The key themes for the 2024 ISA season

Investors pondering their ISA decisions this year may be encouraged by the performance of stock markets since the start of 2024. However, markets are becoming more discerning. It is increasingly clear that companies won’t get a free pass because they’re part of an exclusive acronym, or because they happen to be in the technology sector. Below are some of the key themes investors should be looking at ahead of the ISA season deadline on April 5.

Look beyond the Magnificent Seven

The ‘Magnificent Seven’ led markets higher in 2023, but the grouping has looked increasingly fragile since the start of the year. Meta and Nvidia have pulled away from the pack while some of this elite group have been left looking distinctly less than magnificent. Tesla, for example, is down over 30% for the year to date*. This is a good reason to diversify US exposure beyond the S&P 500 heavyweights.

The small and mid-cap part of the market appears to be picking up steam. The North American Smaller Companies sector has outpaced its regional peers since the start of the year. Over three months, the MSCI USA Small Cap Index is up 13.3%, compared to 12.1% for the MSCI USA Index**. It is very short-term, but it suggests momentum may be returning to this part of the market.

Hugh Grieves, manager of Premier Miton US Opportunities, points out that mid and small-caps have historically traded at a premium to the market, but are now trading some way below large caps: “I can’t remember a time in my career when they have traded at this scale of a discount,” he adds. This fund is a multi-cap option, run by Grieves and Nick Ford. It has kept pace with the broader IA North America sector in spite of the strength of the tech giants – and is ahead over five years***.

For pure small and mid-cap exposure, investors could consider the T. Rowe Price US Smaller Companies Equity fund. This is a well-diversified, flexible fund, holding 150 to 200 companies. It also has some value names sprinkled in, which adds to its diversification potential. T. Rowe Price has vast analytical resources, helping fund manager Curt Organt uncover unique opportunities.

In a recent podcast, Ben James, investment specialist director on Baillie Gifford American, gives insights into why the U.S. remains a prime location for growth investors.

Get prepared for ‘risk on’

Markets have been in a holding pattern for some time. Investors have clung to the predictable growth of the US market and largely neglected everywhere else. In the recent rally, there were signs this was changing. At the same time, the recent Investment Association data showed flows out of Europe and Asia had slowed to near zero****. The Asia data is particularly surprising given that sentiment towards China remains very weak.

These markets are starting from a low base. Europe has been unpopular, with investors assuming that it would either see an energy crisis, a significant recession, or both. For brave investors, a multi-cap option could capture a recovery in sentiment towards Europe. IFSL Marlborough European Special Situations, Janus Henderson European Smaller Companies or WS Montanaro European Income might be ways to play this trend.

In Asia, it would be a brave soul to call the bottom in China, but its negative effect on the rest of Asia may be ebbing, particularly given the recent strength in other parts of the region: India or Vietnam, for example, which are benefiting from high economic growth and shifting global supply chains.

Matthews Pacific Tiger could represent an option to dip a toe back into Asian markets, ready for any potential bounce. It is a carefully-curated, low turnover portfolio run by a well-established specialist team. The fund focuses on domestically or regionally oriented companies that stand to benefit from the long-term evolution and growth of the Asian consumer. Although the fund can invest across all market capitalisations, it tends to favour mid- and small-cap companies. Schroder Asian Alpha Plus would be another option.

Small in Japan

Japan has had an astonishing run, and its strength has continued into this year. The recent decision by the Bank of Japan to raise rates for the first time in 17 years suggests momentum may continue for the country^. It may also help support the currency, removing a major deterrent for international investors.

However, it may be time to rethink how to approach the Japanese markets. The region has seen astonishing strength in its large cap stocks. This has been the first port of call for international investors, such as Warren Buffet. Alongside the Magnificent Seven and Bitcoin, the most recent Bank of America Fund Manager Survey found Japan to be the most crowded trade^^, which should be a warning sign for investors that the big gains may have already been made.

However, there are parts of the Japanese market that have been almost entirely overlooked and seem ripe for a catch-up. These include small and mid-caps and some ‘growth’ parts of the market. This is a particular area of focus for the Baillie Gifford Japan franchise, which runs the Elite Rated Baillie Gifford Japanese, Japanese Income Growth and Japanese Smaller Companies funds. AXA Framlington Japan may be a slightly lower octane version. It has a tilt towards smaller companies and is less extreme in its style tilt than some of its peers, though it has a slight growth bias.

Leave bonds to the experts

2024 was supposed to be the year of the bond, but it has been a more complicated start to the year than many were expecting. The average global government bond fund is down 2.5%^^^, as investors have vacillated over rate cuts. There is still much to like in bond markets – high income, diversification, the prospect of rate cuts – but investors need to take care.

There are also looming concerns over credit quality – bankruptcies are rising^^^^. US corporate bankruptcy filings gained more momentum in February, with 50 new filings, compared to 35 in January^^^^. There are also concerns over the ‘refinancing wall’ – where companies’ fixed term debt expires and they need to refinance at new, much higher rates.

The environment is tough to navigate. In our view, investors need to pick a fund manager with immaculate credit selection skills that can pick their way through individual bonds to find those with good covenants, little refinancing risk and reliable growth prospects – say, BlackRock Corporate Bond fund, or Man GLG High Yield Opportunities. Alternatively, they need to leave the granular allocation in bonds to the experts, perhaps Dickie Hodges on Nomura Global Dynamic Bond, or Jonathan Golan at Man GLG Dynamic Income.

There are some optimistic signs for the year ahead, but investors will need to be strategic to make the most of them. That may mean looking beyond the areas that have worked well over the past 12 months.

*Source: MarketWatch, data at 25 March 2024

**Source: MSCI index factsheet, 29 February 2024

***Source: FE Analytics, total returns in sterling, 25 March 2019 to 25 March 2024

****Source: Investment Association, January 2024 

^Source: BBC, Japan raises interest rates for first time in 17 years, 19 March 2024

^^Source: The Economic Times, 21 March 2024

^^^Source: Trustnet, sector calendar performance, data at 25 March 2024

^^^^Source: S&P Global Market Intelligence, 7 March 2024