Investors rekindling their love for risk assets as sales strengthen

Value has underperformed, bond yields remain low, yet the trajectory of global inflation and economic recovery still looks reasonable enough. 

This backdrop should give investors more certainty over future performance. But many will, and should, be cognisant that things do not always pan out as expected. UK retail investors seemed have shrugged off fears around a stuttering global recovery, reigniting their affection for risk assets. Fund sales have soared in 2017, with net inflows by the end of July surpassing annual figures for the past two years.

During the build up to last summer’s EU referendum and the US election, headlines focused on cash levels. Global fund manager surveys by Bank of America Merrill Lynch reported continuous record-breaking increases in average cash weightings last year, but these have since declined and now sit at 4.8 per cent. Increasing risk sentiment has been seen in net sales. Funds in the IA Money Market sector had witnessed positive net flows every month since the beginning of 2016, but saw £124m of net outflows in July this year.

Simultaneously, investors have been rekindling their love for risk assets. Equities as an asset class have seen positive net sales every month this year. Last year equity funds suffered 10 consecutive months of outflows before offsetting this with £1.1bn of net sales in the final two months. By the end of July 2017, equity funds had seen £3.1bn of net inflows, while multi-asset strategy sales were even stronger.

To adapt an old adage, not all equity sectors are born equal. Net sales have been heavily skewed towards Global funds, which was the best-selling sector three times in the past year. Similarly, US and European equity sales have held up, but it’s the UK where investors seem intent on divesting. The UK All Companies sector has been the worst-selling group eight times in the past 12 months.

To some extent, markets are following suit. In base currency terms, emerging markets have been the star performer of the year, returning 24 per cent, while the US and Europe are both up 12 per cent and the UK has lagged. There are different factors affecting each region. Emerging markets are benefiting from dollar weakness, but also look to have shrugged off concerns over what US monetary policy tightening might mean for stocks. The Federal Reserve has raised rates twice this year and is expected to do so once more, but emerging markets continue unimpeded.

US returns have been driven by its now infamous Fang technology stocks, with market valuations surpassing dotcom boom levels. Concerns linger, but markets march on. Europe’s recovery has kicked into full swing with earnings repeatedly beating expectations. The FTSE 100’s inverse correlation with sterling continues to have an impact, helping compensate for investors’ lacklustre view.

But it is currencies that have piqued most interest. Markets at the start of 2017 were positioned for a stronger dollar and stable euro, yet year to date the greenback is down against both sterling and the euro, as the latter has gone from strength to strength.

Inflation and economic recovery in the eurozone, in the periphery as well as in Germany, has seen increased calls for tightening of monetary policy. However, European Central Bank chairman Mario Draghi has said euro strength is hampering the bank’s plans. This strength has also raised concerns for its equity market. While continued loose policy is a tailwind for stocks, euro strength is hampering exporters and expectations for earnings downgrades are increasing.

In the UK, sterling is down against the euro but up against the dollar, meaning a mixed period for large caps. Brexit-induced concerns over the domestic economy have not yet been borne out, aiding the FTSE All-Share index. The FTSE 250 has outperformed year to date, gaining 11 per cent versus 7 per cent for its large-cap peer.

Taha Lokhandwala is deputy editor of Investment Adviser