As markets move out the Covid crisis environment, JOHCM UK Opportunities fund manager Michael Ulrich has positioned his fund to be on the right side of the new market environment.
The UK market entered 2021 on a positive, according to Ulrich, as global businesses and investment returned to the UK after years of animosity towards the market.
“The UK market is alive and kicking,” he said.
“IPOs are back and it’s clear to us that global businesses still want that UK listing. We’ve got a really great breadth of choice here, UK market remains full of global companies, full of market leading companies.
“The good news is that we’ve got Brexit out of the way, we’ve got vaccinations we’re starting to see investor flows come back into the UK after what’s been a really long period of outflows.”
Ulrich said there have been times in the past when there were few attractive opportunities in the UK market, but that isn’t the case today with better growth and valuation upside than he’s seen for over a decade.
Ulrich manages the five FE fundinfo Crown-rated JOHCM UK Opportunities fund alongside Rachel Reutter. It is run with a growth style bias to large-caps and bigger mid-cap companies. It is unconstrained from benchmarks with a strong focus on growth and valuation upside.
“The investment process is really simple: we start with the tailwinds. It’s not about macroeconomic forecasts, it’s just about identifying those persistent, long-term changes in business and society and government and about making sure that we stay the right side of these tailwinds,” Ulrich said.
At the moment the biggest tailwind in markets is inflation.
Part of the fund’s process is shifting to algin itself with changing market conditions.
“We change when the facts change. That’s really allowed us to do well in different market environments,” Ulrich said.
Applying that to inflation entering markets, Ulrich said: “How we’re responding is making sure we’ve got this portfolio which has this mix of companies that are direct beneficiaries to the rising cost environment.
“Companies that have got the right supply and demand characteristics and companies with pricing powers and inflation linked contracts.”
JOHCM UK Opportunities added four “strategic” new positions during Q1 in response to the increased inflationary environment markets are moving into.
Two of the new positions were mining companies: Anglo American and Antofagasta.
According to Ulrich both companies have the “right commodity mix” of metals such as copper and nickel.
These stocks also benefit from other tailwinds, such as the rise of renewable energy and electric vehicles, which use these metals in production, as well as supply and demand shortages.
According to Ulrich, there is currently a shortage of the metals these companies mine. But these stocks have invested in new long-term mining projects that could address this increasing supply deficit.
“So for those two we’ve got this supply and demand tension that we’re really looking for,” he said.
Another holding added in Q1 was paper and packaging company Mondi.
Again, this is a beneficiary of the supply and demand tail wind and the trend for businesses to transition to a more “closed looped economy” as a part of environmental and sustainability efforts.
“The limited supply [theme] carrying on and already seeing that improved pricing come through to a company whose margins we really like and has a cash profit,” Ulrich said.
The final stock is one that the JOHCM UK Opportunities fund has invested in before, Bodycote, which provides thermal treatments to metals. It has a strong market in the electric vehicle production theme, Ulrich said.
“The real message I want to get across here is we’ve always had this focus on pricing power. We’ve moved and tilted the portfolio and not just [because] we’re protective of cost savings but is it make sure that we’ve got the exposure that actually benefits from more inflationary environments that we’re starting to see,” the manager said.
With the changing tail winds, this has also caused the fund to sell out of several holdings in Q1. These decisions were also driven by valuation concerns, which is a core part of the JOHCM UK Opportunities fund’s process.
“You simply can’t make money if you ignore valuations,” Ulrich said.
“We use our valuation control to manage downside risk and we use it in an absolute not a relative way and we implement, as I said, that sell discipline.”
Two stocks the fund sold out of were Bunzl and Compass, both due to valuations rising to levels which would require higher price margins but Ulrich felt they would struggle to deliver. Concerns over cost inflation concerns were also a factor.
The three other stocks, Rio Tinto, Vodaphone and GlaxoSmithKline, were sold in reaction to the shifting tail winds as well as valuation control.
For Rio Tinto, another mining group, Ulrich said that the company was using 70 per cent of its profits to payout shareholders dividends “starving its business of investment growth”.
“That’s in contrast to the two mining companies we bought in the quarter, they’re both using their cash to reinvest for the long term,” he said.
Rio Tinto has also had significant governance issues after destroying an ancient Aboriginal heritage site for its new iron ore project.
This incident “is a direct example of the financial impact of poor social governance”, Ulrich said.
On GlaxoSmithKline, the manager explained this sell decision was part of upgrading the portfolio for better growth prospects.
“Stocks where our investment thesis simply wasn’t playing out and a key part of sell discipline is about cutting positions where we think we’ve got it wrong,” he said.
The company underwent a management change three years ago and since then the research and development elements “simply hasn’t worked”.
“It hasn’t produced enough new products to mitigate the patent expiries that are coming over the next few years. I think that there’s an increased risk that management are going to use expenses to plug that gap, so we sold GlaxoSmithKline,” Ulrich said.
All of the activity over Q1 2021 has been to “improve both the quality and the growth prospects of the portfolio but it also gives us better valuation upside”, Ulrich said.
“If you look at the top of that portfolio it’s definitely full of growth potential but importantly it’s not full of over valuation,” he added.
“It’s very deliberately been actively managed. It’s been shaped not into a portfolio of stocks that did well over the last decade tried to build a portfolio of stocks which are going to do well over the next decade.”
Over the past five years JOHCM UK Opportunities has made a total return of 34.91 per cent, underperforming against the IA UK All Companies sector (48.60 per cent) and the FTSE All Share index (44.33 per cent).
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
It has an ongoing charges figure (OCF) of 0.89 per cent.