2022 was a year to forget for fund selectors as both bonds and equities were whacked by inflation and rising interest rates, leading to one of the worst years on record for a 60/40 portfolio.
A 60/40 mix comprising the S&P 500 index and the Bloomberg US Aggregate Bond Index, for example, lost 16% last year.
There have only been five years in recorded history when the annual performance for this traditional portfolio was worse and most of these occurred more than during the Great Depression, according to research from UBS.
There were few places for asset allocators to hide with only alternatives offering some relief from the bloodbath in public markets, although even there only a few sub-segments such as macro funds delivered positive returns for the year.
However, there have been signs in recent months that things are starting to turn around as both share prices and bonds have rallied on expectations that the US Federal Reserve will end its hiking cycle during the first quarter.
A number of asset managers have now turned overweight on fixed income, particularly investment grade. While most remain neutral on equities, several of them are factoring in possible rallies during the second half of the year after a shallow recession.
“It also has a heavy stylistic tilt towards quality growth. It will typically outperform in a falling market but underperform a ‘dash for trash’ rally.”
Darius McDermott, Managing Director, Chelsea Financial Services & FundCalibre
The outlook in Asia has been particularly positive as shares in China have rallied following signs that the country is finally beginning to lift its dynamic zero-Covid policy and based on perceptions that the sell-off had been too aggressive with price-to-earnings multiples having reached multi-year lows.
In developed markets such as the US, the rally has not been as strong, although the S&P 500 is still up around 10% from its low point in October.
Against this backdrop, Darius McDermott, managing director at Chelsea Financial Services & FundCalibre, chose the Morgan Stanley Global Brands fund and the Threadneedle Global Focus fund for comparison for this week’s head-to-head.
| Morgan Stanley | Threadneedle | |
| Size | $2.13bn | $1.8bn |
| Inception | 2000 | 1995 |
| Managers | William Lock | David Dudding |
| Three-year cumulative return | 3.65% | 4.51% |
| Three-year annualised return | 3.05% | 3.96% |
| Three-year annualised alpha | 1.30 | 2.22 |
| Three-year annualised volatility | 19.51 | 23.53 |
| Three-year information ratio | 0.10 | 0.19 |
| Morningstar star rating | **** | n/a |
| Morningstar analyst rating | n/a | n/a |
| FE Crown fund rating | ** | *** |
| OCF (retail share class) | 1.64% | 1.8% |
Investment approach
The Threadneedle fund looks for businesses with a strong market position, good long-term growth prospects and high sustainable or growing returns on capital. Companies should also have one or more competitive advantage supporting above average returns.
The fund uses the Porters Five Forces analysis, which examines the threat of new entrants; the threat of substitutes; industry rivalry; power of suppliers and power of customers. Their preference is for consolidated or consolidating industries.
Unlike many global funds, the Threadneedle fund does consider emerging market stocks and has held securities in India and Taiwan in the past, although the bulk of the portfolio remains in developed markets, particularly the US.
“It also has a heavy stylistic tilt towards quality growth. It will typically outperform in a falling market but underperform a ‘dash for trash’ rally,” said McDermott.
The fund holds between 30 and 50 stocks typically but it is very concentrated with a large percentage of the portfolio held in its top 10 positions. Its largest exposure by sector is technology by some distance.
“I’d argue the Threadneedle fund has a slightly stronger quality growth bias – while the Morgan Stanley fund will often lag in cyclical up markets.”
Darius McDermott, Managing Director, Chelsea Financial Services & FundCalibre
Meanwhile, the Morgan Stanley fund is even more concentrated, typically with around 20 to 40 holdings. Due to the specific characteristics of the fund, it is very concentrated around certain sectors, notably IT, consumer and healthcare.
The fund deliberately avoids banks, utility companies, telecoms firms and energy companies due to their reliance on external factors. High-quality industrial companies also feature but need to demonstrate cyclical protection.
When it comes to picking stocks, the fund starts by screening companies for their high returns, which is defined as strong returns on capital, low leverage and low capital intensity. Every stock will also have to yield at least 1%.
