Chelsea picks investment premier league – and lists relegation contenders

1st December 2014

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The headlines scream doom and gloom – from Ebola, the Ukraine, and Islamic State hate crimes to the Chinese slowdown, the end of US Federal Reserve tapering and problems in continental Europe wherever you choose to look.

But even though equity markets went through a shaky patch in October, barring major shocks between now and December 31, most share investors will end up the year ahead. According to Darius McDermott (pictured) at Chelsea Financial Services, in the year to date, the FTSE 100 has returned 3.16%, while the S&P 500 is up 17.60%. Bonds have also performed strongly – to date, the average return from the IMA UK Corporate Bond sector is 5.7%.

The question McDermott poses is: can they continue into 2015? He has split the major unit trust sectors into positive, neutral and negative.

Europe and Japan lead the positives.

Europe has lots of danger signals, McDermott reckons. He says: “There is more eurozone economic malaise, leading to the danger of further unrest in Europe with the growth in popularity of anti-immigration, right wing parties. However, Europe is cheap and Mario Draghi will do whatever he can to drive markets higher. Europe has a universe of 3,000 stocks, so there are plenty of opportunities for a good bottom-up fund manager – returns will improve if the focus towards fundamentals continues and I am seeing early signs of that. On a one-year view I am positive on Europe because of expected QE. We favour BlackRock Continental European and Threadneedle European Select.”

Japan is rarely anyone’s favourite but Chelsea is a fan this time.

McDermott says: “The case for Japanese equities is simple: most other developed markets look fully valued in comparison. Japan is an exception; Japanese shares trade at a 1.3 price-to-book ratio, less than half that of US stocks. The stocks are cheap relative to their own history. Japan’s stock market currently has a price-to-earnings ratio that is only 37% of its 10-year historical average. The unprecedented flow of QE is also a tailwind for the Land of the Rising Sun. For once, Japan may not flatter to deceive, which is positive. We go for Neptune Japan Opportunities and Baillie Gifford Japanese.”

Other positives include India, China (where markets may become more investor friendly) Absolute Return funds, Commercial Property and Commodities.

Two sectors to avoid

Bonds returns have been positive despite much pessimism. But how long can this last? Chelsea’s view is not much longer. Bond investors have been helped by the world’s major central banks having been in uncharted waters for the past five years, leading to historically low levels of volatility, markets awash with liquidity, and record low bond yields.

However if rates rise faster than expected we could see big capital losses. At best, investors will continue to receive your coupon. “So,” questions McDermott, “why bother when dividend yields on many stocks remain surprisingly high. I am concerned that high-yield bond investors are not getting paid for the risk they are taking on. In this tougher and more complex environment I prefer strategic bond funds, particularly in a rising rate environment. I rate PFS TwentyFour Dynamic Bond and Jupiter Strategic Bond.”

Russia should also be avoided – and this is political. McDermott believes “Russia is cheap – but then cheap doesn’t necessarily mean value. The rouble has also plummeted in value, giving investors the potential for a double kicker if stocks are to come back. The problem lies, of course, in Putin’s bellicose approach to foreign policy and whether he plans another iron curtain.” Chelsea cannot find any Russia-leaning fund to recommend.

Other sectors including Global equities, the US and the UK – where the run up and aftermath of the general election next May will produce uncertainty – are rated “neutral”.

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