Model portfolio update: fund winners and losers in Q2 2023

Inflation and interest rates played a prominent role, but economic resilience was a major theme for the quarter, with stronger than expected growth.

The second quarter of 2023 saw a wide range of outcomes — generally positive, with some assets remarkably strong — although this was not a synchronised experience.

Once again, inflation and interest rates played a prominent role, with inflation retreating at different speeds across the world as interest rates near their expected peaks. Economic resilience was another major theme for the quarter, with stronger than expected growth.

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So far, removing the punchbowl hasn’t stopped the party. The unwinding of stimulus after a decade of near-zero rates is a complex undertaking, but inflation is coming down and jobs are holding up. Despite clear pressure building in parts of society — especially households and businesses with debt funding needs — a growing base of retirees are embracing higher interest rates. 

This contrasts with the original consensus that higher interest rates would tip the economy into recession, knocking indebted companies with no profits out and taking the markets down with it.

Against this backdrop the performance of the Low-Cost Growth model delivered the strongest return, while at the opposite end of the spectrum in Active Income and Low-Cost Income models delivered negative returns over the quarter. The Active Income model was negatively impacted by weakness in a number of closed-ended funds, where sentiment in the form of widening discounts often caused added pain. This included the holdings in Balanced Commercial Property (LSE:BCPT), Murray International (LSE:MYI) and City of London (LSE:CTY).

The top performer over the quarter was the Low-Cost Growth Model, which was up 2.22%, with the other growth models Sustainable Growth and Active Growth producing returns of 1.23% and 0.01% respectively. The Active Income Model was down 1.57%, while the Low-Cost Income Model was down 0.03%.

Performance of models over 12-month time periods

Notes *as at 30 June 2023. Portfolio launch date (for monitoring purposes) was 1 January 2019, except Sustainable Growth portfolio, launched 1 October 2019. Data source: Morningstar Direct. Benchmark: Morningstar UK Adventurous Target Allocation. Past performance is not a reliable indicator of future results.

Performance of the three growth model portfolios

Notes *as at 30 June 2023. Portfolio launch date (for monitoring purposes) was 1 January 2019. Data source: Morningstar Direct. Benchmark: Morningstar UK Adventurous Target Allocation. Past performance is not a reliable indicator of future results. ** Sustainable Growth Launched 1 October 2019.

The ii Active Growth Model was flat over the second quarter of 2023 with a return of 0.01%. The model benefited from the inclusion of the Natixis Loomis Sayles US Equity Leaders fund, which was the top-performing fund in the model. The fund is managed by Aziz Hamzaofullari and he and the team aim to identify companies that have difficult-to-replicate business models with competitive advantages. The fund provides investors with a relatively concentrated portfolio of ‘high-quality’ US stocks with long-term sustainable growth drivers that are trading at a discount to the team’s assessment of their intrinsic value. Over the quarter the fund was up 11.91%, as the portfolio includes holdings in six of the seven stocks that drove the bulk of the S&P 500’s strong performance over the quarter, including names such as NVIDIA Corp (NASDAQ:NVDA), Meta (NASDAQ:META), Microsoft (NASDAQ:MSFT) and Alphabet (NASDAQ:GOOGL).

Offsetting this was weakness in F&C Investment Trust Ord (LSE:FCIT) (-3.60%) and Scottish Mortgage Ord (LSE:SMT) (-1.43%), both of which suffered from a widening of their discount as highlighted above. JPMorgan Emerging Markets Ord (LSE:JMG) (-4.04%), also detracted from performance, however weakness here was a result of weakness in the region and in particular China, where continued geopolitical tensions between the US and China had a negative impact on markets, which saw the MSCI China index decline by 12.2% in Q2.

The ii Sustainable Growth Model benefited from the inclusion of the iShares MSCI World ESG Enh ETF USD Dist GBP (LSE:EEWG), which was up 3.6% over the quarter. This fund offers exposure to global large-caps and a blend style profile, due to the optimisation process employed, which has helped reduce the natural growth style bias inherent in the model.

