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Every week, Kyle Caldwell and guests take a look at how the biggest stories and emerging trends could affect your investments, with practical tips and ideas to help you navigate your way through. Join the conversation, tell us what you want us to talk about or send us a question to OTM@ii.co.uk. Visit www.ii.co.uk for more investment insight and ideas.
Hello, and welcome to the latest episode of On The Money, a weekly look how to make the most out of your savings and investments. With the tax year end a month away, I thought it'd be timely to dedicate an episode to those investments that are proving popular with Interactive Investor customers. Joining me to discuss the reasons why certain funds regularly appear at the top of our monthly rankings of the multiple funds, investment trusts and ETFs is Friends of the Pod, Sam Benstead, who, as well as being Instractor Investors bond specialist, regularly, alongside myself, interviews for managers and covers trends within the fund industry. Sam, let's start off with passive funds, which go by the names of index funds or exchange traded funds, ETFs. We've seen this fund type be hugely popular with investors, particularly over the past couple of years, with investors mainly preferring global or US exposure.
Kyle Caldwell:To start off with, could you give your thoughts on the main reasons behind this trend?
Sam Benstead:Of course. So I think the main reason is that performance from passive funds has just been brilliant. So we've seen the biggest US companies become bigger and bigger. And because US shares are such a large part of global indices, they've also powered returns there. So let's take a popular tracker funds, which, is the iShares core MSCI World UCITS ETFs that tracks about 1,500 companies from developed markets.
Sam Benstead:Since launch in 02/2009, that's returned 484% compared with 315% for the average global fund. And that global fund sector also includes passive funds. So huge outperformance from owning the index versus trying to find an active manager to beat the index. And the same is true in The US as well. So BlackRock's S and P 500 ETF over that same period is up 823% versus a 615% gain for the investment associations North America sector.
Sam Benstead:So, again, if you own the index, you've actually probably outperformed an active fund depending on which one you might have picked. Another trend and highlight is that these funds are getting cheaper and cheaper. More and more fund managers are launching active funds. And to compete, one of the main ways they have to do this is on price because they're effectively tracking the same indices. So we've seen lower and lower fees for passive funds, and we haven't really seen that trend in active funds.
Sam Benstead:Now I looked at the the most popular passive funds on our database in terms of assets held. Some key themes here to draw out. So Vanguard's life strategy range are very, very popular. So this is where Vanguard actually builds a portfolio of passive funds for you. So it's kind of an active passive approach, but the building blocks are all passive.
Sam Benstead:The 60%, and the hundred and the hundred percent equity versions are all very popular. And then other funds I'd highlight are the HSBC, FTSE All World Index Funds, Vanguard's S and P five hundred, USES ETFs, iShares core MSI world, Fidelity index world, and Vanguard's FTSE global all cap index.
Kyle Caldwell:Just to echo some of the points you've made there, Sam, as you mentioned, passive funds, they offer a simple and low cost way for investors to gain exposure to the market return of a particular stock market or bond market. And I think, overall, passive funds are a very sensible option for a lot of investors. Whereas with active funds, those that are managed by a professional investor, there is the opportunity for market beating performance, but there's also the possibility of the full manager not beating the index. And those data points that you've just run through, Sam, show that over those long time periods, investors have on average been better off picking an index fund or an ETF. And the reality is that various pieces of research have shown that with active funds more do fail than succeed to beat the market over the long term.
Kyle Caldwell:Personally, I've invested in both passive and active funds. I do think there are some active funds that do stand out from the crowds and can add value. And for me, it does tend to be those full managers that have very long term track records of managing money for at least a decade. Full manager tenure is something that I do take a very close look at when I'm researching active funds. Ultimately, I think, you know, if if a fund manager hasn't performed well, then they're unlikely to still be managing the fund today.
Kyle Caldwell:They won't still be in their post over a long time period. And just to name a couple of examples that are analysts like a Interactive Investor that have long tenures, and these these, funds appear on Interactive Investor's super 60 list, are Capital Gearing. It's had the fund manager Peter Spiller has been in place since 1982. City of London Investment Trust. It's had the same for manager Joe Curtis since 1991.
Kyle Caldwell:And another one I'd highlight is TR Property, which has been managed by Marcus Fairmudge for just over twenty years. And just moving back to The US and global passive fund trends and that Sam just ran through. Obviously, looking looking ahead, a big thing to bear in mind is that The US stock market has become much more concentrated than it has been in the past, and And it's become much more concentrated on a small number of technology companies, the so called magnificent seven stocks, which are Microsoft, Nvidia, Amazon, Apple, Alphabet, Facebook owner, Meta Platforms, and Tesla. Now for the past couple of years, since the start of 2023, those seven stocks have been doing the heavy lifting in terms of driving the performance of the S and P 500 index higher. And combined, those seven companies now account for around a third of the S and P 500 index and over 20% of the MSCI World Index.
