Tough market conditions have led to “bizarre” happenings within fixed income and equity markets, which have in turn created limited but lucrative investment opportunities, according to Nigel Thomas (pictured).
The FE Alpha Manager, who runs the £3.9bn AXA Framlington UK Select Opportunities fund, says in his latest bi-annual Thomas Report that negative redemption yields on seven-year bunds and Japanese 10-year bonds have led to opportunities opening up in areas such as the construction equities space.
At the start of the year, the Bank of Japan introduced negative interest rates for the first time in a bid to revive economic growth. This led to more than $1trn government bonds offering sub-zero yields. A similar move has since occurred in Germany, where active monetary policy and safe haven flows have also led to bonds with negative yields.
Thomas says the Japanese and German governments are therefore slowly accumulating cash and argues that this is likely to be spent on improving infrastructure within the regions.
“If quantitative easing and monetary policy has gone as far as it can in the developed economies, then surely fiscal stimulus should now be the major policy tool,” he said.
“Even if you look at the 20-year bonds in Japan and Germany, their implied cost of borrowing (given their low yields) is approximately 0.5 per cent. Why should we not see a massive increase in infrastructure investment, a new Marshall Plan across Europe, to build new roads, rural broadband, high speed railways, hospitals, ports, runways, etcetera?”
“This infrastructure would not only be a stimulus to growth, but would in due course help productivity. Given our own current chancellor’s attitude to government spending, this may not happen. However, our investment thesis should not ignore this.”
As such, the fund accounts for 8.8 per cent of Breedon Aggregates' issued share capital, which is the largest independent aggregates business in the UK.
The firm, which has a market cap of £871m, owns 54 quarries across the UK which produce limestone, granite, basalt, sand and gravel to sell to construction industries.
Since the stock floated onto the AIM market, it has provided a total return of 656.25 per cent, outperforming the AIM All Share index by 676.95 percentage points.
Performance of stock vs index since IPO
Source: FE Analytics
“UK aggregate volumes peaked in 2007 at 170 million tonnes. Today it is only back to 130 million tonnes,” Thomas continued.
“The executive chairman of Breedon, Peter Tom, is the doyen of the industry and has built a significant portfolio of quarries, asphalt plants and concrete product plants.”
“They are supplying 27,000 tonnes of asphalt to the large new Jaguar Land Rover factory complex at Solihull for example. They have just reported annual results for 2015 with revenue up 18 per cent and pre-tax profits up 46 per cent. Of the 130 million tonnes of aggregates mentioned above, they supplied 8.7 million tonnes of that total.”
Elsewhere in the Thomas Report, the manager states that television advertising is going from strength to strength despite the fact that online platforms are becoming more popular than others in another bizarre market trend.
In what he describes as “the irony of ironies” he says online services Google, Facebook and Netflix spend more than 60 per cent of their own marketing budgets on television advertising. As the companies continue to grow in size, he says their television adverting budgets will also increase.
“According to Thinkbox, the online sector has now become the second-biggest category of advertisers on TV. Their research shows that online businesses spent more than £500m on TV advertising in 2015, [which is] a 14 per cent increase,” Thomas said.
“Facebook was the biggest-spending new TV advertiser in 2015 among 877 brands classified as new or returning to marketing on TV after a break of at least five years. The death of free-to-air TV – surely some sort of nonsense.”
The manager owns shares in ITV. While he admits that a weak first quarter for national advertising revenues lowered the share price, he says the most popular channel to build brands is still television despite the increase in online advertising and the wider range of devices available to watch content on.
Performance of stock vs index over 1yr
Source: FE Analytics
In fact, he argues that it is the growth of online companies that has bolstered advertising spending when it comes to television.
Another abnormality in markets at the moment, according to Thomas, is the sheer number of dividend cuts across the UK blue-chip market, with the likes of Anglo American, Barclays, BHP Billiton, Sainsbury’s, Centrica and Rio Tinto all announcing a reduction in annual dividends over recent months.
He says that the common link between all of the FTSE 100 firms that have cut their dividends is that they have been hit by the deflation of energy, commodity and food prices.
“A great deal of uncertainty persists with slower global growth, compounded in the UK in the short term with Brexit,” the manager explained.
“If deflation gets stronger and investment decisions are delayed, negative rates could slow growth further by way of increased savings. We will endeavour to find good companies that convert a great deal of their profits into cash to continue paying ordinary and sometimes special dividends.”
“Although cyclical companies will have their day in the sun, we believe it is the growing companies that will increase their shareholder returns over the long term.”
Over Thomas’ tenure, AXA Framlington UK Select Opportunities has made a total return of 321.8 per cent, compared to its sector average and benchmark’s returns of 175.54 and 175.97 per cent respectively. It has also achieved a lower-than-average maximum drawdown and a top-quartile Sharpe ratio over the same time frame, although it does have a higher-than-average annualised volatility.
Performance of fund vs sector and benchmark under Thomas
Source: FE Analytics
The fund has a clean ongoing charges figure of 0.83 per cent.