Dewi John examines last year’s investment returns and looks ahead to 2022
Looking back, 2021 combined an accelerating demand for sustainable funds with significant outperformance for the ‘old’ energy stocks they shun. Below, we dive into where the returns came from last year, where the money went (not the same thing) and discuss what that means for this year’s fund market.
The top-performing Investment Association (IA) sector was India/Indian Subcontinent, one of six new sectors launched in September 2021 (Table 1). It delivered an average return of 27.5% during the year. Capital flooded into the Indian market in 2021, attracted by the country’s initial public offering boom, particularly around its tech companies. That said, not much of it has come from UK retail investors, with the IA sector recording outflows of £120m. What’s more, the good times may already have rolled – for now, at least – as Indian equities look expensive in both relative and absolute terms, with a price to earnings (PE) premium to other emerging markets at a multi-decade high, according to analysts.
The sector’s top-performing fund was Alquity SICAV-Alquity Indian Subcontinent, with its Lipper-designated primary share class returning 38.2%. It is a large-cap growth fund, with quite a lot of concentration, as the top five stocks make up more than 30% of the fund.
The second- and third-placed sectors demonstrate a return to favour for oil and gas stocks, which have been beaten up during previous years. Commodities and Natural Resources’ outperformance demonstrates that the sun has not set on these companies, despite the burgeoning popularity of environmental, social and governance (ESG) funds. The sector’s top performer during the year, the iShares Oil & Gas Exploration & Prod UCITS ETF USD A, delivered 70.8% as reviving economies were choked by supply bottlenecks, further elevating prices for what is still the mainstay of global energy.
The chequered performance of sustainables is also indicated by the fact that the dispersal of returns in the sector was driven by the strong performance of oil and gas, while the worst performer, a clean-energy ETF, posted losses of more than 20%, with alternative energy funds plummeting last January after a stellar 2020.
This is also reflected in the top-performing North American fund share class – the SPDR S&P US Energy Select Sector UCITS ETF Acc, returning 53.9% during the year. Its top holdings, Exxon Mobil and Chevron, make up more than 40% of the portfolio. Financials have also driven North American returns, with the iShares S&P500 Financials Sector UCITS ETF USD AGBP placed third and returning 35.7%.
Fourth-placed UK Smaller Companies has continued its strong run compared to the previous year, as has Property Other, which invests in property securities or non-UK based direct property. This is in contrast to UK Direct Property, which, while returning 7.6% for the year, has seen outflows of £4.7bn. Investors remain scarred from the gating of funds – post-Brexit referendum in 2016 and in 2020 especially – and are looking for more liquid alternatives.
In contrast, the sector that has attracted the most assets is Global (Table 2). Four of the top money takers were ESG funds, with all but one of the rest being passives tracking broad global indices such as the MSCI World. That trend to ESG funds is likely to continue, given both investor pressure and the state-level drive for net zero. However, in 2021, that is not been where the returns have been made. And, yes, there’s a theme here – as with natural resources and North America, it’s oil and gas stocks driving returns.
The first and second-placed funds very much fit the bill – Schroder ISF Global Energy EUR Z Acc and SPDR MSCI World Energy UCITS ETF. Of the 21 sectors that lost money last year, 16 are bond. However, the only two that fell more than 10% are emerging markets – Latin America and China/Greater China.
It is unlikely that 2022 will be a much better year for bonds. If supply chain issues persist, as looks probable, so will inflation. Fixed-income portfolios need to be positioned accordingly – lower duration, greater inflation-linked exposure – and this will be a period of avoiding fixed income losses rather than positioning for outperformance. It is also far from clear that bonds will display a reverse correlation to equities, as this is not a stable relationship. However, as a defensive asset they are still important – although some have suggested they be edged out by property, that is far from the consensus. You may not like bonds – they pay little and are deeply unsexy at the moment – but you still need them for diversification and to dampen volatility.
On the positive side, in an inflationary environment, global equities’ popularity may serve investors well, as company earnings tend to rise and fall with inflation. That is, of course, a massive generalisation. Winners and losers will be determined by several factors, not least by the degree that individual companies have pricing power.
Finally, it is clear from both the flow and performance data that the decision to include ETFs in the IA sectors was the right one. Not only have we seen strong flows into these vehicles, but they have delivered sector-leading returns in many instances. You might expect the passive funds that make up the bulk of ETFs would be, almost by definition, mid-table. But sectors are not indices and the latter offer access to increasingly specialised strategies, such as energy or financials, which have benefited from this year’s market drivers.
Last year has shown that passive management is giving active managers stiff competition on more than cost.
Dewi John is head of research, UK & Ireland, Refinitiv Lipper