Inflation and UK bond yields are highly likely to rise from here, according to Fidelity’s Leigh Himsworth (pictured), who said the changes in market conditions will alter where he invests “significantly”. 
The FE Alpha Manager, who runs the four crown-rated Fidelity UK Opportunities fund, said the underlying drivers for the health of the UK economy look positive and that he is therefore adjusting his expectations.
Following several years of negative consumer credit supply, he said that this is now on the turn and the ‘multiplier effect’ will soon return to the UK economy and bolster markets.
“Because banks were in such a difficult position during the crisis, very few of them were prepared to lend into the real economy, so they contracted what they had to try and restructure their own balance sheets,” Himsworth explained.
“You can see that by the fact the money supply in the early part of the financial crisis contracted significantly, even though we were trying to make money as cheap as possible for people.
“Nobody wanted to either lend or to borrow in that period so we saw a significant period of restructuring, a so-called balance sheet recession, that we’ve really only recently emerged from.”
Due to a reluctance to lend from banks, the manager noted that fewer individuals were spending money and bolstering the economy – a cycle that became self-perpetuating.
This is despite the fact loose monetary policy such as quantitative easing and ultra-low interest rates made borrowing cheaper.
“We can see from the consumer credit supply numbers that we had a significant contraction during the period from the end of 2008 to the early part of 2013 that was actually negative. Yes, we were making money as cheap as possible through very low interest rates, but no one wanted to borrow within that period,” Himsworth said.
“Individuals were trying to repair their own balance sheets as well as the banks, so we had a significantly difficult period in terms of generating growth we have only recently emerged from.
“People have been happy to take out loans, banks have been happy to lend to them, and we’ve now very recently started to get the multiplier effect back into the economy and growth has started to be generated again in the UK.”
As such, the manager said the post-2008 pattern of low government bond yields and toppy FTSE 100 valuations – exacerbated by the hunt for yield and the favourability of ‘bond proxies’ – could all be set to change.
Performance of indices since 2008
Source: FE Analytics
Not only are people lending and borrowing once more, he said sterling weakness combined with the multiplier effect will spell the return of inflation in the UK.
“Recent economic prints would support that view – the question is what level will this peak out at? Will we see rampant or unsteady rates of inflation going forwards?” Himsworth continued.
“It’s difficult to see that, partly because we have significant levels of excess capacity in the UK economy and we’ve only recently emerged from a significant downturn.
“So, to expect very high levels of inflation is probably unrealistic, but the levels that we’re currently seeing in the realms or 2 or 3 per cent are probably what we should expect for the foreseeable future.
“That should mean we adjust our expectations, consumers will start to spend again, companies will start to invest again and that’s a very good sign for the underlying economy.”
He said UK bonds yields are likely to see a reversal upwards from the 1 per cent they are at today.
“That does cause us, as UK equity investors, to change the pattern of our own investment. Where we actually invest in the portfolios will change significantly,” Himsworth said.
The manager isn’t the only investment professional to overhaul this portfolio recently, though. As discussed in an article last week, star manager Neil Woodford sold out of his long-standing position in GlaxoSmithKline to help fund new positions in domestic-earners and banking giant Lloyds due to an increased bullishness on the UK economy.
Like Woodford, Himsworth believes the UK market is a very attractive place to be invested at the moment.
“The outlook for earnings is very strong – above 10 per cent – and the median yield on the market is more than 3 per cent,” he pointed out. “They’re very attractive numbers when you consider that UK 10-year bond yields are at around 1 per cent and property has the additional associated problems of illiquidity of assets. We’re at a very good starting point.”
In terms of where he sees the best opportunities, the manager has turned his attention towards financials, growth-oriented stocks and companies that are further down the cap spectrum.
He also aims to tilt the portfolio’s sector weightings towards areas such as supermarkets – which have niche pricing power – and IT firms which are less susceptible to input cost inflation.
“We also maybe want to raise overseas exposure within the portfolio, and perhaps take on stocks as well that have a high element of debt in the overall valuation of the company – the enterprise value of the company,” he explained.
Himsworth aims to do this through a wide range of companies across these sectors that dovetail well together in order to successfully diversify the portfolio.
The £109m fund currently has a portfolio of 54 stocks, which are spread across nine different market sectors. The largest sector weighting is towards financials at 23.1 per cent, followed by industrials at 22.2 per cent and consumer services at 17.7 per cent.
“We have a good strong balance of stocks within the portfolio, from very large companies such as Lloyds through to smaller companies such as Costain, which is involved in construction,” the manager explained.
“But then we have a balance with overseas earnings and different maturity stocks as well. The key point is to have exciting stocks within the portfolio but control the risk of the overall portfolio that’s put together.
“If you look at the top 10 active positions in the portfolio, there’s no significant individual stock position; they’re all controlled, it’s a fairly flat top 10 in terms of relative position.”
Some of the fund’s largest holdings include IT firm Micro Focus, engineering companies Ricardo and Melrose – which the manager is holding for their overseas exposure – and online games specialist GVC.
Cairn Energy gives the portfolio exposure to the oil & gas industry, Dairycrest is a domestic-facing play and insurance company Saga is a means of benefitting from the UK’s ageing demographics. Meanwhile, Tesco gives the portfolio exposure to the food retailing industry which the manager believes will benefit from modest levels of inflation.
“The key element to all of this is that we can see a significant change happening in the UK market and we want to have exposure to that through a well-balanced portfolio that is set for this new environment,” Himsworth added.
Since Fidelity UK Opportunities’ launch in 2011, it has returned 129.5 per cent compared to its sector average and benchmark’s respective returns of 80.89 and 72.58 per cent.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
It has a clean ongoing charges figure of 0.96 per cent.