2018: The storm after the calm
Following a relatively benign 2017, during which investors enjoyed steadily rising equity markets, 2018 was much rougher.
Although we entered 2018 in optimistic mood, buoyed by a healthy global economy rediscovering synchronised growth, it faded soon after the Christmas decorations had come down. Indeed, 2018 was book-ended by levels of stock market volatility not seen since the Eurozone debt crisis in 2011 – the VIX spiked above 35 in both February and December – as the fear gauge averaged 16.6 for the year, up from a record low of 11.2 in 2017.
The factors that contributed to investors’ jitters (trade tensions between the US and China, the pace of Federal Reserve tightening, Brexit and, most significantly, slowing global growth) inevitably took their toll on equity markets as risk appetite diminished. Most countries suffered losses, particularly those in emerging markets, which underperformed developed ones for the first time in three years. The fourth quarter was especially demanding with many indices reaching bear market territory and global equities ended 2018 with their worst annual performance in a decade.
Unusually when markets are in a tail spin, emerging markets outperformed on a relative basis during the final quarter, supported by valuations at a 30%-50% discount to developed markets based on 2019 P/E and P/B multiples. Also contrary to previous years, value outperformed growth during the recent market turmoil and these factors provide reassurance as we enter the year ahead.
Our equity funds were not immune to the market pressures in 2018 and most ended down for the year in absolute terms. Among our larger funds, SKAGEN Global held up best, buoyed by strong performance from its US holdings, to close 2018 above benchmark. SKAGEN Vekst was hurt, we believe disproportionately, for its relatively high energy weighting; the oil price more than 20% over the year as growth fears took hold. SKAGEN Kon-Tiki also had a difficult 2018, largely due to its holdings in Turkey where the stock market fell over 43% in USD as the president fell out with the US and his own central bank. The fund’s Turkish exposure has now been reduced as part of a wider portfolio review. Encouragingly, the team’s work to address legacy positions and strengthen the fund’s risk-reward profile during a transitional year already appears to be bearing fruit and Kon-Tiki outperformed its benchmark in the final quarter of the year.
Our three smaller funds experienced differing fortunes. The newest, SKAGEN Insight, had a tough year; the activist funds it shadows suffered as investors sought safety amid the market uncertainty, rather than companies undergoing or requiring change. We expect the fund’s underperformance to reverse given the nature of these situations – falling valuations increase boardroom pressure – and the significant value within the portfolio. SKAGEN Focus, which is currently more small and mid-cap weighted, also suffered in the flight to safety as the market disregarded fundamentals and larger companies generally outperformed. Finally, our property fund SKAGEN m2 delivered the strongest absolute and relative returns as it outperformed its benchmark for the third consecutive year and is now Citywire’s best global real estate fund measured over three years.
The turn of a new year is often a good time for reflection and while fund management is a continuous process, rather than a series of 12-month periods, the same applies to investment. Following a significant correction but without an economic recession, many asset markets have now been reset. Growth forecasts are arguably more realistic and while some risks remain unresolved, there are clear grounds for optimism. In the US, the Fed appears to be slowing its tightening cycle and there are signs President Trump is willing to compromise on trade with China. Meanwhile, across the Atlantic uncertainty in Europe should lift as Brexit approaches in March, even though the form it will take is still to be agreed.
Despite lower earnings expectations, company valuations generally look attractive, particularly in emerging markets with P/E and P/B ratios currently below their 2000-18 averages. Developing world equites also look better placed to absorb any negative shocks to risk appetite than they were last year as external financing gaps have been closed, interest rates have risen and currencies are cheaper.
My conviction for the year ahead is that the bearish sentiment currently prevailing across equity markets will provide contrarian investors with opportunities, especially if volatility remains elevated, and that those with broad mandates like SKAGEN are best placed to capitalise. Our portfolio managers have identified several exciting new investments amid the recent turmoil and are enthusiastic about the year ahead. As SKAGEN enters its twenty-sixth year of investing, our focus on finding the best undervalued companies to deliver long-term returns for our clients remains undimmed and I look forward to updating you on our progress throughout 2019.