It’s coming home: Has the UK been written off too soon?

Ahead of England’s highly-anticipated World Cup quarter final clash against Sweden on Saturday, Iboss senior investment analyst Chris Rush picks his world-beating UK equity fund manager starting line-up.

With the World Cup well and truly underway, the opportunity to jump on the football bandwagon was too good to pass up, especially considering the possible parallels between asset management and fantasy football. Or, perhaps more temptingly, the parallels between the outlook for UK equities and England’s chances at a World Cup win.

So, with the odds potentially stacked against UK equities, how do we make sure we are as positively positioned as possible going into what looks to be a more volatile market environment? Well, it’s all about team composition and diversification, as we look to select the best fund managers possible.

Strikers

Like any good team, we need to have the ability to score goals, which is to say produce a significant amount of outperformance. Currently, the UK equity market is trading at only 16.7x cyclically-adjusted PE (Cape). To put that into context, this is significantly cheaper than Europe at 18.7x and almost half the price of US equities at 30.4x. It is at times like these we would expect our managers (strikers) to be buying cheaper opportunities and as such, we would assume they are relatively positive on UK domestic stocks which are trading at a discount to those UK stocks that are more international in nature.

Polar Capital UK Value Opportunities

Managers George Godber and Georgina Hamilton are very positive on UK domestic companies, particularly those outside of London. The fund’s value-orientated approach adds a further diversification to the portfolio which is increasingly hard to come by in the UK equity space, primarily because most value funds have done very poorly. George and Georgina have, so far, been the exception, with excellent numbers throughout their tenure.

SVM UK Growth

With 13 years’ experience managing the fund and a managerial track record going back to 1984, Margaret Lawson has proven to deliver top quartile returns over almost all cumulative periods and throughout a multitude of market conditions. However, the fund is more volatile than many other UK equity funds and, due to Margaret’s high conviction style, can go through periods of underperformance. On a discrete yearly basis, the fund is likely to be either at the top of the charts or at the bottom (high beta figure), however the long-term consistency of returns is truly outstanding.

Discrete yearly performance SVM UK Growth – returns for year and percentile ranking

Midfield

These funds are our all-weather funds and should have the ability to not only score goals but also move to a more defensive position when necessary. The flexibility of these funds is paramount to ensure that our overall portfolios can respond to changes in market environment and as such, we wouldn’t expect these funds to be necessarily in the same position at any given time, but rather complement each other’s strengths and weaknesses.

Marlborough UK Multicap Growth

Much like our strikers, fund manager Richard Hallett has a wealth of experience managing UK equities across the market cap spectrum, having managed the fund since 2008. However, Richard is perhaps more consistent period-by-period, outperforming in seven of the last 10 calendar years. Richard has a very flexible approach to sector allocation, while preferring to remain fully invested. A recent example of this is a move away from consumer services toward financials on the back of the potential for UK interest rate hikes.

Unicorn Outstanding British Companies

Perhaps the opposite of the Marlborough Multicap Growth fund in terms of style, the Unicorn Outstanding British Companies fund holds a concentrated amount of stocks and will move towards cash should the team feel it necessary. Additionally, the fund has a relatively fixed sector allocation position and the team’s screening process rules out any energy, oil or materials stocks.

Perhaps the most notable difference though is both teams’ approach to the larger stocks in the Aim market, such as Fevertree and ASOS. Marlborough has been a big supporter of these stocks, while the Unicorn team does not touch any of them purely on a valuation basis. However, much like the Marlborough fund, Unicorn Outstanding British Companies has outperformed in seven of the last 10 discrete calendar years and tends to outperform in trickier market conditions, and vice versa.

As you can see in the chart below, both funds outperform in most cases, but the periods in which that outperformance is generated differs.

Discrete yearly performance – returns for year and percentile ranking

Defence

Some clients are content to invest on a long time horizon and pay little heed to short-term valuations. There is, however, another group that focuses not only on the destination but also on the journey to that destination; they place greater emphasis on volatility and drawdowns. The defensive players in our UK equity line-up are there to reduce volatility in the short term, reduce downside risk and, potentially, provide capital gains in a falling market. Basically, to prevent goals going against us.

Janus Henderson UK Absolute Return and Threadneedle UK Absolute Alpha

Both funds target 66% of UK equity market upside and 33% of the downside by using a mixture of equity longs and shorts. While these funds can act as a handbrake in rapidly rising markets, they have both demonstrated strong returns in more tricky market environments. The crucial point to consider here, because of their significantly lower volatility, is the risk-adjusted returns of both funds. This is to say, are we as investors getting paid for risk taken? The risk-adjusted ratios in the table below show that each fund is providing returns in excess of IA UK All Companies when taking risk into account.

Lazard UK Omega

Currency risk has become more pronounced of late and while the Lazard UK Omega fund is long-only equity and fully invested – both not particularly defensive positions – the important factor here is that the fund is almost entirely invested in FTSE 100 companies. The benefit is the fund’s exposure to internationally exposed equities is significantly higher than many other funds in the sector.

This international rather than domestic exposure offers the portfolio some protection against rapid sterling devaluations, such as we saw on the Brexit vote. Though this is not our core outlook for UK equities, it is important to be aware of the potential risks that Brexit could pose, and therefore a fixed exposure to international UK equities is, in our opinion, a prudent measure to take.

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