Financials and certain domestic-facing areas of the market are offering up far more defensive opportunities than the traditionally 'safe' UK consumer staples, according to Majedie’s Chris Reid (pictured).
The FE Alpha Manager, who heads up the four crown-rated Majedie UK Income fund, says there is a wealth of stocks in these sectors that boast strong balance sheets, have long-term track records and are able to pay attractive yields during even the most challenging market conditions.
"Our main sector weighting at the minute would be financials – we've been looking at them for a couple of years," he said.
"When markets became volatile and people began to worry about financials, because we had done a lot of analysis on them, we were able to know they have changed a lot over the last few years and that they can stick it out."
UK financial stocks have indeed performed well recently, with the FTSE 350 Financials index comfortably doubling the FTSE 350 index over the last six months.
Performance of indices over 6months
Source: FE Analytics
However, this hasn't always been the case – far from it, in fact – as the market area tends to fall out of favour when interest rates are low. Given the continued implementation of ultra-loose monetary policy since the financial crisis of 2008, many investors have steered clear of banks given their subsequently low loan book growth.
Not only are some investors worried the market area is cyclical and too dependent on the broader macro environment, highly-publicised scandals over the years including mis-sold PPI, money laundering fines and 2012's Libor fixing case have also dented investors' confidence in the market area.
Now though, banks and insurers are falling back into favour as markets prepare for fiscal loosening, higher interest rates and a boost to global growth.
However, Reid says the appeal behind financials runs far deeper and says that, from a bottom-up perspective, many banks and insurers look more attractive than ever.
"Almost all financials in the UK have stronger balance sheets [since 2008] and, in a funny sort of way, it is areas like staples that are geared up to the eyeballs and are sitting on piles of debt, versus banks and insurers," he continued.
"If you can really believe in a company that is mistrusted by others can pay its dividend, you get further upside from the re-rating when the stock market catches up, that's what we're trying to do."
Reid points out that banks have endured the 'perfect storm' over the past 18 months, given central bank policy, hefty fines and non-performing loans.
As such, he has gained further confidence in the stocks' abilities to weather almost any scenario.
An example the manager holds in his portfolio is FTSE 250 constituent Tullett Prebon, one of the world's leading interdealer brokers which operates primarily in the financial wholesale sector.
Over the last five years, it is broadly in-line with its index and has outperformed it by more than 30 percentage points over the last year with a total return of 46.09 per cent.
Performance of stock vs index over 1yr
Source: FE Analytics
"We have held them for nearly five years and they have coped with a really miserable environment in terms of their business, because QE has obviously prevented people from exploiting dislocations between markets," Reid explained.
"In that time, because they were net cash, they have actually managed to take over their biggest competitor, have become number one, and now they're moving forward on the growth side.”
"I think the benefit of holding a company like this is that it will probably get a tailwind that it hasn't had for the last five years – more volatile markets and higher bond yields."
Another example of a financial stock in Reid's portfolio is Aviva, which is the largest holding in the Majedie UK Income fund and accounts for 7 per cent of its overall portfolio.
While the firm ran into trouble a few years ago and came near the brink of collapse, the manager says it has since gained a new management team and, after closing and selling one-third of its business, has focused on strengthening its balance sheet.
"Last year they merged with Friend's Life, so now they have this massive cash flow engine coming through that is going to allow them to grow their business," he said.
"The result is a 6 per cent dividend yield and a really strong balance sheet.”
"In a funny sort of way, the UK needs these services more than they did before Brexit because we need more pensions, we need more infrastructure – we need the services these companies are providing."
While Reid is particularly keen on financials, he predominantly adopts a bottom-up stock-picking process based on four "tests" - two of which are financial and focus on balance sheets and valuations. The other two are based on qualitative factors which focus on management strength and the foundations on which the businesses are built.
This process has also led to him holding a number of domestic-facing UK firms, which suffered following the 'leave' majority vote in last year's EU referendum.
"From our point of view, it's a matter of looking for new ideas all the time – if you are open-minded, there are a lot of opportunities," Reid said.
"We bought Marks & Spencer over Christmas for example, it's just the nature of opportunities is going to change a lot compared to 12 months ago.”
"The problem with being too bearish on the world is that it's quite a consensual view and with some of these UK domestic stocks – such as Marks & Spencer – they are pricing in a recession.”
"The one thing we know from the last 10 years is that they can actually cope with a severe recession and they can cope with inflation.”
"That is perhaps the benefit of this fund – because we are constantly rotating as opportunities come through, we're looking at new areas of opportunity all the time."
Since its launch in 2011, the £893m Majedie UK Income fund has returned 112.41 per cent compared to its sector average and benchmark's respective returns of 77.18 and 69.92 per cent.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
If an investor had placed £10,000 into the fund at launch, they would have received £3,110.26 in income alone.
Majedie UK Income has a clean ongoing charge of 0.77 per cent and yields 4.68 per cent.