Stay at home with unloved builders
One of our big themes at the moment is cheap defensive companies. There has been a rush into a number of defensive companies and, as a result, these look very highly rated. Nestle is one example of this. However, there is another set of defensives that is not nearly as highly rated but has many of the same characteristics. Profits and cashflows are reasonably resilient but there are reasons that the market does not like them as much, such as the perception that they cannot deliver the same year-in year-out earnings’ growth as other defensives.
But we believe that, over five years, some of the reasons people give for not owning them are overdone. Valuations are compensating investors and many companies are deploy-ing their strong cashflow into shareholder-friendly activities such as big dividends or buybacks. Telecoms are a good example and we particularly like Vodafone. Management have done a very good job of tidying up areas where the group has over-expanded in the past, and then growing the dividend and buying back shares. The group has also started to get a dividend out of its US business.
Another theme to look at is some of the unloved domestic companies. The world has decided that everything domestic is poor in the UK, letting macro concerns override company fundamentals.
We have been here before. We believe the domestic economy will remain tough but a number of the domestically-focused names are priced to implode. For example, consumer-facing sectors such as housebuilders or some of the high-street names are completely unloved.
Taylor Wimpey is a good example. No one knows what will happen to house prices but we do know what has happened to Taylor Wimpey’s balance sheet. The group has significantly reduced debt and that has substantially reduced risk. You do not necessarily need high house prices to make money as a housebuilder.
Kevin Murphy, Schroder recovery
Phones can be a portal to profit
We have both multi-year observable, investable trends in the portfolio alongside shorter-term tactical viewpoints. An important long-term theme has been the networked world. It is harder to play in a UK-based fund but we have invested in it through the telecoms sector and companies such as Carphone Warehouse.
The adoption of smartphones as a portal to the internet is a good example of how the world is changing. We like Virgin Media, which is benefiting from the increase in broadband penetration, the vogue for downloading films and watching videos on iPlayer. Virgin Media has a fibre-optic network as well.
We also have a developing economies theme, which is based on the global realignment from developed markets to emerging markets. Lots of UK companies are international in their earnings’ base and provide a less obvious way to get exposure to the growth in the emerging world. We hold companies such as BAT , Unilever and Tesco with this in mind.
The UK market is not in fantastic shape and we do have a bias to overseas earnings in the portfolio. One of our short-term viewpoints is that we are cautious on the prospects for the UK economy, which leads us to seek UK companies that are deriving their earnings elsewhere. We have some utilities with domestic earnings but these tend not to be GDP-sensitive.
Ben Russon, Newton UK opportunities
Rely on the defensive
There are two broad themes behind the portfolio positioning at the moment. At the start of this year, it was all about emerging markets-led earnings’ growth. We had a big bias to industrial cyclicals but any country that had exposure to emerging markets was doing well.
It felt uncomfortable to be invested in companies such as WH Smith and William Hill as everyone knew that the UK consumer was under pressure. Analyst expectations were very bearish. Many were trading at less than 10 times earnings and profits were much lower than they had been in the past. In contrast, emerging market companies were trading at around double the weighting, expectations were very high and it was difficult to see what needed to happen for people to become any more optimistic. They were simply too excited about the earnings on offer.
We were much happier selling companies that had done well over the previous two years and redeploying that capital into more domestic cyclical companies or ones that were high quality with stable and reliable earnings but dull and boring, such as the pharma-ceuticals. Now people have re-engaged with the idea that these companies are more defensive and reliable.
In general, this view has not changed and we are still defensively positioned. For us really to shift the portfolio around, we would need to see much more stress in the market. People forget just how extreme valuations can become. When the market sold off, it had begun to move back in the right direction but to shift the portfolio round again, we would need to see the spreads in valuations between defensive and cyclicals widen out much more.
That said, we have tentatively bought back into the mining sector but only at the margin. We would like to see operating profits and commodity prices come back a little before getting too excited, as operating profits still look very high relative to where they have been in the past. It is a case of cheap valuations but expensive profitability. Companies in general are in a very different place from where they were in 2008.
Philip Matthews, Jupiter growth & income
Strength in resources
We are in a world of low global growth and because of all the current issues the eurozone crisis, US debt, widespread deleveraging that is likely to continue.
However, there are pockets of strength, notably Asia, and this means that the global economy is likely to muddle through. In that environment, corporate profitability can continue to show progress.
At the same time, equity valuations look reasonable. The UK equity market is on around nine times forward earnings and has a dividend yield of 4 per cent. Payout ratios are strong. As such, the equity market looks attractive even if growth is sluggish.
However, the euro-zone crisis has left people feeling very nervous, so they are defensively positioned. If those fears dissipate, there is scope for the equity market to make good progress. Some economic data is already coming in better than expected unemployment rates, consumer confidence figures and, more recently, Chinese PMI data. Of course, the final piece is what happens in the eurozone. I do not expect a big plan but at each stage we get more tools for dealing with the crisis.
As a result, the areas that we believe are attractive are those that have been significantly knocked back. We believe that the defensive areas have performed very well over the summer and relative valuations now look stretched. We are particularly keen on the resources sector and are long-term believers in the growth from India and China. Supply struggles to keep up, balance sheets are strong and valuations are attractive. In terms of companies, we like Xstrata and Rio Tinto. In the oil services sector we also like Petrofac and Wood Group.
US economic data is stronger, so we like companies with good US exposure. Wolseley is a good example. It has been a turn-round situation and the new management has done an excellent job of rebuilding the business.
Simon Murphy, Old Mutual UK select equity