Challenges from both the domestic and international spheres have made it extremely challenging for investors hunting lower down the UK market cap scale, according to Amati Global Investors’ Paul Jourdan, who says investors need to take a more balanced approach to risk.
Jourdan, who oversees the five Crown-rated TB Amati UK Smaller Companies fund, said Brexit pressures and a slowing global economy have made building a small-cap portfolio harder this year.
“For us, this year’s been very much about finding the right balance between different possible outcomes … between UK domestic-facing risks and international risks. Both of them have their problems: there haven’t been any easy answers this year,” he explained.
“With so many risks staring you in the face – whether that’s Brexit or trade war risks – our ambition has been to try to be very well diversified. Whatever happens we’re not going to be wholly right or wholly wrong because if you don’t want to be wholly wrong, you can’t also, therefore, be wholly right.”
An area that tends to top investor concerns is the cyclical housebuilding sector, which he said has “effectively stalled” thanks to uncertainty over house prices and the health of the housing market.
“The question is [whether] it’s a pause on the way to a healthy market or is it a pause on the way to a reversing of the trend?” Jourdan said.
As long as interest rates and unemployment remain low it would be hard to see prices come under pressure, said the manager. However, if rates were to begin normalising and unemployment were to rise to more historic levels then that could impact the housing market.
Yet, the market could continue to “muddle along” with the status quo continuing, the fund manager added.
As such, one of the ways the Amati team aim to get exposure to the market is through a holding in buy-to-let lender OneSavings Bank.
“It’s not hugely sensitive to house price falls – although it would be in sentiment terms – but it’s already heavily discounted lots of bad news,” he said. “And actually, in the kind of ‘muddling along’ scenario it does continue to do incredibly well.
“It has been performing – from a business perspective – very strongly. It doesn’t have some of the pressures that housebuilders are exposed to, [such as] wage inflation, build-cost inflation and the potential for labour shortages, which Brexit brings along.”
Another holding playing into the theme is MJ Gleeson, a builder of social housing.
Performance of Londonmetric YTD
Source: FE Analytics
“They work pretty closely with local authorities where local authorities have set land aside typically and sell at a very low cost to MJ Gleeson to allow them to start to build affordable housing,” Jourdan explained.
“It’s a well-known phenomenon that home ownership has a quite transformational effect on an area as opposed to where everybody’s renting. Homeowners have, obviously, a different sense of taking care of the community they’re in and wanting it to succeed.”
He added: “When it becomes clearer what the post-election direction is going to be then we can properly reassess what kind of exposure we want in the more cyclical end of the UK market and housebuilding is probably the purest form of that.”
Nevertheless, Jourdan said the Amati team balances out this domestic risk exposure with more internationally-facing stocks, but with an eye on names that should be able to avoid some of the bigger macroeconomic headwinds.
One of its largest holdings is London-based asset manager Intermediate Capital, which has a very international client base and also invests more outside of the UK.
“It’s creating funds in asset classes where there are very significant buyers from some of the world’s largest investors,” the Amati manager said. “Whether that’s big pension firms or sovereign wealth funds who typically want to try to give up liquidity for higher returns from lower-risk asset classes, like debt and infrastructure-type investments.”
Performance of Spirent YTD
Source: FE Analytics
Another top holding in the portfolio is Spirent Communications, a distributor 5G telecoms equipment and 5G testing equipment, which is poised to take advantage of the global rollout of the technology.
Electrocomponents, meanwhile, is a holding added to the portfolio this year that gives it more exposure to global GDP growth. While it may see some impact from the US-China trade war, Jourdan said it had a leading position in its market and had grown market share.
Finally, oil exposure has also been a good way of sidestepping the currency issues “which has been really punitive for the UK investors” as sterling has devalued against the Brexit backdrop.
“Oil was a depressed market a few years ago and it’s been in a relative recovery mode [since],” he said. “There are certain interesting companies listed in London that were pretty much overlooked and where there’s very strong cash flow dynamics, and one I’ll pick up on is Jadestone Energy, which operates primarily in Australia and actually been very successful this year.”
Given the challenging investment backdrop, the manager has upped cash in the fund to around 9-10 per cent of the portfolio, ready to be deployed.
He concluded: “We obviously have a macro view but the way that it drives investment decisions is always based on specific companies and whether they have an opportunity that can circumvent some of these risks that we’re not liking.”
Jourdan manages the £302.8m TB Amati UK Smaller Companies fund alongside David Stevenson and Anna Wilson.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Over the past three years, the fund has made a 53.74 per cent total return as the IA UK Smaller Companies peer group has risen by 35.15 per cent and the Numis Smaller Companies plus AIM (excluding investment companies) benchmark has made a gain of 20.37 per cent.
TB Amati UK Smaller Companies has an OCF of 0.92 per cent.