Last year’s market rotation from quality growth towards value stocks was long overdue and is set to continue as we head through 2017, according to Premier’s Chris White.
The head of UK equities, who runs a number of funds including Premier Income and Premier Monthly Income, says there are still attractively valued opportunities in financial, industrial and consumer discretionary sectors. However, he says investors must be willing to invest across the cap spectrum to achieve the greatest possible levels of income and capital protection.
White also warns that, while domestic-facing retailers are indeed cheap, it could still be too early to increase exposure to this area of the market.
“Over the last few years, we have become more small- and mid-cap than we were. Our breakdown in terms of asset allocation at the moment is around 40 per cent FTSE 100, about 30 per cent mid-cap and around 25 per cent small-cap,” he explained.
“That has served us very well over the last few years but, post-Brexit, it was a bit of a problem. Last year was what I call ‘revenge of the FTSE 100 index’; after years of underperforming, due to Brexit and the fall-off of sterling against the dollar and euro, our multi-national large-caps suddenly hit an upgrade as a result of overseas earnings being translated back into sterling at a higher rate.
“This meant it looked like they were growing their profits but, underlying, they’re still quite large stodgy companies. But suddenly the headline figures looked like they were growing faster than they are.
“Small-cap income funds got hit hard, mid-cap funds and multi-cap funds got hit quite hard. July and August were uncomfortable months for us but, by the end of the year, we ended up virtually in-line with our peer group. Given that we’re very multi-cap compared to our peer group, I think we’ve done pretty well.”
Performance of fund vs sector and benchmark in 2016
Source: FE Analytics
While ‘stalwart’ stocks were championed by UK investors at the start of the year, expectations of fiscal loosening and its potential to boost global growth – triggered by the election of controversial Republican Donald Trump as president – caused a sharp reversal in market behaviour during the latter half of 2016.
Some investors are wary that this value rally isn’t sustainable, but White believes markets are just on the cusp of favouring the previously unloved cyclical market areas.
“This year, we have started off quite strongly. In fact, the inauguration of Donald Trump was the turnaround moment for our funds and other value funds in the market,” White said.
“That has been a sea change, you can literally point to the date of the US election and say, ‘that’s where it all started’. That’s all about Trump and the reflation trade.
“It’s one of the fastest value rallies we’ve had in recent times so it has been hugely significant. The question is, where do you go from here?
“I think we will get more of the same, certainly for the first half of 2017. The reason I say that is that Trump has only just been inaugurated and his first 100 days are going to be a blizzard of initiatives.”
While investors could point out that the market rally has already taken hold, the head of UK equities believes there are still sectors that are largely under-priced and under-held by investors.
One such area is banks, which remain unloved since the collapse of Lehman Brothers in 2008 and has since been plagued with fines and penalties.
Performance of indices since 2008
Source: FE Analytics
“Banks tend to be more profitable when interest rates are moving and when bond yield curves are sloping upwards,” he continued. “They take deposits off you and hold it there and pay you virtually nothing, but they’ll be lending money out further down the yield curve and, if the yield curve moves, there will be a bigger margin for banks when they’re lending out money.
“The whole environment is much better for banking. If we start to see Trump’s regulation that is probably going to be good news for banks. Banks have seen a lot of regulation and red tape coming their way over the last eight years, some of it quite rightly so.
“But there could be a trend away from that. I think you’ve seen peak regulation, the banking sector is probably still under-owned and there is still plenty of value in banks.”
One of the largest holdings in Premier Income is HSBC, which accounts for 4.8 per cent of the portfolio. White points out that it yields more than 6 per cent and that this dividend now looks far safer than it was 12 months ago.
Not only is the economic backdrop for banks improving, he says HSBC is under-owned within a UK market context and within the IA UK Equity Income sector.
“HSBC looks cheap relative to its big US, global-facing peers, it’s on a P/B ratio of 1.1x, a P/E of 11x and has a dividend yield of 6.3 per cent. It ticks all the right boxes. We have pushed that up to being one of the largest holdings in our income funds,” White said.
“We also own Lloyds – the big yielders. We have always felt it difficult to own RBS and Barclays, and obviously Standard Chartered which pays no dividend.
“Not only do we like the dividends, we like the fundamentals of HSBC and Lloyds. RBS still has a big cloud of regulation over its head and it is going to take a big fine from the US authorities for mortgage mis-selling, which is going to cost billions of dollars.”
Elsewhere, the manager is overweight industrials such as manufacturing companies and support services. He is also overweight consumer discretionary stocks and holds a number of public transport firms as well as drinks wholesaler Conviviality.
Conviviality – formerly Bargain Booze – acquired fellow drinks wholesaler giant Matthew Clark last year and, as such, White says it has the power to buy its stock at cheaper valuations.
Since its IPO in 2013, the stock returned 137.91 per cent compared to its FTSE AIM All Share index’s return of 30.02 per cent.
Performance of stock vs index since IPO
Source: FE Analytics
At the other end of the spectrum, White is significantly underweight what he deems to be ‘bond proxy’ areas of the market such as telecoms, healthcare and pharma, utilities and consumer staples.
“We always have to look for moments to rotate,” he said. “There are one or two retailers that are starting to come up on our value screens but I perhaps feel it is a bit too early for the retail sector, given inflation is likely to move up from 0.7 to maybe 3.5 by the middle of this year.
“As that happens I think it’s difficult to see investors gaining a lot of confidence about the retail sector while real wage growth is turning negative.
“I think you have to keep your eye on retailers because, come the middle of this year, it might be a good idea to actually rotate into something like an M&S, a Dixons or a Next. But right now it feels a bit early.”
Since White took to the helm of Premier Income in 2010, it has returned 94.64 per cent compared to its sector average and benchmark’s respective returns of 75.53 and 65.54 per cent. It has done so with a top-quartile maximum drawdown (which measures the most money lost if bought and sold at the worst possible times) and Sharpe ratio (which measures risk-adjusted returns).
Performance of fund vs sector and benchmark under White
Source: FE Analytics
Over the same time frame, if an investor had placed £1,000 into the fund, they would have received £338.73 in income alone.
Premier Income has a clean ongoing charges figure of 0.86 per cent and yields 4.18 per cent.