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Full cycle

10 MINUTES WITH…Julie Dean by James Smith

Cazenove’s Julie Dean is among the few UK managers who out-performed against the varying market between 2008 and 2010 and highlights her business cycle approach as key.

Dean was one of five managers who left HSBC to join Cazenove in 2002, alongside the recently departed Tim Russell, and she has built up a strong track record on her UK opportunities portfolio.

She took on the UK dynamic fund when Neil Pegrum left in April last year and the group has subsequently merged the vehicles to create a larger pool of assets for the focused UK opportunities offering.

Dean believes the UK equity sector remains exciting, despite being eclipsed by emerging markets in recent years, and points to a big dispersion of returns across an index such as the FTSE 350.

She says: “In 2008, Astra-Zeneca was up almost 90 per cent while HBOS was down by the same amount, reinforcing our view that what you avoid is just as important to overall returns as what you own.”

Dean says the business cycle approach, which the team brought over from HSBC, allows the managers to anticipate market changes and as there is no style bias, saw them outperform in 2008, 2009 and 2010.

Dean currently has beta below the market and holds 43 stocks in the fund, all of which she describes as “sensible businesses”.

“A business cycle does exist, which the authorities rediscovered to their surprise and our cost in recent years.

“The cycle moves through recovery, expansion, slow-down and recession – largely dictated through shifts in monetary policy – and we skew the portfolio depending on the current stage,” she says.

For Cazenove, the key factor for a company’s performance is operational gearing, or the amount of fixed costs.

With more cyclical businesses in consumer or industrial sectors, a higher proportion of costs are fixed. This means when markets enter the recovery stage and sales pick up, there is more leverage on profits and the company will outperform.

In contrast, more defensive sectors tend to have low fixed costs and therefore little operational leverage, allowing them to adapt their cost base according to demand.

The funds will typically be overweight operationally geared cyclicals in the early recovery part of the cycle, take a more balanced stockpicking approach in the expansion phase and then overweight defensives when the cycle starts to slow down.

According to Dean, we are now in the third phase as the global business cycle matures, with manufacturing profits peaking and inflation accelerating with commodity, oil and food prices all rising.

She says: “Western domestic demand is significantly lagging and a continued preference for defensive stocks seems appropriate.

“In the last 18 months, investors buoyed by ultra loose monetary policy have been looking for risk, leading to a bounce in mining stocks, for example. Cyclical stocks have moved to a substantial valuation premium over defensives and works nicely for our approach as we focus more on these latter areas.”
Dean believes the global economy has come back from the brink – but little more.

She says: “Industrial production has rebounded sharply but the inventory rebuild phase is coming to an end now and there is little demand to sustain growth.

“US unemployment has only slightly improved since the credit crisis and while exports and manufacturing have performed well, the service sector needs to reaccelerate before we see a sustained improvement in the West.”

Against this background, Dean is overweight defensive growth sectors and heavy in consumer and industrial cyclicals, as the market waits to see whether the recent slowdown is temporary.

Her key underweight is commodity cyclicals as the group is convinced current prices are too high and the status quo is unsustainable.

“The case for defensives is clear, with premium quality but discount valuations.

“We currently favour so-called scissor stocks, with a low price-to-earnings ratio but better earnings growth prospects than the market anticipates. Investors should remember many defensive names are also exporters to high-growth economies but sell whisky, medicine or intellectual property rather than raw materials,” she says.

“As China moves away from the infrastructuredriven cycle to a post-industrial consumer-led phase, we believe many of these older FTSE companies can outperform.”

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