Industry experts agree that the growth outlook and other general concerns regarding developing countries have been the main drivers of the recent sell-off in equities.
Our data shows that many of the worst-performing stocks this year are defensive UK mega caps such as Unilever, Diageo and SAB Miller, which derive a large proportion of their earnings from emerging markets
Performance of stocks vs index in 2014
Source: FE Analytics
Warren, who achieved FE Alpha Manager status in this week’s re-balancing, is unable to reveal exactly which stocks he is shorting in his fund for compliance reasons; however, he says that the share prices of the UK’s large cap emerging market plays are likely to continue falling.
“We don’t disclose our short book, but it tends to have much more of a large cap bias,” Warren said.
“The reason for this is that as long-term investors, we see better growth in medium and smaller companies and because we don’t want to take liquidity risk by shorting the smaller end of the market.”
“Generally, however, large caps are the areas where you tend to find overvaluations.”
“Recently we have been shorting some of the UK’s emerging market stocks in large cap land. The major reason for this is because these sorts of stocks have been pricing in upgrades in earnings which they haven’t been able to deliver,” he added.
Ben Whitmore, who manages the five crown-rated Jupiter UK Special Situations fund, is also negative on UK stocks focused on emerging markets. He says that while they are not as expensive as they have been in recent years, there is still scope for further share price falls.
“Companies such as Diageo, SAB Miller and Burberry still command a premium to the rest of the market, although they are not on as much of a premium as they have been in the past,” Whitmore said.
“As a fund manager, I want to be greedy. The way I look at it is that given these stocks have all traded on big premiums, what is not to say that they can’t be on big discounts in the future? That is what I will be waiting for,” he added.
Nick Train, who is also an FE Alpha Manager, disagrees with Warren.
He recently told FE Trustnet that the recent “collywobbles” in the emerging markets have handed investors a good entry point into the likes of Unilever and as a result he has been buying more shares in the company for his Finsbury Growth & Income trust.
Warren has headed up the £439.5m Cazenove Absolute UK Dynamic fund with fellow FE Alpha Manager Paul Marriage since its launch in September 2009.
According to FE Analytics, the fund has delivered a positive return in every calendar year over that time and is also up in 2014 so far, despite the fact that markets have fallen.
Warren and Marriage also run the now closed five crown-rated Cazenove UK Smaller Companies fund.
FE Analytics data shows that Warren has returned 97.43 per cent during his time running funds in the IMA universe, beating his peer group composite by more than 45 percentage points.
Performance of manager vs peers since Sep 2009
Source: FE Analytics
While the manager is betting against some of the FTSE’s largest names, he says there are plenty of high growth opportunities in the UK market.
For his long book, Warren looks for companies that fit his and Marriage’s P3M (product, market, margin, management) criteria.
By that, the managers mean long-term growth companies that have a large share of their market, generate good cash-flow, provide margin growth and are run by shareholder friendly management teams (either ones that own a large proportion of the business or that understand their shareholders' needs).
Warren says that given the above criteria and his and Marriage’s “heritage” of running the Cazenove UK Smaller Companies fund, the majority of their best ideas originate from the smaller end of the FTSE All Share.
“XAAR is a classic example and it is still our largest holding,” Warren explained.
XAAR, which is listed on the FTSE 250, supplies industrial inkjet printheads.
The stock has had a stellar run of late, with returns of more than 2,500 per cent over five years. Despite this strong share price performance, Warren sees no reason to sell.
Performance of stock vs index over 5yrs
Source: FE Analytics
“Granted, management doesn’t own a lot of stock but they are great at running the business and managing expectations. It is an absolute market leader as it has something like 90 per cent market share of the ceramic tile printing industry,” he said.
“It has very high margins and generates a lot of cash,” he added.
Our data shows that 11 funds in the IMA universe count XAAR as a top-10 holding, including Unicorn UK Smaller Companies, Schroder UK Smaller Companies and Baillie Gifford British Smaller Companies.
“Kromek is another company we like. It is a small company which IPOd at the back end of last year,” Warren explained.
FTSE AIM-listed Kromek has a market cap of just £74m. The company originated out of Durham University and Warren describes it as a business with a completely unique product.
“It specialises in detection systems and it has three applications: the first of which are scanning applications. They have bottle scanners that are being used more and more as airports are now allowing passengers to take liquids on to their flight, and their technology can tell what type of liquid is in a bottle.”
“Another part is their medical application. CAT scanners at the moment are just black and white, but if your TVs have changed over the years, Kromek are enhancing the quality of medical images.”
“Their third application is in the nuclear market, whereby they can detect nuclear leaks, and they have had a couple of developments in the US,” he added.
Investors in Kromek have seen returns of 15 per cent since it was made public in October last year. Cazenove Absolute UK Dynamic is the only open-ended portfolio to count it as a top-10 holding.
The fund has an ongoing charges figure (OCF) of 1.64 per cent and requires a minimum investment of £1,000.