From the list, managers then analyse whether the returns generated so far are sustainable going forward. They will need to see that the quality characteristics of the firm can be defended and the firm is not too dependent on external factors.
Fund characteristics
Sector allocation:
| Morgan Stanley | Threadneedle | ||
| Information Technology | 33.4% | Information Technology | 29.5% |
| Consumer Staples | 25.6% | Healthcare | 15.9% |
| Healthcare | 22.31% | Financials | 13.5% |
| Industrials | 7.27% | Consumer Staples | 10% |
| Financials | 5.35% | Industrials | 7.3% |
| Consumer Discretionary | 3.86% | Materials | 6.7% |
| Cash | 2.17% | Communication Services | 5.5% |
| Energy | 4.3% | ||
| Cash Equivalents | 1.1% |
Country allocation:
| Morgan Stanley | Weighting | Threadneedle | Weighting |
| US | 73.93% | n/a | n/a |
| UK | 9.52% | n/a | n/a |
| France | 6.69% | n/a | n/a |
| Germany | 5.17% | n/a | n/a |
| Netherlands | 2.1% | n/a | n/a |
| Italy | 0.38% | n/a | n/a |
| Cash | 2.17% | n/a | n/a |
Top 5 holdings:
| Morgan Stanley | Weighting | Threadneedle | Weighting |
| Microsoft Corp | 9.13% | Microsoft Corp | 7.9% |
| Philip Morris International | 7.25% | Mastercard Incorporated Class A | 5.4% |
| Visa | 6.33% | Linde | 4.5% |
| Reckitt Benckiser | 5.73% | Thermo Fisher Scientific | 4% |
| Danaher Corp | 5.34% | Alphabet | 3.7% |
Performance
Since both funds are similar in their high conviction approach in finding some of the best quality businesses with sustainable growth, unsurprisingly their performance is somewhat similar too. Both made losses last year as quality growth suffered.
“I’d argue the Threadneedle fund has a slightly stronger quality growth bias – while the Morgan Stanley fund will often lag in cyclical up markets. However, it has historically offered excellent downside protection when markets have been challenging,” said McDermott.
In terms of volatility, both are driven by their stock selection. The Threadneedle fund has a clear quality growth bias and tends to struggle when its style is out of favour, while at the same time it also has greater exposure to emerging markets. Meanwhile, the Morgan Stanley fund has fewer holdings and ignores several sectors due to the impact of external factors.
In terms of fees, the Threadneedle fund has an ongoing charge of 1.8%, while the Morgan Stanley fund is slightly cheaper at 1.64%. McDermott noted that this seems to be about right for the peer group.
Discrete calendar year performance
| Fund/Sector | YTD* | 2022 | 2021 | 2020 | 2019 |
| Morgan Stanley | 3.56% | -18.07% | 21.45% | 11.91% | 28.36% |
| Threadneedle | 2% | -26.5% | 22.48% | 26.78% | 33.9% |
Manager review
The Threadneedle fund is led by David Dudding, who joined the investment manager in 1999 as an equity research analyst. He managed the company’s European Smaller Companies fund for over a decade until December 2012. He was also lead manager for over 12 years on the European Select fund. In recent years, he has focused more on global equities and he became the lead manager of this fund in April 2013.
Meanwhile, the Morgan Stanley fund is run by a 10-strong team, headed up by William Lock. He heads up the London-based international equity team and joined Morgan Stanley in 1994. There is an open and flat structure to the investment team, who are all London-based. Each member is assigned two or three sectors to cover, as each will have different ways of looking at stocks.
Conclusion
Overall, McDermott views both funds as good options for long-term investors.
“I’d perhaps view the Threadneedle fund as slightly more aggressive, due its emerging markets exposure and David’s strong quality growth bias. The Morgan Stanley fund is higher conviction but has less direct exposure to emerging markets – it has also done well in down markets – as highlighted by its performance in 2022 – and has shown an ability to bounce back quickly,” he said.