Kyle Caldwell:This concentration risk is clearly on the minds of some investors as we've seen over the past couple of months increased demand for some US actively managed funds, including Artemis US Smaller Companies, which is one of the funds in Interactive Investors' super 60 list of fund ideas. So this fund provides investors with exposure to America's innovative, entrepreneurial, and fast growing smaller companies, and it's one of the funds that investors have been focusing on. Sam, could you run through this newer trend? And there's been a couple of other funds that investors have been sizing up. Could you run through them?
Sam Benstead:Yeah. So it's a really interesting trend we've seen, and I'd actually say investors are diversifying their US exposure rather than replacing passive funds with active funds. Two interesting funds we've seen investors buy into recently alongside all the passive funds that I've mentioned before are the Bailey Ifrit American Fund and the JPMorgan American Investment Trust. So Bailey Ifrit American, so it's the same parent company that runs Scottish Mortgage, so their style is quite similar. So they're looking at very high growth, listed businesses in The US, creates a lot of volatility, but also excellent long term returns.
Sam Benstead:And then JPMorgan American Investment Trust actually allocates both to value and growth equities. They have two, distinct parts of the portfolio. So for that reason, it doesn't look too much like the index. Another theme we've seen is investors allocating to equal weighted weighted ETFs in The US. So I'd highlight the Invesco s and p five hundred equal weight uses ETF and the iShares s and p five hundred equal weight ETF.
Sam Benstead:So these funds earn the same amount of every company in that index, which gives it a value tilt compared to the market cap weighted index, which owns more in the giant technology shares, which tend to be more expensive.
Kyle Caldwell:And another sign that investors are becoming a bit more valuation conscious towards the so called Magnificent Seven is the in our II top 50 fund index, which each quarter ranks the most bought funds, investment trusts, and ETFs over a three month period. In the fourth quarter, that index saw every technology funds in the top 50 fall down the rankings. And you can check out the full report on our website at ii.co.uk. It'll, of course, be interesting to see in the next couple of months whether this trend continues, particularly if tech shares have a more prolonged wobble. There was a very short term sell off in response to the sudden rise of a Chinese AI model from deep sea.
Kyle Caldwell:But that literally only occurred over a couple of days. It didn't go on for a very long time. In the next decade, of course, while the Magnificent Seven stocks could continue to do well, it is likely, in my opinion, that it's gonna be less of a smooth rise given that the earnings expectations for those seven stocks have risen to high levels. Would you agree, Sam?
Sam Benstead:Generally, yes. I think investors have good reason to be worried about how large these companies have become. But, actually, I looked at the the valuations of the magnificent seven shares, and, actually, I think the real data will surprise some people as well. So I looked at the forward price to earnings ratio. So that's the current share price divided by the projected earnings per share over the next twelve months.
Sam Benstead:It's a common indicator of how expensive companies are. And these range from 20 times at Google to 123 times at at Tesla. The S and P forward PE is 21 currently. So actually, I think Tesla is a bit of an outlier here. It's quite a different business.
Sam Benstead:If you strip out Tesla, then the average forward PE of the magnificent six is just 29 times. So above the market, but by no means extremely expensive. And if you if you consider how good these businesses are, think of Google, think of Microsoft, and how much they put into research and development, which can lead to new business lines like AI. I don't think these are screamingly expensive companies, but they are definitely more expensive than the market. And like we've discussed already, there is that concentration risk.
Sam Benstead:And if there is a big tech sell off, it will lead to a, well, potentially quite bad effect for for lots of indices, particularly The US and global indices. If you're worried about that, then one fund that may be suitable is Fundsmith equity. So managed by Terry Smith, this is a global equity fund that actually is very light on technology shares. So it's just got 11.4% in tech, and it owns just two of the magnificent seven. And, actually, actually, he owns the two cheapest of the magnificent seven, so Meta and Alphabet.
Sam Benstead:Returns have been very good since launch in 2010, compounding at 15% a year. But over the past five years, they have been a bit disappointing. So the MSCI world is up 80% over the past five years, and Fund Smith equity is up just 49%. And that's because Terry Smith has rejected some of these large, magnificent seven shares. So Tesla and Nvidia, he's been quite outspoken against.
Sam Benstead:And instead he's bought lots of health care names and lots of consumer brands, which have been performing less well recently.
Kyle Caldwell:Those figures you just pointed out, Sam, it is a sizable gap between Fundamentals Equity's performance and the global index over that five year period is. But despite that, I'm not surprised that this fund has remained one of our most popular active funds on the Interactive Investor platform. Smith has a straightforward investment approach. Its performance, as you mentioned, Sam, since launch has been very impressive. And given the fact that he holds considerably less than the MSCI World Index in the Magnificent Seven, then that's one of the reasons behind why the fund has underperformed over that five year time period.
