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Sector focus: The UK All Companies funds meeting the economic challenge

Despite ongoing economic difficulties and a challenging market background, a similar list of funds continues to dominate performance tables for the UK All Companies sector.

Slater Growth remains the peer group’s standout performer over three and five years to mid-October, although its numbers have dropped off in 2012 as risk aversion has spiked once again.

Mark Slater
Mark Slater

Former journalist Mark Slater has more than quadrupled the sector average over three years, highlighting his focus on dynamic and cash generative growth companies at sensible prices.

“Our holdings will typically be in either fast-growing or niche areas as companies able to show consistently dynamic earnings growth will be re-rated upwards, particularly in more difficult markets,” he adds.

“While the average UK quoted company has lacklustre prospects, well-selected growth businesses have continued to produce strong earnings growth.”

Looking at some key holdings, Slater continues to back stocks such as Hutchinson China, citing its strong turnover and profits and no debt.

Speaking earlier this year, he said: “Hutchinson has identifiable tailwinds as the Chinese Government is spending a lot of money to improve the healthcare of urban workers. The company is exposed to the China theme but a healthcare stock is not dependent on whether GDP grows 6 per cent or 9 per cent whereas commodity plays are.”

Other favoured names include IT security company NCC and LED lighting specialist Dialight, which has been the strongest contributor to performance in 2012.

On the former, Slater said: “NCC provides cheap insurance guaranteeing access to computer programmes in the event the manufacturer goes out of business. This is where big corporates pay small amounts of money to ensure they’ve got access to source code from their software providers. This is an almost annuity-style income business, with people renewing each year.”

NCC has also built a second prong to its business in the shape of so-called ethical hacking, with these hackers stress testing people’s internet security.

Other consistent performers over recent years include Liontrust Special Situations and Unicorn Outstanding British Companies, with both seeking out very specific types of stock.

Chris Hutchinson

On the Unicorn portfolio for example,managers Chris Hutchinson and John McClure focus on businesses with a secular growth profile, with several holdings offering a specialist product or service into a niche market.

“This creates pricing power and prevents margin erosion and we tend to own companies with market-leading positions, preferably on a global basis, and lasting competitive strength,” adds Hutchinson.

“We also look for stocks where earnings and cashflows are predictable to some extent and like high recurring revenues and return on capital.”

Other key criteria are a consistent track record of operating performance, low debt levels, experienced management who maintain a meaningful equity stake and clean intelligible financial statements.

“If a company does not meet the majority of these criteria, we simply will not own it,” says Hutchinson.

“British management teams are world class and our engineering skills in particular are unequalled, with Rolls Royce one of our largest holdings for example.” 

Anthony Cross
Anthony Cross

Meanwhile, Liontrust Special Situations – second in the peer group over three and five years –is run by Anthony Cross and Julian Fosh based on their economic advantage process.

Once again, this is an exacting stock filter, with the pair looking for intangible strengths that create defendable barriers to entry.

Economic advantage has three main strands, intellectual property, distribution and recurring contracted revenue.

While UK’s economic outlook remains difficult, Cross says there are plenty of opportunities to invest in companies with global profiles and more than 60% of sales from fund holdings now come from overseas.

“Weremain heartened by the continued strong profit performance of nearly all of our businesses and would highlight names like Diageo,” adds the manager.

“This is a classic export business with long established distribution networks and the company is continuing to grow as it expands into new markets in Asia, Africa and Latin America.”

Cross and Fosh are also fans of NCC, picking up shares cheaply this year when the price fell on the back of a written off project.

With several top-performing managers focusing on mid-caps, it is little surprise to see funds investing purely in that part of the market among the best returners.

Neptune UK Mid Cap ranks third over three years – and heads the list over 12 months – with manager Mark Martin citing less coverage of his chosen area and greater entrepreneurial character as reasons for a Mid 250 bias.

More than a quarter of the portfolio is in consumer discretionary names, although Martin has no exposure to generic high street retailers.

“Hotels and housebuilders are interesting subsectors highlighted by Neptune’s in-house sector research,” he adds.

“The hotel industry is supply-constrained: it is very difficult to build new hotels in prime locations, particularly when debt finance is hard to come by, his is clearly advantageous for incumbent operators. On the other side of the equation, demand is forecasted to stay strong driven by growing corporate profitability, especially in emerging markets.

“Meanwhile, housebuilders are being actively supported by the government as there is a shortage of supply of homes and the construction industry is a strong driver of economic growth.”

Industrials is another key position – also accounting for more than a quarter of assets – with Martin preferring companies that are global leaders in their chosen niche such as BBA Aviation.

Elsewhere, Cazenove’s UK Opportunities fund takes a different approach in the sector, with its business cycle process performing against varying conditions in recent years.

Manager Julie Dean says the cycle moves throughrecovery, expansion, slowdown and she skews the portfolio depending on the stage.

For Cazenove, the key factor for company performance is operational gearing, which basically means the amount of fixed costs.

With more cyclical businesses, a higher proportion of costs are fixed, so 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, meaning they can adapt their cost base according to demand.

Against a tough background, Dean is maintaining an overweight in consumer cyclicals, seeing valuations as still supportive despite the sector’s outperformance in 2012.

“We continue to favour financials over commodities – the former have proved to be a good source of beta in liquidity-driven QE rallies but there are also signs of improving fundamentals for banks,” she adds.

“Investors still seem to be positioned very defensively but if we are correct in our reading of the next phase of the business cycle, economic data ought to start surprising positively – so this defensive skew is likely to unwind.”


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