Wednesday, 6 June 2012

The Core Equity Funds

What are the "Core" Equity Funds?

This post looks at the expected returns on what I call the core equity funds. These are the biggest and most common funds that investors invest in. I identify these as:
  • UK
  • USA
  • Europe
  • Japan (maybe not so popular these days)
  • BRIC
  • Emerging Markets
  • World

I have chosen to review the ETF offered by ishares and as such the returns are based on their fees. The valuation techniques we will use are the same as I outlined in the recent article on China. I will use the same adjustment factor with a historical yield of 4.5% apart from Emerging Markets where I will use 4.25%. The reason I use a lower historical yield is because these are (and always will be) growth markets and therefore the dividend yields will traditionally be lower. Current Emerging Markets like China, Brazil, India will eventually emerge and become developed markets but Emerging Markets funds are dynamic and will move their funds to new markets that are emerging.

For growth rates we will use the IMF forecasts. We will take an average of the real growth for 2012 and 2013 and half it as our margin of safety. Remember these are real growth rates so we will add our inflation expectations of 2.5% a year to give our total growth rate.

Growth Rate = (Average IMF forecast * 0.5) + 2.5% inflation


Starting close to home we have the FTSE100. At present the distribution yield on the ISF.L fund is a respectable 3.75% (gross yield 4.15%). The fund has a low expense ratio of 0.40% which is also attractive.

As far as growth is concerned the IMF estimates are fairly low averaging 1.4% a year over the next two years. This gives us a nominal growth rate of 3.2%.

The good dividend yield gives us a low adjustment rate of -0.40% a year.

Total Return = 6.55% a year

The fund has just recently broken it's 100 day low meaning it's on a downtrend. Remember with large funds this is less important than individual stocks and so the weak price action could represent a good buying opportunity.


Going across the Atlantic we have the American equity market. The dividend yield on the ishares S&P500 fund is a rather miserable 1.47% (gross 1.87%). Again the expense ratio is a fair 0.40% a year.

The growth forecasts for the USA are much brighter than the UK with the IMF giving them an average of 2.25% over the next two years. This gives us a nominal growth rate for our model of 3.62%.

Due to the low dividend yield we get an high adjustment rate of -4.30% a year, suggesting American stocks are currently overvalued.

Total Return = 0.79% a year

The price action for the fund is positive. It's currently in an uptrend and showing strong price action.


With all the problems in Europe at the moment the EUROSTOXX50 has been struggling resulting in a high dividend yield of 5.35% (gross 5.70%). The fund is also the cheapest here with an expense ratio of 0.35% a year.

The IMF forecasts for Europe are very low with an average of just 0.3% a year over the next two years. The nominal growth rate looks a big more respectable at 2.65% a year.

The high dividend yield means there is no adjustment rate.

Total Return = 8.00% a year

As you can see from the chart the price action is pretty negative. Prices have fallen almost 40% in the last 12 months and it's recently broken its 100 day low.


Once a super economy in recent times Japan has been struggling. The current yield of 1.81% (gross 2.40%) is historically high for Japan. The fund is a bit more expensive with an expense ratio of 0.59% a year.

The IMF growth estimates are a modest 1.85% a year average giving us a nominal 3.42% a year for our model.

The low dividends give us a -3.09% a year adjustment rate.

Total Return = 2.14% a year

Japan is currently in a downtrend having fallen considerably over the last 18 months.


BRIC: Brazil, Russia, India and China funds have been popular over the last several years. The FTSE BRIC50 fund pays a modest 2.66% (gross 3.40%) dividend. As with most exotic funds the expense ratio is higher at 0.74% a year.

For simplicity I have used an equal weighting of 25% Brazil; 25% Russia; 25% India; 25% China for the growth rate. This gives an IMF rate of 5.77% giving us a respectable nominal rate of 5.38% a year for our model.

The adjustment rate is a fair -1.39% a year due to the fairly good dividend yield.

Total Return = 6.65% a year

After impressive gains the fund is now on a bit of a downtrend which could represent a good buying opportunity.

Emerging Markets

Emerging Markets funds can produce very good returns but also come with more risk. The current yield on ishares EM fund is 2.08% (gross 2.83%). Again as a more exotic fund the expense ratio is 0.75% a year.

The growth rates are a solid 5.85% a year according to IMF forecasts. This gives us a nominal 5.42% a year for our model.

The fairly mediocre dividend yield gives us an adjustment rate of -2.01% a year.

Total Return = 5.49% a year

An almost identical chart to BRIC due to the fact that BRIC stocks make up a majority of the emerging markets.


How about just buying a World fund and forgetting about it?

The dividend yield is 2.22% (gross 2.72%) with an expense ratio of 0.50% a year. The low yield is due to the fact the USA and Japan have big weightings in the world economy.

The world growth rate according to the IMF is 3.80% a year giving us a 4.40% nominal growth rate.

The low yield results in an adjustment rate of -2.49% a year.

Total Return = 4.31% a year

The price action looks fairly modest although the 100 day low was recently broken.


The table below summarises the above data:

Gross Yield
IMF Forecast
Growth Rate
Adjustment Rate
Annual Return
Europe (EUE.L)
Japan (IJPN.L)
World (IWRD.L)

The high yield on the European fund looks very attractive at present. I would guess that the recent price falls have resulted in an oversold situation in which buying now could yield very attractive returns. The technicals show a down trend and some investors might feel safer waiting for a reversal of the trend before investing. Personally I see the fund as being big enough and including international giants such as Sanofi, BASF, Unilever, Danone, L'Oreal and BMW who gain significant proportions of their profits from emerging markets, the annual return is high enough to warrant the risk.

The UK stock market is also in an attractive position with a 6.55% expected return and for more adventurous investors the 6.65% currently on offer in the BRIC market looks good value.

The USA stands out as looking particularly poor value, although it is also the only fund in the list which is currently uptrending.

No comments:

Post a Comment