The challenging conditions for UK equities brought about by the late market cycle environment and ongoing Brexit uncertainty are creating an opportune environment for a once-popular strategy.
The launch of the UCITS III structure paved the way for new strategies such as the 130/30 fund. These combined a short book typically representing 30 per cent of the fund’s gross market exposure whose proceeds are used to increase its long book to 130 per cent, leaving net market exposure at 100 per cent.
The funds soared in popularity and by 2007 accounted for up to £6bn in assets under management in the UK, according to the Investment Association.
However, when the global financial crisis took hold of markets in 2008 the strategy’s popularity waned as stock markets slumped and sapped investor risk appetite.
Performance of MSCI World index 2007-2008
Source: FE Analytics
There are fewer 130/30 funds around these days, but they haven’t all disappeared.
One such fund is JPM UK Equity Plus, co-managed by Callum Abbot, James Illsley, Nicholas Horne and Anthony Lynch.
Portfolio manager Abbot said the strategy allows the team to take much greater exposure to its strong conviction ideas, which it identifies by using a behavioural finance process to take an “unemotional view” of the entire UK stock market.
“We always have ideas where we like the stocks but also we have those stocks that we don’t like, so we naturally identify the ones we want to get long and overweight in and those we want to avoid and can short those stocks as well,” he explained. “That’s quite different from most fund managers.”
The bottom-up stockpicking approach suits this type of market, said the JP Morgan manager, given the level of disruption going on and the number of “winners and losers” in this environment.
“For the UK equity market it is a good fund structure because it is pretty concentrated,” he added. “If you think about Shell and HSBC really big index weights, but then you have got this long tail of hundreds of stocks that are quite small in terms of index weight.”
As such, the mid cap-biased fund is able take greater exposure to those smaller names in the index and generate greater alpha.
One of the inescapable features of the UK market during the past two years, Brexit, has added a great deal of uncertainty for the economic outlook and made it increasingly difficult for many long-only UK equity managers to position their portfolios.
However, Abbot said the 130/30 strategy gives greater freedom to actively position in stocks that the managers think will outperform notwithstanding the Brexit outcome.
“From a portfolio perspective, we’re viewing Brexit not as an alpha-generating event but as more of a risk event,” he said. “With shorting it becomes almost easier to do because we can look at sector with domestic exposure like general retail.
“We might not want to take a huge view on the sector but we like certain stocks, such as JD Sports where we think they’ve got great relationships with brands like Nike and Adidas, they’ve got support to grow – not just in the UK, but in Europe and the US.
“So that’s got a nice growth story we want to tap into but we can offset some of that by being short on the names that we think face structural issues.”
Performance of stock vs FTSE All Share since EU referendum
Source: FE Analytics
He added: “Regardless of the Brexit outcome – which is extremely difficult to predict – we’re overweight the names that will outperform regardless of what Brexit looks like in the end, and we’re short and underweight those names that we think are going to be in trouble regardless.”
The JPM UK Equity Plus manager said that rather than taking big macroeconomic bets – where it doesn’t have an advantage – the team prefers to try to control exposure, taking risk instead on an individual stock level.
Part of its risk control process is to take positions that are plus or minus one per cent of the benchmark – the FTSE All Share index – leading it to have some key over- and underweight positions within the portfolio.
One such area is housebuilders, which look attractive from a valuation and a yield perspective, although Abbot admits that a bad Brexit could put some of those names in the firing line, leading it to offset those positions with stocks it doesn’t like.
Another overweight area is the oil & gas sector. FTSE 100 names Royal Dutch Shell and BP are among its key holdings, representing 9.4 per cent and 5.4 per cent of the portfolio respectively.
“We think the big oil companies are quite well-positioned to generate a lot of cash in this environment,” he explained. “They took the pain in 2015 when oil price was cratering and what’s been great to see is that they retained a lot of discipline there.
“Instead of the oil price going up and relaxing standards they’ve retained a very cost-conscious capital approach. As the oil price has come off they’ve still been able to generate a lot of cash.”
However, to offset some of the exposure the team has taken underweight positions in smaller exploration & production companies that – even if they keep costs down to a minimum – have debt-laden balance sheets that could become problematic if oil prices struggle.
One slightly overweight sector for the fund – albeit with a more nuanced view – is in financials where the managers have taken underweight positions in some of the global banks and embattled challenger banks.
“For example, Metro Bank we’ve had a long-term short position in,” said Abbot. “We think it’s quite expensive and expectations are quite challenging.
“That allows us to be overweight other stocks where we think they’ve got more potential. We’ve had a long-term overweight in Charter Court Financial, it operates in quite a niche market and pricing is more attractive there and we can offset some of the Metro Bank.”
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
Since launch in September 2015, JPM UK Equity Plus has made a total return of 32.8 per cent against a rise in the FTSE All Share index of 32.19 per cent and a gain of 23.26 per cent for the average IA UK All Companies peer.
The £133.4m fund has a yield of 2.91 per cent and an ongoing charges figure (OCF) of 0.9 per cent.