The funds, managed by the First State Stewart team, have significantly outperformed their peers and indices for many years, but Stuart Paul, managing director at First State, has warned that the run may come to an end.
“We are not market timers but the fact is that our style has been too popular for too long and we are overdue a period of underperformance,” he said on a client webcast.
The style of the First State Stewart team is to invest in so-called ‘quality’ stocks, which tend to be defensive firms with high recurring cashflows and strong management.
Historically, these defensive stocks would be expected to underperform when the overall market rises, as market rallies tend to favour cyclical or deep-value stocks.
However, quality defensive companies outperformed, both in Asia and emerging markets as well as the developed world, in 2012 and early 2013 as investors sold out of bonds but were not bullish enough to buy cyclical companies.
The result is that quality stocks have reached high valuations. This has led Tom Prew – co-manager of the Global Emerging Markets Leaders fund with Jonathan Asante – and Alistair Thompson – co-manager of the £6.5bn Asia Pacific Leaders fund with Angus Tulloch – to warn of expensive valuations on the stocks in their funds in recent weeks.
The range also includes a selection of single-country Asian and emerging market funds, alongside Mr Asante’s Worldwide Equity fund and David Gait’s Sustainability funds.
Mr Paul said that the “comments from Tom and Alistair on valuations ring true across the team and we are acutely aware that we are due for a difficult environment at some point”.
He said the team invests with this knowledge in mind and they were “well prepared for it”.
The funds have become favourites among investors for their ability to outperform in the long run.
Adrian Lowcock, senior investment manager at Hargreaves Lansdown, said his analysis showed Mr Tulloch had outperformed the MSCI Asia Pacific excluding Japan index by 5.4 per cent per year since 1988, while the emerging market fund had consistently been in the top quartile of its sector since its launch.
However, performance in the short term has been less impressive, with both funds in the bottom quartile of their respective sectors in the past three months, according to FE Analytics.
Experts agreed that the First State teams’ style could be set for a difficult period, especially if there was an economic recovery, which would lead to a value-led stockmarket rally.
Gavin Haynes, managing director of Whitechurch Securities, said investors in recent years had “really favoured” the stocks First State invests in and said valuations were looking “really stretched”.
He said it was “refreshing” to hear such a “candid claim” from a fund management group, but added that it was easier for First State to make such statements because “a number of the funds were soft-closed and others were reaching capacity”.
Mr Lowcock said he had recently met with Mr Tulloch, who said the market was becoming increasingly difficult for stock-pickers because sectors were moving up or down in tandem with no stock-specific distinctions.
First State deviates slightly with cyclical play
While the funds managed by the First State Stewart teams are unlikely to radically depart from their quality defensive bias, they have been buying more cyclical stocks in recent months.
Tom Prew said he had recently sold out completely from Mexican media company Televisa on valuation grounds and had been buying into Indian stocks towards the end of the summer and early autumn when the market was weak and valuations were low.
He added that he was looking for “unpopular cyclical companies” to invest in, but he would need to be sure minority shareholders would fully benefit from the firms’ rising profits, which was not guaranteed with emerging market companies.
Alistair Thompson has also been adding to cyclical companies in the Asia Pacific Leaders fund, which he runs with Angus Tulloch. Furthermore, he has taken his India weighting to its highest level in more than a decade, buying into jewellery firm Titan.
But Bestinvest analyst Ben Seager-Scott said that although the managers had been raising their weightings in cyclical companies recently, he believed they would never move away from their core focus on quality defensives because the style had outperformed so well in the long term.
