By GRAHAM FROST 27/10/2006
If you examine your portfolio valuation closely, you may have noticed some ‘star’ fund managers having a rather difficult time over the latter half of this year. Have the managers of these funds suddenly lost their touch or is there a more rational reason for this change in fortune?
To find the answer it’s important to take a look at what drove the market before, during and after the downturn experienced this summer. The charts below highlight this nicely:
You can see that mining stocks (which broadly represent sectors that benefit from strong global growth) performed very well during the earlier part of the year relative to utility companies (representing defensive stocks). This position reversed following the stockmarket downturn and subsequent recovery from mid May onwards. In simple terms, investor appetite for riskier assets weakened as inflation worries resurfaced at the same time as perceptions of global growth prospects were cooling. This caused a sell off in the best performers, e.g. mining stocks, hurting funds with high exposure to this and other cyclical sectors such as basic materials and technology.
| "the recovery has largely been driven by defensive stocks such as utilities..." |
Although indices are now not far off their highs in most markets, the recovery has largely been driven by defensive stocks such as utilities, i.e. those companies whose earnings are expected to grow whatever the economic conditions. Many funds whose managers have a reasonably optimistic outlook and are positioned accordingly have understandably suffered, for example: Artemis UK Growth, New Star UK Special Situations, Fidelity European, Artemis European Growth and JPM Japan.
The managers running these funds believe many of the stocks they hold currently look good value versus the defensives that have been driving the recovery. Provided optimism prevails, investor appetite for the types of stock that hurt the performance of these funds should recover, boosting returns and getting the funds back on track.
Will optimism prevail?
The Federal Reserve appears to have stopped raising rates in the face of a weak housing market and slower consumer spending. Although lower energy and raw material prices will ease inflation, this may be offset by higher wage growth. The pattern is similar in the UK – inflation remains a threat. Moreover, we think that central banks may pay more attention to asset bubbles developing in the future, as the impact of these when they burst can be severe. Japan is a prime example. Consequently, there is a risk that interest rates will be raised further than markets anticipate. Nonetheless, we feel that world growth is slowing from lofty levels and this will itself ease inflationary pressures allowing interest rates to be lowered later in 2007. Commodities, while volatile, enjoy a reasonable outlook which should contribute positively towards investor optimism.
| "attractive opportunities may well drive investors back towards less defensive stocks..." |
Overall, it’s hard to get excited by the outlook for world markets. However, fears of rising inflation and a global slowdown may have been overdone this summer which, coupled with some attractive opportunities, may well drive investors back towards less defensive stocks. This would be good news for many high profile funds.