Kyle Caldwell:Of course, that's not the only factor, but it certainly has been a headwind. And Smith has been very upfront in addressing performance. And he appeared on our podcast last September, and we covered, performance in that episode. And he's also appeared elsewhere in the media. He's certainly not one to go away and hide.
Kyle Caldwell:I'm just gonna now run through four other active funds that have featured in our top 10 most overall funds, which include passive funds and investment trusts over the past year. So firstly, there's Royal London Short Term Money Market. This fund owns a diversified basket of relatively safe bonds that are due to mature soon, normally within a couple of months. This fund offers investors the prospect of earning an income on their cash with minimal risk. Its yield is close to 5%, and it is competitively priced as its yearly ongoing charge is naught point 1%.
Kyle Caldwell:Next is from the the complete polar opposite end of the risk scale, which is Scottish Mortgage. So this investment trust invests in disruptive growth companies that are listed on the stock market, and it also has around a quarter of its portfolio in private companies, which retail investors cannot buy themselves. Just to give you a flavor of its investment approach, its top three holdings are Elon Musk's SpaceX, Amazon, and Latin American ecommerce giants, MercadoLibre. Next is another adventurous fund, Jupiter India. So this fund offers exposure to a fast growing economy that has very favorable demographics, including a young population.
Kyle Caldwell:India stock market has performed very well in recent years, and investors buying today will be hoping that that purple patch continues. I mentioned before that I like to see full managers have a very long track record in the same post at the same full management firm, running the same fund or investment trust. And this full manager, who's called Avanash Vazirani, has a long tenure. He's been in charge of the fund since 02/2008. And the fourth act of funds to highlight that has been proven very popular with our customers is Greencoat UK Wins.
Kyle Caldwell:This is an investment trust. As the name suggests, it invests in UK wind farms, and it is appealing to income seeking investors as it aims to provide investors with a yearly dividends that increases in line with RPI inflation. That aim has been successfully achieved each year since the investment trust was launched in 2013. And that track record, as well as its high yield, which is currently 8.7, have been attracting investors. So, Sam, to me, it seems that, you know, investors are looking to have exposure globally or to The US mainly through passive funds.
Kyle Caldwell:And then they're looking to have some sort of some tactical positions with active funds.
Sam Benstead:Yeah. That's right. And these four funds offer something that passive funds really struggle to do. A couple of comments on them. So rural London short term money market has been incredibly popular.
Sam Benstead:It aims to give a cash like return, and that return is really closely linked to the Bank of England interest rate, which has been higher for longer than many commentators would have expected. But interest rates are coming down. Could be a couple more cuts this year. Let let's see what happens to inflation. So that will bring down yields on this fund as well.
Sam Benstead:Scottish Mortgage has been out of favor for a while, but actually you may have noticed that returns have really picked up over the past twelve months. So that share price is up 45%, really paying off for investors that have stuck with it through a difficult period. And it's anyone's guess what will happen in the future, but it's a very high risk fund with lots of smaller, fast growing companies that could perform very well or actually disappoint, but it's having a great twelve months. Duped India another really strong performer but actually if you check your holding this year down about 8% so far year to date up 64% over three years but not having the best year so far so actually you know maybe investors are a bit more more worried now about valuations in Indian shares after a really hot run and then on green coat UK wind I just highlight that actually while you do get a big yield at the moment a lot of that is due to the share price falling significantly so actually your total return has has been negative over the past couple of years for holding that that trust even though you have been picking up large inflation adjusted dividends.
Kyle Caldwell:And just to add one further fourth, Sam, to the point you just made is I think it's very important for investors to remember that a high yield does not mean market beating returns from a total return perspective when both capital and income are combined. And I think also with dividends, it's it's also important to bear in mind that dividend growth may be higher for funds investment trust to have lower yields today compared to other funds that have higher yields today. So I think those are a couple of other things to bear in mind. I wanted to next turn our attention to fund types that have been flying more under the radar at the moment. Despite there being no shortage of commentators pointing out over the past couple of years that The UK stock market is cheap versus other regions and versus its own history, Retail investors have been shown a real lack of interest.
Kyle Caldwell:I mentioned earlier the II top 50 fund index that, that we do each quarter. In the fourth quarter, we saw only four UK funds in that top 50, And they were City of London Investment Trust, which I mentioned earlier is managed by Job Curtis. He's he's he's been managing that investment trust since 1991. And it has, the longest track record of increasing its dividends year in, year out. It's increased its dividends every year since 1966, which is one of the key attractions and and why it's one of the most popular investment trusts with Interactive Investor customers.
