Model portfolio update: fund winners and losers in Q3 2023

There was positive performance across all models apart from the Sustainable Growth model, which produced a negative absolute return over the quarter.

Global equities and bonds rose modestly in sterling terms over Q3 but fell in US dollar terms, thereby giving up some of the gains made in the first half of 2023. Economic indicators continue to paint a murky picture in the US, the UK, and Europe, and inflation continues to dominate the market narrative. With inflation generally on a downward trend, the Federal Reserve and the Bank of England have recently hit pause in their respective monetary tightening programmes but have given indications of a “higher for longer” interest rate environment, quashing any hopes of rate cuts in the near term.

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In equities, value once again outperformed growth in most regions with energy stocks leading the way on the back of a rapidly rising oil price and a series of supply cuts. Stocks in the communications and financials sectors rose too, while utilities and consumer staples produced negative returns.

Against this backdrop, the Active Growth and Low-Cost Income models produced the strongest returns, while at the opposite end of the spectrum the Sustainable Growth model delivered a negative return over the quarter, largely reflecting the underperformance of growth vs value. The Low-Cost Growth model also produced a positive return over the quarter, while the Active Income model was down slightly driven largely by the negative return of Murray International (LSE:MYI) and to a lesser extent by the negative return of the M&G Global Dividend fund.

The top performer over the quarter was the Active Growth Model, which was up 1.54%, with the other growth models, Sustainable Growth and Low-Cost Growth, producing returns of -1.10% and 0.77% respectively. The Active Income Model was down 0.26%, while the Low-Cost Income Model was up 1.47%.

Performance of models over 12-month time periods

Notes *as at 30 September 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 September 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 up 1.54% over the third quarter of 2023. Stand-out contributors to performance over the quarter were funds with a value style bias, including Dodge & Cox Worldwide Global Stock, JPM US Value and Jupiter UK Special Situations.

The Dodge & Cox Worldwide Global Stock fund invests in mostly large-cap stocks that look cheap on a range of valuation measures. The approach relies on bottom-up, fundamental research of companies and industries and favours businesses with good management, competitive advantages, and good growth potential. These may also be businesses that are under a cloud at the time of purchase. The fund was up 4.53% over the quarter and benefited from overweight positions, as well as stock selection, in energy and financials and from positive stock selection in communication services.

The JPM US Value team focuses on US large-cap stocks with consistent earnings, high returns on invested capital, conservative financials, and strong management. There is also flexibility to dip into cyclicals and beaten-up stocks when opportunities arise. The managers won't pay too large a premium for stocks, quality or otherwise, and valuations are critical to buy-and-sell decisions. The fund was up 2.28% over the quarter and benefited primarily from an overweight in the energy sector and underweight in technology as well as from positive stock selection in healthcare.

Completing the list of top performers in the model is the Jupiter UK Special Situations, which was up 4.58% over the quarter. The managers of this fund adopt a clear value approach that aims to identify longer-term valuation anomalies by looking for stocks that have an attractive P/E ratio when calculated using 10-year average earnings, or which look attractive on an earnings yield to return on capital basis. This, plus the slight bias down the market-cap scale, have been beneficial over the quarter.

Offsetting the positive returns of these funds were the holdings in Fundsmith Equity (-1.74%) and JPMorgan Emerging Markets Ord (LSE:JMG) (-1.15%), both of which have a quality-growth style bias and suffered as growth stocks underperformed.

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While the ii Sustainable Growth Model includes a small allocation to managers with a value style bias, most notably the Schroder Global Sustainable Value Equity fund, it continues to be dominated by managers with a growth style bias, in keeping with the profile of most Sustainable funds. As such this bias was detrimental to performance over the quarter with the largest detractors from performance including the holdings in Impax Environmental Markets Ord (LSE:IEM) and Baillie Gifford Positive Change. Overall, the ii Sustainable Growth Model was down 1.10% for the quarter.

Impax Environmental Markets Ord defines its investable universe 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. The portfolio tends to favour growth stocks in the smid-cap space and show sector bets that deviate significantly from broad global indexes. The growth bias, exposure to US and European small-caps and the overweight to the utilities sector, were all headwinds over the quarter. The NAV weakness was exacerbated by a widening of the discount, which resulted in a share price decline of 9.13%.

