RWC UK equity manager highlights “pockets of real value”

John Innes is the portfolio manager of the RWC UK Focus Fund.

After making all-time highs in the spring of last year UK equities have had a significant retracement on various economic and political fears.

The asset class remains good value for those investors looking for real growth over the medium term and particularly so against the exceptionally low return safe havens of bonds and cash.

Citibank strategists have said that the UK equity market is the best value against bonds for a hundred years!

Stock markets have to always “climb the wall of worry” and they have been doing this in the face of a series of both economic and political concerns since the financial crisis of 2008.

In economics we have had stories of “double-dips” and “triple-dips”, rising UK interest rates, “taper-tantrums”, Eurozone crises and now fears of a recession in the US, a Chinese meltdown and deflation.

Sadly for the doomsters the facts are not supporting their theories. The data still suggests that global growth, although not spectacular, remains reasonable and recent stimulus measures by the ECB and the Chinese authorities amongst others should maintain this.

In politics over the last two years we have had the Scottish Referendum, the continuing Greek drama, the UK general election and now the looming EU referendum and US presidential election.

In general, however, democratic electorates tend to vote in favour of jobs and security and avoid the risk of economic dislocation unless the government is noticeably incompetent or corrupt.

Within the UK stock market there are pockets of real value. The popular defensive stocks still look reasonable value against bonds on current generationally low yields, but any reversal
of this seemingly overvalued market will more than likely lead to underperformance of these types of companies.

Our philosophy, which has been successful for many years, is to search for investments in the less fashionable areas of the market.

At the moment this is leading to a shift in favour of some of the larger capitalisation and more liquid companies that have been severely de-rated for some time.

During the panic over the oil price and commodities at the end of last year and the start of 2016 we significantly increased the investments in the natural resources sectors.

We were buying Shell on a dividend yield of up to 9% and although it has been now been re-rated to a yield of some 7% we feel that there is still a lot further to go as the oil price stabilises and the company continues to cut substantial costs.

Financials are also now heavily out of favour, particularly banks that are almost at a thirty year relative low. Our preferred company is Lloyds Bank that has dealt with all the regulatory demands ahead of the other domestic banks, has recently returned to the dividend lists, but the share price has been depressed by the government selling down their stake.

Economically cyclical shares have also suffered over the last few months owing to fears over the global economic outlook, but we continue to favour stocks such as International Consolidated Airlines (a continuing beneficiary of lower oil prices), construction stocks (particularly those exposed to the strong US market such as CRH and Wolseley) and general retailers that have underperformed over EU referendum concerns despite robust trading.

We furthermore have a few recovery stocks such as Thomas Cook and Balfour Beatty where new management teams are working hard to improve returns with some success after a period of difficult trading.

Given the overall heightened level of anxiety amongst the investment community, this investment strategy might seem riskier than the average, but history suggests that a non-consensus view can result in significantly better rewards over time.

Our investment process of supporting incentivised management teams working hard to improve returns for shareholders in cheaply valued companies should continue to act in investors’ interests despite the inherent volatility of equity markets.

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