Passive funds tracking the “unloved” UK market, a wide universe of global stocks and the long-term opportunities being created in emerging markets could be attractive options this ISA season, according to Hargreaves Lansdown.
While markets have gone through a decade-long bull run, research by the fund supermarket suggests that valuations are not expensive when compared with history and could therefore still be at a decent entry point.
Laith Khalaf, senior analyst at Hargreaves Lansdown, said: “Global stock market valuations typically look in the middle of their historical range. Most are trading below their long run averages, with the exception of the US.”
Global market valuations
Source: Hargreaves Lansdown
The above table shows current valuation measures for major global stock markets and their long-run averages, along with their dividend yield. Current values are shaded green where they are below historical averages and red where they are above.
Hargreaves Lansdown prefers to use the cyclically adjusted price-to-earnings ratio (CAPE), which measures how current share prices relate to the last 10 years of company earnings, thus giving a longer-term perspective on current market valuations.
“With the exception of the US, the main international markets are trading below their historical averages,” Khalaf said. “None are so far below the average we would say they are in clear bargain territory, though the data still suggests it’s a reasonable time to invest.”
Starting with the passive pick closest to home, Khalaf pointed out that the UK is “an unloved market right now” following the country’s decision to depart the EU and the ongoing confusion over how this will eventually be achieved.
The closely watched Bank of America Merrill Lynch Global Fund Manager Survey has shown that the UK has consistently been the consensus underweight for asset allocators over recent years. The latest edition of the survey found that net 28 per cent of fund managers are underweight the UK, although this remains above the maximum bearishness of the 41 per cent underweight seen in March 2018.
Turning to his passive recommendation, the Hargreaves Lansdown analyst said: “Legal & General UK Index is a simple fund which tracks the returns of the FTSE All Share and has an extremely low annual fund management charge.”
In tracking the FTSE All Share index, the L&G UK Index fund offers exposure to 98 per cent of the UK's market capitalisation and has 636 constituents. The largest sector is financials, which account for 26.34 per cent of the index, followed by oil & gas (14.04 per cent) and consumer goods (13.91 per cent).
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
L&G UK Index has returned 180.44 per cent over the past 10 years, has a tracking error of 0.65 per cent and an ongoing charges figure (OCF) of 0.10 per cent.
When it comes to taking global exposure, Khalaf went for L&G International Index, which tracks the FTSE World (excluding UK) index and invests in more than 2,300 companies across the globe.
He said that the global tracker is a good idea for those who want to spread their investments widely as it brings instant geographical diversification to a portfolio.
“Just over half the fund is invested in the US stock market, as that dominates on the global stage,” the analyst said. “While the US is one of the more expensive markets around, it’s consistently confounded sceptics for a number of years by continuing its upward march.”
As shown previously, the US is trading above its long-run average although Khalaf argued that the deviation from the historical average “is not significant enough to make a compelling case for ignoring this market”. The measures for the US included in Hargreaves Lansdown’s valuation analysis are based on returns data running back to 1973.
L&G International Index has made 236.97 per cent over the past 10 years, has a tracking error of 3.01 per cent and an ongoing charges figure (OCF) of 0.13 per cent.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
Khalaf also recommended that investors take some exposure to emerging markets to participate in their potential for strong growth.
“Emerging markets make up about 85 per cent of the world’s population but only 45 per cent of the global economy, so there’s bags of room to grow, plus they’re responsible for a swelling global middle class who are spending more and more on goods and services,” he said.
“Consumption by China’s middle classes is expected to overtake America’s by 2020, and India is forecast to become the biggest spender in the following decade.”
The Hargreaves Lansdown analyst pointed to the iShares Emerging Markets Equity Index as a good tracker to use for this part of the market. It gives exposure to more than a thousand companies listed in over 20 countries in the FTSE All-World Emerging index.
The iShares Emerging Markets Equity Index tracker has posted a 54.39 per cent return over the past five years, has a tracking error of 2.39 per cent and an ongoing charges figure (OCF) of 0.26 per cent.