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Is an inflexion point arriving for UK value funds?

14 April 2016

FE Trustnet investigates one of the most vaunted equity market trends of recent months many professional investors are backing.

By Daniel Lanyon,

Senior Reporter, FE Trustnet

UK value looks set for a rebound following tentative improvement in market sentiment, according to Gavin Haynes, managing director of Whitechurch Securities, who has recently been upping his exposure to this underperforming part of the market.

Stocks that are trading for less than their intrinsic worth – or the ‘value’ part of the UK equity market - has generally outperformed the ‘growth’ part, these being companies whose earnings are expected to grow over time, over the past 15 years.

However, in recent years this trend has reversed.                                                                     

Value has been increasingly out of favour among UK investors since the recovery from 2014’s autumn market correction, as growth and quality stocks - those with dependable and growing dividends - have dominated.

Performance of indices since September 2013

 

Source: FE Analytics 

Few trends in markets continue indefinitely, however, and several experts have started to increase exposure to UK value. Haynes is one such example.

“We have been increasing exposure because of the valuation gap that has continued to widen between growth and value areas. We are seeing more opportunities in value stocks than in growth and income areas,” he said.

The manager says the pertinent example is in mining stocks, which have suffered hard falls over the past five years.

"Any time you get some positive news from China, such as yesterday [with export data showing growth] mining stocks bounce significantly," he added.

Benjamin Matthews, investment analyst at Heartwood Investment Management, says there have been a number of factors driving the underperformance of value over growth and quality stocks in recent years.

“Investors' insatiable hunt for yield has continued to benefit large companies with relatively stable businesses and with reasonable levels of dividend yield,” Matthews said.

“On the other hand, concerns about the persistently modest rate of global economic  growth and falls in commodity prices have adversely impacted the more cyclical parts of global equity markets- notably mining, energy and financials.”


“This trend is not unprecedented but the degree of valuation differential between non-cyclical and cyclical companies is, in our analysis, extreme. We therefore continue to have a bias towards value equities in our portfolios as we believe greater medium term potential returns are available

Currently the picture is mixed. Value orientated strategies have tended to be among the best and worst performing UK equity funds in 2016 so far.

Across the three UK equity sectors in the Investment Association universe – the IA UK All Companies, IA UK Equity Income and IA UK Smaller Companies – there are 399 funds. The top performing four funds of 2016 all have a strong value tilt.

These are the Standard Life UK Equity Recovery, Schroder Recovery, Schroder Specialist Value UK and Schroder Income.

Performance of funds and index in 2016

 

Source: FE Analytics 

The latter three funds are all headed by Schroder’s Kevin Murphy and Nick Kirrage who head up the firm’s UK value team.  In contrast, the likes of MFM Slater Recovery, Jupiter UK Growth and CF Canlife UK Equity all have a strong value tilt, and are three worst performances this year. 

To increase exposure to UK value, Haynes has been buying more income-focused value strategies. He has recently been buying the £955m Schroder Income Maximiser fund headed by Thomas See.

"It is the epitome of a value fund,” Haynes said.

He has also been buying £286m JOHCM UK Dynamic, headed by FE Alpha Manager Alex Savvides.

“While it is not an equity income fund but it does invest in dividend producing shares, but we put in the value/ recovery bucket,” Haynes added.


Part of the attraction for Haynes is the managers’ holdings in the beleaguered mining stocks of the FTSE All Share, which have been battered in recent years. However, in recent months they have staged an impressive rally.

“Both of these funds have mining exposure. Our view is really because miners have been hit so hard for such a long time, it just felt that they just got a bit too cheap and unless you are in the global recession doom-and-gloom camp. We are not.”

“We haven't been buying mining funds directly, those are going to remain very volatile but we think having zero exposure could potentially leave to under performance.”

“In the weeks we've seen since the middle of February we have seen quite a sharp recovery. Having no exposure could be painful when the wind changes so we are comfortable playing that theme through and investing with managers with a recovery/value stance.”

Performance of indices over 5yrs

 

Source: FE Analytics 

FE Alpha Manager Alex Wright, who heads the £2.6bn Fidelity Special Situations fund and has value/contrarian approach, argues value stocks are set to rally in 2016.

“In the current environment, a contrarian investor cannot help but be attracted to those parts of the market that don’t fit the quality perception, and where a wider range of investment outcomes is possible. Many of these ‘value’ categories have some exposure to the economic cycle.”

“Using broad brush strokes; banks, oil and construction stand out to me as areas that seem to be pricing in a recession.”

“There is a good deal to be worried about in the global economy (when isn’t there?). But based on the many conversations I and our team are having with company management, I believe the chances of a ‘muddle-through’ scenario are much better than the market expects.”

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