The fashion for focusing on companies with cash on their balance sheet has gone too far, according to
Philip Matthews, manager of the
Jupiter Growth & Income fund, who says that investors are missing out by avoiding companies with debt.
Matthews
(pictured) says that companies with gearing are now cheap on a valuation basis and he has been upping his exposure to these names as a result.
"One area we are finding opportunities is in companies that have gearing on their balance sheet," he said.
"Having gone into 2008/2009 with lots of investors not really understanding the negative impact of gearing when things go wrong, over the last three years investors have really been praising companies with cash on the balance sheets, and that has gone too far."
"Whilst we are sensitive to the negative impact of gearing when things go wrong, it can work in your favour in up-markets."
Matthews has built positions in property company Granger, pub company Spirit group and private equity firm 3i, all of which have substantial debts.
The strategy is paying off, with Jupiter Growth & Income up 15.37 per cent over six months while the average fund in the IMA UK All Companies sector has made 14.21 per cent and the FTSE All Share index has made 12.19 per cent.
Performance of fund vs sector and benchmark over 6m
Source: FE Analytics
The £365.8m fund is also a top-quartile performer over three, five and 10 years, according to data from
FE Analytics, and is yielding 2.8 per cent.
Matthews has a rigorous concentration on value, which leads him to switch exposure between sectors as valuations dictate.
This has led him to buy in to stocks in areas of the market that many investors have been shunning, such as those dependent on the UK consumer.
"Last year, GDP growth was dismal in historical terms and also against expectations, but some of the best-performing companies were from those sectors most exposed to the UK consumer, for example Barrett the housebuilder, Dunelm in retail, and TalkTalk," he said.
"This is not an investment approach driven by top-down thinking, for a couple of reasons."
"One, it’s very difficult for investors to get that right over the long-term. But more importantly, it is not a very good predictor of which stocks are going to perform well or badly. Last year was a very good example."
Matthews says that the low valuations of the companies meant they were better able to withstand a poor year for the market.
He adds that his research shows that those companies which are in the lowest quintile in terms of P/E (price/earnings) significantly outperform over the next five years.
"Low valuation has been a strong predictor of future returns," he said. "So valuation is key."
The manager and his team screen for stocks with the best combination of value and returns and look for where profits are strong in cyclical terms.
"We look at price-to-10-year average earnings as much as forward earnings, and operating margins within a historical context."
Being led by this kind of analysis means that the make-up of the fund can change substantially.
In 2009 the company had a high weighting to more cyclical names such as Next, Rolls-Royce and IMI, while in 2009/2010 it had more exposure to companies dependent on Government money.
Currently the manager likes financial stocks such as Schroders, the LSE and Tullett Prebon.
"Currently, financials are one of the few areas of the market where we are able to see some earnings momentum coming through."
He says that HSBC is still looking cheap in historic terms, despite a strong run that has seen it make 27.75 per cent over the past 12 months.
Performance of stock vs index over 1yr
Source: FE Analytics
"Its valuation is relatively low compared to where it was in the past. We think it will be able to use its deposits more efficiently and grow earnings."
In comparison, he says that defensive, "bond-like" equities such as consumer staples are now looking expensive, having been re-rated for their more defensive properties.
Matthews says that he sees mixed signals in the state of the UK market, making it hard for him to call its overall direction.
"Valuations still look relatively cheap in absolute terms, looking at trailing price-to-earnings."
"We are relatively cautious, however, given where operating margins are within the market. We think for large parts of the market, profits are looking cyclically extended."
"However, earning levels have fallen so we think balance sheets are robust enough to cope with a drop-off in profits if it happens."
"Long-term valuations are looking expensive, however, with the Schiller P/E at 14.4 times compared with a historic average of 12.7 times."
Jupiter Growth & Income requires a minimum initial investment of £500 and has an ongoing charges fee of 1.77 per cent, according to data from
FE Analytics.
Matthews also co-manages Jupiter Income.