviva Investors European Corporate Bond A increasing 7.9% over the year. Several funds such as Morgan Stanley Euro Corporate Bond A EUR, Raiffeisen-Euro-Corporates R A and Nordea 1 – European Diversified Corp Bd BP EUR have made marginal changes of no more than 2% across credit buckets.

Table 1. Average Credit Bucket Holdings in Lipper Global – Bond Euro Corporates Sector (data to 31 May 2014).

Source: Lipper, a Thomson Reuters Company.

The lowest end of the investment grade spectrum, BBB, remains the “sweet spot” for active bond fund managers; the average fund allocation to BBB holdings in the sector at the end of May 2014 was 43%. However, the sector is highly skewed. One fund for example – KBL EPB Bond Fund-Selected Inv Grade Corp Euro – has 88% of its holdings in BBB securities. Of the top 20 funds ranked by BBB exposure, only 5 have reduced exposure to this credit bucket in the last 12 months. Only 7 funds in a sector of 322 have less than 10% of their holdings in BBB rated securities.

Although this is only a high level snapshot of the current credit status of this sector, more detailed analysis reveals a high degree of differing concentrations within the investment grade spectrum. Investors need to examine carefully where their corporate bond fund is invested and what the mandate of the fund permits. Choosing a corporate bond fund on performance alone and without due consideration of the portfolio composition could result in unexpected concentrated exposures to a particular credit bucket.

Lipper’s Jake Moeller presents highlights of a presentation by James Sym, manager of the Schroder European Alpha Fund,  June 3, 2014. 

REUTERS/Denis Balibouse

No sooner was the review of Schroder European Alpha Plus doing the rounds when it was announced that Mr. Howard-Spink was relinquishing control of the fund and handing the reins over to James Sym. If Mr. Howard-Spink had made his decision at his presentation in March, he certainly didn’t show it. Perhaps his stated intention to initiate a bucket of small-cap stocks was a clue to his thinking and interests, but his decision to concentrate solely on his Schroder ISF European Special Situations Fund means at least his expertise remains with the group.

A fund manager departure can be a traumatic event for a fund house. This is particularly the case where team infrastructure doesn’t provide clear succession. Unique to this situation, there is not only a new fund manager but a materially different style directly imported from a different fund house. Mr. Sym was drawn from the Cazenove talent pool and has been running what was the former Cazenove Schroder European Alpha Income Fund since May 2012; it is the methodology of this fund that will in the main be adopted for European Alpha going forward.

Mr. Sym is an advocate of business-cycle investing and analyses the sensitivity of company earnings within this to allocate stocks into a particular style bucket. He believes Europe is now in the mid-expansionary phase (citing the improvement of PMI data throughout the region) but with a relatively depressed earnings environment. He recognises that the “crisis discount” in Europe has evaporated and the fast money has gone but that even since the 2012 rally, current valuations are quite normal rather than stretched.

His P/E analysis suggests we are in an environment that justifies 7%-9% equity returns. Furthermore, with nearly 50% of stocks in Europe having a higher dividend yield than their corporate bond yield, asset class price relativity is still very supportive. Thus, he believes there are ample stock-picking opportunities in this market; he identifies financial, industrial cyclical, and certain growth stocks as his current preferred buckets and overweighted sectors.

 Table 1. Performance of Schroder European Alpha Plus and Alpha Income

Source: Lipper for Investment Management

Mr. Sym aims to outperform at all points of the cycle and, unlike Mr. Howard-Spink, does not have a consistent quality bias. By his own admission, poor performance could arise because he has positioned the portfolio wrongly for a particular point in the cycle, not because his style is out of favour. The Alpha Plus portfolio has quickly and almost totally been transitioned into Mr. Sym’s incarnation (he still holds a legacy position in BNP), but the portfolio now has totally different style biases to Howard-Spinks. Expect the Alpha Plus portfolio to have around 70% commonality to its Income counterpart (high yielders that Mr. Sym has bar-belled into his income portfolio such as Orange do not appear, for instance).

There are many inferences you can make from this change, and they are positive. It reflects well on Schroder’s Cazenove acquisition, since this is a clear example of where they’ve successfully been able to integrate intellectual capital. It reflects well on James Sym. Schroders is fiercely protective of its brand goodwill and wouldn’t have appointed him without its own rigorous due diligence. Finally, Mr Sym himself, although only having a fledgling track record, is off to a promising start appearing at ease in his new higher profile role.

Lipper’s Jake Moeller examines changes to the composition of the IMA Sterling Corporate Bond High Yield sector.

REUTERS/Yuriko Nakao

April 2014 saw €4.1bn net inflows into bonds funds in Europe as interest in the asset class continues. The highest average debtor quality within the IMA Sterling High Yield sector is to B-rated securities (36%). This is followed by BB-rated securities (33%). Interestingly, these positions have been relatively stable; 12 months ago average exposure to B- and BB-rated securities was 33% and 32%, respectively. This represents only a small average increase to riskier B exposure. Looking at combined C-rated exposure (C+CC+CCC), there has been no change over the year (constant at 8%).

Five years ago average exposure to combined C-rated securities was 5%. Therefore, it is difficult in aggregate to say that high-yield bond funds contain higher credit risk today than they did five years ago. Certainly, average yields in the sector have dropped (4.6% for May 2014, 5.2% for May 2013, and 8.6% for May 2009), but rather than slavishly taking on more risk, it is likely many fund managers in the high-yield sector have merely become more discerning in their stock selection as the beta play in bonds has petered out. A 5% average increase in the sector to unrated securities (now at 10%) is likely a more expansive use of risk budget in what is now a very low default-rate environment.

