Martin, who heads up the five crown-rated Neptune UK Mid Cap fund, says the fact that there hasn’t been a correction for some time makes the event more likely and means investors should be vigilant. “The markets have performed so strongly for so long, you feel at some stage they will pull back,” he said. “A 5 to 10 per cent correction wouldn’t surprise me.”
“If we were to see a correction, people are so accustomed to the lack of volatility that it could come as a real shock to them. When you haven’t seen a pullback in the market for such a long time, investors should be additionally vigilant for it. It’s something to be aware of.”
Martin believes investors have become complacent following the rise in equity markets and improvement in economic indicators, but he says there are a number of managers, such as Invesco Perpetual’s Mark Barnett, that are cautiously positioned, waiting for some of the "toppyness" to dissipate.
Martin says a dip in prices could be healthy for the market because it will allow investors to buy back in at lower levels.
“Be careful what you wish for, but it might not be too unhealthy if we see a pullback,” he said.
Martin adds that while developed stock markets are near or at record highs, many companies are trading on lower price/earnings (P/E) ratios relative to history. He paints a rosy picture for the medium- to long-term outlook for equities, particularly mid cap stocks.
The FTSE is inching its way up to 7,000 points – although it has been oscillating between 6,800 and 6,900 points for weeks – and the S&P 500 has eclipsed all-time highs several times since the start of the year. It is trading at 1,949.37 points at the time of writing, just below its high of 1,951.27, reached on 9 June.
Year-to-date performance of indices
Source: FE Analytics
“It was a terrible time to be investing in 1998 and 1999, but at 14 times P/E, history suggests we should get 7 to 8 per cent real returns per year for the next 10 years,” he said.
During 1998 to 1999, forward P/E ratios were consistently above 20 times, peaking at 25 times at various points before the tech boom. The average forward P/E ratio over the last 15 years has been roughly 16 times.
“When valuations are reasonable, you don’t need to be worried about the clouds on the horizon. It’s when valuations are high that you need to be worried about the blue skies.”
“A lot of people are concerned because the FTSE is reaching new nominal highs and the last time it did that was 1999. That was a heck of a long time ago. The bond guys had a bull market for 35 years. Sure we’re six years in, but after an unusual period of markets flatlining for quite a long period.”
Martin says the economic picture has improved and earnings have been revised, which leads him to believe there is still “interesting value” to be found in the FTSE 250.
The fund has consistently been one of the best performers in the IMA UK All Companies sector, delivering top-quartile returns over one, three and five years.
It has made 186.14 per cent over the last five years, nearly doubling the returns of the sector and putting it well ahead of the FTSE 250 index.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
Perhaps unusually for mid cap funds, much of Neptune UK Mid Cap’s outperformance has come in down markets. Although mid cap funds tend to sit at the more aggressive end of the risk spectrum, Martin says he has engineered Neptune UK Mid Cap to hold up in difficult markets in addition to outperforming on the upside.
“Because of the structure of the fund, historically it has performed well during periods of volatility,” Martin said. “I sort of designed the fund to be an ‘all-weather’ fund.”
This has certainly been the case for the £154m portfolio. The fund's launch date in December 2008 meant it missed out on the worst of the credit crisis that year but was able to take advantage of the cheap market conditions. It rebounded ahead of its peers in the IMA UK All Companies sector in 2009, picking up 40.06 per cent, though it did lag behind the FTSE 250 index that year.
However, when markets hit troubled times in 2011, Martin’s fund was able to deliver positive returns of 3.65 per cent while its peers and the index were down 7.04 per cent and 10.06 per cent, respectively.
Source: FE Analytics
Martin credits his outperformance on the downside to a focus on valuations – making sure he is not paying too much for the risk he is taking on in a company – and “checking under the bonnet” to ensure the corporate structure can withstand difficult market conditions.
“It’s an important test for me,” he said. “If markets were to fall 10 per cent, would I feel comfortable buying more? In all cases in my fund, we would feel comfortable buying more [of an individual stock].”
Martin also says it is important to diversify holdings, which is why the fund is comprised of three "silos" – structural growth, recovery and turnaround/self-help stories. Martin holds at least 20 per cent of the fund in each of the three silos.
“I adhere to it as a discipline,” he said, “not putting all my eggs in one cyclical basket.”
The Neptune UK Mid Cap fund has ongoing charges of 0.8 per cent.
