UK stocks’ performance over the past two quarters, in the face of innumerable macroeconomic headwinds, is a testament to that. "It was amazing how much was thrown at the market in Q1. December was a plus 7% month, so there was ample opportunity for a pullback at the start of the year"," says Lloyd Whitworth, a fellow member of Lazard’s UK equity team.
Indeed, The FTSE All-Share Total Return Index grew by just 1.1% in Q1 2011 as the market finally wilted slightly in the face of bleak political and macro-economic news. But the team at Lazard believe there are a number of reasons why UK equities can continue to perform well in 2011, even as economic growth expectations are scaled back once again.
"The expectation at the start of 2011 was that growth would be easier to come by. It was a classic low P/E situation – why pay up if growth is easier," says Custis. Now, he says, "we are almost back to where we were at the end of last year".
He believes stocks such as Burberry as an example of a company that is "on relatively high ratings", but, crucially, also have "good visibility and that continue to perform well".
Custis and Whitworth add that a breakdown in the 20-year high correlations seen across the market over the past two years will also make for a better stock picking environment, to the benefit of their UK Omega Fund, which has a concentrated portfolio of between 25 and 35 stocks.
Stock selection
Recent purchases in the fund include supplies group Wolseley, which the team believe can achieve peak margins without a US economic recovery, resources firm Cape and insurer RSA, which the team see as a second derivative emerging markets play.
Custis says the Omega fund, which has returned 16.65% over one versus a UK All Companies average of 15.56%, and 12.5% over three years versus an average of 8%, also took advantage of the market effects of recent MENA volatility, stepping in to buy "one or two stocks that have bounced back very sharply".
The team takes a less positive view on financials, however. The Lazard UK Alpha Fund pared exposure to HSBC in March, Whitworth citing the fact that the bank’s US business, Household, "still has a lot to see through".
"The market has seen a floor in that several times," Whitworth says. Custis adds that HSBC’s first quarter results "highlight the drag of having to hold more and more capital".
"The ROE these banks are going to earn is coming down and down", he adds. "Barclays says it intends to achieve a 15% return on equity by the end of its planning cycle. To achieve that you need all business segments firing at all times, and in reality that doesn’t happen very often".
Custis and Whitworth have also been adding to the likes of Experian, in part due to its EM exposure, and 3i, where they believe the market has focused too much on concerns over domestic, governmental business lines rather than its capabilities elsewhere, such as in Germany.
But the pair remain convinced that the UK is the best place to gain access to such opportunities. Says Whitworth: "the UK has a higher return on equity than any other market in sterling terms, and falling correlations will play into our hands as well. It is a good story".
