The year 2012 was a very strong one for UK equities – particularly mid caps – but the manager of the five crown-rated Neptune UK Mid Cap fund says a combination of cheap valuations and improving investor sentiment will mean 2013 is just as strong.
"There are a lot of things to be positive about, and crucially, markets are still cheap," Martin (pictured) commented. "The All Share is on a price/earnings ratio of 12 times, which is usually associated with an annual return of 10 per cent." "First of all, we expect M&A to increase – there are a lot of large companies that have cut costs and their margins are very high. There’s not much room for these margins to expand and we expect there to be an increase in investment as a result."
"I do think we need to see some more stability in the markets though, as the biggest thing holding back chief executives is volatility."
"A lot of what Mario Draghi said last year about standing behind the euro helped, but there are still a few things to be watchful of, like the German and Italian elections."
"That said, I think the markets will move past these concerns."
Martin highlights AG Barr – a UK drinks manufacturer that he holds in his portfolio – as an example of a stock that is already benefitting from M&A. The stock is in the process of merging with Britvic.
The manager is also optimistic about the "funding for lending" scheme – a government policy that allows UK banks to borrow at more appealing rates – which he believes will give the UK consumer a welcome boost.
"This is a major positive for 2013, in my opinion," he said. "Household and corporate credit quantities have improved and the latest survey suggests this will either improve further, or stay at the same level."
"The survey also suggests that the reason for the improved credit quantities is a result of the funding-for-lending scheme, which is very encouraging."
Martin believes the significant demand for house builders – a sector in which he is significantly overweight – highlights the improving state of the UK consumer market.
Finally, he points to the "patent box" policy, which will enable UK companies to apply a lower rate of corporation tax to profits earned after 1 April 2013 from their own patented innovations, as another possible driver of performance.
"This is a very positive move for tech companies and also healthcare companies – an area I’m overweight in," he said.
"This will be very positive for these companies, as it drops the rate of tax to 10 per cent."
"This is a nice little tailwind. It’s good the government is incentivising R&D and we’re seeing more businesses investing their ideas in the UK as a result."
Healthcare is currently Martin’s biggest sector position, making up more than 30 per cent of the portfolio.
Commenting on the mid cap market in particular, Martin says investors would be wrong to view this area as expensive, even though it had a very strong 2012.
"The All Share is trading on 10.9 times next year's earnings, while the FTSE 250 is on 12.2 times," he explained. "Some may say this makes it expensive, but if you look a little more closely, this isn’t the case."
"The top-20 companies in the FTSE 100, which make up a big share of the total index, are rated very lowly at 10.4 times, while the 80 smallest companies are on 13 times."
"This is a better comparison and it’s encouraging to see valuations are still at cheap levels."
Performance of fund vs sector and index over 1-yr
Source: FE Analytics
Neptune UK Mid Cap is up 39.96 per cent over the last year, compared with 24.91 per cent from its FTSE 250 benchmark, and 15.1 per cent from the average IMA UK All Companies fund.
Only one portfolio in the sector – Standard Life UK Equity Unconstrained – has returned more.
Since its launch in December 2008, the fund is up 171.04 per cent – beating its benchmark and sector by 38.82 and 95.78 percentage points, respectively.
Martin’s fund requires a minimum investment of £1,000 and has a total expense ratio (TER) of 2 per cent. In spite of its very strong absolute and relative performance, it only has £48m assets under management (AUM).
Martin will speak in more detail about his 2013 outlook during a series of presentations at the Alpha Generators roadshow later on this month, which will take place across nine locations in the UK.
If you’re a financial adviser and are interested in going to one of these events, please register here.