Much of 2017’s third quarter has been focused on the growing spat between the US and North Korea, which threatened to prompt a spike in investor caution. 
Recent months have seen the leaders of the two countries issue a series of threats to the each other. US president Donald Trump has said North Korea faces "fire and fury like the world has never seen" if it continues to threaten its allies and last month used a UN address to threaten to “totally destroy” the county if forced to defend itself.
North Korean leader Kim Jong Un has also called Trump a “mentally deranged US dotard” and said he will “pay dearly” for his threat to destroy North Korea. This came after North Korea test-fired intercontinental ballistic missiles over Japan’s northern island of Hokkaido and tested a hydrogen bomb.
However, these events – headline-grabbing as they were – have done little to derail investors, who continue to pay more attention to the words of the world’s central bankers than the risk of a fresh conflict. In the following article, we look at how markets and the funds that invest in them have fared over the third quarter of the year.
Asset classes
As the bar chart below shows, oil was the strongest performer of the seven broad areas of the market we have looked at here. FE Analytics shows the S&P GSCI Brent Crude Spot index was up 12.94 per cent in sterling terms over the three-month period. Indeed, Brent crude has just enjoyed its biggest third-quarter increase since 2004. The rally in oil has been aided by a production cut deal by global producers led by the Organization of the Petroleum Exporting Countries, which makes it more likely than a three-year supply glut could start to ease.
Returns of asset classes during Q3 2017
Source: FE Analytics
Bank of America Merrill Lynch recently said in a note: “Brent crude oil prices have gone from strength to strength as surplus oil stocks are being depleted. Importantly, this rally is supported by a tighter physical market, providing a fundamental backbone that was not present before.”
The quarter also saw continued falls in the VIX, which is often referred to as Wall Street’s ‘fear gauge’, despite the escalating war of words between the US and North Korea. While this suggests traders are relatively unconcerned by the risk of increased stock market volatility, Cidel Asset Management head of multi asset class mandates Bill McKay recently warned about relying too much on this one measure.
“While that may give the appearance that everything in the market is just fine, we are certainly wary of becoming complacent,” he said. “It is also true that some measures of volatility can be misleading. For example, a number of strategies have been developed in recent years that can artificially inflate the volatility index numbers in the short term due to sudden large buying or selling of equities in the market. Therefore, investors are well-served when they appreciate that the VIX is not an all-encompassing measure of risk.”
Geographies
While the return made by global equities was relatively muted, some areas of the globe did perform much better than others. The Euro STOXX index led the pack with a total return of close to 5 per cent, buoyed by growing confidence in the health of the European economy. Upbeat economic data has come as the European Central Bank has hinted at tighter monetary policy, which prompted a rally in the continent’s banking sector.
A recent note from Barclays Capital said: “Our European strategist Dennis Jose remains positive on the outlook for European equities. European valuations are near the trough levels of 2003 and prospects for earnings are the most positive in nearly five years. He does worry that the US stock market appears expensive on most measures and if a bear market were to materialise in the US, then Europe would probably suffer as well. However, abnormally high multiples on US stocks appear to be driven by low and stable inflation, stable GDP growth, easy monetary policy and high profitability. Our economists’ forecasts suggest that this benign environment remains in 2018.”
Geographical indices performance in Q3 2017
Source: FE Analytics
Emerging markets also had a strong third quarter with a 4.46 per cent gain in the MSCI Emerging Markets index. Although a rallying US dollar and rising US Treasury yields hurt emerging market assets towards the end of the quarter, investors remain positive on the area given the attractive valuations and strong fundamentals in place.
Maarten-Jan Bakkum, senior emerging markets strategist at NN Investment Partners, said: “Emerging markets continue to be supported by tailwind. In recent months, three potentially negative factors have in fact been fairly easily digested. These factors are the intensification of the conflict between the US and North Korea; the confirmation in the data that the Chinese slowdown has started; and the Fed's clear message that it continues to normalise monetary policy in the US. The capital flows to emerging markets have not been reversed by these three developments. Indeed, interest rates in the emerging world have continued to fall and emerging equity markets continue to perform well. The main explanation for this is the improving outlook for economic growth in most emerging countries.”
Equity funds
Looking at the Investment Association equity sectors and it’s IA China/Greater China where the biggest third-quarter gains were seen, with an average total return of 7.27 per cent. Mike Shiao and William Yuen's Invesco PRC Equity fund made the highest return of the quarter after rising 13.34 per cent. HSBC Chinese Equity was in second place with a 11.59 per cent return while Matthews Asia China Small Companies was up 10.86 per cent.
The IA UK Smaller Companies sector also had a relatively strong month and generated a 5.38 per cent total return as investors continue to grow more confident about the domestic economy. The top returner in this peer group was Paul Jourdan, Douglas Lawson and David Stevenson’s TB Amati UK Smaller Companies fund, up 11.52 per cent while TM Cavendish AIM made 10.89 per cent and Jupiter UK Smaller Companies gained 9.96 per cent.
