Out with the new

A change of leadership in the US equity market is underway - but it’s not as simple as a shift towards more cyclical stocks. 

A glance at the performance of some US equity fund favourites makes clear one obvious change: past winners are starting to underwhelm a little.

Baillie Gifford American - the quintessential Fangs fund, in that all four of the big-name tech stocks feature in its top 10 holdings - sits in the fourth quartile year-to-date. The Fangs have posted respectable returns this year, but they’re no longer propelling returns or even beating the index.

Yet prospering isn’t as simple as just ignoring these stocks. Look at the most popular active US funds held by DFMs, according to our database, and plenty have struggled to outperform this year. Two funds with almost no exposure to the Fangs - Fidelity American Special Situations and Miton US Opportunities - have also lagged peers in 2019. They’ve done likewise over a three-month timeframe, despite the market rotation seen since September.

One reason why US strategies of all stripes have begun lagging the market again might be the resurgence enjoyed by ‘old tech’. Wells Fargo strategist Christopher Harvey tells the FT that three such stocks - Microsoft, Apple and Intel - are “chronically underowned” by active managers. The trio have returned an average of 42 per cent this year in dollar terms, more than twice the S&P 500.

When it comes to discretionaries’ preferred US equity funds, Microsoft is far from underowned: plenty of managers have long since bought back in. It’s no coincidence that Artemis US Select, one of the best performers of 2019 and of growing interest to wealth managers as a result, has some 6 per cent in the stock.

But it’s true that Apple and Intel are far from popular: of the 38 US all-cap growth strategies in our database, just two - UBS US Growth and Axa Framlington American Growth - hold Apple in their top 10. And not a single fund counts Intel among its top holdings. DFMs pondering the longevity of the current shift in style leadership should also look a little closer at which funds are best placed to benefit.

A shift in temperature

What a difference a few weeks makes. Investors have been concerned all year about the prospect of a slowdown in economic growth, the end of the current cycle, and macro headwinds. Those worries were still front and centre as the fourth quarter begin. Now the headlines note that “reflation trades are ascendant” and ask if markets can “repeat the 2016-18 boom”.

The instinctive reaction is that it’s far too soon to make definitive statements on this front. Optimists, on the other hand, might suggest the 2016-18 period never really went away: attitudes may have been glum this year, but returns have held up well. 

Either way, the current change in tone is being prompted by the rise in bond yields and slight improvement in economic data that we mentioned last week.

This isn’t just a US story: Japanese and European sovereign bond yields have also been on the rise. A slump in emerging market currency volatility has also raised the prospect of a carry-trade comeback. Moves like those support recent claims that US markets’ ascendancy might not last much longer.

Much of this may ultimately prove to be mean reversion behaviour. Even if a fully-blown reflation trade fails to materialise, the shifts have raised the prospect of a continuation of the goldilocks environment for a while longer. 

Some investors will now fret that rising bond yields, rising equity markets and falling volatility can’t continue in tandem indefinitely. If bond prices continue to fall, equities could start to show signs of nervousness again. But for the moment, the change in tone is being seen as an unalloyed positive. 

Following suit

The latest Pridham report, released last week, is a sign of the times for asset managers. Fundsmith is still flying the flag for star manager culture, but the rest of the top 10 by net retail sales looks rather different. 

Its top two positions are home to firms whose passive business nowadays far outstrips their active offerings: BlackRock and Legal & General IM. And ESG-focused providers are also starting to muscle in: firms like Royal London, Liontrust and Rathbones all saw particular success with such offerings in the third quarter. 

At a time when fund flows continue to struggle in sum, sustainable approaches are increasingly proving a differentiating factor - for those with established offerings, at least. As with passives, companies who belatedly attempt to jump on the bandwagon might find it harder than they think to capitalise on a booming market.