Examining the market in aggregate overlooks the dispersion of credit exposures within the high-yield sector. Investors need to look very closely at which credit bucket is dominant in their investment. There have been some marked shifts in credit exposures over the past 12 months, and the sector is far from homogenous. AXA Pan European High Yield Bond Fund has significantly increased its exposure to B-rated securities during 2014 and currently has 55% of its exposure there—19 percentage points above the sector average. Similarly, Aberdeen High Yield Bond Fund has over 65% of its exposure to B—one of the highest exposures in the entire IMA sector. On the other hand, some funds in the high-yield sector are quite happy to fish in the BBB investment-grade pool. Ignis High Income Bond Fund and Invesco Perpetual High Yield are two examples of funds that have credit allocations in the lower-risk space.

Table 1. Changes in AXA Pan European High Yield Bond Fund Risk Return over 1, 3 & 5 Years

Source: Lipper for Investment Management/ Eric Ho

Correlations between credit exposures and performance are difficult to verify, and much more rides on assessing the quality and pedigree of fund managers and their ability to stock pick. Looking at the one-year performance of the sector (to the end of May 2014), top-quartile Marlborough High Yield Fixed Interest Fund, which has returned 9%, has over 50% of its portfolio in B-rated debt. Another top performer—Schroder Monthly High Income—which has returned 10%, has done so with 36% in B-rated debt.

Lipper’s Jake Moeller presents highlights of a presentation by Andrew Neville, Portfolio Manager, Global Smaller Cap Equities, June 4, 2014.

“First, furthest, and fastest” might sound like a variation of the Olympics motto, but it is in fact the small-cap equity (SCE) mantra of fund manager Andrew Neville. He advocates SCE investing with considerable gusto and some compelling facts. The bases of his mantra are that SCEs rise first among all equities in a recovering economic cycle, they rise furthest, and in the first 12-24 months following an economic downturn they rise considerably faster than large-cap stocks. He points out that this is also true in reverse as you approach within nine months of an economic decline, but he argues that good active stock selection can mitigate the relative downside.

REUTERS/Anthony P. Bolante

Mr. Neville has been with Allianz 15 years and now presides over the SCE franchise. Since May 2010 SCEs had been run by one team in San Francisco, but this resulted in a U.S.-centric bias in the overall portfolio. Now the fund is run by four regional teams in San Francisco, Frankfurt/London, Tokyo, and Hong Kong. Each team acts with a high degree of autonomy, with their influence in the overall portfolio being weighted by the relative weight of each region in the MSCI Global Smaller Companies benchmark (currently U.S. 58%, Europe 24%, Japan 11%, and Asia 7%). With each regional team running its own portfolios, it passes on its high-conviction ideas into the global portfolio. This results in a 180-stock portfolio with 95% active share and approximately 3% tracking error. Mr. Neville is primarily there in a risk-management role to ensure that no factor, style, or currency risks get above 20% of the portfolio.

For the SCE sector alone Mr. Neville points out that in every ten-year rolling period Allianz has examined, an investor would never have lost money from investing in SCEs. In the ten years to January 2005, for example, SCEs generated 100%—an amount generated similar to that of the ten years to January 2014. The worst ten-year return ever made was that to March 2009, when SCEs returned only 26%. Furthermore, in every ten-year rolling period SCEs have always outperformed global larger-cap stocks over the same period.

Table 1. 10 Year Performance of Global Large Caps v Small Caps

Source: Lipper for Investment Management

Mr. Neville believes the SCE field is so fertile for active stock-pickers because, by the Allianz definition of small-cap (<US$5 billion market cap), there are some 16,000 smaller companies globally, representing 90% of new listings. With only 4,300 companies in the MSCI World Smaller Companies Index, this gives enormous scope to generate informational advantage. Of the 16,000 SCE stocks, Mr. Neville points out that 5,500 are not covered by a single European or U.S. analyst. With 20% of these companies being Asian, local-analyst representation able to communicate with Japanese- or Chinese-speaking management is well placed to reveal potentially untapped alpha.

Table 2. Average Number of Analysts Covering Stocks in Major Markets

Source: JP Morgan, Allianz GI as of April 2011–reproduced with permission, Allianz GI.

Given that we are now five years into the current stock market cycle and, according to Mr. Neville, global SCEs are “fastest” in the 12-24 months after a downturn, what are the implications for a potential investor who has missed out on much of the action? There is still good reason to invest. Allianz sees no economic slowdown in the next two years, and if SCEs don’t turn until nine months before the next slowdown, then—although valuations are less supportive than they have been—global SCEs at 1.23x P/E to Growth are still cheaper than large companies at 1.33x P/E to Growth. So, for example, it is easier for an SCE to get from 30% to 35% growth than it is for a large-cap to get from 5% to 6% growth.

Table 3. Relative Performance of Allianz Global Small Cap Equity v Lipper Benchmark

Source: Lipper for Investment Management/ Eric Ho.

Mr. Neville and his team are confident they can find SCE stocks that are likely to grow considerably. Last year they had sold all exposure to SE Asia because of the effects of tapering, but they have re-entered the region via an Indonesian consumer stock. Within Europe they see attractive ideas in construction and the peripheral European consumer. In the U.S. they are looking at industrial exporters into Europe. Currently, the overall portfolio is procyclical, being overweighted in consumer, overweighted in industrials, and overweighted in technology.