Performance of equity sectors in Q3 2017
Source: FE Analytics
The worst performance came from IA North America, where the average fund made just 0.72 per cent over the three-month period. Investors have been cool on the world’s largest economy as many have grown cautious of the high valuations now being seen in its stock markets.
From this sector, the strongest returner was New Capital US Growth – which was up 5.94 per cent, reflecting that growth stocks, and especially those in the technology sector, had a strong quarter. M&C Miller Opportunity sits at the bottom of the performance table, however, with a 4.55 per cent loss.
Bond funds
When it comes to fixed income funds, the strongest Q3 performer by far was IA Sterling High Yield. The average member of this peer group made a 1.53 per cent total return during the quarter, as investors returned to the asset class after several months of sideways trading; there appeared to be some concerns about potential overheating in the corporate bond market, but these have eased and inflows have jumped.
Paul Causer and Thomas Moore’s Invesco Perpetual High Yield fund, which focuses on bonds issued by companies with predictable earnings and recurring cash flows, leads here with a 3.42 per cent total return. Schroder High Yield Opportunities is up 2.91 per cent and L&G High Income Trust made 2.72 per cent.
Performance of bond sectors in Q3 2017
Source: FE Analytics
The quarter’s weakest returns can from the IA UK Index Linked Gilts sector, which, despite being up close to 6 per cent at one point, ended the period with a 63 basis point loss while the IA UK Gilts peer group was not far behind. Gilt yields rose over the quarter on the back of higher inflation and a more hawkish Bank of England.
Commenting recently on this, TwentyFour Asset Management portfolio manager Chris Bowie said: “Our own view is that one hike in the near term is quite likely. The MPC [Monetary Policy Committee] can easily justify this on the grounds of taking back the emergency cut that followed the Brexit vote in June last year. [But] we think the risks of further base rates rises in 2018 looks small at this point, but we will need to keep a close eye on the data for signs of any domestic inflation. The front end of the yield curve should remain well behaved in this case. We are still bearish on gilts and duration overall, but do we have great expectations of future base rate rises? In short, no.”
Multi-asset and specialist funds
With the multi-asset and more specialist areas of the Investment Association universe, it was the IA Technology & Telecommunications sector where the average fund made the highest quarterly returns. The typical fund here made a 2.56 per cent (although they peaked at more than 5 per cent earlier in the period), with Pictet Robotics’ 6.24 per cent being the strongest gain. Henderson Global Technology made 5.09 per cent while Polar Capital Global Technology was up 4.58 per cent.
In the IA Specialist sector, which was the second strongest performer with a 2.39 per cent gain, it was Brazilian and Russian equity funds topping the table thanks to factors such as the stronger oil price. JPM Brazil Equity, HSBC Brazil Equity and Neptune Russia & Greater Russia all made more than 15 per cent returns during the three months in question.
Performance of multi-asset and specialist sectors in Q3 2017
Source: FE Analytics
The IA Mixed Investment 0-35% Shares sector was the worst performer after making just 38 basis points in the quarter. Funds in this peer group have to maintain a less risky profile and therefore tend to have a high allocation to gilts, which, as we have seen, went through a lacklustre three months.
JPM Global Macro Balanced, which is managed by Talib Sheikh, Gareth Witcomb and James Elliot, made the peer group’s highest return of the quarter after it rose 3.36 per cent; the portfolio is built using a macro-thematic approach that the managers claim offers greater diversification and more focused positioning than more traditional balanced funds. The lowest return came from SVS Brown Shipley Cautious, which was down 1.23 per cent over the quarter.
Industries
Finally, when the performance of the various industry groupings are examined for the third quarter it’s clear that basic materials had the strongest run. The FTSE All Share Basic Materials index made 13.82 per cent during the three months, putting it ahead of FTSE All Share Oil & Gas (up 11.38 per cent) and FTSE All Share Technology (up 6.37 per cent).
Gains in basic materials stocks were led by industrial metals and mining companies – the FTSE All Share Industrial Metals & Mining index was up 56.36 per cent, despite it being hit with a sell-off in the final month of the quarter.
Performance of FTSE industries in Q3 2017
Source: FE Analytics
This was reflected in flows to and from commodity exchange traded products (ETPs). EFT Securities commodity strategy director Nitesh Shah recently wrote: “As industrial metal positioning started to look stretched in August, we saw outflows begin and that continued as prices fell. However, last week [w/c 25 September] as prices of most metals started to show signs of reaching a trough, inflows resumed. Speculative positioning in the futures market have pared back and volumes of trading in Shanghai have fallen indicating momentum trades are being shaken out.”
The worst performing industry in the third quarter was healthcare, as the FTSE All Share Health Care index posted a 5.46 per cent fall. This was driven by falls by pharmaceuticals and biotechnology companies.