Mark Barnett, who manages nearly £20 billion for Invesco Perpetual, is confident he can turn performance around in 2018.
It is almost four years since Mark Barnett was given arguably the toughest job in fund management: stepping into the shoes of Neil Woodford, who is widely regarded as one of the UK’s most successful investors.
Barnett was not an apprentice when he stepped up to the plate: he had been managing portfolios for Invesco Perpetual since the late 1990s and had proved his worth in the job by consistently maintaining an edge over the wider UK stock market. But in taking over the £10.2 billion Invesco Perpetual High Income fund and £5 billion Invesco Perpetual Income fund, Barnett accepted the challenge of running much larger portfolios than he had previously overseen – and with the territory came greater scrutiny.
Moreover, he was also handed a bigger workload, as lead manager on three funds and four investment trusts. Over the past year or so his duties have been cut back: he no longer oversees Invesco Perpetual Select UK Equity fund or Keystone investment trust. He now manages five funds, the three others being Perpetual Income and Growth investment trust, Edinburgh investment trust and Invesco Perpetual UK Strategic Income.
Since Barnett assumed control of the two mammoth income funds on 6 March 2014, he has experienced, to borrow the famous football commentator cliché, a game of two halves. Initially, as the chart shows, Barnett’s stockpicking skills outwitted the index, at a time when he had to sell some of the largest holdings he had inherited to deal with the redemptions that followed Woodford out of the door.
However, over the past 18 months or so performance has taken a turn for the worse, so much so that over the near four years since Barnett took the hot seat, both the headline funds have underperformed the FTSE All-Share index’s gain of 32.5 per cent. Invesco Perpetual High Income is showing a return of 28.2 per cent, while Invesco Perpetual Income is up 25.5 per cent, FE Analytics data shows.
He is not alone in going through a rough patch. His old colleague Woodford has also been slipping down the performance tables. A closer look at both investors’ portfolios reveals certain commonalities that have caused both performances to dip. Most notably, both Barnett and Woodford have focused on domestically oriented UK companies, such as retailers, housebuilders and insurers. This area of the market has been given the cold shoulder since the Brexit vote. The winners have been the big international corporations, whose overseas earnings benefited, at least initially, from the pound depreciating against the dollar and the euro.
Both managers argue that UK stocks exposed to the UK economy have been unfairly penalised by the wider market and that at some point the crowd will come around to their way of thinking. They also share the view that sentiment towards the UK economy is far too bearish, which has led both domestic and international investors in their droves to dump UK shares. Over each of the six months to last November, money was withdrawn from the Investment Association’s UK All Companies and UK Equity Income sectors. Over the period billions of pounds exited UK funds.
Painful and costly
Barnett accepts that performance of late has not been up to scratch, but he remains confident that he has tilted the portfolio towards the part of the UK equity market where the biggest bargains lie. ‘Over the past couple of years performance has been disappointing. I have been on the wrong side of the sterling move, and it was painful, as well as costly, to see one of my biggest holding, Provident Financial, fall so heavily last summer,’ he says.
‘The way I have positioned the funds does feel uncomfortable, but I am not going to let the performance of the past two years deter me from investing in the area where I think there is a significant amount of value. At the end of the day, I am an active manager and taking a contrarian view, so it is a fact of life that I will behave differently from the index.’
Domestic stocks are offering ‘depressed valuations’, which makes him a ‘happy buyer’. He says: ‘The market believes the UK economy is going to run out of steam, which is why there continues to be this polarisation between domestically focused stocks and international names. I think these fears are misplaced and that the underlying UK economy is in better condition than the market believes.’
Barnett points to the UK’s unemployment rate, currently at a 42-year low, as a sign of economic strength. Last November’s interest rate rise is another sign that the economy is in a healthy state, he says, and there’s further scope for more monetary easing in 2018. ‘I wouldn’t be surprised if the market consensus is wrong and interest rates rise a couple of times over the next year or so, although of course any increase is not going be aggressive.’
He adds: ‘I am not saying the UK economy will race away, but I do think it is performing better than expected and that there’s too much pessimism, which is reflected by the valuation anomaly present in the UK stock market. Domestic stocks are trading on price-to-earnings ratios of less than 10, half the multiples international earners are offering.’
He highlights Next as one of the standout bargain shares in the UK market. It offers a total dividend yield (including special dividends) of around 8 per cent. ‘The dividend is backed by strong cash flows, and my view is that the market is overly pessimistic about the threat of Amazon and other online retailers, particularly when Next itself has been responding by upgrading its digital offering,’ he says.
The UK property sector is also offering low valuations, which has led Barnett to invest in Shaftsbury and Derwent London. Oil shares have also been on Barnett’s shopping list, including those of BP and Royal Dutch Shell. Market-beating yields of 5.9 and 5.8 per cent respectively catch the eye, but some investors, including Woodford, are steering clear on the grounds that the businesses are over-distributing and that their dividends may fall away. Barnett does not share these concerns.
Appraising the unloved sectors
One area on which he is lukewarm is the UK banking sector. Woodford avoided domestically focused banks for well over a decade, but he returned to the sector last year when he snapped up shares in Lloyds Banking Group. But Barnett is steering clear.
‘I don’t think the dividend growth forecasts that have been made by bullish analysts are going to come through for UK domestic banks. The sector remains challenged in terms of the regulatory outlook. I don’t agree that banks have reached a sort of regulatory stalemate and will now be in a position to pay higher dividends,’ he says.
Backing an unloved part of the market to bounce back is a ‘lonely place to be’, Barnett says, and the risk is that domestic stocks remain out of fashion, particularly if the UK economy takes a turn for the worse. The Brexit negotiations, which will rumble on until the UK leaves the EU next March, add a big dose of uncertainty . He is hoping for a soft Brexit. However, he says: ‘ I think UK market sentiment is misplaced. There’s a disconnect that is not reflected in the price tags on domestic stocks.’
Another headwind that could derail Barnett’s prognosis is inflation, which in November hit its highest level since April 2012. Inflation reduces consumers’ spending power, which hampers the domestic businesses he has slanted his portfolios towards. The UK’s low productivity is also a problem. Barnett has a counter argument to both of these threats as well. He describes the current 3 per cent inflation rate as ‘temporary’, as it still factors in the sharp fall in sterling following the Brexit referendum. Once this falls out of the equation, he expects inflation to cool.
On the issue of the UK’s low productivity, he says a pickup in wage growth, which has been anaemic for some time, is the answer to the problem. ‘The absence of wage growth has meant that employers have been able to hire extra labour, which has driven productivity down. But if wage growth returns, businesses will get more out of their existing employees rather than hire more people.’
My best investment...
Reynolds American, which I owned from 1998 until it was taken over earlier this year by British American Tobacco.
My worst investment and lesson learnt...
Worst investment was probably Yell. A reminder to tread very carefully when buying into companies which appear to offer attractive recovery potential. Sometimes these businesses are so cheap for a reason.
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In my dreams my alternative career would have been a professional tennis player.
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