The UK’s geopolitical and macroeconomic backdrop has meant it is “frustrating” trying to find new domestic-facing portfolio opportunities, according to Janus Henderson's Laura Foll (pictured), who said 2017 feels like the toughest year for stockpicking since she joined the firm in 2009. 
The co-manager of the £417m Lowland Investment Company, which she runs alongside James Henderson, said the duo reduced the gearing of the trust from a leverage in the ‘low teens’ to 5 or 6 per cent in the aftermath last year’s EU referendum result.
While the managers are very much bottom-up and have a value bias, Foll said factors such as the ongoing Brexit negotiations and the UK consumer squeeze have created share price uncertainty among many small- and mid-cap companies.
“Things are moving really quite quickly,” she said. “When it comes to stocks that are domestically-exposed to the consumer at the moment, there just isn’t a buyer out there for them no matter what the rating. [Brewery] Marston’s now has a yield of more than 6 per cent and it’s still going down.
“It’s frustrating. There’s this constant debate about what is priced-in and what isn’t priced-in, and what we’re finding is that when the results come out and they’re bad, they aren’t priced-in.”
One example of a stock that has been volatile is furniture company DFS which, despite achieving positive performance figures at a headline level, suffered when its trading update disappointed investors.
“Everyone has had a few of these stocks where they just feel immensely frustrated with the share price,” the manager explained. “Before it had its profit warning about a month ago, a lot of the analysts were arguing that the earnings forecast had come down, it had already de-rated and recession was priced in. In reality, the day it had those results the shares fell 20 per cent.
“What we’re learning – and it is a continuing learning process – is to be very wary of anyone telling you a UK recession is priced into these stocks. Because the day the results come out, it won’t be.”
That doesn’t mean to say that these stocks aren’t good investments, however. Foll pointed out that DFS has coped well during market corrections in the past by squeezing out other competitors through increasing its advertising spend.
It is also worth pointing out that, regardless of the difficult investing landscape, Lowland Investment Company has achieved a top-quartile return over the last year, having outperformed its average peer by 8.89 percentage points with a total return of 27.07 per cent.
Performance of fund vs sector and benchmark over 1yr
Source: FE Analytics
“Even though we feel frustrated, the performance doesn’t really reflect that,” the manager said. “It has been quite a good performance period, it’s just that we feel it has been quite difficult. I think a lot of fund managers feel like that at the moment.
“Even though markets have been good, if you went down to the floor the mood wouldn’t be buoyant. There’s a lot of quite frustrated people out there.
“I think it’s because, when things are going wrong out there, they are really going wrong.”
When stocks in the portfolio are falling in price, the managers are not using this as a sweeping opportunity to increase their weightings. This is because they currently remain cautious, given high levels of uncertainty in the UK market.
“The value investor in us would say ‘yes add to DFS’ but actually we haven’t because we don’t know what the UK consumer is going to do. And the data that is coming in is not looking good at the moment,” Foll explained.
“We feel like we are just too early to start adding to things like that when the operational leverage of those companies is really quite high. If sales fall 3 or 4 per cent that’s one thing, but if sales start falling 10 per cent, that really hurts your earnings in a way that is not priced in.”
Aside from rising inflation and stagnating wage growth squeezing consumers, the manager said Brexit-related uncertainty is also a potential headwind for domestic-facing companies.
“A lot of the companies we meet tell us an industry-specific reason why they’re worried about Brexit,” she continued. “We ask every company that we meet what they think about Brexit and whether they have a back-up plan.
“The companies do have back-up plans – such as moving their plants to Europe – they are thinking these things through very thoroughly. The types of companies we own have very strong management teams.
“But it doesn’t mean there won’t be a period of uncertainty for them. Each of them have individual concerns and will be explaining this to the government. But if you’re a small-cap company in the UK, you are not at the top of the government’s priority list right now. They’re all feeling a bit uncertain.”
In a bid to minimise risk, Foll and Henderson maintain a highly-diversified portfolio of 126 holdings. While it may look as though there are large sector overweights relative to the benchmark (Lowland has a 30 per cent weighting in financials and more than 25 per cent in industrials), each stock within each market area moves very differently.
Within industrials for instance, their holdings in Rolls Royce would move with the aerospace industry, Johnson Service Group would move with textile-related services and BAE would move with defence spending.
“This feels the toughest [year] since I joined for being a UK fund manager with more exposure than the market to domestics, given our small and mid-cap weighting,” the manager added.
Foll and Henderson aim to allocate roughly one-third of the portfolio to large-caps, mid-caps and small-caps respectively and, at any one time, they will hold no more than 50 per cent in blue-chip index constituents.
That said, there are indeed stocks in the portfolio that reside further down the cap spectrum but have underlying overseas revenue exposure.
One such example is FTSE AIM constituent Somero Enterprises, which specialises in concrete ground-levelling equipment.
Performance of stock vs index over 5yrs
Source: FE Analytics
Despite being listed in the UK, Foll said a majority of its revenue comes from the US.
“The machines cost $150,000 upwards and it’s pure capex,” Foll said. “There’s no maintenance spend, it’s purely based on whether you have the confidence to spend the money on one piece of equipment that makes your concrete floors perfectly flat.
“It’s very much dependent on the confidence of US consumers. Recently it has seen a good uptick in sales driven largely by Trump – business owners are feeling happier. It already had a net cash balance sheet but it is continuing to add to that. We’re getting a decent size dividend which they will pay this month.”
Contrary to their cautious outlook, the managers are positive on the prospects for UK dividend growth this year – particularly among small- and mid-cap companies.
“We can’t really rely on analysts’ forecasts for dividend growth at this end of the market so we do it ourselves, but we tend to be more conservative in the types of dividend growth we assume,” she explained.
“So, we feel pretty comfortable with the level of dividend growth and hopefully we can continue at that 7 to 8 per cent level that it’s been at historically.”
Over five years, Lowland Investment Company has returned 93.92 per cent compared to its sector average and benchmark’s respective returns of 63.95 and 78.81 per cent.
Performance of trust vs sector and benchmark over 5yrs
Source: FE Analytics
Had investors placed an initial £10,000 into the trust at the start of this time frame, they would have received £2,195.53 in income alone.
The trust is currently 12 per cent geared, yields 3.2 per cent and is trading on a 3.2 per cent discount. It has ongoing charges of 0.64 per cent.