Since the financial collapse in 2008, markets have been behaving erratically, subject to the whims of investor sentiment and central bank intervention. Legget (pictured), manager of the Standard Life UK Equity Unconstrained fund, says that the risk on/risk off environment is finally coming to an end, meaning that stock prices will no longer be dictated by either extreme pessimism or euphoria.
Fundamentals, he says, will now be the most important factor when picking stocks, meaning that similar companies will no longer perform in unison.
"As a result [of sentiment], you had stocks moving in two baskets," he explained. "But this year has been very different."
"To use the example of banks, there has been an opportunity to make a lot of money in banks this year by owning Lloyds. Equally, there has been an opportunity to underperform the market quite significantly by owning another bank – Standard Chartered."
Investors who selected Lloyds at the start of 2013 have seen the UK bank outperform the FTSE All Share by nearly 50 percentage points, while those who hold Standard Chartered have lost 5.6 per cent, nearly 25 percentage points behind the All Share.
Year-to-date performance of stocks vs index
Source: FE Analytics
Legget says investors can no longer take overarching sector bets because the correlations within sectors have broken down this year.
"Historically over the last three or four years, sectors have moved in lockstep, with all the stocks typically going up or going down," he said.
"But there’s much more differentiation this year and we’re seeing a big breakdown in correlations between individual stocks."
The manager says this trend became apparent to him when his fund, which was the best performer in the entire IMA universe in 2012, became comparatively less volatile than its peers even though its holdings remained relatively unchanged.
FE data supports his view: over the last five years, the Standard Life UK Equity Unconstrained fund was more than 10 percentage points more volatile than both the IMA UK All Companies sector and FTSE All Share, with an annualised score of 26.89 per cent.
However, this figure has narrowed significantly over the last 12 months compared with the sector and index, to just 13.08 per cent. The FTSE All Share has an annualised volatility score of 11.63 per cent and the IMA UK All Companies sector 10.37 per cent, according to FE Analytics.
Legget’s fund is one of the best performers in the entire sector over the last one, three and five years, more than tripling the returns of its peers over the longer time frame. It has also significantly outperformed the FTSE All Share over each period.
Since launch in September 2005, Standard Life UK Equity Unconstrained has made 293.2 per cent. The sector and index have returned 71.24 per cent and 70.82 per cent respectively over this period.
Performance of fund since launch vs sector and index
Source: FE Analytics
Legget looks for companies that provide a growing stream of earnings and that are under-appreciated by the market at large.
He has cut back on his exposure to the UK consumer because the sector has had such a strong run over the last 12 months and has recycled money into Europe instead.
"Europe is in the foothills of the re-rating you’ve seen from things like Howden Joinery," he said.
Legget is also selectively buying back into UK names with exposure to emerging markets, where he expects to see a change in fortunes over the medium-term.
One of the manager’s highest-conviction bets, making up 2.9 per cent of the fund, is Howden Joinery, the leading supplier of kitchens and joinery products to small builders in the UK.
The stock has benefited from a significant re-rating, picking up 93.4 per cent over the last 12 months. As a result of its stellar outperformance, Legget thinks the stock is starting to look expensive and says it will need earnings growth of 60 to 70 per cent in order to drive it back to levels where it looks fair value.
While it is a stock the manager continues to hold, he says he expects to see more limited upside from here and a steadier, more boring return in the future.
Legget has recently picked up a holding in out-of-favour bank Standard Chartered. While the stock is down so far this year, Legget says it is one of the few stocks that has de-rated in a market that has re-rated.
"There is significant scope for a re-rating at some stage over the next three years as investors get more optimistic about emerging markets again," he said.
Standard Life UK Equity Unconstrained requires a minimum investment of £1,000 and has ongoing charges of 1.9 per cent.
