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By Russel Kinnel and Christine Benz | 11-17-2016 12:00 PM

Small Value Soars, Emerging Markets Sink Post-Election

Morningstar's Russ Kinnel explores which funds rose and which fell after the market's first take on the impact of the Trump administration.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The 2016 election boosted some mutual funds and detracted from the performance at others. Joining me to provide a recap of some of the biggest winners and losers since the election is Russ Kinnel, he is director of fund research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Good to be here.

Benz: Russ, this is a very admittedly short period of time, and things are moving around pretty quickly. But you took a look at some of the mutual funds that have had big gains since the election--equity funds in general really jumped after the election results were announced. Why do you think that is?

Kinnel: Well, it's just the market's first guess, and we'll have a lot more guesses between now and even the day Trump takes office. But I think people were thinking about less regulation for some industries, people thinking about infrastructure build-out, which is a key part of Trump's platform. So there are few things that were motivating investors there.

Benz: Perhaps lower tax rates as well. So, let's take a closer look at some of the funds you identified as having--some of equity funds you identified as having particularly good performance. One theme that jumps out when we look at some of these top performers over this little bit of window of time, is that, it was good to be a small-value fund, where you had a couple of Royce funds on this list and a few others. Why do you think that that category performed especially well?

Kinnel: Small value had a really nice run, and among the funds that did particularly well, we see big holding in industrials, big holdings in tech. I think the industrials are partly reflecting the idea of infrastructure build-out, they had some materials exposure, which I think reflects a couple things. One, people think inflation is going to rise. Two, a lot of the materials companies are polluters. People are expecting EPA regulations to be relaxed, so that's another part of it.

The tech side we've seen some small-cap tech has done better than large-cap tech, so that's been boosting them too. So, yeah, it's usually a kind of quiet sector, but right now small-value is really having explosive rally.

Benz: OK. Another fund that made the list among the top five performers in this one-week period since the election was Fairholme fund and that is a large-cap fund. Let's talk about what's going on with that portfolio, what in that portfolio has performed especially well recently.

Kinnel: Yeah, it's interesting because going into this going into November, Fairholme was in the bottom decile of its peer group, now it's hopped all the way to the top quintile of its peer group …

Benz: For the year-to-date.

Kinnel: For the year to date, and a big part of that is, it's got a big chunk of its portfolio in Fannie Mae and Freddie Mac preferreds and those have really rallied on the news. So, it's really turned the fund around, of course it's a very focused fund with a really unusual portfolio. So, it's kind of a given that it's going to have these big swings.

Benz: Right, these boom and bust cycles have characterized its performance in the past certainly. Let's look at the other side of the ledger, just as a general headline, one thing we've seen, and I know you and the team have been keeping close track of this is the fact that bonds have really sold off since the election results. Why have bonds been so adversely affected?

Kinnel: I think worries about rising interest rates, worries about a growing deficit, obviously if you spend big on infrastructure and cut taxes on the other hand, you are talking about growing the deficit. So, there is a lot, and then just I think general uncertainty is out there. So, there are number of concerns out there and then of course the Chinese own a big chunk of Treasuries out there and there's some worries about that as well.

Benz: And concerns over inflation, I know are definitely weighing on the bond market.

Kinnel: Sure.

Benz: So, at the top of the list in terms of the worst performers in the very recent past was a PIMCO fund that on emerging-markets debt that is denominated in local currencies. Let's talk about that and why such a formula would be so negatively affected by these election results.

Kinnel: That's right. Well, emerging-market currencies have gotten hit hard, obviously things like the peso is going to get hit hard given Trump's animosity with Mexico. But in general, emerging markets have sold off, so you have emerging markets selling off, then of course bonds are selling off. Put them together and it's particularly hard on emerging-market bonds.

Benz: OK, and then, emerging-markets equity, another category that has been quite hard hit let's talk about what's going on there? I think a lot of people had hoped that this would be a good year for emerging-markets equity after a few rough ones, but this election has definitely hurt a number of EM equity funds.

Kinnel: That's right, emerging markets look like one of the more attractive areas, because it hasn't done that much in the last few years. But here it is again sinking, and I think that one of the reasons is simply fears of trade wars, which of course would hit emerging markets hard. But in a way, it's kind of contradictory. If the U.S. is rallying because all economies are dependent on trade, and so in some ways, I think these will have to sort themselves out. I would think eventually either U.S. markets will come down to emerging markets or emerging markets will go back up, because we're all interrelated and all the economies depend on one another.

Benz: Right. So, my final question for you Russ is, after we have the kind of performance movement that we've had recently for both stock and bondholders, how should investors react to events like this? Is it a reason to make any changes to their portfolios?

Kinnel: Probably not. If you've got a good plan, the best thing you can do in these times is stick to it, because it's very hard to predict what's going to happen in the short term. I mentioned, we've got our best guess so far, and that's going to change all the time, and certainly I think volatility is here to stay. So, I think you want to stay diversified, you want to stick to your plan, you want to think about, what are defensive ways to protect myself, if the next volatile move is a down move, and I think that means diversification, understanding conservative investments to protect the downside. But in large part, there is only so much you can do.

Benz: Don't try to be a tactician hero.

Kinnel: That's right, for sure.

Benz: OK, Russ. Thank you so much for being here to provide this recap.

Kinnel: You are welcome.

Kinnel: Thanks for watching. I'm Christine Benz for Morningstar.com.

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