Where to place your bets in 2014

I’m not staying out of the festive party game, says David C Stevenson. Here are his tips.

It’s that time of year again, when professionals review their past performance and give their views on the year to come. I don’t want to be left out of this festive party game, so I’ve dug into the funds data to see what’s been curious, odd or just plain wrong about the last 12 months.

Below, I’ve listed the top-five performing sectors over the year to 30 November, according to investment-trust trade body the AIC. European smaller-companies funds just sneaked past Japanese equities in the 12-month returns league, followed by Asian Pacific property funds and UK smaller companies.

Yet I’m also drawn to an arguably more informative set of numbers – flow data (courtesy of Deutsche Bank) for European exchange-traded funds (ETFs) and discount/premium data on investment trusts (from Charles Cade’s team at Numis Securities).

The ETF data show us what investors have been putting their money into, while the premium/discount numbers tell us what’s become fashionable (as discounts turn to premiums) and what’s unloved (with big discounts). The ETF data show that money has flooded into US assets (mainly stocks), followed by Japan.

I shall refrain from any Japan comments (I’m no bull), but I think investors should be careful on US equities. By just about any measure, US equities look overbought. Don’t be surprised by a correction of 10% or more. I’d also wager that those huge US equity inflows will unwind as other areas become more interesting.

An even bigger story is the money flooding into income-focused equities and tracker funds. The average UK-listed global income growth investment trust, for instance, yielding an average of 4%, is trading at a 3.5% premium, which worries me. But it’s nothing compared to infrastructure funds (yielding 5.2%), at a 6% premium, or UK property real-estate investmenttrusts (yielding 5.3%) at a 12% premium.

As we get more esoteric, the numbers become more extraordinary – the various Nimrod airplane-leasing funds trade at 16%-31% over net asset value (NAV), while litigation funds such as Burford and Juridica trade at 20%-30% above NAV.

I’ve long been keen on these alternatives (so hopefully you’ve made decent profits), but I can’t help but be concerned that we’re all effectively treating equity-income funds as shadow corporate-bond funds. If there’s even a hint of rising interest rates, anything that looks and smells like a risky bond will drop in value. So if you’ve ridden the income wave, I’d counsel caution.

In Europe, it strikes me that something is very wrong when French equity outflows over the last 12 months come to only $500m, while German equity ETFs have lost over $5bn. I know which I’d treat with extreme care – and it isn’t Germany!

But the periphery still holds promise. Inflows into Spanish ETFs have been steady (up $750m) but not huge – my hunch is that this particular speculative trade may have much further to run.

Several other opportunities stand out. Investors have clearly bought into the genius of private-equity fund-manager John Moulton, bidding up his closed-end funds to a 15%-18% premium. But private-equity funds of funds are still in the dog house, with the average discount still around 20%: Pantheon International Participation (LSE: PIN) looks reasonably priced.

Single-manager hedge funds also still trade at decent discounts, including many of the highly regarded Brevan Howard funds. If markets have a wobble or two these could be a useful hedge.

The average global growth trust – Alliance Trust (LSE: ATST), for instance – still sports a big discount, not helped by the sector’s small but noticeable exposure to poorly performing emerging markets.

If we see a limited rebound in emerging-market equities (especially in China), that discount could narrow. Or you may just want to invest directly in an emerging-market fund such as Advance Developing Markets Trust (LSE: ADMF) or the Templeton equivalent (LSE: TEM).

I also think UK smaller companies funds havefurther to go as the UK economy surprises to the upside. So the likes of the Standard Life UK Smaller Companies Trust (LSE: SLS) could hit an even bigger premium.

Last but by no means least – although commodity ETFs have seen huge outflows (especially gold), energy- focused funds have barely registered on the radar. Specialist investors are playing a waiting game focused on the oil price and Iran. That uncertainty will have a direct impact on the mega-contrarian bet of the decade, Russian equities.

Russian ETFs continue to get a lot smaller in terms of assets under management – they lost over $400m last year alone – and if oil prices remain weak, this collapse in confidence may accelerate. But if oil prices stabilise, and natural gas prices rise, we could see Russian shares shoot up in value. The db x-trackers MSCI Russia ETF (LSE: XMRC) is one way to play it.

Sector 1 year* 3 years 5 years 10 years
European Smaller Companies £152.60 £151.13 £253.05 £398.7
Japan £151.13 £157.51 £210.73 £172.58
Property Direct – Asia Pacific £143.82 £120.38 £205.69
UK Smaller Companies £143.75 £182.36 £405.56 £405.60
Japanese Smaller Companies £143.64 £165.33 £215.05 £139.93
Based on £100 invested and annual expenses of 3.5%. Source: AIC.