BoE governor Mark Carney cooled expectations of an early rate rise yesterday, warning that the economy had not yet returned to “normal”.
Newman says that he supports this approach, and the UK economy couldn’t handle rate rises at this point.
“My only concern is that things over-heat, which would be more of a short-term trading opportunity,” he said.
“If we see early rate rises markets may panic. Do we then see a reversal in the pick-up in the construction market which has been central to the recovery?”
“That would be our one concern. But a steady slow normalisation of funding rates is probably a good thing.”
Newman’s £389m fund has been one of the long/short funds to make money this year, returning 0.96 per cent as the FTSE All Share has risen 3.19 per cent.
Performance of fund vs sector and index in 2014
Source: FE Analytics
FE Trustnet highlighted yesterday that many of the most highly-regarded long/short funds have struggled despite the market seemingly perfectly adapted to their style.
Newman says that the conditions for his long/short strategy have massively improved over recent years thanks to improving liquidity and decreasing correlation between individual stock returns.
The manager explains that many of his peers were caught out being heavily short emerging market focused and defensive companies when the markets shifted from growth to value in March.
He has also made money by being short a lot of the high growth stocks in the FTSE 250 which had become consensual positions.
However, the manager is returning to the other side of both these trades, driven by his expectations for eventual rate rises.
“We are trying to find ways of making money in a rising interest rate environment,” he said.
“That’s why insurers and banks are worth sticking with. Both of those businesses normally will benefit from rate rise cycle.”
Newman explains that banks benefit from a rising rate environment by borrowing on short term rates and lending at higher longer term rates. Insurers will benefit from the boost to their income as yields rise.
Data from FE Analytics shows that the banking sector has struggled this year, and is down 4.19 per cent compared to gains of 3.19 per cent for the index. Results from a number of the major banks have disappointed markets.
Performance of indices in 2014
Source: FE Analytics
Life insurers, on the other hand, have done exceptionally well despite the sharp sell-off after the budget.
Many managers have saw the sell-off as a value opportunity, and funds like Newman’s with large positions have done well.
The largest position in the Henderson UK Absolute Return fund is a 3.9 per cent stake in L&G. The fund’s largest sector exposure is a 13 per cent net long position in financials, including positions in banks as well.
The Henderson fund has also taken out short positions in consumer stocks selling into emerging markets.
Emerging markets saw a spike as the highest growth areas of the market sold off in March, in what Newman refers to as a rally for defensive assets.
“As ever we are also looking to take the other side and we are returning to our emerging market assets which have been some of the biggest beneficiaries of QE,” Newman said.
The manager says he remains short a number of large consumer companies selling into emerging markets which are likely to suffer as the liquidity of quantitative easing is withdrawn.
“These companies have been valued as structural growth stories over the last few years but might just be more geared to emerging market leverage.”
Data from FE Analytics shows that some of these companies, such as Unilever and SABMiller, have seen a surge in the more risk-off atmosphere since March.
Performance of stocks in 2014
Source: FE Analytics
Newman says that in his short book he is also looking for companies with excessive leverage as a hangover from the pre-crisis period.
“One area you don’t want to be in when funding pressures rise is companies that have not addressed their pre-crisis balance sheets,” he said.
“I can find you at least 10 companies on the UK market with net debt to EBITDA over 10 times, typically later cycle consumer exposed names in the consumer, travel and retail spaces.”
Newman says that he is adding to his shorts in these areas. Companies with high levels of debt have been helped by low rates over the last few years but once rates start to rise their funding costs will increase, he warns.
The fund, which Newman manager with FE Alpha Manager Ben Wallace, has ongoing charges of 1.07 per cent and is on the FE Select 100.
