The funds that could see big gains this year

The Japanese stock market was one of 2013’s big winners
The Japanese stock market was one of 2013’s big winners

But if you want your investments to do well, avoid 2013’s winners

WITH the FTSE 100 nearing an all-time high and the S&P 500 rising by 29.6 per cent, 2013 was a bumper year for equity investors. Those who had backed a fund manager investing in small British companies or Japan – last year’s big winners – would have seen an average of 37.4 per cent and 26.1 per cent gains respectively. And those invested in the Legg Mason Japan Equity fund, the year’s joint-top performer, would have seen a whopping 65.63 per cent gain.

Smaller companies – by their nature a higher risk investment – may have taken the top prize, but is the sector’s run likely to continue this year? “They can outperform in the longer term due to the higher growth potential of small, new companies, but they do look expensive,” says Peter Sleep of Seven Investment Management. So the key is in finding a good manager who can add value. Adrian Lowcock of Hargreaves Lansdown likes the Cazenove UK Smaller Companies fund, which has seen 46.6 per cent growth in the past year.

BIG WINNERS
What of the year’s other big winner – Japan? The effects of Abenomics have been encouraging thus far, with Japanese GDP growth in recent quarters outstripping many other developed nations. And “monetary expansion has weakened the yen, enhancing the competitiveness of Japan’s exporters. There may be further to go should the dollar strengthen,” says Jason Hollands of Bestinvest. He likes the GLG Japan Core Alpha Equity fund for the more “gung-ho” investor. Manager Stephen Harker focuses on large cap stocks, with the portfolio including exporters like Sony and Nintendo.

As for the US, fund manager Samantha McLemore – whose Legg Mason Capital Management Opportunity fund took third prize in 2013 – may be bullish (claiming it could be one of the best-performing global stock markets this year), but others are more sceptical. “US equities are looking quite expensive, and earnings momentum is unconvincing,” says Hollands.

EURO POTENTIAL
As for Europe, Sleep thinks Continental Europe could do well in 2014. “The last five years have been tough for European companies, but those that have survived are very sensitive to a pick-up in sales and earnings, should the region see any GDP growth.” He likes the Edinburgh Partners European Opportunities fund, which has seen 23.6 per cent one-year growth, compared to the 19.1 per cent sector average.

In exchange-traded funds, look for those with broad exposure to smaller companies in Europe as well as the main markets. Sleep likes the Source GLG European ETF. “It has a good record of steady outperformance with low tracking error.”

And while emerging markets had a torrid time in 2013 on fears over the Chinese slowdown and the potential impact of QE tapering, Hollands thinks they could be the “wild card” market this year. They look tantalisingly cheap, on about 10 times 2014 earnings. A good place to start is the Lazard Emerging Markets fund, currently down 5.6 per cent over the past year compared to 6.3 per cent for its wider benchmark. But they are more volatile than developed markets, so investors should be careful about jumping in.

LOOKING FORWARD
Past performance, of course, is not a guarantee of future success, and if they follow historical patterns, 2013’s winners won’t be in for another big year. Consider this: the Legg Mason Japan equity fund may have seen huge gains in 2013, but it has proven volatile, seeing a 73 per cent drop between 2006 and 2009. The Axa Framlington Biotech fund saw a similarly stellar performance, with biotech outstripping the wider pharmaceutical sector in 2013. But from an investor point of view, “it would have been very hard to predict that it would have performed so strongly, and just as hard to predict when it will stop performing,” says Lowcock.

So while UK Equity Income funds may not top the league tables (the UK stock market is highly efficient and widely researched), they may be a wiser option, with Markit Research forecasting that British companies will pay £72.4bn in dividends in 2014. It thinks investors in the oil and gas industry, where large companies have capped spending and are selling assets, will get the best dividend deal. Just this week, Barclays declared Royal Dutch Shell as its top pick for 2014.

The research also concluded that companies in the mining sector could be the year’s biggest losers, with total payouts falling around 11 per cent. Falling commodity prices and escalating production costs contributed to the poor performance of mining and resources companies in 2013, with gold mining funds dominating the bottom performers. Gold fell by 28 per cent and the broad Commodity Index dropped by 1.2 per cent. But, again, valuations are starting to look attractive. “Momentum, however, remains negative. A good contrarian long-term play, but catching the falling knife requires some bravery,” says Hargreaves Lansdown’s Richard Troue.

HARGREAVES LANSDOWN: THE THREE FUND MANAGERS WHO COULD BOUNCE BACK IN 2014

■ TOM DOBELL: M&G RECOVERY
A lack of M&A activity in recent years, combined with an investor focus on better quality firms, has affected performance. But M&A activity is starting to pick up, and Dobell has an impressive long-term track record.

■ SEBASTIAN LYON: TROY TROJAN
Lyon focuses on capital preservation, and held defensive assets which performed poorly in 2013. But in the past, he has been successful at getting the big macro-economic calls right.

■ BILL MOTT: PSIGMA INCOME
Mott became too focused on the long-term view, missing shorter-term opportunities in 2013. But his strength is his understanding of the economy. As the recovery gathers pace, his views should be better reflected in the stock market.

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