Energy and basic industry: Fraser Lundie, manager of the Hermes Multi Strategy Credit Fund
The contribution of the energy and basic industry sectors to the overall risk of the global high yield market has risen in notional weight terms. Taking duration times spread (DTS) as a measure, which takes account of duration and credit quality, the two sectors together account for 36.7% of the risk in the market – a 40% increase over 12 months. But while the risks within high yield have been dramatically skewed towards basic resources, we believe the current scenario could provide investors with a compelling contrarian opportunity.
Both of these sectors have underperformed recently, but I expect to see divergent performances within these areas as stressed companies begin to engage in much more bondholder-friendly corporate activity at the expense of near-term equity performance. We are currently seeing opportunities in Range Resources, which benefits from being a low-cost producer, significant proven reserves, and is increasingly looking like an M&A candidate given the depressed equity performance of late.
The significant change in the market also reinforces the importance of a global mandate, as the road ahead will require the ability, nimbleness and flexibility to navigate in and out of both sectors and geographies.
European banks: Stuart Mitchell, founder of S. W. Mitchell Capital and manager of the SWMC Capital European Fund
Most analysts have in our view failed to appreciate the intensity of the European recovery, which as earnings growth becomes increasingly ‘visible’ throughout the year, should lead to significantly higher share prices. The market, however, remains compellingly valued with shares pricing in an unusually bearish decline in returns on capital into perpetuity. The more domestically orientated companies are trading at, in many cases, a 50% discount to their counterparts in the US.
Highlights of the accelerating recovery in domestic demand include a particularly strong quarter from the banking sector, with, most notably, results from BNP, Intesa and Commerzbank significantly exceeding expectations.
We still believe the market has failed to appreciate the benefits of a rapid recovery in financial margins coupled with draconian cost cutting and easing regulatory pressures. We are therefore focusing on the strongest retail banking franchises such as Lloyds and Intesa, where we think returns should rather rapidly return to pre-crisis levels.
Consumer goods: Ben Peters, manager of the Evenlode Income Fund
Consumer branded goods companies with significant sales exposure to emerging markets have been hit by China-driven stock market volatility. However, recent results in the sector were a reminder that despite tough conditions globally, these businesses enjoy a resilient demand profile (shampoo, soap, toothpaste, beer, cigarettes etc.), pricing power and good levels of cash generation.
We view the long-term drivers as unchanged for these businesses despite the current slowdown, but there has been a marked divergence in price movements between those and companies that are less exposed to emerging markets, such as Reckitts. Our positioning reflects the relative valuation opportunity, where we have much bigger weightings towards Unilever, Diageo & P&G than Reckitt Benckiser, for example.