While the fall in sterling since the Brexit referendum has had a positive impact on internationally focused UK stocks, Invesco Perpetual head of UK equities Mark Barnett has begun turning his attention to opportunities elsewhere.
The FE Alpha Manager says the past 12 months had been “great” for markets, which were up by 25 per cent, with earnings already improving during the course of 2016 before the sterling devaluation.
Market sentiment had been further boosted by “increased levels of optimism around global growth” and the election of Donald Trump, who had backed reflation policies during the campaign.
However, Barnett says last year’s returns would be difficult to replicate over the next 12 months.
The Brexit referendum result saw investors flood into internationally focused FTSE 100 stocks, as concerns were raised over future negotiations with the bloc.
The devaluation of sterling also made companies with non-sterling revenue streams seem more attractive to investors.
Performance of sterling vs euro & US dollar over 1yr
Source: FE Analytics
He said: “We must remember that 70 per cent of the UK market’s revenues is non-sterling-denominated currencies, so the big influence of a sterling devaluation on the market and positively impacting market-earnings forecasts.”
Yet, with internationally focused stocks having risen over the past six months, pushing the FTSE 100 to record highs, Barnett has begun to sell out of them in favour of those more geared into the UK domestic market.
He said: “I’ve been trying to sell out of some of the more internationally focused businesses, where I hold them, and buy into some of the more domestically focused businesses, where the ratings, I think, are at odds with the reality of these businesses.
“I think the market has taken, as a result of the fall in sterling, quite a pessimistic view in certain sectors on the performance of domestically focused businesses, and that’s been where I’ve been seeing opportunities.”
Barnett says that while the market has been sector driven and may remain so, the UK equities team would not be changing how it manages its fund range.
“We are still very focused in on fundamental analysis at the stock level and we believe that that, over time, creates differentiated performance,” he explained.
On a sector basis, there have been some changes, however.
Martin Walker, UK equities fund manager, says its overweight position in the mining stocks has been reduced. Walker said there had been a re-rating of companies in the sector, noting that commodities had been trading “significantly below the cash cost of extraction”.
“Whether they’re undervalued today really depends on what you believe commodity prices should be going forward,” he said.
“I’ve spent the last several years – well, actually, a lot of my career – talking to commodity analysts.
“The thing I’ve come to learn is that no one really has any strong insight into this. But having said that, often I think that marginal cash cost and movements in that can be quite significant.”
Walker says current sector holdings such as Glencore and First Quantum were focused on exposure to base metals areas such as copper, which he believes are “fundamentally challenged” from the supply-side.
Elsewhere, the manager says there is value within the banking sector having performed well during the final quarter of the year.
He said: “I’m focusing the portfolio generally on areas where banks are still trading at a significant discount to tangible book.
Performance of Barclays over 1yr
Source: FE Analytics
“So, for example, Barclays, which currently trades on a 20-25 per cent discount to book value, I think there’s an interesting story there, where they can get returns higher by cutting costs and also by what looks to be a cyclical recovery that’s coming in the investment-banking market, having had many years of downturn.”
Royal Bank of Scotland is a significant holding for the manager, where he notes management is “absolutely passionate about driving costs down”.
Lloyds, another holding in the portfolio, presents a different story, says Walker. While trading at a premium to book value the bank has made “very good returns” driving cash into the business and dividends.
He added: “What I have done in the sector is I’ve now exited HSBC. When I was buying the shares or this time last year, the shares were at a 30 per cent discount to tangible book value; they’re now at a 20 per cent premium to tangible book value.
“I think HSBC is a great business. It has great franchises globally but I think a large part of its profit recovery is now reflected in the share price and, as a result, I’ve exited the shares.”
Barnett says there are also other niche areas in the broader financial services sector where the team see good opportunities, such as life insurance busineses and non-traditional firms such as sub-prime lender Provident Financial, litigation finance firm Burford Holdings and stock exchange LSE.
“So, in a sense, I’m taking this is as a much more bottom-up, stock-specific way of exposing the portfolio to areas of the financial-services industry, where I think there’s a very strong investment case rather than taking a top-down, macro view,” he said.