This year has been a tough one for investors in growth, but it has also had a detrimental impact on those value managers not heavily invested in tobacco and miners.
Indeed, while the Polar Capital UK Value Opportunities fund sounds as though it should perform well when value stocks rebound, so far this year it has lost 11.8%, a below-average return in the IA UK All Companies sector.
This comes after a strong showing in 2020, when the fund made 20.1%, beating both its average peer and the FTSE All Share benchmark index.
Total return of fund vs sector and benchmark since Jan 2021
Source: FE Analytics
Georgina Hamilton, co-manager of the fund, said performance had been strong up until September last year, when the market rotated.
“One of the things that we have suffered from, but is also a massive opportunity, is that we are a multi-cap fund and 75% of our investments is in the mid- and small-cap part of the market,” she said.
“Since September the underperformance of the FTSE 250 versus the FTSE 100 has been larger than during Covid, Brexit and the global financial crisis. It has been catastrophic and huge in comparison to previous major events.”
Performance of FTSE 100 vs FTSE 250 over 1 year
Source: FE Analytics
While value funds have done well, she said this has been limited to large-cap tobacco, miners and oil, which are areas Polar Capital UK Value Opportunities has little exposure to.
“There has been a tailwind for value and we would expect in the future when value is doing well to deliver a better performance versus the index, but at the moment that has been swamped by our multi-cap focus,” she said.
However, the lack of catch-up from the mid-cap space means that these stocks have a lot of potential in the future.
One such stock is Breedon, which co-manager George Godber said is a “really interesting” business in the current market environment.
The firm, which makes concrete, cement and asphalt for the infrastructure market in the UK, has had a tough past 12 months with shares down 27.5%.
Total return of Breedon over 1 year
Source: FE Analytics
“Interestingly if you look at the profit upgrades and analyst expectations, you have seen very steady increase in expectations. These guys are operating and delivering, yet you have had a savage derating,” said Godber.
He added that the market also appears to be in rude health, with infrastructure output expected to rise by 40% more than at any other point in the past 30 years, largely driven by the building of HS2.
“You have a strong end market coupled with a business that can cope with inflationary pressures and that is on a modest valuation having massively derated,” he said.
Godber also mentioned Dunelm, the furniture and furnishings store, as another that has been thrown out with the bathwater.
“It is a very high-quality retail business in the FTSE 250 that has taken substantial market share over the past few years, partly because it is very good on digital and partly because it is good at its value proposition,” he said.
The firm has benefited from a broad range of suppliers, which has allowed it to keep on top of demand during the most recent supply chain disruptions, while its key relationships with manufacturers have meant that it managed to maintain its number of goods available.
Historically, the share has always been on the more expensive side, Godber said, trading at around 20x earnings, but at present this has dropped to 10x.
“If you believe that the drivers that have led to its outperformance over the past 20 years can continue, you will look back in three years’ time and think ‘what a bargain that was’,” he said.
“It is a winner. It is taking market share yet there doesn’t seem to be any difference in performance between those taking market share and those that aren’t. The market has been blunt, saying: ‘Anything consumer facing is dead’, which has caused a big compression in valuations without considering other factors.”
Total return of Dunelm and Premier Foods in 2022
Source: FE Analytics
A third company that can recover, and which the team has been adding to, is Premier Foods, the food brans business behind much-loved favourites such as Mr Kipling, Sharwoods and Ambrosia.
Hamilton said: “Typically there aren’t many of these businesses in the listed space at all because they are quite stable cash-generative companies that often get bought by private equity.”
Most rivals, such as Unilever, are viewed as quality-growth companies, placed on large valuations, but Premier Foods has struggled in recent years as mismanagement meant it required substantial restructuring and balance sheet help.
“This particular business has been a real turnaround. The new management team have completely sorted out the balance sheet and transformed it, but it hasn’t been given the credit of that,” she said.
“You have all of these great brands that are now performing but the company is sitting on a valuation of 9x earnings, which for a branded foods business seems totally mad.”
One potential issue is the health of the consumer, with fears that persistently high inflation, which has already led to a cost-of-living crisis, will continue to depress people’s spending, but Hamilton thinks the company will prove resilient.
“When brands are working they are given more shelf space in supermarkets and I think this has momentum there. But also, some people stop going to restaurants and start doing more at home, and therefore spend more at the supermarkets. So, historically in times of consumer pressure it hasn’t struggled,” she said.