by Scott Middleton, Chartered Financial Planner, James & George Collie Financial Management Limited

Executive Summary

• The James & George Collie Model Portfolios again posted a positive return during Q2, extending the gains made in the first quarter of 2017
• Equity markets continued their upward trend in the second quarter of 2017, with an improving global economic outlook, reduced political uncertainty and positive corporate earnings revisions providing support across regions
• For sterling-based investors European, Asian (ex Japan) and Emerging Markets equities have been the standout performers year-to-date, with UK, North American and Japanese markets also enjoying positive returns in the first half of 2017
• In contrast, conventional gilts sold off in June, reversing the gains seen in the first quarter as Bank of England policymakers debated whether to raise interest rates.

Review of Q2 2017

While the general election itself did not have a massive impact on bond yields, one of the most important points to note during the second quarter of 2017 was that conventional gilts posted negative returns, as the perceived change in attitude of central banks towards normalising monetary policy caused a sharp spike in yields. The ensuing speculation about austerity policies being watered down, as well as a potentially softer Brexit, also did not help gilts, leading to a total return of -1.3% from the FTSE Actuaries UK Conventional Gilts All Stocks index over the period.

As highlighted last quarter, the James & George Collie Model Portfolios remain underweight fixed interest from an asset allocation perspective, a function of our relatively cautious stance on bonds in general given the historically low level of yields on offer. This positioning once again added to relative returns, though the majority of the outperformance seen over the quarter was generated at the underlying fund selection level.

Turning to equity markets, and the FTSE All-Share posted a total return of 1.4% over the quarter, with mid- and smaller-cap companies again outperforming their larger counterparts. Year-to-date total returns for the FTSE Small Cap (ex IT) and FTSE 250 (ex IT) now stand at 8.8% and 8.4% respectively, comfortably ahead of the 4.7% return from the FTSE 100 index. The period also saw a continuation of “growth” stocks outperforming “value”, with sectors such as Oil & Gas, Basic Materials and Utilities posting negative returns over the period.

The James & George Collie Model Portfolios active UK equity holdings outperformed over the quarter, with a number of managers extending their relative gains year-to-date. The Artemis Income, Investec UK Alpha and CF Woodford Equity Income funds were three such examples, all benefiting from strong performance at the individual stock selection level as well as their underweight exposure to those poorly performing sectors mentioned above. The James & George Collie Model Portfolios allocation to the smaller end of the market also delivered firmly positive returns, with the River & Mercantile UK Equity Smaller Companies fund enjoying continued strong performance from long-standing holdings across the AIM market.

Turning to international equity markets, Europe was the standout performer during the second quarter, with the FTSE Europe ex UK index returning 4.6% against an improving political, economic and corporate backdrop. In France, the election of Emmanuel Macron was received positively by markets, with significant asset flows into the region arising from the successful navigation of this perceived political hurdle. Pleasingly, the James & George Collie Model Portfolios European equity exposure outperformed at the fund selection level, while the overweight allocation to the region also contributed to relative returns. We further increased the exposure across several of the strategies towards the end of the quarter, while also making a change to our holdings. Further details can be found in the next section.

North American equities ended down in sterling terms over the quarter, a function of the dollar weakness seen during the period. The James & George Collie Model Portfolios exposure also finished in negative territory, underperforming the broader market as the Old Mutual North American Equity and Schroder US Mid Cap holdings lagged modestly.

Elsewhere, returns from the James & George Collie Model Portfolios Asian allocations were positive, with the BGF Asian Growth Leaders – a new holding introduced in March – also benefiting from its exposure to technology names. In Japan, the Baillie Gifford Japanese Income Growth fund continued its strong start to the year with another quarter of outperformance.

Finally, the James & George Collie Model Portfolios Absolute Return exposure delivered a marginally positive return over the quarter, with the Invesco Perpetual Global Targeted Returns and – within the lower-risk strategies – Newton Real Return funds the standout performers. Returns from the James & George Collie Model Portfolios Commercial Property exposure were positive on both an absolute and relative basis, with the F&C Property Growth & Income fund enjoying a particularly strong quarter to bring its year-to-date return to 7%.

Q2 2017 Changes to Portfolios

To summarise, the key changes made to the James & George Collie Model Portfolios asset allocations over the quarter were as follows:

• The James & George Collie Model Portfolios exposure to European equities was increased, a move that reflects our continued positive outlook for this market on the basis of an improving economic environment, diminishing levels of political risk and positive corporate fundamentals.

• The James & George Collie Model Portfolios exposure to Japanese equities was again selectively increased, with the allocation maintained as one of our key overweight exposures at the regional level.

• We have closed our modestly underweight allocation to UK equities across the portfolios, a move that reflects more our constructive outlook for risk assets than a wholesale change in our view on the domestic economy.

• We have increased the exposure to Absolute Return funds within the James & George Collie Moderately Adventurous and James & George Collie Defensive portfolios, having already raised this allocation within the James & George Collie Balanced and James & George Collie Cautious portfolios earlier in the year.

