Four big fund trends in 2021, how will they fare next year?

Each of four of the key investment trends of 2021 now looks finely balanced, writes David Prosser.

The headline figures will tell you that 2021 was a very good year for global stock markets: by mid-December, the FTSE 100 index was up just shy of 13% since the beginning of the year, with the S&P 500 in the US up around 25%. Still, this data masks some significant shifts in the dynamics of the market, with key trends potentially reaching genuine turning points.

The question for 2022, in each case, is which way now these trends and the funds with exposure to them?

Investment experts counsel caution. Philippa Gee, the managing director of Philippa Gee Wealth Management, warns that volatility and uncertainty remain unusually elevated. “You cannot apply a typical and usual economic cycle to current investment markets,” she warns. “Investors have to prepare for the unexpected, given the pandemic, with a need to diversify as much as possible, and to monitor your positions closely.”

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It’s a reasonable warning. Each of four of the key investment trends of 2021 now looks finely balanced.

Value or growth?

Take the age-old battle between investment strategies targeting value stocks, offering more “jam today” but lower long-term earnings potential, or growth stocks, offering more of the latter. At the beginning of 2021, the latter had long been in the ascendancy, with the valuation lag between value and growth stocks in the UK at its widest point since the financial crisis of 2008. But over the first half of the year, the market began to shift.

Some of the stocks that had powered growth styles faltered; the technology sector, in particular, already on lofty valuations, was unsettled by anxieties such as the Chinese government’s regulatory interest in the sector. Meanwhile, the prospects for traditional value sectors such as banking, energy and even transport began to look up, boosted by the roll-out of Covid-19 vaccines, the fiscal and monetary stimulus provided by governments worldwide, and rising inflation.

With growth stocks making up ground in the second half, however, the jury is out on what lies ahead. “Rotation has been a theme during 2021 and there is little reason to believe this will change in 2022,” says Richard Hunter, head of markets at interactive investor. “Switches between value and growth stocks, and indeed cyclical and defensives, have tracked the prospects of economic recovery.”

It could be that inflation proves to be the clincher, he says. Industries including financial services, energy, materials, housing, and parts of consumer all have strong pricing power enabling them to pass inflation on to customers; technology companies and other growth stocks, by contrast, see the value of their future earnings devalued by higher inflation.

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For investors who agree, research from FE Trustnet identifies a broad range of funds with strong performance during periods over the past decade when value stocks have done better. They include VT Cape Wrath Focus, Schroder Responsible Value, JOHCM UK Equity Income, GAM UK Equity Income and Schroder Recovery.

Alternatively, the investment trust analyst team at JPMorgan Cazenove published extensive research earlier this year on funds with a track record of focusing on cheap and undervalued stocks in their portfolios. It ranged from funds such as Fidelity Special Values (LSE:FSV), City of London (LSE:CTY) and Merchants (LSE:MRCH) in the UK, to global vehicles such as AVI Global (LSE:AGT) and Ruffer Investment Company (LSE:RICA).

The great dividend recovery

What about another shift we saw in 2021 – the return of dividend income following a year in which companies worldwide cut their payouts in the face of the Covid-19 crisis? In the UK, for example, Link Group predicts that total dividends for 2021 will total £93.2 billion, a 44% increase on the previous year; the third quarter of the year alone saw dividend payments of £34.9 billion from UK companies.

Keith Bowman, analyst at interactive investor, is optimistic this is one trend that is likely to endure. “We are unlikely to see a return to the dividend suspensions suffered at the very start of the crisis because corporations have, where possible, adjusted to working under the pandemic,” he argues.

Bowman adds: “However, increased outlook uncertainty due to the new variant could see payments left unchanged, as opposed to increased, or raised at a reduced rate.”

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One way for investors to navigate that uncertainty could be to turn to the investment trust sector, given that closed-ended funds have a unique ability to smooth out ups and downs in dividend earnings by retaining some income in better years to sustain pay-outs in leaner times.

“There are currently 23 trusts investing primarily in equities that have a dividend yield of 4% or higher,” points out Iain Scouller, head of the investment trust analyst team at Stifel. “For those investors prepared to take equity risk, the yields on these trusts may be attractive in the current low interest rate environment. Most of these trusts offer exposure to overseas markets, as an alternative to the UK. Many of them also have substantial dividend reserves, and have a good record of delivering annual dividend growth.”

The commodities boom

The strength of the commodities sector has been another major story of 2021, with funds invested directly in commodities or in businesses in the sector benefitting from higher prices as global demand has recovered. Coal prices rose 86% over the first 11 months of the year, with oil up by 46% - but a broad range of materials, from coffee to uranium, bounced too.

“Historically, investors turn to commodities as a source of portfolio diversification and as a hedge against rising levels of inflation, but prior to this year commodities had been in a bear market for over a decade,” says Dzmitry Lipski, head of funds research at Interactive Investor.

He adds: “Improved sentiment towards the asset class reflects structural trends including economic recovery from the pandemic and inflation fears. along with infrastructure spending and hence higher demand for materials.”

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That thinking partly explains interactive investor’s decision earlier this year to add WisdomTree's Enhanced Commodity ETF (LSE:WCOB) fund to its Super 60 list of recommended funds. The list also includes the iShares Physical Gold ETC (LSE:IGLN) fund, and FTF ClearBridge Global Infrastructure.

That said, Bowman thinks the commodities recovery is one trend that may not last long into 2022. “The recovery is now under threat on a number of fronts: the discovery of the Omicron variant, and increased global social restrictions over the winter months could affect demand and prices - returns to working from home now overshadow the oil price, for example,” he says.

“Also, the US Federal Reserve’s move to reduce stimulus through its bond-buying programme into 2022 reduces liquidity to buy assets across the board, including commodities. Concerns for interest rate rises given elevated inflation also overshadow commodities going forward.”

China’s regulatory crackdown

Finally, the future direction of China’s stock market – and its broader economy – is a crucial consideration for the year ahead. In the key technology sector, but also in areas such as education and financial services, tough interventions from the government during 2021 saw regulation tightened significantly.

That dampened the growth prospects of companies directly in the firing line, and undermined confidence in the broader economy, already facing problems such as a mounting corporate debt crisis. In October, the International Monetary Fund (IMF) reduced its forecasts for economic growth in China for both 2021 and 2022, to 8.0% and 5.6%, respectively.

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Ewan Lovett-Turner, head of investment companies research, thinks further volatility in China cannot be ruled out – but also that policymakers are conscious of the consequences of their interventions, particularly given the need to sustain growth and keep China’s economy on track.

“The changes to the education sector were more extreme than most expected, and several businesses models are in tatters, but we expect this to be the exception rather than an approach replicated across sectors,” Lovett-Turner says. “We would expect changes in the technology space to be more measured. Innovation remains a key pillar of China’s five-year plan, and therefore we do not expect it to seek to regulate the internet sector out of business.”

Dale Nicholls, manager of interactive investor Super 60 constituent Fidelity China Special Situations (LSE:FCSS), is also optimistic. “It clearly has been a volatile period, but we have seen times like this before, and most likely will see them again,” he says. “While the combination of risks is negatively impacting sentiment towards China currently, history teaches us that these are usually the periods that offer the most attractive opportunities.”