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Elliot Farley: Don’t rush back in to Europe

The year began on an optimistic note with strong returns across equity markets in all major regions. But, amidst the euphoria, investors should not lose sight of the economic headwinds faced by many economies in the developed world.

While the outlook has certainly improved for many countries in recent weeks the challenge remains to shake off the shackles of low growth. For those running global portfolios, making the right calls on which markets will succeed and identifying those that are likely to struggle will clearly continue to be both a source of returns and an essential component of risk management. But this is not made any easier by markets that have become increasingly correlated on macroeconomic policy.

Add to this correlated, low-growth scenario an already respectable starting point for equity market valuations and the returns from selecting between markets alone are unlikely to meet the expectations of many investors, particularly when we take into account the risk of inflation eroding away returns.

In such a climate, active management becomes more important than ever. Choosing skilled and experienced fund managers who demonstrate a clear investment thesis backed up by their strong conviction. Just one such example found within our own equity portfolios is Nick Train, who holds a long-term, high conviction portfolio of around 25 stocks in his CF Lindsell Train UK Equity fund.

Returning to our starting point of identifying the risks and opportunities in individual markets, we continue to favour the US, where the recovery has continued to gain momentum and longer-term growth drivers are in evidence with the competitive dollar and the development of shale gas moving the nation towards energy self-sufficiency.

We also maintain our belief in the prospects for the growth markets in Asia Pacific and the emerging market regions, where economic expansion is gathering pace once more.

An overweight position in Japan rewarded us in January but we feel a little more cautious towards the country now as investors watch to see if its leaders will match their talk of structural reform with the necessary action.

In sterling terms continental Europe offered the strongest performance of any major region in January, with the peripheral nations leading the way as fears for the Eurozone continue to dissipate.

However, we continue to look in vain for the longer-term drivers that would underpin a self-sustaining recovery in the region. On that basis we have not followed those rushing back into the Eurozone seeking to benefit from a shorter-term improvement in investor sentiment.

We do, however, have confidence in our line-up of active funds within the region, Baring Europe Select and BlackRock European Dynamic, to add value as they did through 2012 in identifying the individual investment opportunities the region presents.

In terms of the UK, we have edged up our sensitivity to risk a little and introduced a greater exposure to small cap stocks, which should be better placed to perform as gradual recovery comes.

In short, we continue to work hard to identify the regions and markets where more favourable macro conditions will provide a tailwind to allow our selected fund managers to use their stock-picking skills to best effect and achieve outperformance for our investors.

Elliot Farley is co-manager of the T. Bailey Growth fund


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