Portfolio manager Mike Deverell on how post-election political clarity in the UK has helped drive a revival in the equity market.
One subject we have been almost constantly talking about over the past few years has been political uncertainty. “You haven’t been able to get away from it,” says our long-term growth portfolio’s manager Mike Deverell, of Equilibrium Asset Management. “Trump, Brexit, the US-China trade war: it has all had a big impact.”
Deverell points out that Equilibrium has consistently been a supporter of Asian and UK markets, particularly smaller company stocks, but that world events have been holding back returns in those markets. “We said we’d need to see some certainty on these events to see a turnaround,” he says.
In the last quarter of 2019, however, it seems that has started to happen. “What we’ve seen, particularly since December, offers at least some certainty,” says Deverell. “We had the election, which lets us know what’s happening with Brexit – in the short term anyway.”
What’s more, on the same day as the election (12 December 2019), Donald Trump announced that phase one of the US trade deal with China had been agreed. Deverell says: “While phase one of the trade deal is not massively significant, it at least means [the trade war] is not escalating for now.”
Unsurprisingly, the best performers in the portfolio over the past quarter were primarily those with a focus on UK domestic stocks. This was in large part due to the increased certainty regarding Brexit.
According to Deverell, international investors have started to move back into UK stocks. He says: “Think about a European or US investor looking at the UK. All surveys show they have been underweight on the back of Brexit fears.” After the success of the Conservative Party in the 12 December election, “the first thing they did was cut their underweight position by buying the FTSE 100 or FTSE 250”.
Marlborough Special Situations was the portfolio’s best performer, returning 9.6% over the three-month period. “That’s done really well,” says Deverell. “While it has some FTSE 250 exposure, it holds mostly small-cap stocks. As a result, it has had a pretty difficult couple of years. But we felt it was unfairly punished and that there are good companies in the fund that are good companies despite Brexit.”
The second-best performer was Royal London UK Equity Income, which returned 7.1%.
Nick Train’s Lindsell Train UK Equity fund fell in value by 2.4% in the quarter. The fund invests in stocks with international exposure, so its holdings were not likely to benefit from the so-called Boris bounce. However, it has come under strong criticism lately, with many critics raising the alarm about its inability to sell out of large holdings it has accumulated, in the event of a run of redemptions by investors. The fund recently lost its Morningstar gold star status.
Deverell says: “We are not massively concerned about that. Train does have very big positions and the fund is quite large now, so it is on our radar and it might struggle to repeat its performance, given its current size, but I don’t think there is much to worry about yet. It is certainly not another Woodford in the making.”
Still vigour in the rally
However, with the Boris bounce now done and UK assets to some extent back in favour, is it time to sell some of the portfolio’s UK-facing funds and take some profits? Deverell thinks not. He says: “The rally in UK assets has still got quite a bit to run.” He adds that while investors have been moving from underweight towards a more neutral position, few are yet overweight.
Indeed, Deverell has added a new UK domestic-focused fund to the portfolio: Miton UK Value. The purchase was funded using the portfolio’s cash, which now stands at zero.
He says: “We bought this the day after the election. We were already overweight in UK small cap, but after the election we extended this.”
The new fund can invest in UK stocks across the market cap spectrum, Deverell explains: “It has a value bias: it looks for stocks that are pretty cheap.” With so many UK stocks currently cheap, this focus should give the fund plenty of investment opportunities. “In terms of places to be and returns, UK value is the place to be, rather than just UK small caps,” Deverell adds.
Brexit was not the only risk on which the election result provided some clarity. Under the leadership of Jeremy Corbyn, the Labour Party had committed itself to nationalising certain UK industries, including infrastructure companies, should it come to power.
One portfolio constituent, Lazard Global Listed Infrastructure, has a position in National Grid, one of the companies Corbyn promised to bring under public ownership. Partially as a result of this threat disappearing following the Conservative Party’s election victory, both this and the portfolio’s other infrastructure fund have done well.
Meanwhile, both have also benefited from the broader market uplift over the last quarter of 2019, with infrastructure stocks often moving roughly in line with the market.
That, however, is not the whole story. Deverell points out that governments around the world, including the Tory government in the UK, have been committing themselves to increasing infrastructure spending. This bodes well for companies involved in the sector.
The portfolio’s bond funds were star performers through much of last year. More recently, says Deverell, “generally bonds came off after a strong performance”. Bond funds broadly provided returns close to zero in the last quarter. The portfolio’s worst performer, however, was L&G Allstocks Index Linked Gilt Index, which suffered a loss of 10%.
