Which funds offer the best value at the start of 2023?

At the start of a new year, we ask a range of experts to name the fund sectors and types of funds they believe are looking attractively priced.

Investors have a fine line to tread in 2023. They need to prepare for the worst while simultaneously hoping for the best. The economic situation looks treacherous – with recessions likely across most major economies, but markets could turn some way before an economic recovery. History suggests missing the bounce could be expensive.

Only a handful of sunny optimists believe the major economies of the UK, US and Europe will escape recession in 2023. Inflationary pressures and higher interest rates will continue to exert a strong drag on economic growth as consumers and corporations wind in their spending. The debate is only over the depth and duration of any economic pullback. Against this backdrop, some caution is warranted.

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On the other hand, being too defensive would be a mistake. Markets tend to turn long before a recovery in the wider economy materialises. In the Global Financial Crisis, the market bottomed out in early 2009, long before the global economy appears on a sound footing. During the pandemic, it bottomed out eight months before a vaccine became a reality.

Why staying the course pays off

It is one of the great investment truths that missing a handful of days in markets puts a significant dent in overall returns. The most recent JP Morgan Asset Management Capital Markets survey found that missing the best 10 days in markets over the last 20 years has reduced an investor’s annualised return from 9.76% to 5.56%. Miss the 30 best days and it drops to just 0.79%. It also shows that many of these good days happen just after bad days - seven of the 10 best days in markets occurred within 15 days of the 10 worst days.

James Calder, chief investment officer at City Asset Management, sums up the dilemma: “Our portfolios are defensively positioned, reflecting the weakened global outlook. Going into 2023 this defensiveness will persist. Our next move will be predicated on an improving backdrop, a fall in inflation, an acceptance of peak rates, and attractive valuations.

“At that point, it will be appropriate to increase risk within portfolios, but we recognise that doing so will feel uncomfortable. Missing the turn in the market leaves too much on the table.”

Bonds backed to shine in 2023

In building a portfolio that both defends against market volatility and participates in a recovery, bonds are – finally – an investor’s friend again. This may seem a bold claim after a year in which ‘safe haven’ UK government bonds have lost over 20%, and while interest rates are still rising. However, yields are now at more normal levels.

Kelly Prior, fund manager on the multi-manager people team at Columbia Threadneedle, explains: “The inflation and interest rate genies are out of the bottle and, while they may have peaked in many instances, they are likely to linger for a while yet. The run that we have seen in fixed income assets in the very recent past is a nod to the volatility that we are likely to see in the coming year. The point is this type of market brings a bounty of mispriced opportunities for those that put the work in, and remember in bond world, as long as your borrower remains solvent you get your interest and capital back at the end of term.”

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She likes the Man GLG Sterling Corp Bond run by Jonathan Golan: “It is good old-fashioned bond investing but done in a very targeted way. [What] Jonathan and his team are looking for are issues that are off the radar of the broader market, that have overestimated credit risk, and under-appreciated cashflow dynamics. He isn’t looking to buy the safest debt in the market as this rarely gives you the best upside. Instead, he relies on his and his team’s underwriting skills.”

Calder suggests Artemis Target Return Bond, which has exposure to bonds with short lifespans. Such bonds are less sensitive to changes in interest rates. Calder points out: “The default of the portfolio is to invest in a concentrated portfolio of short-dated sterling denominated investment grade bonds. However, exposure is dynamic and has ranged between 15% and 50% since inception in 2019.”

Gavin Haynes, investment consultant at Fairview Investing, picks Jupiter Strategic Bond, which is part of interactive investor’s Super 60 investments. He says: “Bonds have not proved defensive during the inflationary period in 2022, but should prove better placed in a recession. This fund is positioned with recession as the base case scenario - due to the Federal Reserve’s obsession with not returning to 1970s inflation. It is invested across government, investment grade and high-yield corporate bonds with a focus on stock-picking to avoid defaults.”

Equity fund picks for 2023

Recovery is still plausible in the second half of the year. Inflation may moderate and with it, the appetite of the Federal Reserve for further rate rises. Markets may move some way ahead of the economy and investors will need to be ready for the bounce.

Calder suggests the Jupiter UK Dynamic Equity Fund, which focuses on UK mid-cap equity investing. Mid-caps have been hit hard over the past 12 months, with a gap opening up before operational and share price performance. This brings hope for recovery.

Others see some interest in emerging markets. Nick Wood, head of investment fund research at Quilter Cheviot, picks the JPMorgan Emerging Markets (LSE:JMG) fund: “Emerging markets have been the laggard of 2022, not helped either by the strong dollar, or the headwinds facing China. There are plenty of reasons to remain cautious, especially on the uncertainty that comes with investing in China, but we think an allocation may prove to be one of 2023’s best ideas.”

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The fund is run by Leon Eidelman and his team with a bias towards higher-quality growth companies. Wood adds: “At present, the fund is relatively balanced, having increased its exposure to financials in recent months, but also retains a significant weighting in technology.

“India is the largest overweight geographic position in the fund relative to its index, as it looks to take advantage of demographic changes that are ongoing in the country, meaning investors are not overly exposed to the issues facing China. It also has good exposure to emerging market consumer, a long-term structural growth driver in the region.”

Haynes focuses in on Asia, picking the FSSA Asia Focus fund. He admits Asian markets have had a torrid time in 2022, but believes the rolling back of China’s zero-Covid policy could prove to be a catalyst for recovery in 2023. This fund has around one-third invested in Greater China and also provides good exposure to the long-term growth potential of India.

Mark Preskett, senior portfolio manager at Morningstar Investment Management, also likes China, picking Baillie Gifford China as a recovery play. He says that a dismal year has left China looking very cheap and while the reasons for its weakness are clear – from lockdowns, to the common prosperity policy, which has hit the education, tech and property sectors – there are now a lot of good companies trading at low valuations.

Where to look for income

If 2023 could be another bouncy year for capital returns, many investors will prefer the comfort blanket of an income strategy. Bonds are once again in the mix for income, having seen yields rise significantly this year. Prior likes the Jupiter Monthly Income Bond fund, run by Hilary Blandy.

She says: “Sitting alongside the better-known Ariel Bezalel, Hilary has quietly honed her skills as a portfolio manager in recent years, having set up and managed the analyst research team as it grew and matured with the fixed income franchise at Jupiter.

“The fund has a natural bias to shorter-dated issues, with an unsurprising focus on bottom-up opportunities but always with an eye on overall portfolio construction. A small fund affords the manager flexibility – which in the coming quarters should be a significant advantage as we see volatility but also opportunity.”

Haynes picked the Artemis Corporate Bond, which is 95% invested in investment-grade corporate bonds under the guidance of Stephen Snowden. Preskett likes AXA Global High Income, a global high-yield fund.  

While the economic outlook doesn’t give significant cause for optimism in the year ahead, valuations for both bonds and stock markets are far lower than they were a year ago. This gives fund managers a range of opportunities to work and the good ones should be able to make hay, even if the sun isn’t shining.