In a review of the year written at the end of 2011 I concluded with the statement: "Looking ahead, the outlook remains as murky as ever but the urgency of a eurozone solution means that the potential outcomes are both diverse and binary, and largely dependent on the decisions of politicians and central bankers around the world."
Well, here we are almost a year later and although it’s fair to say that the outlook still remains murky, the extent to which the European Central Bank has indicated its willingness to support the banking system has provided underlying support to markets and resulted in risk assets once again rallying strongly.
Shares Performances: Sectors, Size and Size
Financials Top the Leaderboard
In sharp contrast to 2011 when financials were one of the worst performing sectors within the equity market, this year they have been one of the best. In the UK, for example, financials are up in excess of 30% to December 10, 2012.
Elsewhere, again in contrast to 2011, strong sector performances have come from more cyclical areas so far this year, including travel & leisure, industrials and consumer goods. However, all that glitters is not necessarily gold and the mining sector has lagged on the back of fears of a slowdown in China.
Value Beats Growth
Stylistically, value has outperformed growth. However, unlike the cases of 2008 and 2011, this time round it has not been about quality. Rather, the focus has been on companies that had the potential to recover and, in the context of the UK, were priced for a continued poor domestic environment.
From a fund perspective, funds focussed on this space have been among the best performers in the UK. Schroder Recovery (
rated Bronze) and Fidelity Special Situations (rated Silver) stand out as two such examples.
Small Is Beautiful
From a market-cap perspective, small has been beautiful and across the world small caps have generally outperformed their larger counterparts. Indeed, UK Small Cap Equities have been one of the best performing asset classes globally. Interestingly, though, this has not extended across all small-cap indices and the FTSE AIM All Share index (although not only comprised of small companies) is broadly flat year-to-date, possibly reflecting the extent to which illiquidity in the AIM market has inhibited performance.
Fund Performances: Small-Caps Outperform; Large Funds Lag
The market trends highlighted above have unsurprisingly been reflected in the performance of Morningstar’s fund categories over the year. Unlike 2011, when nearly any kind of risk cost fund managers and their investors, 2012 has seen a reversal in this trend, at least for most periods in the year.
Strong Small-Caps Hampered by Growth Bias
Within the Morningstar UK Equity categories, the UK Small-Cap and UK Mid-Cap Equity categories fared best, significantly outperforming the larger-cap and style-focused categories. That said, the average fund in the Morningstar UK Small-Cap Equity category struggled to beat the FTSE Small Cap Index. This can be partly explained by the growth-bias within the average fund in the small-cap category relative to the index, which is heavily tilted towards value issues and also therefore the relative outperformance of value over growth in the period.
Risk Pays Off in Fixed Income
From a fixed income perspective, as we have seen in equity markets, higher-risk assets have dominated the performance tables with high yield bond categories topping the performance tables and government and inflation-linked bond categories sitting closer to the bottom. Emerging market debt has also performed rather well.
Big Can Mean Sluggish
Taking a peek at how the largest funds fared, the results were not overly encouraging. Of the largest funds domiciled in the UK (above £2 billion), 45% have underperformed their respective Morningstar categories. Given the volatile market environment that characterised 2012, oscillating between “risk on” and “risk off” periods, it helped for managers to be nimble and reposition their portfolios swiftly. The majority of funds with significant assets in their coffers tend to have relatively low portfolio turnover rates.
The biggest UK domiciled fund though, Standard Life Global Absolute Return Strategy (rated Bronze), with some £14 billion in assets under management, delivered well and still managed to outpace most of its peers in the Morningstar Alternative – Multistrategy category.
Be Wary of Short-Termism
That said, it’s important to remember not to over-emphasise one year’s returns as it rarely tells you much about a manager’s skills. Getting it right once is statistical noise, nothing else. Indeed, a big year may as likely be a contrarian indicator as a positive sign.
Incorporating 2011 into the picture, one could argue we have once again witnessed a reversal of the trend and managers taking a longer term view should have benefited from this.
New Launches: Trend for Flexible Funds
With respect to fund launches, there have been 139 new fund launches in the UK this year, according to Morningstar’s database (this of course excludes the launch of the RDR ‘clean’ share classes for existing funds). Managed funds took the lion’s share of those launches, with 63 new funds launched, and most notably within the Flexible Allocation sector (21 new funds). The next most popular asset class was equities, with around 40 new funds launched, followed by fixed income with 16.
Within the equity space a number of equity income funds were launched this year; Fidelity Global Divided, Cazenove European Income and Martin Currie European Equity Income being three such examples.
Fund Flows: Fixed Income Dominates But Equities Back in Favour
Looking at the IMA’s fund flows data, fixed income has continued to dominate with net sales of £4.4 billion to the end of October. This compares to net inflows of only £169 million in equities and £1.9 billion in mixed asset funds, indicating perhaps a heightened desire to sub-advise the asset allocation decision and coinciding with the number of new fund launches.
Encouragingly, however, equity was the leading asset class in October 2012 for the second consecutive month with net retail sales of £550 million – the highest since April 2012. This is in contrast with an average outflow of £9 million over the last 12 months.
The UK All Companies sector, however, continues to be the worst-selling sector for the third consecutive month. Three of the top five selling sectors in October were sectors focusing on income returns – one fixed income sector (£ Strategic Bond) and two equity income sectors (UK Equity Income and Global Equity Income).
Can Central Banks Get Investors Buying Shares Again?
Looking ahead, the global economy appears to have subsided into a period of sub-par growth with little prospect of a return to above trend until 2014. Equity risks remain and near-term worries over the US “fiscal cliff” will likely increase volatility. Even so, economic and financial trends have resulted in coordinated policy responses from governments and central banks that should be sufficient to gradually encourage investors to rebuild equity weights in portfolios.
From a fixed income perspective, the decline in main market government bond yields was driven by fear and financial repression rather than normal fundamental valuation, with yield levels justifiable to those investors only caring about return of capital rather than return on capital. This has been the case for some time and, although yields look set to remain at lowish levels, the medium-term trend is upward.
Investment grade corporate bonds offer better value with spreads likely to continue to narrow. Even so, yields are at or close to all-time lows, and, with the possibility of rising government yields, some capital loss may well offset the pick-up in income.
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The information, data, analyses, and opinions contained herein (1) include the proprietary information of Morningstar OBSR, (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar OBSR, (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be correct, complete, or accurate. Morningstar OBSR shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses, or opinions or their use. Indices mentioned are unmanaged and not available for direct investment. Although index performance data is gathered from reliable sources, we cannot guarantee its accuracy, completeness or reliability; except as otherwise required by law.
