The manager of the SVM UK Opportunities fund thinks the rotation could continue for some time and expects plenty of volatility in the short term as a result; however, he says he has no plans in following the consensus and buying up traditional defensive large caps with little growth potential.“There’s more opportunity at a better price in the small to mid-cap space,” said Veitch (pictured).
Veitch is wary of the global recovery, pointing out that the picture isn’t as rosy as he thought at the start of the year. He expects a bit of pain in the near-term for that reason.
“The global recovery is on track but it will be a shallow recovery,” he said. “It’s not going to be your father’s or your grandfather’s type of recovery.”
The manager says the “mixed” economic data coming from the developed world means it’s time to worry more about risk protection than grabbing as much upside as possible.
However, rather than buying what he considers expensive defensive stocks, Veitch is letting cash drift up in his portfolio. He now holds roughly 15 per cent in money markets – well above average for the average active stockpicker.
“It’s prudent to focus on risk control at this juncture,” he said.
Jupiter’s Steve Davies is even more relaxed about the rotation out of mid caps.
He thinks domestic cyclical companies, particularly in the FTSE 250, are best placed to benefit from the UK economic recovery, and is buying up the most battered of these for his Jupiter Undervalued Assets and Jupiter UK Growth funds as a result.
“It was perhaps inevitable that many investors at the start of 2014 would question whether the strong gains for mid-cap stocks, and UK domestic equities in particular, had run its course,” he said.
“While we believe shares in many of the UK domestic companies we owned still had room to appreciate, we thought some kind of correction might be due. We consolidated our gains and decided to keep our powder dry by raising the proportion of our fund we held in cash.”
“Six months later, and the rotation into large-cap stocks has dramatically narrowed the appeal of these companies relative to the mid-cap sector – the valuation gap in other words has narrowed considerably. Mid-cap stocks, meanwhile , have continued to benefit from the resilience of the UK economy with earnings forecasts being revised upwards in a number of cases.”“By contrast, many of the international companies that make up the FTSE 100 have been lowering their earnings outlooks as a rise in sterling against the world’s major currencies hits exports and the ongoing emerging markets slowdown crimps revenues.”
As well as mid-caps, both Davies (pictured) and Veitch see value in the banks, which they think are currently unloved and undervalued by the wider market.
“I still like the banks and expect the improvement in economic outlook to feed into a better top-line for banks,” Veitch said.
The SVM manager likes HSBC, which he says is trading at its lowest price to book level in almost 25 years, and Lloyds, which he thinks will start to pay out a dividend in the near future.
“We recognise we have been wrong on the banks so far but to us they are still some of the best valued companies in the market,” he said.
Over the last 12 months, the banks have diverged from each other. Lloyds, which performed strongly in the latter half of 2013, is up 9.87 per cent, outperforming the FTSE 100. HSBC, on the other hand, is down 13.83 per cent.
Performance of stocks vs index over 1yr
Source: FE Analytics
Davies thinks banks are “the most obvious contrarian trade” in the market.
As Veitch highlighted with HSBC, he says many a trading well below book value, even though the outlook for banks looks better than it has done at any time since the financial crisis.
“The banks themselves continue to focus on driving down costs through various self-help initiatives. The sector should also benefit when interest rates do start to pick up,” he said.
Davies has started to reduce his cash level in Jupiter UK Growth, which now stands are 5 per cent of the fund, down from 10 per cent earlier this year.
The fund, which Davies runs with co-manager Ian McVeigh, is a top quartile performer over three, five and 10 years, and also ahead of its peers over 12 months.
The flagship £114.8m SVM UK Opportunities fund has had a tough time over the short term, down 5.01 per cent over six months, compared to a loss of 1.37 per cent from the IMA UK All Companies sector average.
However, the longer-term picture is much brighter; since Veitch took over the portfolio in January 2006, the fund is up 85.48 per cent, putting him ahead of both the sector and index.
Performance of fund vs sector and index since Jan 2006
Source: FE Analytics
Veitch tends to favour cyclical stocks, which leads to severe bouts of volatility when investors are most nervous.
The fund took a nosedive in 2008, falling much farther than its peers and the index, for example.
The manager says that experience taught him that downside protection was important and has since made moves to dampen volatility in the portfolio.
Indeed, over the last three years, the fund is significantly less volatile than it has been historically, and in line with the average fund in the sector.