• The James & George Collie Model Portfolios cash levels were selectively reduced in the process.

At the fund selection level, we have introduced a new active fund within the James & George Collie Model Portfolios European equity allocation, while also moving the James & George Collie Model Portfolios active Emerging Markets equity holdings to an equal-weighted basis.

Starting with Europe, we have exited the James & George Collie Model Portfolios exposure to the BlackRock Continental European Income fund in favour of the Henderson European Selected Opportunities fund. This move concludes the work undertaken to increase the economic sensitivity of the James & George Collie Model Portfolios exposure to the region, and was decided upon in the wake of the first round of the French election, when our positive outlook for European equities was reaffirmed.

The addition of the Henderson fund to the strategies removes some of the more defensive biases that we had identified as a potential source of concern in a pro-cyclical market environment. John Bennett, the manager of the fund, is pragmatic in nature and his current positioning of the portfolio reflects our own broadly positive outlook for the region. Indeed, the fund’s investment process provides the flexibility to rotate into sectors that are typically under-represented within the BlackRock fund, and Bennett’s recent activity has certainly increased the “value” characteristics of the portfolio in recent times, with a move away from Healthcare in favour of an increased allocation to Banks the most notable example. The rationale for this rotation was based partially upon the valuation premium of certain sectors appearing high relative to history, but also the team’s view that selected European Banks are finally investable, both in terms of their financial strength (with their dividend yield well covered) and lowly valuations.

Paired alongside the incumbent allocation to the JOHCM Continental European fund, the result of this change is an exposure to two ‘core’ active managers that better reflect our outlook for European markets. Both remain broadly positive in their outlook and positioning, as well as relatively large cap in nature, and ensure synchronicity with our overweight allocation to this region.

The final change of note was the repositioning of the James & George Collie Model Portfolios active Emerging Markets equity holdings to an equal-weighted basis, having previously been tilted in favour of the more “value”-orientated Lazard Emerging Markets fund. The resulting position ensures a more balanced exposure to the low beta, high quality bias of the Henderson Emerging Markets Opportunities fund alongside the positive tilt towards global reflation obtained from the Lazard holding.

At the headline level, there is little quarter-on-quarter difference to our positioning across the James & George Collie Model Portfolios. Rather, it is the emphasis of these tactical allocations that we have changed. As such, we remain biased towards equities, with North America, Europe (ex UK) and Japan our key ‘overweight’ positions relative to strategic benchmarks. This is in contrast to the UK, where we maintain a ‘neutral’ allocation.

Within the James & George Collie Model Portfolios bond exposure, we retain a cautious stance overall. Although gilt yields did rise modestly during the last quarter, they still remain close to historical lows and do not appear to offer much value, especially when elevated levels of inflation are taken into account. Unfortunately, most other parts of the bond market also look expensive following a prolonged period of strong returns. We are therefore focusing on quality and liquidity, while also seeking to earn a competitive return. We remain of the opinion that yields will be slow to rise, and expect the Bank of England to keep interest rates low for the foreseeable future.

Elsewhere, we have further reduced the portfolios’ cash levels, having already lowered levels earlier in the year, ensuring that the strategies now hold only a very modest overweight position. And finally, Absolute Return holdings have been selectively increased across the strategies, though alongside Commercial Property we retain our ‘underweight’ position to Alternatives within the portfolios.

Conclusion

Eight years into the economic cycle and with equity markets touching new highs, exceptional year-on-year returns and no sign of a correction, it is hardly surprising that many investors are feeling cautious. However, a combination of rising nominal GDP and relatively slow monetary tightening is a benign environment for risk assets, and strong 2017 corporate earnings will provide additional support. While the tapering of central bank balance sheets requires close monitoring for signs of tighter credit conditions, equities can still make progress. A modest rise in bond yields should also be expected.

The past year has seen above average sector rotation and this has provided opportunities for active investors. Falling bond yields in recent years have helped “growth” stocks out-perform “value” and, although the former are now looking expensive, valuations are still nowhere near “tech bubble” territory. If tapering by central banks results in a steeper yield curve, “value” stocks – typically represented in most markets by financials – could come back into favour. Analysts’ forecasts of a 14% increase in global corporate earnings puts world equities on a forward price/earnings ratio of 17x. This is above the longer-term average, but by no means extreme. The US looks the most expensive and Asian/ Emerging Markets the cheapest with Europe (including the UK) somewhere in the middle. Income-seeking investors will continue to be attracted by dividend yields and these are well supported by profits at this stage in the cycle.

When it comes to making investments, there is no substitute for taking specialist advice, but remember that markets can be volatile and the value of investments can go down as well as up.

For more details on how you could invest within the James & George Collie Managed Portfolios please contact Scott Middleton on 01224 581581 or by email at This email address is being protected from spambots. You need JavaScript enabled to view it. to arrange an appointment.