The election of Donald Trump in November was simply the “icing on top” of the reflationary trade last year, according to Fulcrum’s Nabeel Abdoula, who said this trend is set to continue over the medium- to-long term.
This is despite the recent pullback in investor sentiment; while there was indeed an aggressive growth/value rotation across markets during the second half of last year, quality growth stocks have once again been favoured by investors as inflation expectations and hopes of fiscal policy have dipped.
Performance of indices over 1yr
Source: FE Analytics
Abdoula said there are of course regions that are set to benefit from greater levels of inflation than others and, as such, urged investors to be selective when it comes to their equity exposure.
“If you think about how our ideas come through via core themes and how they translate into ideas, one of the themes that we have been running within the portfolio now for a couple of years is this concept of global reflation,” the portfolio manager explained.
“But throughout the last two years, the impulse from the global expansion has really come from various parts of the world and today we think that is happening in European economies.
“So in our portfolios, a direct mapping of that macroeconomic phenomenon is through ownership of European equities versus US equities.
“This is not saying that European equities will go up, it’s saying European equities will go up more than US equities or will go down less than US equities if the market is going down.”
Fulcrum currently has three portfolios – its Diversified Absolute Return and Diversified Core Absolute Return funds reside in the IA Targeted Absolute Return sector, while its Diversified Growth fund is in the IA Flexible Investment sector.
The team combines fundamental research of the global economy – to navigate long-term economic cycles – with behavioural analysis of markets which market activity with mispriced opportunities.
It does so through adopting a series relative value market-neutral strategies– such as owning European equities versus US equities – and as such, the team does not have to hold a directional view on any markets they don’t feel the need to.
“The reflationary dynamics were really self-sustaining and Trump was the icing on the top. What has come off in the last six months is the icing but the underpinning of the inflation dynamics and the global expansion continues to be very much in place,” Abdoula explained.
“If you look at the US, I would be hard-pressed to believe we are in the same place that we were in the middle of last year. Inflation has disappointed.
“That’s why our orientation in the expansion is about the impulse moving more towards European equities, because using our tools internally, that’s where we see the recovery gaining momentum. Whereas in the US, we see momentum and activity fading a little bit.”
When it comes to Europe, however, some managers believe it is already a consensus view that European equities are yielding significant opportunities.
Performance of indices over 1yr
Source: FE Analytics
However, Abdoula argued that the fundamentals suggest the market area still has further to run.
“When you look at the potential for the outperformance of European equities relative to the US, one measure that can help you grapple with that is the valuation – the relative valuation of US versus European equities,” he explained.
“On that metric we see the opportunity for around a 10 per cent outperformance from here of European equities versus the US.
“In absolute terms when you look at them in isolation, all equity markets look somewhat rich. So if you have a fund manager who is directional, they would not see much value across the equity markets because valuations are rich compared to fair value on average.
“But on a relative basis, there continues to be outperformance in Europe, particularly versus the US equity market.”
When it comes to fixed income, the team believes G7 government bonds have very limited capabilities of delivering meaningful medium-term returns, even if yields do dip lower over the very short term.
Elsewhere though, it has a long position in Mexican government bonds which are yielding approximately 7 per cent. The team also believes the Mexican government will cease its tightening cycle which, in turn, would cause government bond yields to drop and prices to therefore rise.
Another emerging market strategy Fulcrum holds in its portfolios is the Turkish lira versus the Brazilian real. While both economies are undergoing difficulties, Abdoula points out that the former has deteriorating political dynamics while the other latter is potentially improving.
“From a yield perspective and in an environment where cash rates are close to zero, the argument for having some exposure to emerging markets in one’s portfolio makes sense,” he reasoned. “I think our approach is to be more selective when we look at the emerging market universe in general.
“Our view today is we’re less convinced about the broad opportunities in emerging market returns but we think there are definitely significant opportunities in specific situations.”
In terms of how positive the Fulcrum team is on the macroeconomic backdrop, Abdoula said it is “above-average bullish” based on the portfolios’ sensitivity to broader equity markets.
“When you look at the medium term, equities continue to be the asset that has the potential to deliver the returns that investors seek,” the portfolio manager explained.
“They do so with higher volatility, so the change in markets today is really about the fact that equities are the only ones that are able to deliver the returns that investors seek, and that all the other assets have now been priced out in terms of real return expectations.
“That puts investors in a bit of a difficult situation, which is if you go for equity returns, you have to be able to tolerate these episodes of 20 per cent downwards turns.
“What we’re saying is there are alternative ways of generating this with a more stable path and that involves an element of relative value in your approach. If you’re exposed solely to directional markets, then equities are the only place where you have prospects for real return expectations.”
Over five years, the £985m Fulcrum Diversified Absolute Return fund has returned 21.08 per cent and has done so with a maximum drawdown – which measures the most potential money lost if bought and sold at the worst possible times – of 7.87 per cent.
Performance of fund over 5yrs
Source: FE Analytics
As a point of comparison, had an investor placed all of their money into an equity-only MSCI AC World tracker instead, they would have experienced a drawdown of 10.97 per cent over this time frame (and a 97.78 per cent total return).
The fund has a clean ongoing charges figure of 1.26 per cent.