The Newton UK Opportunities fund will continue to have nothing in mining companies and UK retail banks for the foreseeable future, according to its manager Paul Stephany, who says the outlook for both sectors is as murky as ever.
Stephany, who has run the £367m[1] fund since February 2013, is generally bearish on the global economy, believing returns from stock markets will be a lot lower in the coming years than they have been since the period after the financial crisis of 2008. He points to the huge amount of debt in the financial system as one of the biggest challenges.
This view means he is largely avoiding cyclical companies (companies whose price is considered to be more sensitive to the ups and downs of the overall economy), whose earnings are extremely dependent on economic growth. A classic example, he says, is UK retail banks which have become more popular with investors in recent years.
“Two of Newton’s most important themes right now are state intervention and the debt burden and those have encouraged us to minimise exposure to the banking sector,” Stephany (pictured) said.
His major problem with the sector, he explains, is that central banks around the world have tried to solve the issue of widespread debt in the economy by simply throwing more debt at the problem.
He says this will inevitably cause issues in the future, and believes the still fragile banking sector will bear the brunt of those problems.
Unlike many of his peers in the Investment Association UK All Companies sector he has nothing in Lloyds, the FTSE 100-listed bank, as he says its fortunes are tightly linked to the performance of the UK housing market.
Lloyds’ share price has performed very well over recent years, with stronger economic growth and management’s cost-cutting measures boosting the outlook for the company. The fact that the UK government has begun to sell its stake in the bank, which it took up during the depths of the financial crisis, has also been met positively by investors.
The manager believes the company is exposed to any falls in what are elevated UK house prices, with affordability multiples[2], especially in London looking very stretched.
While he doesn’t think interest rates will be raised from their ultra-low levels until 2016 or 2017, if the Bank of England were to push rates up any earlier, it would be disastrous for the bank.
“It all comes down to disposable income and mortgage payments are the biggest portion of people’s spend. Even small changes, such as moving from 3% to 5% interest rate on a mortgage could add a pretty scary £150 pounds per month to a typical first time buyer’s repayments.” he said.
Nevertheless, a number of high profile managers have been upping their exposure – the amount an investor has invested in any given market/sector/company/region. Many have been drawn to the increasing chance of Lloyds paying significant dividends (A sum paid regularly by a company to its investors as a reward for holding their shares).
Stephany questions how high the dividend will be and shares in the company are already expensive, in his opinion.
The manager also has nothing in mining companies such as BHP Billiton and Rio Tinto, pointing to slowing economic growth in China and lower global demand for raw materials as reasons to be wary.
“With China slowing, we have no exposure to mining within the fund,” Stephany said.
[1] As at 31 December 2014.
[2] “affordability metrics” refers to the ratio of average wages to average house prices for home buyers.
Stephany is concerned about the degree to which the country’s central bank’s balance sheet has ballooned, and views China as another example of a government “throwing debt on debt.” After years of investment-led growth, he thinks there is over-capacity in the Chinese economy, highlighting the so-called “ghost cities” and recent falls in property prices as an early warning signal.
“It is classic bridge to nowhere economics,” he added.
Stephany expects commodity (a raw material or primary agriculture product that can be bought and sold) prices to remain weak for some time and doesn’t currently have any mining exposure. However, the significant share price falls of November and December means he is reappraising the sector for opportunities.
Performance of Rio Tinto versus FTSE All Share over 2yrs
01/01/2012 - 31/12/2014
| 01/01/2010 - 31/12/2010 | 01/01/2011 - 31/12/2011 | 01/01/2012 - 31/12/2012 | 01/01/2013 - 31/12/2013 | 01/01/2014 - 31/12/2014 | |
|---|---|---|---|---|---|
| Rio Tinto | 34.58 | -29.02 | 15.91 | 0.51 | -8.75 |
| FTSE All Share | 14.51 | -3.46 | 12.3 | 20.81 | 1.18 |
Source: FE Analytics at 31 December 2014. Past performance is not a guide to future performance.
Rio Tinto has considerably underperformed the wider UK stock market over recent years and the manager warns that investors are being naïve if they think that the stock, and others like it, is going to rebound sharply.
This is in contrast to the views of a number of experts, who have become increasingly positive on the efforts of new company management teams to cut costs and return more to shareholders in the form of dividends.
Though Stephany understands why more people are turning to mining stocks for income, he thinks the outlook for the sector is still too challenged. He believes the price of iron ore could stay low for some time to come, putting particular pressure on the sector.
Instead of investing in banks and miners, Stephany has a high weighting to more defensive areas of the market – companies which can generate earnings which aren’t overly dependent on economic growth.
He counts the likes of Diageo, the drinks company, British American Tobacco and AstraZeneca – the large-cap pharmaceutical company – as top-10 holdings.
According to FE Analytics, the fund has returned 34.51 per cent since the start of 2013, meaning it has considerably outperformed both the Investment Association UK All Companies sector and its FTSE All Share comparative index1 – which is a fund’s baseline for comparison.
Past performance is not a guide to future performance.
Performance of fund versus sector and index since Jan 2013
01/01/2013 - 31/12/2014
| 01/01/2010 - 31/12/2010 | 01/01/2011 - 31/12/2011 | 01/01/2012 - 31/12/2012 | 01/01/2013 - 31/12/2013 | 01/01/2014 - 31/12/2014 | |
|---|---|---|---|---|---|
| Newton UK Opportunities | 14.75 | -4.64 | 12.41 | 22.14 | 10.12 |
| FTSE All Share | 14.51 | -3.46 | 12.3 | 20.81 | 1.18 |
| IA UK All Companies | 17.53 | -7.04 | 15.05 | 26.21 | 0.64 |
Source: FE Analytics as at 31 December 2014. Past performance is not a guide to future performance.
It has also considerably beaten its comparative index in 2014, which has been a tough year for the UK stock market. The fund is up 10.12 per cent in 2014, while the FTSE All Share has returned just 1.18 per cent. (Source FE analytics as at 31 December 2014)
Stephany attributes those returns to his dynamic approach to picking companies, in that he blends both value and growth styles. Value investing is a strategy whereby managers pick stocks that trade for less than their intrinsic value, while a growth investor seeks out stocks with what they deem good growth potential which tend to trade at high valuations. He also invests across the market capitalisation spectrum, with around 30% of the Newton UK Opportunities being invested in mid-caps and 70% in large caps.
Stephany is a stock-picker, meaning that he focuses on the fundamentals of companies rather than trying to predict wider market movements. He does take the Newton Investment team’s “global themes” into account when constructing his portfolio, however.
1- An index from the same sector as the fund used against which to compare the fund’s performance.
Past performance is not a guide to future performance.
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