Developed equity markets have risen almost uninterruptedly since the financial crash, with 2011 the only down year over the period. FE data shows that the likes of the FTSE All Share and the S&P 500 have returned more than 110 per cent over five years.
Performance of indices over 5yrs
Source: FE Analytics
Mundy, who manages the £1.8bn Investec UK Special Situations fund, is renowned for his deep value, contrarian approach to investing, but currently sees such a lack of value that he’s holding back 10 per cent in cash.
He says the recent bull market has been largely due to increasing investor appetite for risk rather than the underlying profitability of companies, making such a rise completely unsustainable. “We’ve found that, in general, as valuations have gone up and earnings haven’t gone up as high, markets are stretched,” Mundy explained.
“Not just at a market level, but across a lot of stocks and sectors. We have really struggled to find new and interesting ideas recently. For us, it is just as important looking at the downside as the upside. We think, how much can we lose?”
“Valuations are very punchy in the most parts of the market. They really are.”
There has been a number of leading fund managers, like Mundy, who have recently voiced concerns about stock market levels.
FE Alpha Manager Martin Gray told FE Trustnet that he saw next to no value in developed world equities while FE Alpha Manager Iain Stewart said that a substantial correction was inevitable over the coming years.
Small and mid-caps are areas of real valuation concern for Mundy. Both have been major beneficiaries of the recent rally, with the FTSE 250 and FTSE Small Cap both averaging around 25 per cent in each of the last five calendar years.
Source: FE Analytics
Nevertheless, as a recent FE Trustnet article highlighted, small cap funds have become increasingly popular with investors this year with the IMA UK Smaller Companies sector being one of the best sellers so far in 2014.
Bulls on the sector say the rally can continue as not only is there a greater selection of opportunities lower down the market cap spectrum, but investors will also benefit from the recovering UK economy.
Mundy, however, says such an argument is ill-advised.
“I don’t really get [this argument] – in 2008 the UK economy was doing really, really badly and that was the time to buy mid-caps,” he said.
“That suggests you want to be buying mid-caps when the outlook is terrible, which is what I would agree with. We think that a lot of these mid-caps are already discounting a lot of good news and there is no real great proof that GDP is an indicator of markets.”
Mundy says that investors who are piling into small and mid-caps now are buying in at completely the wrong time.
“Of course, they might make 100 per cent and then get out in time before it all kicks off, but they have left it very, very late,” he said.
“I would be interested to know why they are doing it now instead of four of five years ago. Lots of those stocks, mid-caps in particular, have gone up five or six times over that time.”
“You can’t go back in history and why these people didn’t buy these stocks at a much cheaper stocks is largely irrelevant. However I think it is good to be aware that they are paying much, much higher valuations now than they have had to over the last five years.”
Mundy has managed his Investec UK Special Situations fund since August 2008.
According to FE Analytics, over that time it has been a top quartile performer in the highly competitive IMA UK All Companies sector with returns of 226.31 per cent and has beaten the FSTE All Share by more than 50 percentage points.
Performance of fund vs sector and index since Aug 2002
Source: FE Analytics
The fund has only underperformed the sector in three of the last 10 discrete calendar years and is a top quartile performer over rolling seven and 10 year periods. It is also second quartile over three and five years and beat the sector in 2013 and is outperforming so far in 2014.
Mundy says that building a portfolio in the current environment, given his views on lofty valuations.
However, he says the areas of the FTSE 100 are the best of a bad bunch and says that if investors want UK equities, they are the stocks to hold.
“The large companies – for instance we hold HSBC, BP, Shell and Glaxo – have been side-lined in this bull market,” he said.
“We see self-help opportunities in those companies and they are making themselves less complex and in the case of the oil companies, more cash generative. They are just simplifying their operations.”
Mundy added: “They are not really reliant on a large macro story and all are under reasonably new management.”
While Investec UK Special Situations sits in the IMA UK All Companies, it has a yield of more than 2 per cent. The fund has clean share class ongoing charges of 0.84 per cent.
