While it transpired there were pockets of stellar investment opportunities in the market, however, it seemed unanimous that the UK should be approached with caution.
MFM Slater’s Mark Slater (pictured) said: “While one of the risks out there is the upcoming election, I think the biggest risk for the average company is more that the general climate is just difficult at the moment.”
“The problems in Europe haven’t gone away. A lot of companies did a good job in the last few years increasing margins, and that’s going to be tougher going forward. Wages are going to start increasing. In the past a company could very easily move its manufacturing to a low-cost country, that’s now getting tough, and most of the ones that could do it, have done it.”
In light of this, FE Trustnet explores which UK sectors might have the odds stacked against them.
Mark Slater – High street banks and gaming stocks
Slater said: “Typically we’re less involved in the more cyclical sectors, but there are exceptions to that and really we’re just trying to avoid trouble and trying to focus on the niches where companies can do well. If there’s a clear headwind, we’d rather not be invested.”
Slater and his team go out of their way to avoid problems before they happen. An example of this is William Hill, which they dropped from their portfolio last year.
“In the case of William Hill there was a very clear, strong headwind both from the new taxes on gambling and also from regulation,” Slater said. “The betting terminals they have are a very big part of their profit and they were under attack, so it was too uncertain for us to continue to be involved.”
“For us it just doesn’t make sense to be invested until they come out the other end, which could be a year, it could be two years, it could be five years, or it could be never.”
Slater believes that the financial sector also holds some potential pitfalls, particularly in terms of banks.
“I think that for the average bank life is really tough,” he said. “Every time I open the newspaper, there’s another fine. Governments all over the world quite like fining banks now and I think it’s gone beyond whether or not they behave well, they’re just a source of revenue that all governments will miss, so in my view, they’re going to keep doing it.”
“Having said that, for instance, we own the Close Brothers which has a banking operation, but it’s a challenger bank in a much better part of the market where I would say there’s more of a tailwind.”
Slater added that a further tailwind for the Close Brothers is that high street banks are having to shed business because of the introduction of new regulations.
Nick Kirrage – Traditionally defensive high-yield stocks
FE Alpha Manager Nick Kirrage of Schroders said: “In the current environment, many of the traditionally defensive high-yield stocks are very highly valued – areas such as food and beverage companies, utilities and tobacco.”
“History shows that valuations are the key to future returns and if you overpay, be it for growth or perceived stability, you will struggle to make money.”
Despite this, however, Kirrage has holdings in capitalised power generation through company Centrica, who recently suffered an underperformance.
“Its recent results were disappointing and included a 30 per cent cut in the dividend,” Kirrage said. “The announcement saw the shares fall by 8.5 per cent, but as a result of the fall, the shares still yield 4.8 per cent after taking the dividend cut into account.”
Centrica is currently under pressure as a result of uncertainty about future regulation and concerns over historic capital allocation.
Kirrage said: “We believe the new CEO and financial director, however, offers a chance to address some of these capital allocation concerns, and that structural factors in the UK present as much an opportunity as a threat with historic underinvestment in UK power supply, making Centrica’s assets more valuable.”
The star manager believes Centrica is among the best-capitalised power generation companies in the UK.
“Given profit margins are current running at half the long-term average, a modest recovery would likely lead to a significant re-rating,” he added.
James Henderson – Banks
Like Mark Slater, Henderson’s James Henderson is also bearish towards UK banks at the moment.
“We continue to be concerned about future prospects for earnings and particularly dividend growth from the banks,” he said.
“In our view, the future capital requirements for the sector remain unclear, and until this has become more fully established, their excess capital position and future returns are very difficult to forecast.”
However, Henderson does have a holding in Provident Financial which, along with its consumer division, has a fast-growing bank called Vanguis.
He said: “From a low base Vanguis already has 1.3m customers in the UK and is looking to grow further, up to as much as 1.8m customers, so it is very much a fast-grower in the industry and operates in an area of the market with comparatively little competition.”
Vanguis is one of the few banks to focus on providing credit cards to those with a lower credit rating.
Anthony Cross and Julian Fosh – Regulated industries and utilities
Star investment duo Anthony Cross and Julian Fosh from Liontrust only invest in UK companies which they think have distinctive, intangible strengths that competitors struggle to reproduce.
“We are unlikely to invest in companies in regulated industries due to the challenges of generating growth and sustaining high profits in such an environment,” Fosh said.
“The key ability for a company to translate barriers to competition into sustainable financial returns is the possession of pricing power. We therefore have no exposure to the utilities sector, for example.”
“Ownership of assets such as water and energy distribution networks are prohibitive to new market entrants and, for this reason, usually attract the attentions of regulators whose role it is to protect the consumer from the potential for monopoly pricing.”
As such, Cross and Fosh do not have any holdings in these sectors. However, they do own Smart Metering Systems, which provides its products and services to the utilities industry.
Cross said: “The company operates metering systems and databases on behalf of energy companies and it now has contracts with 17 gas suppliers, representing over 80 per cent of the UK industrial and commercial market.”
“Last year, it acquired Utility Partnerships, giving it scale in the provision of electricity meters and data management services.”