Following a period of strong outperformance last year, economically sensitive and UK focused stocks – particularly in the FTSE 250 index – have fallen considerably in 2014, with investors looking to rotate their portfolios into the relative safety of mega-caps. While several leading fund managers have voiced concerns about the outlook for mid-caps, Davies – manager of the £120m Jupiter Undervalued Assets fund – says that the negative sentiment has been overdone.
“One of the main changes we have made recently has been to bring down our cash level from around 10 per cent to 5 per cent,” Davies said.
“We have been adding to some of our existing positions following the recent rotation in markets. Investors have quite violently moved away from areas which have done well and stocks that are interest rate sensitive.”
“We just feel this has left some companies ridiculously cheap.”
Having considerably outperformed the FTSE 100 last year, the FTSE 250 index has lost money in 2014 while the blue-chip index has ground out a positive return.
This has hurt the large majority of active UK managers who have benefited from their overweights in domestic cyclicals. Davies is a good example; according to FE Analytics, his fund has dropped into the bottom quartile this year with losses of more than 2 per cent.
Performance of fund vs sector and index in 2014
Source: FE Analytics
Among the mid-caps he has been buying up recently include Thomas Cook, Dixons and auto-retailer Inchcape. Our data shows that all three of those stocks have lost money over the last three months.
“The overriding point is that the upside of the portfolio is substantially greater than it was three months ago. It has been a difficult quarter for active managers, but the opportunity is now much greater,” Davies explained.
“While the share prices of these companies have been clobbered, their earnings are coming through stronger and stronger. From a valuation point of view, domestic cyclical stocks are looking attractive; much more so than large cap defensive companies.”
Though Davies is clearly bullish on the UK equity market, various managers have been “de-risking” their portfolios over recent months.
Kames’ David Pringle warned FE Trustnet last month that the sell-off in mid-caps was a prelude to a wider market correction and FE Alpha Manager Iain Stewart believes that some of the biggest bubbles of all-time are being created.
Indeed, Davies is one of very few managers who is putting his cash weighting back into the market.
He admits that there will be periods where volatility will pick-up over the coming 18 months, pointing to the Scottish referendum, a potential interest rate rise and the general election as all potential catalysts. However, Davies says that now is a very good entry point for long or medium-term investors.
“I don’t think that we are finished with the choppiness by any means and that markets will just move serenely upwards from here,” Davies said. “However, we are in a phase where we have improving economic growth here in the UK and US, and potentially even in Europe.”
“Post the rotation we have seen, cyclicals look at a lot more appealing.”
Davies took over Jupiter Undervalued Assets in January 2012.
According to FE Analytics, it has been a top quartile performer in the highly competitive IMA UK All Companies sector over that time with returns of 52.36 per cent, beating the FTSE All Share by close to 20 percentage points in the process.
Performance of fund vs sector and index since Jan 2012
Source: FE Analytics
Davies is a bottom-up stock picker and has set-up his portfolio, which comprises of just 35 stocks, for a recovering UK economy.
One of his largest sector weighting is financials and more specifically banks. His biggest individual holding is in Lloyds, which makes up more than 9 per cent of the portfolio and has been one of his best performers.
Performance of stock vs index over 2yrs
Source: FE Analytics
Our data shows it has returned more than 150 per cent over two years. The shares currently trade around 75p, but the manager’s price target for the stock is north of £1. He also holds Barclays and Royal Bank of Scotland in his fund.
While Davies has been using his cash to add to existing holdings, he has also been taking part in some recent floats. He says he steered clear of initial public offerings (IPO) in the first couple of months of the year as he was concerned about inflated prices.
However, with sentiment more negative than it was earlier in the year, he believes it is now a good time to consider new companies coming to market.
“To be frank, we look at it on a case by case basis and look at the downside and upside of each one; but we have participated in TSB and Zoopla,” he added.
Jupiter Undervalued Assets’ has clean ongoing charges of 1.02 per cent. As well as being lead on this fund, Davies co-manages the £1.1bn Jupiter UK Growth portfolio with Ian McVeigh.
