Incorporating macro themes into bottom-up stock selection as well as maintaining the right amount of different style ‘baskets’ are some of the best ways to buy into the UK value market, according to SVM Asset Management’s Neil Veitch.
The manager, who heads up the four crown-rated SVM UK Opportunities fund, says there are many pitfalls that investors can find themselves in when it comes to looking for attractively-valued cyclicals.
If these are avoided, he says the UK value market is still yielding plenty of opportunities for those who believe last year’s market rotation still has further to run.
Performance of indices over 1yr
Source: FE Analytics
“Since a few months after Brexit, I certainly feel that we’re in something of a sweet spot for value,” Veitch (pictured) said. 
“Markets have rallied and have rallied hard, but I think there is further to run. That is because many of the deflationary pressures are beginning to subside and we haven’t seen too much cyclical excess come into the system just yet.
“Therefore, I think central banks will be more inclined to let the economy run hot rather than raise rates prematurely and throw off any recovery.”
Given that main economic indicators across the globe are improving, the manager believes the UK market will perform even better than it did in 2016, when the FTSE 100 finished the year on its highest annual return since 2009.
He believes there is a synchronised global recovery taking place, given that China’s economy has stabilised significantly compared to last year and the US economy has gained momentum over the last three-to-six months. That said, he urges investors not to be complacent.
“There is always a risk that that the economic pick-up in Q4 disintegrates. There has generally been a pick-up in economic activity in the fourth quarter over the last five years and, in the following first quarter, it dissipates and unfolds as the year progresses, generally because of some geopolitical shock or economic concern,” he warned.
“Last year it was concern around China. There is always the risk that something resurfaces to that effect but, this year, it is difficult to see what that would be.
“You have improving economic activity, interest rates are going to remain low, fiscal policy is on the agenda across the world, animal spirits are reawakening, and I think M&A activity will pick up this year given where sterling is.”
Performance of currency versus US dollar over 1yr
Source: FE Analytics
While Veitch believes now is a great time to be in value and cyclical stocks, he says there are a number of common mistakes that should be avoided to best utilise the market area.
One such mistake, according to the manager, is applying entirely bottom-up research when it comes to stock selection and ignoring macroeconomic themes.
“I think it’s a very quaint concept for managers to say they can macro-proof their portfolio, ‘I just buy companies and they see us through hard times’. It just doesn’t wash,” Veitch, who classes himself as a bottom-up investor, said.
“We’d all love to be able to buy 20 stocks that are all such high-quality businesses that they will see you through regardless. The reality with fund management stock-picking is as much about the price you pay as what you’re buying.”
While he says it is relatively straight forward to identify a good business, the manager says it is a case of finding the appropriate level of risk versus reward.
“We have a value bias and, to have a value bias, you fundamentally have to believe in some sort of concept of reversion to the mean,” he continued. “You can debate, particularly in today’s digital world, how strongly that occurs.
“But fundamentally, there has to be some sort of belief in reversion to the mean. For many growth stocks, the hurdle rate is too high. A lot of them are trading on very high multiples, and implicit in that they can sustain their growth for a period of time.
“The reality is that the world doesn’t work like that. Yes, there are two or three businesses perhaps in each market that do have superior and sustainable returns; it’s our job to try and identify those.”
As part of his investment process, Veitch categorises his investments under eight different ‘baskets’, which include ‘defensive’, ‘cyclical’ ‘consumer cyclical’ and ‘technology’, among others.
While the manager tends to adopt a value approach to investing, he believes stock diversification is important in terms of management style and function.
While 42.5 per cent of the portfolio is in what he deems to be cyclical stocks, for instance, 20 per cent are in defensive names such as Imperial Brands, GlaxoSmithKline and BT.
“We are prepared to pay up for growth stocks if we believe that growth can be sustained, whereas many managers with that value type of bias eschew growth stocks at any price,” Veitch continued.
“Everything in investment is many more shades of grey than it is black and white. Black and white is an easy narrative. It’s easy for fund managers to trot out the usual generalisations and attitudes. Most of it is a load of nonsense.”
He points out that another common mistake when it comes to value investing is categorising all stocks under the same umbrella.
For example, many investors may well shun value stocks given their outperformance versus growth, when in fact he says there is still a wealth of opportunities in the market area.
This is why he has divided his portfolio into various baskets, which show the varying levels of cyclicality across the fund.
“I have some sympathy with the idea that maybe some industrial cyclicals have run further than they should have on the expectation the economy is improving,” Veitch continued.
Performance of index over 1yr
Source: FE Analytics
“Having said that, the reality of investment is that stocks never trade on earnings multiples versus profits. The market is, in many senses, a simple beast. And as long as forecasts are being upgraded, generally the share prices will follow.
“You end up in a situation, whereby stocks end up trading at peak multiples of peak profits and finance theory tells you the complete opposite. The market should be a discounting mechanism, it should see the peak profitably and put a lower multiple on it.
“In some highly cyclical sectors that does occur, but in many sectors it doesn’t. The market extrapolates, it likes to draw straight lines, it convinces itself that secular growth is structural growth, and it puts a higher multiple on it.
“In short, I think selectively some cyclical stocks probably have run too far, but there’s a danger in making a generalisation that all cyclical stocks have run too far.”
The £145m SVM UK Opportunities fund, which has been managed by Veitch since 2006, is in the top quartile for its total returns over three and five years relative to its sector average. Over the last decade, it has returned 91.56 per cent compared to its average peer and benchmark’s respective returns of 67.03 and 72.12 per cent.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
It has a clean ongoing charges figure of 1.05 per cent.