SINGAPORE (Dec 24): The US economy enjoyed one of its most robust performances when it reported its fastest rate of GDP growth in nearly four years in 2Q2018. The strong growth, which was driven by higher fiscal spending and tax cuts, should have extended the bullish run seen in US equities over the last few years. Instead, trade tensions with China and fears of a US slowdown have taken the wind out of the sails for US equities.

It is, then, perhaps surprising that the top-performing Singapore-registered funds in 2018 are dominated by those that largely invest in US equities, according to Morningstar data. Among these funds, the crème de la crème are those that have high exposure to the healthcare sector.

One such fund is the AllianceBernstein International Health Care fund, which seeks capital appreciation through investments in healthcare and health sciences companies worldwide. The fund returned 10.1% and outperformed its benchmark — MSCI World Health Care Index — so far this year to Dec 14.

With a size of nearly $1 billion, the fund is geographically skewed towards the US, with 73.4%, according to its factsheet as at Sept 30. The fund’s top three industry allocations are pharmaceuticals at 38.7%, healthcare equipment and supplies at 25.3% and biotechnology at 19.7%. Its top holdings include Pfizer, UnitedHealth Group and Roche.

AllianceBernstein portfolio manager Vinay Thapar says the outperformance was driven by the fact that the healthcare sector has benefited from a combination of upside participation, and downside protection, versus the broad market. As such, the fund was less exposed to high volatility, unlike the technology sector, Thapar tells The Edge Singapore. Astute selections in the medical device segment, such as avoiding investing in US-based drug distributors, also helped, he adds.

Similarly, the Legg Mason ClearBridge US Large Cap Growth Fund has done well too, having returned 5.5% in the same period and outperformed its benchmark Russell 1000 Growth Index. The fund’s top three sector allocations are IT at 32.4%, healthcare at 16.6% and communication services at 12.0%. Its top holdings include Amazon.com, UnitedHealth and Adobe.

“Specifically, stock selection in the IT and healthcare [sectors] drove performance,” says ClearBridge Investments, sub-investment manager of the fund and an affiliate of Legg Mason. ClearBridge points out that it typically initiates a position at times of controversy or underperformance, which was the case for Adobe. “In addition, our strategy of taking an underweight position in industrials also contributed to the positive fund performance.”

Staying on top or going down?

On Dec 19, the US Federal Open Market Committee signalled that it expected just two rate hikes in 2019, instead of three previously. This comes as part of the Federal Reserve’s efforts to normalise monetary policy, as long as the economy continues to improve. But a lowered rate trajectory projected by the FOMC may suggest slower growth ahead. The big question now is whether these top performers can continue to do well in 2019. It was only in 2017 that top-performing Chinese equity funds emerged as the darlings of investors, and they were expected to do well in 2018 too. Many of these funds are now languishing, however, at the bottom of the Singapore fund universe.

Take, for instance, the JPMorgan China A-Share Opportunities Fund. It had a negative return of 22% so far this year, compared with a positive return of above 30% in 2017. The fund managed to outperform the decline in its benchmark, CSI 300 (Total Return Net) Index, though. As at Oct 31, its top three sector allocations were financials at 32.3%, consumer discretionary at 14.2% and healthcare at 13.3%. Its top holdings include Ping An Insurance (Group), Kweichow Moutai and China Merchants Bank.

Rebecca Jiang, portfolio manager of the JPMorgan fund, blames the plunge in Chinese equities on the China-US trade tensions, among other things. “Following the strong start, both onshore equities and currency plunged as a result of the US’ surprising decision to proceed on tariffs on Chinese imports,” she says. “Investors’ risk tolerance has been pulled down by growing risk of a trade war, hawkish [Fed] statement and poor China economic data, alongside a significant slide in the [renminbi].”

Nevertheless, Jiang reckons her fund will do better in the long term because it uses an internal valuation “signal” to forecast five-year expected returns for invested companies to judge the “best opportunities”. “At the moment, that signal is close to a record high — in the high teens. This means that, for investors getting into the market now, average subsequent returns on a five-year basis could be in the high double-digits,” she explains. “That’s significantly higher than the China equity market long-term average returns, which is closer to about 10%.”

As such, Jiang says she is buying on dips. In particular, the fund is selectively adding internet, software and healthcare services names that have attractive valuations and secular growth potential. “Where we can find companies in which we fundamentally believe in their long-term growth prospects, we’re happy to get them at cheaper prices. As such, we haven’t made material adjustments in any of our China A-shares portfolios,” she says.

That said, Jiang is cognisant of the risks ahead. For one, the fund is susceptible to ongoing concerns over the trade war between China and the US. She says a protracted trade war is in no one’s “best interest”, including the US. “Their real incomes will decline, should tariffs and/or a broad relocation of manufacturing [activities] to more expensive locations result in higher prices for consumer goods,” she says. In addition, the Chinese government’s efforts to reduce corporate debt levels have resulted in “missteps” and “micromanagement in others”. These actions could repeat themselves as China continues to seek economic reforms while balancing fiscal and monetary policies in response to internal and external macro events.

Fund managers of US equity-exposed funds say they are optimistic of their performance despite the challenging outlook ahead. Alex Gold, portfolio manager of Fidelity Funds Global Healthcare fund, says the broader risks of a late phase in the economic cycle poses a “challenge” to equity markets in general. “In the event that investor sentiment shifts unfavourably, the fund’s performance could be hampered on an absolute basis, although I would still expect it to outperform the broader market because of its inherent quality bias and the defensive nature of the healthcare sector.”

AllianceBerstein’s Thapar also remains positive on healthcare stocks, especially those with a heavier technology focus. “Technology is really still in its infancy, not only in terms of equipment or biotechnology but also big data analytics in drug trials,” he says. “We also see a lot of opportunities in therapeutics, particularly in oncology and neurology, Alzheimer’s disease, pain management and diabetes.”

On the other hand, Peter Bye, UBS asset management’s portfolio representative, believes the UBS USA Growth P-acc fund can generate long-term value across an entire market cycle. “We have identified long-term secular themes — cloud computing, healthcare, machine learning [and] media disruption — that will continue to yield investment opportunities,” he says. Its top three holdings are Microsoft, Amazon.com and Apple.

Still, ClearBridge is taking a cautious stance. While revenue growth remains strong, the fund house expects earnings growth to taper over the next 12 months as the benefit from US stimulus fades. “As active managers, we are monitoring the macro environment [and] checking in regularly with our portfolio companies. [We are] adding and trimming positions to manage risk in the portfolio. We cannot rule out the potential for a black swan event to impact individual companies or the wider market,” it says.

Frank Thormann, portfolio manager of US large cap equities at Schroders, is cautious too. “In the light of this slowdown, we believe attractive returns may be earned by focused stock-picking and emphasising strong pricing power, relative insulation from rising cost pressures and company-specific catalysts, which will allow them to sustain above-average growth.”

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US equity funds are top performers for 2018; 2019 may be a different story

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