Back in April, I wrote a piece explaining why investors shouldn’t give up on bonds just yet. Given the heightened volatility in equity markets this year, I thought it might be a good idea to take a closer look at this asset class, too.
The VIX index, which predicts market volatility and is known as “the investor fear gauge”, is up almost 18 per cent so far this year (the higher the VIX, the greater the expectation that a big market move could happen in the future). This is a far cry from how it performed over the same time frame last year, when it was down 36.39 per cent, according to FE. But why?
UK, US, European and even Japanese central bank policy is beginning to converge and monetary policy is now going in the same direction; after years of quantitative easing, tightening has begun. This tends to suggest that economies are returning to normal – a positive sign, but also one that means we could be late in the economic cycle.
Should investors shy away from equities and lower their return expectations?
But the volatility might not be because the cycle looks long in the tooth. After all, many investors have been calling the end of the bull market for quite some time now. I think equities are much more volatile because the stock market’s biggest nemesis – uncertainty – has reared its head, amid a culmination of unrelated events which simply weren’t predictable; as is often the case.
Brexit negotiations have become increasingly frayed, with heated discussions surrounding a hard or a soft Brexit prompting Cabinet resignations. There are fears that US president Donald Trump will intensify trade wars with China and the EU, which could affect the price of goods and services across the globe. Sky-high inflation and eye-wateringly high interest rates in some parts of Latin America (notably Argentina and Brazil) have caused entire industries to go on strike. And, if you add to this some pretty sharp currency movements and a rising oil price, it becomes clear why investors have been more jumpy in 2018.
But in such an uncertain landscape, should investors shy away from equities and lower their return expectations, or is there a happy middle ground?
Time to break the mould?
Plenty of investors are becoming cautious on equities. Recent data shows that, in June, funds sold in Europe suffered their biggest outflows in almost five years, according to Lipper. Meanwhile, the most recent available data from the Investment Association shows that funds in the Targeted Absolute Return sector – which many have turned to for diversification – were the best-selling products among UK investors in May.
Personally, I am erring on the side of caution, ensuring that portfolios are well diversified in terms of asset class, region and even investment styles. However, I would caveat this with the fact that I don’t think equities are synonymous with taking lots of risk. For me, it’s about maintaining a long-term time horizon and, of course, picking the right managers.
Attractive equity options
There are a wealth of equity funds available which don’t take on huge amounts of risk, compared with some of their peers.
In the UK, we like Carl Stick’s Rathbone Income fund. It has managed to increase its dividend pay-out during 24 out of the last 25 years which, if Stick manages to keep up the good work, should provide a good cushion against rising interest rates and market falls. The manager looks for the long-term, high-quality “dividend winners” and picks them using a thorough 10-step process.
For those looking for a regionally diversified global equity fund, Fidelity Global Dividend might be a good option. Manager Dan Roberts considers himself a value investor, but not in the typical sense. His key requirements are that investments have understandable business models with predictable, steady returns. Stocks tend to be well-established dividend-payers before they are given a place in the portfolio.
For investors looking to add some emerging market exposure, it might be good idea to find an income-paying fund – again, to help protect against market falls. We like Magna Emerging Markets Dividend, as manager Mark Bickford-Smith looks for well-managed and robust businesses which can increase their dividend pay-outs. This tends to lead him to lower-risk investments relative to some of his peers. However, it is important to point out that emerging market equities are usually higher-octane than their developed market counterparts.
Of course, we can’t predict the end of the market cycle, nor can we predict any market wild cards that we get dealt. There will always be a reason to be fearful and there will always be events which take us by surprise. But we still think it pays for investors to allocate some their portfolio to equities in order to achieve a good risk/reward balance.
Darius McDermott is managing director of FundCalibre