With the FTSE 100 index hitting consecutive all-time highs in January, is it time to be cautious about investing in UK equity funds? Oliver Brown, investment director at R.C. Brown, highlights some of the ways an active fund manager can add value for investors in these challenging times.
Following the strong performance by the UK equity market in 2016 and the short term uncertainty that the Brexit process continues to generate, it is not difficult to be cautious about the outlook for UK equities in 2017 – a stance which seems to be being taken by many advisers at the moment.
Despite this, we remain broadly positive towards equities in 2017 noting that whilst the UK stockmarket is not offering exceptional value, it does not appear to be expensive either when we compare with history or with other major markets, particularly the US.
Looking for value
Indeed, I can tell you that parts of the market do still offer reasonable value, a rotation that we’ve already started to see with banks, oil and mining stocks starting to find favour, funded out of bond proxies such as consumer staples whose valuations have become increasingly stretched. Much of the UK stock market gain which we saw in 2016 happened as a result of the depreciation of sterling against global currencies, in particular the dollar, following the Brexit referendum result. It is possible that we may see a partial reversal of this, which would put pressure on the large number of dollar earning companies in the FTSE. Nevertheless, the fears of a global recession that were surfacing at the start of 2016 have subsided and expectations of growth, particularly in the US, have risen.
So, with the FTSE recently hitting all-time highs and many advisers beginning to question if and where value can still be found in UK equities, it’s time to consider a range of options. Of course, when it comes to building robust and well diversified portfolios for clients, advisers have concerns about closet trackers, and also about the risks to diversification through different funds having many of the same underlying holdings. You’re trying to minimize risk after all, not to increase it!
As fund managers, at R.C.Brown we take a common sense approach to the macro-economic outlook, knowing that consensus, whatever that is, is likely to be wrong. We do not attempt to outsmart consensus. Instead, we construct a well-diversified portfolio of 50-70 stocks, nearly all of which we have purchased using our primary opportunities approach. This is where we seek to buy into companies that are having liquidity events at a discount to the prevailing market price thus protecting our downside risk.
We look to buy into good quality companies in four ways. Firstly, at IPO, this is our opportunity to buy in at ground level and in some cases this leads to exceptional returns. Secondly a share placing by the company to raise money, typically for expansion purposes. Thirdly, a placing by a known strategic or forced seller where we are comfortable with their reasons for selling. And fourthly, occasionally we may buy large blue chip stocks in the secondary market on market setbacks on diversity grounds. For advisers looking for increased portfolio diversification, this can give reassurance that our approach is different to that of other asset managers.
Interestingly, 2016 saw the lowest value of funds raised on the UK market since the financial crisis of 2008. Nevertheless, we still saw a number of attractive opportunities in the small cap arena. We expect this to continue in 2017 and also anticipate seeing mid and large cap IPOs that were delayed due to the considerable market and political uncertainty which existed last year. A number of these companies are likely to go straight into the FTSE 100 index. One example here is the telecoms company Telefonica, which this year is expected to seek a flotation for O2 to reduce their parent company’s much indebted balance sheet. Whilst not being such household names, TI Fluid Systems and Misys both failed to float in 2016, but may try again in more sanguine market conditions during 2017. Logicor, an owner of warehouse facilities whose clients include Amazon, is expected to be the largest IPO in the UK for a number of years with a predicted flotation during the first half of 2017.
A stable market background coupled with historically low UK interest rates should also result in plenty of M&A activity all of which is good news for investment managers. Again we expect to see a considerable number of placings as companies look to expand, consolidate their sector and grow profitability. With the FTSE 100 currently trading above the 7000 level, we also expect to see a large number of secondary sell downs, as private equity in particular look to exit their investments in order to recycle capital into new opportunities. The government is widely expected to sell its remaining stake in Lloyds bank, putting it fully into private ownership. These are all examples where managers with a proven strategy can seize opportunities to capitalize on real value situations which might not be open to others. For financial advisers seeking to diversify in order to minimize risk and volatility, then this is key.
As ever, there will be bouts of market volatility given the global growth concerns, rising interest rates and a political outlook that has rarely looked as uncertain. Despite this, we believe that our approach of buying into companies that typically have a growth and quality bias and which we buy at a discount to the prevailing market price, provides us with the opportunity to perform well across a variety of market conditions.
- Primary opportunities or liquidity events are often useful ways for investment managers to buy into a company. The price is fixed, you can buy in size and all news should be out in the market place.
- Stick to companies that have quality characteristics – strong market positions, good and stable margins, potential market disruptors, and management who deliver.
- In times of uncertainty and market volatility, it is important to hold your nerve as you buy at even greater discounts. In time, this will produce even stronger returns as markets recover.
About Oliver Brown
Oliver is investment director at R.C. Brown. He is the manager of the MFM UK Primary Opportunities Fund and other segregated accounts whilst also leading R.C. Brown’s research into UK ‘primary’ market opportunities. He graduated from Birmingham University with a degree in Money, Banking and Finance, he qualified as a Chartered Accountant with Grant Thornton, where he worked with listed clients in a variety of sectors, specialising in the construction, leisure and IT industries. He joined RCBIM in 2006 and is the current President of Bristol Junior Chamber of Commerce.