The manager says he’s rotating out of cyclical stocks in the £1.8bn fund because valuations have risen so dramatically. “Valuations have moved up as the outlook has improved. Those [stocks] are no longer offering such good value opportunities.”
“The valuations were so cheap they didn’t rely on recovery. With the performance we’ve had that’s more difficult to do because valuations have got to such a high level. It’s more difficult for these types of companies to make significant progress.”
“Some of these companies – retailers, airlines, house builders – were operating in a benign environment. Valuations have moved up a long way. They can continue to do well but the extent to which they do better than everything else has narrowed significantly.”
He adds that these types of companies are historically sensitive to interest rate rises, a risk he thinks investors aren’t taking seriously enough.
The manager’s repositioning fits with the thesis of Liontrust’s Julian Fosh, who says he expects quality to outperform cyclicals as the market comes to focus on earnings growth.
Matthews, who has been running the Schroder UK Alpha Plus portfolio since October last year, says he’s been changing the portfolio since he took over from previous manager Richard Buxton.
“We run money in very different ways. I’ve been broadening out the portfolio,” he said.
Matthews says he typically ran portfolios of 50 to 70 stocks in his time at Jupiter, so he has a broader portfolio construction.
The manager also tends to prefer less cyclical companies, though he admits that the concentration toward domestic cyclicals he inherited was the “right place to be.”
However, Matthews says he more interested in UK companies that can hold up better when record-low interest rates do inevitably rise.
“I’m moving into less overtly interest rate sensitive parts of the market. You’re not going to see the same levels of earnings momentum, but the risk/reward advantages are better at the moment,” he said.
“Some of these other areas are providing you with earnings growth but also better downside protection. It’s an insurance policy if things do get worse. It makes sense to broaden out your portfolio in that environment.”
Matthews says he has been buying stocks like medical equipment manufacturing company Smith & Nephew, software company Sage Group, oil and gas giant Royal Dutch Shell and tobacco heavy-hitters British American Tobacco (BAT) and Imperial Tobacco.
Matthews says he topped up his exposure to Shell, which was already in the portfolio, over the last six months, making it the largest holding in the fund.
“It’s one of the most hated parts of the market, but the cashflow is high and the cover is relatively high on dividend yields now,” he said.
“Oil and gas is one sector where value still exists. There’s been a shift in the mood of management of the large oil companies. Valuations look attractive.”
Shell has outperformed the FTSE 100 over the last one, three, five and 10 years, but over the last six months it has returned six times that of the market, picking up 12.64 per cent.
Performance of stock vs index over 6 months
Source: FE Analytics
Shell has a yield of 5 per cent and is trading on a price to earnings ratio of 13.6, the cheapest the stock has been since 2009.
The manager is also looking to life insurance companies, whose share price were hard hit on the back of Budget changes announced last month.
“They’ve been hit on the back of the Budget, but I’ve been using it as an opportunity to add,” he said.
One stock Matthews likes is Partnership Assurance Group, which he says was most negatively hit by the changes in the Budget. The stock had earlier disappointed when it listed on the stock exchange last year.
The FTSE 250 annuity provider is down an eye-watering 66.58 per cent over the last six months, but Matthews thinks the stock’s recent poor performance is more of a buying opportunity.
When it comes to process, Matthews starts from the price and works his way through a number of corporate criteria from there.
“We’re trying to find cheaper companies and marrying that with return on capital,” he said.
He adds that he tries to avoid chasing momentum, which is helped by a solid grounding in valuation.
“We’re constantly reassessing where the market has got to. It keeps you from falling in love with parts of the market,” he said.
In the short time period since Matthews took over the portfolio, it has lagged both the IMA UK All Companies sector and the FTSE All Share, picking up 1.76 per cent over the last six months.
However, Matthews track record as a manager has outshone his peers over the last three, five and 10 years.
Over the last decade, Matthews made 142.38 per cent for investors while the peer group composite made 108.76 per cent, according to FE Analytics.
Performance of manager vs peer group over 10yrs
Source: FE Analytics
Beyond Royal Dutch Shell, Matthews also has exposure to domestic UK banks, which he thinks are a good medium-term recovery story. Barclays and HSBC are both in his top-10 holdings, as is wealth manager St James’ Place. Financials are the highest sector weighting in the portfolio, at 23.3 per cent, followed by healthcare stocks at 13.45 per cent.
The fund has ongoing charges of 0.9 per cent.
