Moving up the market-cap spectrum while buying industrials and supermarkets but remaining underweight commodity-related stocks is the best way to approach the UK equity market at this point in time, according to FE Alpha Manager ‘hall of famer’ Leigh Himsworth. 
Though the last few weeks have been a fruitful period to be invested in the UK equity market, the FTSE All Share has posted some hefty drawdowns over the past year or so and many think this volatility is set to continue given headwinds such as China’s growth slowdown, highly unpredictable commodity prices and the upcoming referendum on the UK’s membership of the European Union (EU).
Himsworth (pictured) has held his FE Alpha Manager status in every year since the ratings were introduced in 2009 thanks to his long and enviable track record.
Performance of Himsworth versus peer group composite
Source: FE Analytics
He has the ability to invest right across the UK equity market in his £74m Fidelity UK Opportunities fund – thanks to its all-cap mandate and nimble size – and in this article the manager explains how he is positioned for the year ahead.
Move up the market-cap spectrum
Fidelity UK Opportunities has been heavily biased towards mid and small-caps over the last few years, a call which has worked well given the FTSE 100 index has borne the brunt of the market selling.
Indeed, the portfolio has been a top quartile performer in the IA UK All Companies sector and beaten the FTSE All Share over one and three years.
However, Himsworth says now is the time to increase the fund’s weighting to large-caps given the low valuations on offer, the need for greater liquidity and rising headwinds.
“As far as the portfolio is concerned, given issues in terms of the US bond market, the improving outlook for the UK but some of the fears surrounding the EU referendum, I think it is wise to move up the market-cap scale so we are insulated liquidity-wise against some of the scares,” Himsworth said.
“Sterling may come under pressure as a consequence of the EU referendum, so it’s wise to try and increase exposure to overseas earnings within the portfolio. In the UK market, that is very easy to achieve given that nearly 60 per cent of the earnings within the FTSE All Share are generated overseas.”
“It is very, very easy to tilt our exposure to different economies around the world and to different industries and so forth.”
Buy industrials
Also, given his focus on valuation, he thinks now is an opportune time to buy into the industrials sector.
FE data shows that, owing to fears of a global industrial recession sparked by China’s slowing economic growth, the FTSE 350 Industrial Engineering Index has fallen a hefty 26.73 per cent over two years compare to a 0.56 per cent dip in the wider FTSE 350.
Performance of indices over 2yrs
Source: FE Analytics
Though many fear more pain is still to come, Himsworth has taken the plunge thanks to his contrarian nature.
“It is also wise, in the near term, to raise the industrial exposure within the portfolio. Industrial stocks and sectors had a very tough year last year, partly due to exposure to oil and mining companies and some of the tougher economic markets around the world,” he said.
“However, as that has become priced into markets, some areas are starting to look appealing price wise.”
Largely avoid oil and mining stocks
Though these areas of the market have fallen even further than industrials, Himsworth says now is not the time to be taking big bets in oil and mining stocks as many of the challenges they faced last year have not dissipated.
That being said, he is maintaining a degree of exposure to commodity-related stocks as he feels sentiment could turn towards the bombed-out areas in the not-too-distant future.
“I remain nervous on oil and commodities partly because the far eastern economies remain under pressure, particularly China, who have been one of the main drivers of demand for mining stocks,” Himsworth said.
“Equally, with oils it is very early days in terms of the stabilisation of the oil price. However, there are signs that both of those sectors are showing a degree of stability in terms of a modestly improving outlook like with supply being cut.”
He added: “It means the portfolio does have exposure to those areas, but we are nervous in the near term.”
Buy supermarkets
Finally, however, he says food retailers – a value call that has not worked over the past year – is an attractive area of the market.
The listed supermarkets have had a torrid time recently thanks to increased competition in the form of budget competitors, over-capacity during a price war and, in some instances, dodgy accounting. This has led to dividend cuts for the likes of Tesco and Morrisons.
However, he says opportunities have arisen of late.
“Some unloved areas are also starting to look interesting, having had a very tough period for a few years,” he said. “Notably, food retailing in the UK has been under severe pressure for a very long period of time as seen by the performance of Tesco, Sainsbury’s and Morrisons.”
Performance of stocks versus index over 3yrs
Source: FE Analytics
“It’s an area that the portfolio hasn’t had exposure to at all for a number of years but, for the first time, we have taken a holding in Sainsbury’s on the basis that: one, the stock was looking very cheap having suffered from moves to online shopping, moves to discounting and moves to very high end in the form of Waitrose and M&S.”
“However, a lot of that now looks very much baked into the price to the extent that now looks like a very interesting entry point and the outlook seems to be improving as we have seen the worst of the food price deflation take effect.”
“If we do see some sterling weakness, we might see some food price inflation come back given the UK does import the bulk of its foodstuffs from overseas.”