Deverell says there were two reasons for its poor performance. First, index-linked gilts tend to be long-dated, and long-dated bonds usually undergo more exaggerated movements. This was the case in the third quarter of 2019, when the fund returned more than most other bond funds.
Second, there was increased positivity about Brexit. Fears of a no-deal Brexit and potential rate cuts to alleviate it dissipated, so UK bonds have seen a reversal in price, which explains the L&G Allstocks fund’s losses.
Trade deal positivity
As already mentioned, the agreement on phase one of a new trade deal between the US and China bought much-needed relief to markets, including those in Asia. As a result, Schroder Asian Alpha achieved a healthy return of 5%. Europe, being reliant on exports, also benefited, with BlackRock European Dynamic returning 4.9%.
Japan, however, continued to struggle, with Baillie Gifford Japanese declining by 2.9%. Deverell says Japan struggled as a result of the trade war, as many of its companies are reliant on exports. However, the country failed to benefit from the subsequent turnaround enjoyed by other Asian markets. He puts this down to disappointing internal economic data and a strong yen, which dampened overseas demand for exports.
Deverell has long been clear about his bearishness on US equities and his resulting underweight position. He says: “We’ve spoken before about price-to-earnings in the US. Nothing has changed looking at the situation today. Everything we look at confirms our concerns on a purely valuation point of view. Alongside price-to-value, you can see that the ratio between the US stock market and GDP is at an all-time high. These and other metrics all typically mean lower returns in future.”
Deverell thinks there are better opportunities elsewhere. He says: “A lot of people might hold 50% in the US, but we think that’s a dangerous thing to do.”
Mike Deverell is an investment manager at Equilibrium Asset Management.
UK weighting has proved its worth in the recent equity rally
|Fund||Sector||Value at purchase (£)||Current value (£)||Gain/loss since purchase (£)||Gain/loss since purchase (%)||Three-month change (£)||Three-month change (%)|
|Royal London Short Dated High Yield Bond||Fixed int - global high yield||4,990||5,341.57||341.57||6.8||32.77||0.6|
|BlackRock Corporate Bond Tracker||n/a||4,990||5,502.31||502.31||10.0||-39.92||-0.8|
|Jupiter Strategic Bond||£ strategic bond||4,990||5,490.55||490.55||9.8||-42.46||-0.8|
|TwentyFour Dynamic Bond||£ strategic bond||4,990||5,628.47||628.47||12.6||93.51||1.8|
|L&G Allstocks Index Linked Gilt Index||n/a||4,990||5,021.53||21.53||0.4||-495.40||-10.0|
|Kames Property Income||Property||4,990||5,118.38||118.38||2.4||1.60||0.0|
|H2O Multi-returns||Targeted absolute return||4,990||6,871.45||1,871.45||37.4||210.51||3.8|
|FP Foresight UK Infrastructure Income||Infrastructure||5,990||6,392.06||257.79||4.4||257.79||4.4|
|Janus Henderson UK Absolute Return||Targeted absolute return||5,852||5,868.85||16.85||0.3||16.85||0.3|
|Lazard Global Listed Infrastructure||Equity - other specialist||5,803||6,176.76||1,176.76||23.5||181.05||3.4|
|CF Miton UK Value Opportunities*||UK all companies||5,932||6,033.44||100.56||1.7||100.56||1.7|
|CF Miton UK Multi Cap Inc||UK equity income||4,611.74||611.74||15.3||303.76||6.7|
|Royal London UK Equity Income M Acc||UK equity income||3,990||4,841.87||841.87||21.0||310.97||7.1|
|Lindsell Train UK Equity||UK all companies||3,990||5,468.05||1,468.05||36.7||-114.86||-2.4|
|Marlborough Special Sits||UK smaller companies||3,990||4,991.52||991.52||24.8||480.96||9.6|
|Baillie Gifford Japanese Co.||Japan||7,990||9,847.47||1,847.47||23.1||-285.77||-2.9|
|BlackRock European Dynamic||Europe ex UK||4,990||6,569.20||1,569.20||31.4||300.15||4.9|
|Vanguard US Equity Index||n/a||5,990||7,946.89||1,946.89||32.4||105.40||1.5|
|Schroder Asian Alpha||Asia Pacific ex Japan||7,990||9,993.19||1,993.19||24.9||464.16||5.0|
Note: *Bought on 13 December 2019. Less £20 dealing costs for sale of old fund and purchase. Portfolio inception was 1 April 2017. Source: Equilibrium, as at 1 January 2020.