Take advantage of underlying trends and avoid gambling with your money.
- Cheng Jingyan | Published on 15 Jul 2021
All things considered, 2021 has been a decent year for investors thus far. While meme stocks and cryptocurrencies caught attention through their blistering rallies (and subsequent bouts of volatility), the broad equity markets, away from the limelight, have also performed well. Even under the shadow of the pandemic, global equities are now trading at their record highs, driven partly by the rising vaccination rates worldwide.
Figure 1: Led by the US, global equities are at their record highs
Barring any major mishaps, the gradual vaccination deployment – if it continues smoothly – puts us at the cusp of a new normal. The pandemic has brought about such major changes in our lives that we expect the world to see the periods pre-COVID and post-COVID as two distinct eras. More significantly, for investors, the start of a new era typically has its own economic implications.We are already starting to see hints of the new era unfolding. First, strong economic data and initial inflation prints have sounded a loud and persistent warning bell. Despite the Federal Reserve (Fed) reassuring investors that inflation is transitory, we expect a rising likelihood of an earlier-than-expected unwinding of crisis relief measures. Ultimately, we believe that the current low-interest rate environment is unsustainable and unlikely to persist for much longer. This makes it paramount that investors start positioning their portfolios accordingly.
So, how should investors position themselves for the second half of 2021?
In the first half of the year, the winners were undoubtedly value stocks as they bounced off their pandemic lows. In particular, sectors like Financials saw a series of positive catalysts that led to their outperformance, while their growth counterparts saw massive headwinds in rising rates.
Figure 2: A rare opportunity for Value as it stole the limelight
For the second half of the year, we continue to favour equity, and advocate for a quality and fundamental focus.
The challenges Fixed Income faces as an asset class will likely persist, with low yields and rising rates making it difficult for investors to find value within the space. For lower-risk investors or as part of a risk-management portion of one’s portfolios, we recommend taking an unconstrained approach, to prevent too much exposure to interest rate risk.
Within the equity space, rather than the value-centric plays in 1H2021, we believe that investors should be style agnostic moving forward. While higher inflation/interest rates generally benefit equities as a whole, not all equities are made equal. Companies that tend to benefit from these macroeconomic conditions are those with strong earnings and a competitive advantage – and these can be summarized quite nicely under one word – quality.
Aside from quality, other key fundamental trends should also continue to favour certain sectors and regions over others. Some pertinent trends worth highlighting are:
- Asia’s continued ascendance, particularly China,
- Strong commodity demand, driven by electrification and infrastructure development,
- An increasing rate of digitization as tech continues to permeate more aspects of our lives.
With these factors in mind, our fund picks will centre around quality and the underlying trends highlighted above. Without any further ado, here are our top 5 fund picks for the second half of 2021:
1. Allianz Global Opportunistic Bond Fund
Fund’s strong risk management and low correlation to equity makes it a strong diversification choice
In the fixed income space, we advocate for an unconstrained approach to manage interest rate risk. Fixed income portfolios should achieve the goals of stable income and low risk to principal, and interest rate risk and low yields make these objectives challenging to achieve. To achieve this, we believe that unconstrained bond funds are the best approach for investors to take, and among them, the Allianz Global Opportunistic Bond Fund stands out for its superior risk management characteristics and low correlation to equity.
Unconstrained bond funds differ from traditional bond funds as they exhibit higher flexibility within their asset choice decisions. This allows the funds to invest across the spectrum of fixed income assets, use derivatives, take short positions, and even make currency overlays in the asset choice decisions. This flexibility allows the funds to manage duration more effectively without taking on too much credit risk.
Its maximum drawdown across the last 3 years is -3.50%, which is exemplary considering that we have had two big shocks for bond markets in that time. This drawdown occurred during March 2020 as the pandemic fears took over, and even when rising rates caused a bond market selloff earlier in 2021, the fund remained resilient in perhaps a textbook example of how unconstrained bond funds can help mitigate interest rate risk.
For investors looking to manage risk in their likely equity heavy portfolios, this is an excellent diversification choice.
Figure 3: Performance of the Allianz Global Opportunistic Bond Fund
2. Fidelity Sustainable Strategic Bond Fund
A potential beneficiary of underlying ESG trends
One of the key trends of 2020 and 2021 thus far has been increasing focus on climate change, and by extension, ESG investing. We expect to see record ESG bond issuance and ESG fund flows this year, and a potential beneficiary from this is the Fidelity Sustainable Strategic Bond Fund.
Overall, the fund’s overall strategy is quite similar to our recommended bond fund – the Fidelity Global Bond Fund, with both funds having similar returns and strong risk management characteristics. However, the Fidelity Sustainable Strategic Bond Fund has some slight nuances in strategy that make it our preferred choice moving into the second half of the year.
The Fidelity Sustainable Strategic Bond Fund exhibits lower duration and higher credit exposure, which we believe to be more appropriate considering the current macro environment of rising interest rates and strong global economic recovery. While this does increase the market risk of the fund, reducing some of its diversification benefits, we believe making some difficult tradeoffs is inevitable in a challenging environment for bonds as an asset class.
In addition, the Fidelity Sustainable Strategic Bond Fund’s performance will potentially be buoyed by a further global emphasis on ESG. With ESG criteria becoming increasingly important, particularly for many financial institutions, fund flows into the sector will continue to increase and serve as a catalyst for the sector. In addition, increased ESG bond issuance should widen the investment universe, creating more investment opportunities for the fund to perform.
