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JOHCM’s Savvides: Unloved UK equities look attractive but you need to be selective

16 March 2018

Alex Savvides, manager of the JOHCM UK Dynamic fund, outlines why the UK is being overlooked by investors and where he sees opportunities.

By Jonathan Jones,

Senior reporter, FE Trustnet

Negative international sentiment towards UK equities means the asset class is on the discard pile and should therefore be of interest to any dispassionate investor, according to JO Hambro FE Alpha Manager Alex Savvides

Last month saw the return of volatility with evidence of inflationary pressures and the threat of faster interest rate rises causing a short but intense sell-off in equities.

Indeed, global equities – as represented by the MSCI All Countries World index – have fallen 84 basis points so far this year, though the index lost 8.56 per cent from its peak in January to its trough in February.

“Although difficult to pinpoint the specific trigger for the market fall, it was most likely a reaction to US wage inflation pressures emanating from the ongoing strength in the US labour market, made worse by the recent rapid rises in the US equity indices,” Savvides (pictured) said.

“Whilst the strengthening data was not new news it poured fuel onto an already nervous US bond market, which was still trying to digest the implications of the Trump administration’s successful passing of the Tax Cuts and Jobs Act in late 2017.”

However, the reaction was even more severe in the UK, with the FTSE All Share down 5.86 per cent year-to-date.

Performance of indices over YTD

 

Source: FE Analytics

“Conditions in the UK market remain governed by the overriding uncertainty created by Brexit,” the FE Alpha Manager of the four FE Crown-rated JOHCM UK Dynamic fund said.

From a data perspective, where US 10-year treasury yields have risen by 46 basis points (bps) since the start of the year to the end of February, in the UK the 10-year gilt yield is up by 31bps.

Meanwhile, the UK unemployment rate for the three months to December was 4.4 per cent versus the US’s 4.1 per cent. Wage inflation in the UK rose by 2.6 per cent in December and by 2.5 per cent for the final three months, compared to 2.9 per cent wage growth in the US.


UK inflation, driven higher by a weak pound sterling, remained at 2.7 per cent (CPIH) in January (or 3 per cent excluding housing costs), whilst in the US it is at 1.7 per cent.

UK inflation figures

 

Yet in the US there is expectations that new Federal Reserve chair Jerome Powell will raise interest rates three times in 2017, with just one priced in from the Bank of England governor Mark Carney.

“In many ways conditions might be tighter in the UK. Labour supply is falling in the UK post the Brexit vote and productivity remains low,” Savvides said.

Ultimately, it is confidence that is the missing link in the UK, he added, with Brexit hanging over the country and dissuading investors.

The most recent Deloitte CFO survey showed that UK CFOs became as pessimistic about Brexit as they have been since the referendum with UK economic growth their second major fear.

However, the potential rewards from executing a reasonable trade deal with the European Union (EU) are “abundantly clear” and would “unshackle the UK economy” from the current drag of weak domestic demand, Savvides said.

The manager added: “This would make current expectations of one or two interest rate rises over the next 12 months seem rather conservative.”

As such, while the short-term outlook is tough, the risks high and international sentiment towards the asset class extremely negative, UK equities are “on sale” and should therefore be of interest to any dispassionate investor, he noted.

But it is important to know where to look and to be selective, as the recent market correction has made it an active month for the UK stock market with investors becoming more discerning about balance sheets.

Continuing the trend seen in the back half of 2017 there has been a rapid increase in profit warnings from challenged businesses; this was particularly evident in the support services sector where just under a quarter of listed companies issued a profit warning in 2017 and in the general retailers where a third downgrade estimates.


In better news, there has been a pickup in merger and acquisition (M&A) activity with Sky, GKN, Fidessa, Laird and Stadium Group all having recently announced takeover approaches, creating share price boosts.

“We expect a continuation of M&A activity given the blend of underperforming companies with attractive valuations, strategically challenged companies needing to diversify and technological shifts driving a search for both protection and growth,” Savvides said.

Of these, both Sky and GKN are in the JOHCM UK Dynamic fund. The Sky deal provided a modest performance boost at the end of the month although it is a small position in the fund.

GKN, meanwhile, was bought more recently following interest from Melrose and, if the bid fails, the manager said he would be “happy to be exposed to the underlying restructuring story that has been kicked off within GKN at pace since the announcement of Melrose’s unsolicited interest”.

“If Melrose is successful in its bid on the current terms, we would be happy to take more of the bid as stock and recycle the cash component into Melrose, having had previous experience of the latter's turnaround capabilities when it bought FKI in 2008,” he added.

 

Savvides heads up the four FE Crown-rated JOHCM UK Dynamic fund, which since its launch in 2008 has returned 194.10 per cent to investors, as the below chart shows.

Performance of fund vs sector and benchmark since launch

 

Source: FE Analytics

It invests in distressed businesses that are turning around and seeks to add companies that are overlooked by the market due to short-term underperformance.

The portfolio is on the FE Invest Approved list, although the analysts said it should be viewed with a minimum of a three-year time horizon to allow the recovery process to take effect.

The £934m JOHCM UK Dynamic fund has a yield of 3.42 per cent and a clean ongoing charges figure (OCF) of 0.81 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.