There are areas of the UK domestic market that are priced for “reasonable despair” despite growth forecasts being revised upwards and sterling weakness attracting international trade, according to Man GLG’s Henry Dixon (pictured). 
The manager, who heads up the £522m Man GLG Undervalued Assets fund, says his opportunity set has risen significantly relative to this time last year.
While he believes there are headwinds on the horizon for the UK economy which could have a knock-on effect on markets, Dixon says there are sectors that have too much risk priced into them.
“The reason our opportunity set has risen is the very depressed share prices that we’ve seen in certain cases within the UK market,” he said.
“Some of these are now enjoying estimates momentum - earnings expectations for the market in aggregate are being revised higher and earnings are growing.
“It’s the first time in five years we’ve been able to say that and it’s certainly welcome.”
Last year was difficult for many active UK fund managers, particularly during the run-up to and immediately after the EU referendum.
As sterling depreciated, investors flocked en masse into global-facing stalwart stocks while domestic-facing areas of the market suffered. Given that many managers are overweight domestics relative to the FTSE All Share, a majority struggled to beat the index.
Dixon admits that his fund’s returns were hit by this during 2016, despite its performance improving after the sharp growth/value rotation experienced during the second half of the year, which was caused by the increased likelihood of fiscal expansion in the US and the UK.
Performance of indices in 2016
Source: FE Analytics
However, he warns that investors shouldn’t be complacent and says this cyclical upswing won’t continue forever.
“If we look at the market around Brexit, I think you could very definitely take that as an overall belief that yields would be lower for longer, forever. Clearly the Trump presidency turned that on its head at quite literally breakneck speed,” the manager said.
“I think there’s a lot now for Trump to deliver on for some of the savage gyrations we’ve seen to be valid and perpetuated.
“We wouldn’t wholeheartedly want to sign up to the case that ‘this is it’, we would always want to go with the notion that it’s important to be very selective in areas of value rather than offer a blanket approach.”
In addition, Dixon warns that fiscal loosening and a rise in global growth could eventually lead to rate rises in the UK, as it has done in the US.
He believes value investors should keep a close eye on this, particularly given that the amount of debt within the UK market has more than doubled over the last decade and now stands at more than £450bn.
“We’ve clearly had the good news with regards to fiscal policy and have had maybe a bit of a cyclical upswing, but we’re very definitely of the view that the natural endpoint after that is for interest rates to rise,” he said.
“If interest rates rise in certain instances where there is a significant amount of debt on balance sheets, we think that clearly could present problems.
“I think what we have to disaggregate from the good news is how much has been priced in and also, the secondary effects of interest rate rises and the pressure that will put on balance sheets.”
To mitigate this risk, Dixon is looking at areas of the UK market that are trading on particularly depressed valuations but offer upside potential that has been overlooked.
Examples of such sectors, according to the manager, include challenger banks, airlines and, in some cases, retailers.
“In terms of domestic UK, we’ve looked back through 30 years of data on G20 devaluation to work out the message for growth and inflation. The definite feel is that there’s the ability for the demise of sterling to stimulate growth as it has done in the past,” he said.
“Therefore from that perspective, we still feel there are very definite areas of the UK market that are priced for reasonable despair.
“When we finalised our work on this history lesson on devaluations in November [last year], I think that was quite a controversial view. Two to two and-a-half months on from that, it is becoming less controversial as you are seeing growth forecasts being revised up.
“Markets are definitely pricing something in close to a recession and that feels harsh in places. So where you can find the domestic portions of the UK market being priced in quite a depressed fashion, we’re looking to express a view against that.”
An example of a stock that Dixon thinks is particularly attractive at the moment is manufacturing company McBride, which is Europe’s largest producer of own-brand products. It has achieved lacklustre returns recently due to concerns that inflation will put a strain on the end consumer.
Performance of stock vs index over 1yr
Source: FE Analytics
However, Dixon says the stock could actually benefit from inflation, as consumers are more likely to switch to own-band products to counteract price rises. He also believes consumer purchasing power in the UK has been underestimated.
“We should be alert to the amount of debt within the stock market but what I don’t want us to be too depressed about is the level of debt within the consumer space,” he reasoned.
“I say that for two reasons which I think are incredibly important: for the first time since we’ve had reliable data - and our data goes back to the mid-80s - it is the first time we can find a situation where deposits at the bank actually outnumber loans. That is very important when it comes to framing our thoughts for rate rises and how that is going to impact the consumer.
“The other thing to put the significant deposit base into context, is it’s the first time for as far as our data stretches that the deposit as a percentage of GDP has risen above 100 per cent.
“In the middle of the 1980s, deposits at the bank were about 55 per cent of GDP. What you tend to find with people who are very bearish on the consumer is they’ll only look at one side of the balance sheet and they’ll look at how much debt he has.
“They will never look at how many assets he has and, to be a bit more balanced on our view on the UK, we definitely want to get the message across that there is a significant portion in the asset side of the consumer balance sheet.”
When it comes to Brexit-related uncertainty and how this will impact domestic stocks, Dixon says the trade deal with Europe is going to be “unbelievably complicated”.
However, even if Article 50 is triggered at the end of March, he points out that the UK’s trade agreement with the EU remains steadfast until March 2019.
“In a capitalist world, European companies will find it has to turn their backs on UK goods in the event that they are similar to other goods they can buy, because clearly they are now so much cheaper,” the manager said.
“I know the trade negotiations will be tricky, but there is a two-year period now where there could be the opportunity to export more to the European market and it’s simply a function of the currency.”
Since its launch in November 2013, Man GLG Undervalued Assets has returned 28.6 per cent compared to its FTSE All Share benchmark and sector average’s respective returns of 22.01 per cent and 20.99 per cent.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
It has done so with a second-quartile Sharpe ratio (which measures risk-adjusted returns), a third quartile annualised volatility and a third quartile maximum drawdown (which measures the most money lost if bought and sold at the worst possible time) over the same period.
It has a clean OCF of 0.9 per cent and yields 1.96 per cent.