The coronavirus pandemic that blighted 2020 has thrown up some challenging periods for investors, but it has also created quite substantial opportunity in certain sectors.
Artemis chief investment officer Matthew Beesley has identified three investment areas – UK equities, the small-cap space and high yield credit – which he believes are contrary to the direction of the wider market.
Below, Trustnet finds out why Beesley expects these three areas to outperform in 2021.
UK equities
“It’s certainly not controversial to say the UK equity market is unloved,” said Beesley. “Fund flow data shows more outflows than any other of the developed markets.”
Indeed, November’s Bank of America Global Fund Manager Survey showed UK allocations are at their lowest level since the start of the survey in 1999 and on average asset allocators are a third underweight the region.
Uncertainties linked to Brexit and the handling of the Covid-19 crisis has further compounded the performance of the UK overall, as shown in the performance of the FTSE All Share against the MSCI AC World Index.
Performance of FTSE All Share vs MSCI ACWI YTD
Source: FE Analytics
With a resolution to both Brexit and Covid-19 expected next year, investors would be able to take advantage of the large value dispersion of discounted UK equities.
“All UK equities are tarred with the same brush regardless of underlying business fundamentals,” he said. “There is a discount today simply because the underlying equity is based in the UK.”
Beesley adds that investors over the last few years have been “mesmerised by growth”.
“In the UK there is a dearth of exciting growth companies, and conversely there is a plethora of unattractive value stocks that investors haven’t been interested in,” he added.
However, due to the cyclicality of the UK market, the out-of-favour sectors look set to come into favour at some point next year.
The expected earnings growth of 43 per cent in 2021 is a stark difference to the 42 per cent decline in earnings this year versus 2019.
This change in earnings growth historically drives p/e (price-to-earnings) expansion which then drives market performance.
Beesley also expects corporate buyers and private equity intervention if the low valuations persist.
Indeed, in the last two months, £22bn worth of companies have been subject to takeovers or approaches.
Small-cap
Beesley’s second contrarian call is the opportunity within the small-cap space.
While small-cap stocks have outperformed large-cap over the last 10 years, over the last two years small caps have lagged behind.
But as Beesley explained, this lag also creates significant opportunity as we head into next year.
“It’s an economically sensitive asset class,” he said. “These companies are younger, less well established, have more variable cash flows, weaker balance sheets and less capital available to them.”
There is also a discount opportunity across all geographies, especially in the UK where there is 15 per cent discount for small-cap vs the FTSE 100.
As such, the managers of Artemis’ smaller companies’ funds in the UK and the US are bullish on the opportunity.
Cormac Weldon, manager of the Artemis US Smaller Companies fund, is bullish considering how geared the asset class is into domestic growth in the US.
The UK managers are equally as optimistic as UK smaller companies have the double discount of being undervalued and by virtue of being in the UK.
High yield credit
The chief investment officer explained that investment grade credit has outperformed high yield by about 4 per cent. While this is not remarkable, this is unexpected and has created clear opportunity.
High yield credit vs investment grade credit
Source: Bloomberg
“It’s likely that loose monetary policy should provide a strong tailwind for the high yield market in 2021,” Beesley said.
He noted that major monetary policies, like quantitative easing, tend to take time to trickle down to the high yield market.
“However, when it does react it has a significant impact,” he added.
“Ultimately, we’re nearing a recovery phase for credit and given the massive impact that central bank actions have already had on the government and corporate bond markets it could be that high yield is the last place where we have these elevated spreads in yield for investors to take advantage of.”
According to David Ennett, who works on the global high yield strategies at Artemis, the opportunities are beset by the potential risks.
Ennett outlined that the yield pickup is still meaningful and the significant dispersion in sectors is especially important for active managers.
However, ongoing central banks purchase of bonds and the sector dispersion is counterweighted by significant risks in the asset class.
Slower growth due to vaccine delays, inflation and the dangers of the default cycle all pose potential headwinds if realised.