Three risk-on opportunities

Investment managers spend a long time telling you what might go wrong: capital is at risk, you may lose more than you put in, past performance is no guide. However, every now and then, it’s nice to look on the bright side. What if optimism rose? What if the global economy outpaced expectations? It is worth considering your options for a sunny day as well as a rainy one.

These ‘risk on’ options tend to have a certain profile. Investors will either make or lose a lot of money. Therefore, they are not for the faint-hearted. However, investors looking at these options today have a notable advantage: traditional risk-on options, such as smaller companies, emerging markets, or biotechnology, are cheaper than they have been for some years.

This is in contrast to the other go-to risk-on option, which is technology. After a strong run of performance, the sector looks expensive on most measures. Any investor with a meaningful allocation in the US stock market, or even a global fund, is already likely to have a relatively high weighting in technology. Topping up even more may leave your portfolio lop-sided.

Emerging markets

For some time, emerging markets have struggled to make progress. While India has been strong, China has been difficult and aggregate performance has been unexciting. Nevertheless, emerging markets are a rich source of opportunity, full of innovation and plugged in to some of the most important global themes – rising consumption, the energy transition, AI supply chains.

Most importantly, China may start to become a tailwind rather than a headwind. In the past few weeks, policymakers in China have taken measures to stimulate the economy, which has prompted a significant rally in markets. Investment managers suggest this might be just the start.

Sharukh Malik, portfolio manager on the Guinness Asian Equity Income fund, says: “This was unexpected. The politburo changed its tone on how to manage the economy. In the same week, we also saw significant policy easing from the central bank, cutting interest rates by more than the market was expecting, plus more support for the property market, and more support for the consumer. For the first time, the central bank started allocating funds towards the stock market. We saw a rally in onshore and offshore markets as a result.

“We think policy moves are in the right direction, but need to increase. We think this is quite likely over the next few months. Even with the rally in stock markets, the country remains attractively valued compared to the broader region.”

Emerging markets could fulfil their role as the growth engine of a portfolio once again. In addition to the Guinness Asian Equity Income fund, we like GQG Partners Emerging Markets Equity and FP Carmignac Emerging Markets. For the brave, FSSA All China is an option for pure China exposure.

Smaller companies

Smaller companies are a natural choice for the risk-on investor. They tend to do well when the economy is growing and there is plenty of confidence around. They have been hit hard by the rising interest rate environment, and worries over economic growth, but with monetary policy reversing and valuations at rock bottom, it may be time to give them another look.

Investors have a choice of UK, European and North American smaller companies funds. All look good value, and all should benefit from a change in the interest rate environment. The average North American smaller company is larger than the average European or UK smaller companies, but in every region, they will benefit from a revival in the domestic economy.

European Smaller Companies may be an interesting area, because Europe tends to be a ‘risk on’ market, and smaller companies the punchiest part. George Cooke, manager on the Montanaro European Income fund (which invests in small and mid-cap companies), points out that the recent strong performance for large-caps over small-caps is anomalous and should ultimately unwind.

He adds: “For the last two and half decades, (investing in small-caps) has worked a treat, but it’s been the most difficult time for small-caps since the 1990s. Small companies have got down to levels as cheap as we’ve seen relative to the overall market. You now pay a lower valuation for small-caps than the wider market. The last time that happened was in the depths of the Global Financial Crisis.” For investors, the fund’s income mandate should provide a layer of protection.

For those looking at UK smaller companies, we like TM Tellworth UK Smaller Companies and WS Amati UK Listed Smaller Companies. In the US, we like T. Rowe Price US Smaller Companies Equity and Artemis US Smaller Companies.

Healthcare and biotechnology

Healthcare and biotechnology used to be seen as a compelling structural growth area, favourably exposed to shifting demographics, but it is another story that has got lost in the vogue for all things AI. Nevertheless, it remains as robust as ever. The United Nations estimates that the global population over 60 will more than double to around 2.1 billion by 2050*. In the US, healthcare spending for those aged 65 and over is around 2.5x higher than it is for working-age adults**. Huge amounts of capital are likely to flow towards the sector over the next decade. There is also plenty of innovation – from GLP-1 obesity treatments to mRNA vaccines, immunotherapy for cancer, and all the way down the medical supply chain.

Yet the performance of healthcare companies, and biotechnology companies in particular, has been lacklustre and looks due for a change in fortunes. For investors with a taste for this part of the market, the FTF Martin Currie US Unconstrained fund has a 34% allocation to healthcare***. Generalist funds we like in this area include Polar Capital Biotechnology and Polar Capital Healthcare Opportunities.

This is a good moment for the braver investor, who is willing to accept higher risk in pursuit of punchier returns. It has been a risk-averse climate, which has left many higher growth options on appealing valuations. At a time when investors have focused on what can go wrong, it is worth remembering that it might go right.

*Source: World Health Organisation, 1 October 2024
**Source: CMS, NHE FactSheet
***Source: fund factsheet, 31 August 2024

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.