What to own alongside Fundsmith or a low-cost global tracker fund

While Fundsmith Equity and global index funds are popular with investors for very good reasons, it is also worth considering global strategies that adopt a different style or approach. Cherry Reynard asks experts for some fund ideas. 

For much of the past decade, investors have gravitated to global funds such as Terry Smith’s Fundsmith Equity, or low-cost index funds or exchange-traded funds (ETFs) focused on the MSCI World index.

This strategy has served them very well, providing exposure to many of the strongest investment areas in recent history, from technology giants such as Apple Inc (NASDAQ:AAPL) and Microsoft Corp (NASDAQ:MSFT), to healthcare titans Novo Nordisk A/S ADR (XETRA:NOVA) or UnitedHealth Group Inc (NYSE:UNH), to top consumer brands L'Oreal SA (EURONEXT:OR) or LVMH (EURONEXT:MC).

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Change in macro backdrop could lead to new winners

However, there is a question mark over whether this strategy will prove as effective over the next decade. Investing history suggests that few strategies outperform indefinitely, and market leadership will ebb and flow. Equally, the market backdrop is now significantly different to the environment that has prevailed in recent years, with higher interest rates and persistent inflation changing the flavour of markets.

Adam Norris, investment analyst on the Columbia Threadneedle multi-manager people team, says: “Investors will have performed handsomely over the past 10 years in large-cap quality growth stocks. Inflation was subdued, interest rates low and increased global connectivity enabled businesses to scale at a rapid pace, rarely seen in the history of financial markets. There was only one game in town.

“At least two of those three drivers have significantly changed in the past two years, with interest rates at multi-decade highs and inflation proving difficult to control. Profit margins are retreating after a supernormal boost post-Covid, yet stock market valuations remain elevated.”

Few would call time on the dominance of these behemoths in the short term. The performance of the Nasdaq for the year to date shows how quickly the market can revive given the right catalyst – in this case the growth of artificial intelligence. However, it does suggest that investors need a back-up plan.

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Dan Brocklebank, head of Orbis UK, says: “We don’t tend to be good at recognising regime shifts and investors can be surprisingly slow to change the flavour of their portfolios. Many investors are not as diversified in practice as they think they are.”

Orbis analysis shows that the average correlation across the four largest funds in the Investment Association’s Global sector is 90%. Even looking across the top 10 funds, it doesn’t drop significantly, its research shows.

Brocklebank points out that many global equity funds have a significant concentration in the US, which looks significantly overvalued relative to its global peers. Equally, they are unlikely to have meaningful exposure to potential growth areas, such as Japan, emerging markets or even the unloved UK, where stock markets may be ripe for reappraisal by global investors.

The MSCI World index, for example, is currently 69% weighted to the US, with just five stocks - Apple, Microsoft, Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOGL) and NVIDIA (NASDAQ:NVDA) - accounting for over 15% of the index. Japan is just 6.3%, the UK is just 4.1%. Emerging markets are barely represented at all.

Options to add greater diversification

How can investors redress the balance? Gavin Haynes, investment consultant at Fairview Investing, says adding a global equity income strategy with a high active share (over 80%) can bring some equilibrium to a portfolio. He suggests the Guinness Global Equity Income fund, managed by Ian Mortimer.

“Global equity income currently feels well positioned, with dividends likely to have increasing importance in an environment of lower economic growth. This fund has a focus on companies growing their dividends, which has historically provided inflation protection.

“It has a total return focus with 35 stocks and a low turnover. Its key sectors are consumer staples, industrials, healthcare and financials - but no banks. It has an active share of 89% so is very different from the index.”

Ollie Rubinstein, an analyst for City Asset Management, suggests Fidelity Global Dividend as another option. He points out that the fund, a member of interactive investor’s Super 60 investment ideas, has an inherent ‘value’ bias, adding: “It targets a 25% dividend premium over the MSCI All Country World Index, which will diversify the style risk of traditional global portfolios. Also, the emphasis on free cashflow generation and conservative balance sheets has, historically, helped them to outperform a falling market.”

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The style problem is important. Historically, growth and value have each had periods in the sun, but growth has been in favour for over a decade, and value tentatively started to revive in 2022. Most of the traditional global funds favour growth sectors, such as technology, leaving investors with relatively little exposure to value areas such as mining, financials or utilities. They are also focused on larger capitalisation companies.

Targeting dividend strategies will help, but to rebalance more explicitly, Haynes likes the Artemis Global Income fund. Managed by Jacob De Tusch Lec, the fund has a ‘value’ focus and takes a multi-cap approach, with one-third of the fund in mid-sized companies.

For more concentrated small and mid-cap exposure, Haynes suggests the LF Montanaro Global Select fund: “This is Montanaro’s global best ideas fund with only 30 companies. It can be volatile at times but could be a higher-risk option to sit alongside core global equity exposure.”

Sustainable focus missing piece from global jigsaw

A sustainable tilt is the other important element missing from traditional global funds. Norris believes investors shouldn’t neglect this potential growth spot. He says: “Governments globally are firmly committed to spending to finance the planet’s need to decarbonise. In particular, the United States’ Inflation Reduction Act (IRA) provides significant tax incentives for clean energy technology to be produced and manufacturing capabilities rebuilt in the US.

“While the official projections are for a not-to-be-sniffed-at $350 billion in subsidies, IRA tax credits are uncapped, meaning that the actual bill could be closer to $800 billion. It’s also expected to trigger a multiple of that figure in private investment, making it the most significant climate legislation in history. It could support jobs and inflation over a number of years.”

With that in mind, he likes the FTF ClearBridge Global Infrastructure Income fund, which provides exposure to those infrastructure companies set to benefit from the energy transition. Inflation-protection is built into their business models, which means the fund’s income stream should rise in line with prices. The fund is also in interactive investor’s Super 60 list.

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Norris adds: “Investee companies typically have three common attributes. The first is a regulated return on their asset base, providing revenue certainty. The second is that leverage is overseen by a local regulator, protecting against excess as debt costs rapidly increase. The third - and most important - is the passthrough of inflation into company revenues and profits, leading to healthy dividend growth.”

In a similar vein, Haynes likes the Janus Henderson Global Sustainable Equity fund, which follows 10 sustainable development themes. These themes guide idea generation and identify long-term investment opportunities. The fund also has strict avoidance criteria, steering clear of any company that contributes to environmental and social harm. This, says Haynes, helps ensure they are on the side of the disrupters rather than the disrupted.

Janus Henderson Global Sustainable Equity is one of the options in interactive investor’s sustainable list of funds ideas – the ACE 40.

Norris says: “It would be foolish to suggest large-cap quality growth stocks are down and out – returns year to date certainly suggest otherwise. However, investors should also recognise the benefits of diversification in their global equity exposure.”

Investor portfolios have been pointing in one direction for some time – growth-focused, large cap equities. That has been a good strategy, but investment portfolios should reflect the possibility that a different environment may lie ahead.