The likes of Unilever, SAB Miller and Reckitt Benckiser have attracted a huge amount of investor attention recently as their stable earnings, healthy balance sheets and strong dividends have made them ideal alternatives to over-priced bonds.
However Murphy, who manages the Old Mutual UK Opportunities fund, says that they are now very overvalued and as a result he expects them to underperform over the coming six to 12 months.
The manager, unlike the majority of his peers in the IMA UK All Companies sector, has the ability to take short positions in his portfolio and is therefore looking to benefit from their inflated valuations.
“It’s really about the fact that those stocks' valuations have become too high in terms of their ratings,” he said.
“These companies have exhibited very stable characteristics, such as low volatility of earnings, being very cash generative and having great brands. My take on it is that investors have gradually rotated from bonds into a lot of those sorts of stocks.”
“Unilever, for instance, had a P/E ratio of around 14 times a couple of years ago and now is at 20 times. SAB Miller now has a P/E ratio of 22 times.”
“That has, in part, been down to the fact you are getting a little bit of the emerging markets growth story. However, the main driver has been because investors have been searching for high-yielding defensive stocks as they have been nervous about the state of the world,” he added.
According to FE Analytics, Unilever has made 93.57 per cent over five years, while Reckitt Benckiser and SAB Miller have returned 122.47 per cent and 204.05 per cent, respectively.
Performance of stocks over 5yrs
Source: FE Analytics
However, Murphy doesn’t expect that trend to continue.
“The first reason is because people are generally becoming more confident about the world,” he said.
“The second, and more important, reason is that bond yields are rising. That not only puts pressure on bonds as prices are falling, but it also has a negative effect on bond-like equities.”
“One final piece to the jigsaw is that emerging markets growth is slowing. There has been a slowdown in consumer buying and foreign currency movements have been going against them – so their earnings have been coming under pressure.”
“That gives my position additional help, but the primary reason I am shorting the stocks is because of their valuations,” he added.
Although the outlook for some of the more defensive FTSE 100 companies may look uncertain, they are still widely held by fund managers.
Unilever is one of the most popular UK stocks, appearing in 96 IMA funds' top-10 holdings. Reckitt Benckiser is held by 47 funds in their top 10, and SAB Miller 12.
FE Alpha Manager Nick Train is a fan of Unilever – it makes up 8.3 per cent of his five crown-rated CF Lindsell Train UK Equity fund.
He is maintaining a high exposure to the stock because he thinks its long-term prospects are good, but he recently told FE Trustnet that he expects it to underperform in the short-term, due to its previous lofty valuation and the fact that growth in the emerging markets is starting to slow.
Murphy agrees with Train, saying the likes of Unilever, SAB Miller and Reckitt Benckiser are high-quality companies. However, at this point in time, the manager says they just don’t represent a good investment.
“These sorts of stocks will always be highly rated by the market because they are good companies. However, their current ratings have gone too far now and I would expect a correction,” Murphy added.
Murphy has managed the £6.1m Old Mutual UK Opportunities fund since its launch in September 2011.
It sits in the IMA Unclassified sector and doesn’t have a benchmark. Old Mutual UK Opportunities has returned 20.03 per cent since its launch. As a point of comparison, the FTSE All Share has returned double that amount over this time but the fund has been far less volatile.
Performance of fund vs index since Sep 2011
Source: FE Analytics
Murphy is also shorting the FTSE 100-listed Severn Trent.
Eight funds count it as a top-10 holding, one of which is FE Alpha Manager Francis Brooke's Trojan Income. However, Murphy says it is another company that is likely to disappoint over the coming year.
“The reason why we are negative on Severn Trent is because we feel it will come under increasing pressure from regulatory changes. All the recent election rhetoric has been about cutting down the cost of living and I think that will be detrimental to Severn Trent,” he added.
Severn Trent has already had a volatile year. The stock itself has returned more than 11 per cent over the past 12 months; however as the graph shows, its share price fell massively in June and Murphy says investors should expect that trend to continue.
Performance of stock over 1yr
Source: FE Analytics
Old Mutual UK Opportunities has an ongoing charges figure (OCF) of 1.99 per cent and requires a minimum investment of £1,000.