The model also benefited from strong performance from the Stewart Inv Global Emerg Mkts Sustainability fund, which benefited from an underweight in China.

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The key detractor from performance was the holding in Impax Environmental Markets Ord (LSE:IEM), which suffered from NAV weakness and discount widening in equal measure to end up with a quarterly loss of 4.3%. The investable universe for the fund is defined by applying a screen on environmental, financial quality, and valuation criteria. Portfolio candidates must derive at least 50% of their sales from environmental activities, such as energy efficiency, water infrastructure, and pollution control. Attractive prospects are then vetted in a detailed and structured 10-step process. The portfolio tends to favour growth stocks in the mid-cap space and show sector bets which deviate significantly from broad global indexes. The underweight to the US, the mid-cap growth bias and overweights to the utilities and materials sectors, were headwinds over the quarter versus the mainstream MSCI ACWI Index. However, NAV returns were closer to those of the fund’s Ecology peer group average and have been good over the longer term.

The stand-out performers in the ii Low-Cost Growth Model were L&G Global 100 Index and Vanguard US Equity Index. The L&G Global 100 Index fund tracks the performance of the S&P Global 100 Index and has both a large-cap bias and an allocation of around 14% to Apple Inc (NASDAQ:AAPL), its top holding, which also performed strongly over the quarter. Vanguard US Equity Index, is a passive fund that tracks the S&P Total Market index and also saw strong returns with the competitive ongoing charge of just 10 basis points ensuring most of this flowed through to investors.

On the flip side the Fidelity Index Emerging Markets produced a negative return of 1.88%. As highlighted above, weakness in Chinese equities resulted in negative returns in emerging market equities. Weakness in UK equities meant that the allocation to Fidelity Index UK, which was down 0.63%, also detracted from performance.

Performance of the two income model portfolios

Notes *as at 30 June 2023. Portfolio launch date (for monitoring purposes) was 1 January 2019. Data source: Morningstar Direct. Benchmark: Morningstar UK Adventurous Target Allocation. Past performance is not a reliable indicator of future results.

Against a backdrop that once again saw funds with a growth style bias outperform those with a value style bias, the income models faced a headwind, as most funds in these models tend to have a value style bias.

The performance of the largest detractor in the ii Active Income Model was, however, less about its value style bias and more about the underlying asset class and the widening of the discount in the closed-ended structure, as highlighted above.

Balanced Commercial Property trust was once again one of the weaker performers in Q2. As was the case from Q1, the cause was once again the move in the discount, which widened significantly despite the underlying NAV showing a slight increase (the market return was -18.5% over the quarter). The trust provides exposure to prime UK commercial property with a heavy bias towards central London and South East England and has been subject to negative views on the future prospects for commercial property in the face of domestic economic uncertainty and variable data on the future demand for office space. The discount now stands at slightly more extreme levels than peers and we may see management moving to reduce this through further buybacks if that persists.

Murray International, Bankers and City of London were further examples of trusts that suffered disproportionately as a consequence of the widening of their discount.

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Offsetting this to a small extent was positive performance from Morgan Stanley Global Brands Equity Income, which was up 2.22%. The fund aims to deliver an enhanced income yield, with income delivered from two sources; dividends from a portfolio of high-quality stocks and equity index call option premiums. The natural income from the equity portfolio is enhanced by the call overlay to meet the overall yield target of 4%. The fund benefited from its bias to higher-quality growth stocks.

The ii Low-Cost Income Model was broadly flat over the quarter, with a return of -0.03%. The two key detractors from performance included the SPDR® S&P Global Div Aristocrats ETF GBP (LSE:GBDV), which was down 4.3%, and the Vanguard FTSE UK Equity Income Index, which was down 3.43%.

The SPDR S&P Global Div Aristocrats fund has a significant bias to mid-cap stocks and at the sector level to real estate, both of which detracted from performance over the quarter, while UK equities and particularly those with a value style bias produced negative returns over the quarter, thereby resulting in negative performance from the Vanguard fund.