Kyle Caldwell:The other three are in the top 50 index that invest in The UK where iShares core FTSE one hundred ETF, WisdomTree FTSE one hundred three times daily leveraged ETP, and Vanguard FTSE one hundred ETF. So City of London is the only active fund in the top 50 for the fourth quarter. Sam, for investors that are looking at The UK and think that it is undervalued, a way to potentially double down on that is to back a full manager that seeks out value shares. Are there any funds that invest in that way that you will particularly highlight?
Sam Benstead:So if we just take funds from our super 60 list, which is compiled by our research team, there are two that stand out for me. And the first is Fidelity Special Values. This is an investment trust managed by Alex Wright since 2012, and it looks to identify unloved UK companies that have the potential to recover. So the manager buys into such situations at an early stage, which means as a very contrarian fund. Some of the top shares are Imperial Brands, that's the Tobacco Group, NatWest, and Reckitt Benckiser.
Sam Benstead:Another fund on the super 60 list looking at undervalued UK shares is RGI UK Recovery. So this has a small cap bias with about a third in smaller shares, and it splits its portfolio into three sectors, growth, quality, and recovery. And recovery is 61% of the fund at the moment, so it has got a bias towards those value names which are not performing so well that could have potential to bounce back in the future. And the fund is quite interesting. It owns over 400 companies, so it's very diversified.
Sam Benstead:And even though it is a value fund, it's happy to own more expensive shares that are going through difficult periods that could lead to a recovery. So it owns Diageo and Unilever in its top 10 positions.
Kyle Caldwell:And as well as The UK, Two other areas that I think stand out that investors have been given the cold shoulder are Europe and Japan. So Sam, let's start off with Europe. So what stands out for me is that Germany stock market, the tax index, has of late been notably outperforming other European stock markets. I do think that performance has been going somewhat under the radar. And one of the key reasons behind its strong performance has been SAP, which is the computer software giant, it has performed really strongly over the past year.
Kyle Caldwell:At the same time of Germany's stock market performing well, the prospects for Germany's economy has been gloomy. And this is an example of the fact that stock market and economic performance are not one of the same. And this is particularly the case with Europe in general, given that it's home to many world leading companies that make a lot of their money globally rather than just in Europe.
Sam Benstead:And that's one of the things that the managers of lots of European funds will will will tell us that investing in Europe, but actually these companies earn money from all over the world, and they are world leading brands. I'd highlight Fidelity European, which is a member of our super 60 list. They own the likes of SAP and ASML and Novo Nordisk, and they say the same thing that these world class businesses aren't really European necessarily. They are global businesses. This funds looks for dividend growth as actually a proxy for a well run company.
Sam Benstead:They think that if a company is raising its dividend each year, then it's a good cash generated business with sensible management in place.
Kyle Caldwell:And finally, I wanted to briefly cover off Japan. So one of the big positives for investors sizing up Japan are its ongoing corporate governance reforms. So in in very short, we could focus a whole episode on this. The aim of these reforms are to make Japanese companies better for shareholders, such as by trying to get the companies to return more cash to investors in the form of dividends. And in time, it's hoped that if Japanese companies do return more cash to shareholders, then this will encourage both domestic and international investors to put more money into the region, which in theory will boost share prices.
Kyle Caldwell:So, Sam, another plus point at the moment for investors sizing up Japan is that it is a relatively cheap market compared to other regions.
Sam Benstead:That's right. So looking again at price to earnings ratios, the current p of the Japan index is about 14, similar to The UK. So if The UK is cheap, so so is Japan. And there's there's plenty of ways to access Japanese equities. Funds are an easy way of doing so, and I just highlight a couple from our best buy list.
Sam Benstead:So the MAN Japan core alpha funds has been a very strong performing active option. It's in the top 25% of performers in its peer group over one, three, five and ten years, returning 159% over the past decade. And then you could also look at a passive option and the one our fund research Japan index. Fees are just 0.13% annually and it tracks the 500 largest companies in Japan. So performance hasn't been as good as the active fund but they have been excellent still.
Sam Benstead:So over the past decade, this index fund has risen 118%, so not as high as the active fund, but still a very strong return.
Kyle Caldwell:That's all we have time for for today. In terms of other unpopular and undervalued areas, an obvious one that I've missed out is China, but that was deliberate on the grounds that I did recently interview Dale Nichols of Fidelity, China, Special Situations, and Investment Trust. So in that Pocus episode, which was published on January 30, among the topics discussed were the opportunities, risks, and Donald Trump's tariff threats. So if you missed it, then do go back and check that out. My thanks to Sam, and thank you for listening to this episode on The Money.
Kyle Caldwell:If you enjoyed it, please follow the show in your podcast app and do tell a friend about it. If you get a chance, leave us a review or a rating in your podcast app too. You can join the conversation, ask questions, and tell us what you'd like to talk about via email on 0cm@ii.co.uk. And in the meantime, find more information and practical pointers on how to get the most out of your investments on the Interactive Investor website at ii.co.uk. And I'll see you next week.