While UK equities had a flat year in 2014, our data shows the FTSE All Share has delivered returns of more than 150 per cent since the market bottomed after the financial crisis in 2008, with most active managers gaining even more thanks to the strong performance of small and mid-caps over that time.
Performance of index since Mar 2009
Source: FE Analytics
The UK index has also posted a positive return in each of the last six years, except in 2011 when it fell 3 per cent thanks to the European sovereign debt crisis.
A number of experts, such as Neptune’s Robin Geffen, have already warned that 2015 will be a very difficult year for UK investors due to the inevitable heightened political risk in the lead-up to the election.
However, politics aside, Hall – who has been an FE Alpha Manager in every year since the ratings were introduced in 2009 – says the major concern for investors is that after years of strong returns, value in the UK equity market has been bled dry.
“I think it is fair to say that in our 25 years of doing this, we have never seen so many expensive stocks out there. It is very difficult to find compelling value,” Hall (pictured) said.
“But that doesn’t mean you stop trying. You work hard at it and much of our strategy over the past 18 months has been to use any periods of volatility to buy when people get concerned. However, when the stock market gets up towards the top end of its trading range, we are not shy to admit that it does become more difficult.”
Hall’s thoughts are echoed by his colleague and fellow FE Alpha Manager Paul Spencer, who has built up a strong track record as manager of the £960m Franklin UK Mid Cap fund.
Spencer will only invest in FTSE 250 stocks and will sell if a company rises or falls out of the index. He also says he won’t ever build up cash in his portfolios as trying to time the market is a “fool’s game” in his opinion.
However, due to the lack of value, he says he has never held as few stocks as he does at the moment.
“I like to run a concentrated, focused portfolio and it’s probably as low – in terms of number of stocks – than we have ever had at the moment at 36 stocks,” Spencer said.
“It’s definitely at the lower end of where I think the natural size is, but that is a reflection of the fact that the market has presented the least amount of attractive opportunities than it has done for some time.”
“But that’s natural when you consider where the market has come from over the last three to five years. It would be foolish to say that now is a once-in-a-lifetime investment opportunity. Valuations have become stretched as earnings haven’t driven [the rally], it has largely been re-ratings.”
Mid-caps have been one of the prime beneficiaries of the rally over recent years.
They have surged as the UK economy has moved into recovery mode, but prices have also been bid up by so-called ‘mid-cap tourists’ who have tried to add alpha relative to the FTSE All Share by upping their exposure to the index.
According to FE Analytics, the FTSE 250 index has returned 108.8 per cent over five years, comfortably beating the FTSE 100 and even the FTSE Small Cap indices, over the period in question. Spencer’s fund has outperformed all three indices over that time.
Performance of fund versus indices over 5yrs
Source: FE Analytics
Data from Bloomberg shows the FTSE 100’s P/E ratio is 15.86 times, while the FTSE 250 and FTSE Small Cap indices are on multiples of 18.98 times and 26.55 times respectively.
Spencer has not only been reducing his number of portfolio holdings, but he has also started selling areas of the market which could be worst hit if there were to be a correction. An example of that is financials, especially within his asset manager positions.
“We find it difficult to sit here, look you in the eye and say the market looks fully valued and then try and rationalise why we should have an overweight position in areas of the market that are clearly highly correlated to equity market valuations,” he said.
“That has resulted in me virtually halving our Jupiter holding over the past few months.”
Richard Bullas, who took over the Franklin UK Smaller Companies fund with Spencer in June 2012, also says that at 40 stocks it is the most concentrated he has ever had his portfolio.
The manager says that while there have been sustained outflows out of the IA UK Smaller Companies sector over recent months, he thinks the market is still getting over the excesses of early last year.
“We had this frenzied IPO market in Q1 last year with the likes of AO World, Pets at Home and Just Eat coming to the market at very, very high valuations and there was an awful lot of money chasing them,” Bullas said.
“We sat back throughout the whole period just in bewilderment about what was going on in terms of valuations and the prices that were paid.”
The Franklin UK equity team of Hall, Spencer, Bullas, Colin Morton and FE Alpha Manager Ben Russon are highly rated by fund buyers and manage a selection of UK funds.
One of their most unique, however, is the £83m Franklin UK Managers’ Focus fund. The portfolio is split between the five managers, who all run an individual part of the fund.
Morton, as manager of the Franklin UK Equity Income fund, looks after the blue chip portion of the portfolio with Russon, who runs Franklin UK Opportunities. They both look after up to 10 stocks each, which represent their best ideas from their own funds
Spencer has up to 10 mid-caps and Bullas has up to 20 small-caps, while Hall overseas the portfolio to make sure there isn’t too many biases or overlaps.
According to FE Analytics, Franklin UK Managers’ Focus has been a top quartile performer in the IA UK All Companies sector since its launch in September 2006 with returns of 109.31 per cent. Its FTSE All Share benchmark has gained 61.92 per cent over that time.
Performance of fund versus sector and index since Sep 2006
Source: FE Analytics
It is also top quartile, and has beaten the index, over one, three and five-year periods and on a discrete basis the fund has outperformed in five of the last eight calendar years, including falling markets like 2008 and strongly rising markets like 2013.
Franklin UK Managers’ Focus has an ongoing charges figure (OCF) of 0.85 per cent.