Despite the fund’s more aggressive strategy (compared to both the Fidelity Global Bond Fund and the Allianz Global Opportunistic Bond Fund highlighted earlier), but its lower duration, higher credit exposure (higher YTM), and potential to benefit from ESG fund flows makes it an attractive tactical play for 2H2021 and beyond.
Figure 4: Performance of the Fidelity Sustainable Strategic Bond Fund
3. Schroder ISF Latin American Fund
An attractive region driven by commodities exports
One of our top picks for the first half of 2021, as well as one of its top performers, this region remains one of our favourites moving into 2H2021.
One of the region’s core economic drivers is its commodity exports, and driven by structural trends, we expect global demand for commodities to remain high. These trends include the various infrastructure plans put forth by governments worldwide, such as the US & China, as well as the ongoing electrification leading to strong demand for industrial metals. Combined, these factors should continue to support commodity demand.
Next, we also see one of the key headwinds of the region, which is a strong US dollar, as likely temporal in nature. A weaker USD eases the region’s USD debt repayment stress, lowering default risks as well as supporting commodity prices. EM equities, more specifically LatAm ones are slated to benefit given their high commodity exposure.
Finally, we expect pandemic-driven issues to ease as vaccination rates pick up, particularly outside the developed markets. We are finally seeing some of these Emerging Markets starting to have access to vaccines, and this should slow down the pandemic that has weighed heavily on them for the past 18 months. A reopening of the region, and tourism, in particular, is a cherry on top of an already compelling idea, making the Schroder ISF Latin American Fund one of our top picks.
Figure 5: Performance of the Schroder ISF Latin America Fund
4. UBS (Lux) Equity Fund – Greater China
Focus on quality and long-term growth should position them for success
Chinese companies have had a torrid 2021 so far, plagued by a variety of headwinds, some of which are self-inflicted. The Chinese government’s relentless tech crackdown has continued to pressure some of its leading lights, with ride-hailing Didi its latest victim. In addition, where its “first-in, first-out” situation regarding the pandemic has led to its strong performance last year, the tides have turned. As one of the first economies to withdraw their COVID-19 relief measures, Chinese equities have appeared less attractive to their developed market counterparts, where markets remain flush with liquidity.
However, the rise of China cannot be understated, with the economy on track to become the world’s biggest by the end of the decade. We believe that investors should look past the short-term market noise, and look to invest in the long-term growth of the region.
Also, as some of the aforementioned developed markets start to ease their COVID-19 relief measures, Chinese equities should start to appear relatively more attractive. We see this as a potential catalyst for Chinese companies for the second half of 2021.While it is impossible to put a timeline on when regulatory risks will start to ease, we believe that the UBS (Lux) Equity Fund – Greater China Fund’s focus on quality and long-term growth should position them for success for 2H2021 and beyond. We also opt for a Greater China approach for some additional semiconductor exposure through Taiwan.
Figure 6: Performance of the UBS (Lux) Equity Fund – Greater China
5. Blackrock Next Generation Technology Fund
Diversified, global exposure to a theme too important to ignore
Disruptive Innovation has had a shaky start to 2021 thus far, with the investment theme’s long-duration nature and high valuations making it particularly vulnerable to rising rates. Despite these near term challenges, disruptive innovation remains a theme too important for investors to ignore, especially with technological changes happening faster than ever. Without exposure to disruptive innovation, investors risk being left behind by a rapidly changing world.
The fund ticks all the right boxes when it comes to investing in the theme, employing a well-diversified strategy across 80 – 120 different companies. A diversified approach makes sense as identifying tomorrow’s winners is ultimately a numbers game, with many innovative tech firms and start-ups failing in their nascent stage of growth for a variety of reasons. Yet, all we need is a handful to become the next Google, Apple, or Tencent, and the investment would have paid itself back multiple times over.
In addition to being a more fitting strategy to the theme, this diversification also helps to provide additional resilience to the fund itself, significantly improving its risk metrics in an inherently risky theme to invest in. We feel that the significant improvement in risk metrics is well worth the slight trade-off in returns.
Figure 7: Blackrock Next Gen’s diversified approach is reflected in its superior risk metrics
On top of its diversified approach, we also like the fund for its balanced geographical allocation. Markets outside of the US are typically more challenging for investors to access, due to having less available information and often come with the drawbacks of higher fees. The fund provides a fuss-free, cost and time effective method of investing in these assets, leveraging on the size and expertise of Blackrock’s experienced research team. Through this fund, investors can now gain exposure to leading companies that were historically harder to access, such as Kakao Corp or Samsung SDI, both listed in South Korea.
Ultimately, we believe the Blackrock Next Generation Technology Fund plays a strong complementary role to the O’Shares Global Internet Giants ETF (BATS:OGIG) and/or the Blackrock World Technology Fund due to its geographical and size approach. Having exposure to both will provide investors with a portfolio that’s well-positioned to capture future growth opportunities globally.
Figure 8: Performance of the Blackrock Next Generation Technology Fund
Closing Thoughts
Not all assets are made equal, and as governments start to turn off the liquidity tap, these different assets will react differently. It is in such environments where quality and fundamentals shine, as investors now have to be pickier in their assets choices. Backed by strong fundamentals and underlying trends, these are our Top 5 Picks for the second half of 2021.
