24th April 2020

This week we identify which funds you might buy and why.  There is clear potential if you take a decade-long view, and that is our context today.  Yet there is much uncertainty in the next 6-24 months, so next week we will look at the “how” – how to buy into these fund choices on a decade-view, while also navigating the turbulent waters of the period immediately ahead.

Last week we discussed: a relatively optimistic case for the unfolding health crisis based on the McKinsey report; the lessons of 1918, both good and bad; why this is not Great Depression II; and the investment case for the cautious optimist.  Today we follow up all of that with specific fund ideas. [Obviously these are generic ideas, and we will be in touch with advised clients with tailored input]

Donning the garb of the cautious optimist makes it easier to be optimistic about the opportunities of the coming decade, while also being appropriately cautious due to the uncertainty of the next 6-24 months.

We looked at some of these opportunities in the January TopFunds Guide, 38th edition, and here we update those and add to them.

For the avoidance of doubt, these are for those wanting growth – so even where there is an income fund below, it is because of its potential with the income-reinvested.

These sectors are my focus:

  • UK growth (UK All Companies sector)
  • UK equity income
  • UK smaller companies
  • Asia
  • China
  • Japan
  • Global emerging markets

The US and Europe are not included.  The US stock market remains a bubble, and would have to be a lot lower before we would consider buying.  Europe (strictly the EU) has had a fundamentally unstable structure since the introduction of the euro – it just needed some shock and major downturn to expose this, and they are now midst that.  It is unclear how the EU will resolve this structural problem, which seems set to grow in the weeks ahead.

More positively, the UK is uniquely positioned for change, with a decade of necessary re-structuring in the post-Brexit world.  Of course there are risks as well as opportunities.  But the last General Election created a huge mandate for change.  The coronavirus has not changed that, and it might spur it forward.

There are many opportunities to be seized in areas such as construction, infrastructure, manufacturing and technology.

We don’t see this same positive combination of factors in other countries – we have in the past, but not today outside the UK.

We are looking for “bounceability”, by which we mean an outstanding fund over years past which has been badly beaten up in 2020, and which (probably) has the greatest recovery potential.  Quality at beaten-up prices.

It is funds invested into medium-sized or smaller companies which are our focus.  That is because they are more domestically focussed, whereas in the FTSE 100 are companies much more global in nature.

Our choices are:

  • Franklin UK Mid Cap
  • Royal London UK Mid Cap
  • Merian UK Smaller Companies Focus
  • Liontrust UK Smaller Companies

The first three are in the category of longer-term winners based on our internal Vintage Ratings.  But they have been beaten-up in recent months – so they have bounceability.

Liontrust is a fund we have recommended with great success for a number of years.  It fell less than all other smaller company funds year-to-date, and remains a fund to buy on our decade-view.

We were also keen to select equity income funds – that is funds which invest into the stock market, and pay above-average dividends.  In this case, as we are looking for growth funds, we assume those dividends are re-invested back into the fund.  In the longer run (certainly 10 years) it is the re-invested dividends which drive the returns.

To build a short-list we use our unique Income Tool.  This quickly identifies funds which have consistently grown their dividend payouts over the last 10 years, and thereby pulled up the fund value.  Of this short list we then identified those which had fallen most, and these are:

  • JOHCM UK Equity Income
  • Janus Henderson UK Responsible Income

Turning to the rest of the world, we start with a broadly-based Asian fund.  As we have been saying for quite a few years, this is The Asian Century.  Younger and less indebted nations (mostly, with notable exceptions), and growing middle classes which will increasingly dominate the globe.

Using our Vintage Ratings to identify the long-term winner, one fund stands out:

  • Investec Asia Pacific Franchise

Interestingly neither this nor any of its nearby peers have fallen that much this year – down just 6-10%.  Unusually in these fund selections today, this is the only one with a heavy tech weighting, in the likes of Alibaba and Tencent.

Before turning to China and Japan, a point about smaller company funds, and why they give investors an edge.

Firstly, it is inherently easier for small company to double profits than a larger company – elephants can’t gallop.

Secondly, these businesses are much less well researched, particularly by the investment banks who require much bigger companies into which they can invest their billions.

Looking first at China, small businesses are at the forefront of their transformation of recent years, which is away from large capital-intensive industries and products, and towards innovation and consumption.  Key sectors are tech, healthcare, automation, and education.

There are plenty of small entrepreneurial companies.  Of 1,900 small companies, 75% are either not formally covered by any analyst, or one at mostIn contrast, in the US 70% of small companies are tracked by 3 or more analysts.

Our choice, which remarkably is up more than 22% so far this year:

  • Matthews Asia China Small Companies

Now Japanese smaller companies.  This was one of original Trades of the Decade way back in 2009. The reasons:

  • Cheap and under-researched
  • Potential to unlock growth through reforms

Not much has changed since then, and the opportunity persists.

This means opportunities lie hidden from most investors.  Again, looking for a longer-term winner, but a bit beaten-up this year, our choice is:

  • Baillie Gifford Japanese Smaller Companies

Last but not least, global emerging markets.  In the last TopFunds Guide (January, 38th edition) we drew attention to research which highlighted the longer-term value in emerging markets, and the total lack of value in the US.  In particular we were (and remain) interested in funds with a Value-style.

[Value-style means the manager is seeking to buy the shares of individual companies which are cheap without good reason, on the basis that one day the market will recognise this, and the share price will bounce.]

The obvious choice was, and remains:

  • M&G Global Emerging Markets

It has been hit hard year-to-date (down 25%), and that just makes it look even better value.

Here are all those 10 funds again:

UK

  • Franklin UK Mid Cap
  • Royal London UK Mid Cap
  • JOHCM UK Equity Income
  • Janus Henderson UK Responsible Income
  • Liontrust UK Smaller
  • Merian UK Smaller Companies Focus

Overseas

  • Investec Asia Pacific Franchise
  • Matthews China Small Companies
  • Baillie Gifford Japanese Smaller
  • M&G Global Emerging Mkts

The subject line of this email was “10 Funds For The bounce”.  This suggests one movement, and instant recovery.  If only.  Sorry, I mis-led you.

The reality is much more likely to be a series of lurches and false starts before we can begin to relax – and that point might still be some way off.  With that in mind, next week we look at how you might position into some or all of these funds.