It has been a strange start to 2015 for UK equities as while macroeconomic headwinds such as the Greek debt negotiations, the prospect of interest rate rises in the US and political uncertainty in the UK have persisted, the FTSE 100 recently broke through its record high.
Also, due to a lower oil price and quantitative easing in the eurozone, the FTSE All Share and the average fund in the IA UK All Companies sector have delivered returns of close to 10 per cent over the past three months, according to FE Analytics.
Performance of sector and index over 3 months
Source: FE Analytics
However Newman, who heads up the £500m long/short Henderson UK Absolute Return fund with fellow FE Alpha Manager Ben Wallace, is reducing his net market exposure at this point in time and is adding new shorts to his portfolio.
“In terms of the year ahead, we’ve been very active with repositioning the portfolio over the first few months of 2015,” Newman said.
“What we have seen is an equity market that initially continued the strength we had seen over the previous couple of years and that provided an opportunity to reduce our net exposure. The fund started 2015 with 40 per cent net exposure; we’ve reduced that down to 15 per cent.”
“That’s due to combination of longs being booked out as they have hit their price targets and new shorts coming into the fund.”
During Newman’s investor update, which was recorded yesterday afternoon, listeners were asked what they thought would be the biggest source of volatility for UK equities over the coming three months and the majority said they were expecting a market correction.
Newman agrees as he is concerned that value, especially for long-only managers, is now very hard to come by.
“When we look at spot valuations in equity markets, they optically seem full particularly if you look on earnings measures. P/E ratios look extremely high at the moment.”
“I can find upside in equity markets at the moment, but it’s much more an enterprise value approach. Money is cheap to borrow at the moment and if we see companies deploying their cash piles, securing finance at very low rates, buying back shares or entering M&A deals – I can see how segments of the equity market can still have upside but it’s much more balanced.”
He added: “You can see that in our net exposure, which is down at its lowest level for a couple of years now.”
The FE Alpha Manager isn’t just concerned about valuations though, as he thinks political uncertainty will become a major issue for UK investors over the year ahead.
A number of FE Trustnet readers have dismissed concerns about the upcoming general election, pointing to the fact that the FTSE All Share has delivered decent returns in four of the last five election years.
Source: FE Analytics
The exception was in 2001, though the index’s losses were more to do with the September terrorist attacks and the deflating of the dotcom bubble than anything else. However, Newman says May’s election is likely to be a lot different.
“The hard thing when we think about the UK is that this will be an unusual election,” he said.
Newman’s major concern is that the UK electoral system is designed for a two-party system. He points out that in the 1950s, 97 per cent of voters either voted for the Conservative or the Labour party but in 2010 the figure was lower than 40 per cent.
“We’ve seen a big splintering of choice and if we believe the opinion polls, neither of the main single major parties will have the necessary number of votes to form a majority government,” he said.
“This causes issues not only when we think about the security of the UK recovery, but also in terms of the stock market itself. The first thing to say, from our point of view, is that I would expect net exposure to remain low or even go net short into the vote itself.”
Newman added: “We will want to exploit that negativity, if indeed panic and nervousness leads equity markets lower.”
Wallace is not the first manager to be concerned about the build-up and result of the election, as the likes of Neptune’s Robin Geffen and Henderson’s Bill McQuaker, who is also an FE Alpha Manager, have reduced their exposure to the UK due to the political uncertainty.
“You’ve got an election coming up which is extremely difficult to call, and that speaks to uncertainty. On top of that, it’s quite difficult to conjure up an election result that plays well with financial markets,” McQuaker (pictured) said earlier this month.
Despite those bearish comments, a recent FE Trustnet poll showed that 70 per cent of readers said they weren’t taking profits from their UK funds despite the FTSE’s high level and the political concerns.
Clearly, a high proportion of those 1,800 who voted could well have long-term time horizons and are therefore unfazed about periods of short-term volatility. Nevertheless, Newman says he expects his short book to be his main “profit centre” in 2015.
“My best guess for the year ahead is a flat-to-down, volatile and range-bound equity market. That ability to for the short book to generate positive returns even in market sell-offs is something that we have worked hard on to preserve and I’m hopeful we will deliver again,” he said.
Newman and Wallace started their long/short strategy in 2004 over which time they have returned 209 per cent while the FTSE All Share has gained 136 per cent. That includes a 28 per cent gain in 2008 – when the UK equity market fell 30 per cent – as a result of their decision to go net short the index.
However, their Henderson UK Absolute Return fund launched into the IA universe in April 2009 over which time it has returned 46.1 per cent.
While the FTSE All Share is up 110.24 per cent over that time, the fund has been three times less volatile and has had a maximum drawdown, which measures the most an investor would have lost if they had bought and sold if they had bought at the worst possible times, which is three times lower than that of the index.
Performance of fund versus index over 2yrs
Source: FE Analytics
As the graph above shows, Wallace and Newman’s positioning has worked well for investors over the last couple years’ volatile environment.
Henderson UK Absolute Return features on the FE Select 100 and analyst Charles Younes says it is a good choice for investors who want to diversify their portfolios and limit downside risk.
“This fund could be a good option for an investor who wants to invest in the stock market while limiting risk. The ability to short stocks has allowed the managers to limit losses in falling markets in the past and sometimes to make a lot of money,” Younes said.
Henderson UK Absolute Return has a clean ongoing charges figure of 1.06 per cent.