The managers of the Baillie Gifford Positive Change fund look to invest in new, innovative, transformational industries including energy transition, electrification, material revolution, genetics, AI and quantum computing, with a focus on companies that are looking to enable these discoveries and drive change in their industries. The managers therefore target high-growth stocks with strong long-term potential, and, as a result, the stocks held often trade at high near-term valuation multiples. This clear growth focus detracted from performance over the quarter with the fund down 7.35%.

Offsetting this was strong performance from the Schroder Global Sustainable Value Equity fund, which produced a positive return of 3.34%. The fund is an unusual product offering both sustainable characteristics and a clear value bias relative to mainstream benchmarks. There is a focus on companies deemed to be industry leaders or best in class versus peers in terms of sustainability, while the underlying stock selection methodology follows the established team process that seeks to identify contrarian, recovery ideas with strong financials. The value style and the bias down the market-cap scale were both positives over the quarter.

Positive contributors to performance in the ii Low-Cost Growth Model included Fidelity Index UK and L&G Global 100 Index. Fidelity Index UK tracks the FTSE All-Share Index, which benefited from allocations to energy and basic materials stocks. The L&G Global 100 Index fund tracks the performance of the S&P Global 100 Index and to this end benefited from its bias to large-cap stocks. The model was up 0.77% for the quarter.

On the flip side the Vanguard Global Bond Index fund was down 2.34% and the Vanguard FTSE Developed Europe ex UK Index (LSE:VERG) fund was down 2.01%.

The Vanguard Global Bond Index fund tracks the Bloomberg Global Aggregate Float Adjusted and Scaled Index, which includes over 20,000 investment grade and government bonds from across the globe with maturities over one year and the returns are GBP hedged. The GBP hedge meant that the fund did not benefit from US dollar strength relative to sterling and thus resulted in negative returns over the quarter.

Performance of the two income model portfolios

Notes *as at 30 September 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.

While ordinarily one might expect the value style bias to have been a tailwind to performance of funds in the income model; negative performance from, in particular, Murray International Ord, resulted in a marginally negative return of -0.26% for the Active Income Model.

Murray International Ord saw a marginal drop in its NAV over the quarter, but in share price terms the weakness amounted to over 5.55% as the discount widened. This widening coincided with the announcement that the long-term manager of the trust, Bruce Stout, is due to retire in 2024. The two existing co-managers will continue to run the trust using the same broad philosophy, but the loss of Stout is clearly a negative.

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Elsewhere, M&G Global Dividend was down 2.21%. The fund's investment strategy is to identify companies that understand capital discipline, have the potential to increase dividends consistently and are undervalued by the stock market. Dividend yield is not the primary consideration for stock selection. The fund's holdings are selected from three categories: quality, where the sustainability of a company's return on capital is under appreciated by the market; internal change, where a company's restructuring is leading to an improvement in returns; and external change, where a change in the external environment is allowing a company's assets to benefit from a step-up in return. The fund’s balanced approach means that it does not have a distinct value style bias and therefore it is not surprising that the fund didn’t benefit fully from the outperformance of value stocks. Stock selection was the key detractor from performance over the quarter, particularly within the financials and energy sectors.

Offsetting this was positive performance from Balanced Commercial Property Ord (LSE:BCPT). The trust provides exposure to prime UK commercial property with a heavy bias towards central London and southeast 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. After an extended period of weakness due to concerns over rising interest rates and demand, the portfolio provided investors with a more pleasing return of 4.32% in Q3 2023. This share price return reflected an uplift in the underlying value of holdings and a reduction in the discount, as investors recognised that peak interest rates were drawing nearer.

Man GLG Income Professional targets three types of stock: those that are cash generative and trading below their estimate of the company's asset value; those where the company's profit stream is being undervalued relative to the cost of capital and there is positive earnings momentum (with the caveat here of a yield of at least that of the market); and for this income mandate the team also targets companies with net cash balance sheets and strong free cash flows, which can lead to positive dividend surprises. This, plus the slight bias down the market-cap scale, have been beneficial over the quarter, with the fund delivering a positive return of 4.53% over the quarter.

The ii Low-Cost Income Model was up 1.47% over the quarter. Among the key contributors to performance were the holdings in the Vanguard FTSE AllWld HiDivYld ETF $Dis GBP (LSE:VHYL), which was up 2.61%, and the WisdomTree Emerging Markets Equity Income ETF (LSE:DEMS) ETF, which was up 4.90%. Both funds have a distinct value style bias, which was beneficial to performance over the quarter.