Some experts claim to see light at the end of the tunnel while for others the economic situation remains all doom and gloom. Whether you sit in the bull or bear camp, when it comes to investing, the one thing of which you need to be certain is that your clients are invested in good funds run by high quality managers.
Mike Felton, who runs M&G UK Select, is a great example of a quality manager. Currently in the cautious camp, Felton believes the US consumer is facing a perfect storm. The housing market is slowing, credit conditions have tightened, job growth is slowing, and rising energy and food bills are finally affecting the wallet.
The UK economy has all the same problems and more. He feels both the commercial and residential market “looks sick” and that we are probably a year behind the US in the cycle. We have become a heavily indebted society, so much so that for every £1 of GDP growth, the UK has borrowed £4.20. Additionally, there is a huge reliance on the finance sector and Felton says this is a dangerously lop-sided structure. It is not a rosy picture.
Big institutions such as the Bank of England feel the correction in credit markets has gone too far and that the worst of the global crisis could be over. The attention is now quickly reverting to inflation.
But, according to Felton, inflation is not the issue as deflation remains the biggest risk in a recession. As economic growth is on the decline and falling house prices have a deflationary effect, individuals cut their spending, forcing businesses reliant on discretionary spending to slash prices.
What does this mean for the M&G UK Select Fund? Felton’s strategy is to put safety first. In a concentrated portfolio of 30-40 holdings this is imperative. He is avoiding companies with high financial gearing and favouring those with strong balance sheets, sustainable dividend growth and an ability to withstand an economic downturn.
He believes earnings’ forecasts are too high and is expecting earnings’ downgrades and dividend cuts to come through from many companies. So, as earnings are set to become this year’s scarce commodity, Felton is looking for earnings’ security, often found in companies where the risk is diversified by geography or through a broad spread of products.
As many of these are bigger companies, it is not surprising to find around 80 per cent of the portfolio in large caps – the highest it has been since Felton has managed the fund.
The fund is underweight in consumer areas and banks. Interestingly, the fund manager is neither bullish nor bearish on the banking sector but notes that if bank valuations are correct, then the rest of the market needs to fall further to “catch down” to the valuation levels.
One of the advantages of this fund is it is designed to go anywhere without being constrained to an index. At its core are bigger companies that are typically long-term holdings with the aim of lowering volatility. Around this core are satellite holdings considered to be undervalued special situations. These are held for the shorter term and may be more volatile but make up a smaller proportion of the overall portfolio. The style is therefore very much bottom-up and pragmatic.
The fund’s approach is something we favour. Why be boxed into a rigid style or benchmark? In an environment where market volatility is likely to remain high, this fund is well placed to take advantage of the opportunities with its pragmatic approach. Despite the polarised opinions on the global economic climate, the key is to invest with superior managers such as Mike Felton and, over the longer term, investors should be well rewarded.
Meera Patel is a senior analyst at Hargreaves Lansdown