Although the UK equity outlook remains clouded by Brexit and Covid-19, there are still plenty of higher-quality companies to be found that should prove more resilient to the challenges, according to Aberdeen Standard Investments’ Louise Kernohan. 
Kernohan, manager of the £421.9m ASI UK Equity fund, said the “overhang” of Brexit has coloured opinion towards the UK equity market for the past four years.
As a result, UK equities are “cheap on pretty much whatever multiple that you look at relative to other developed markets”.
“I think it’s because the UK is quite small and from the outside we look quite troubled because of all the political turmoil that’s happening,” she said. “And so you can kind of see why people just think ‘Well, I just won’t bother’.
“And with the benchmark being so weighted towards oil companies and the domestic banks, to an outsider might not look so attractive.”
However, the ASI manager said this presents an opportunity from a stock picking perspective to build a portfolio of quality companies that bear little resemblance to the benchmark and have little correlation to the UK economy or exposure to Brexit.
“What I mean by quality is really looking for businesses that have the ability to grow regardless of what’s happening in the wider economy,” she said.
As part of its process, Kernohan and the asset manager’s 16-strong UK equity team assign quality ratings to UK listed companies and whether they are under- or overvalued
One such example in the ASI UK Equity fund is Abcam, a global supplier of antibodies to the research community.
“It’s a bit like an Amazon-type business model, but for antibodies for scientific researchers,” explained Kernohan. “It’s very niche, but they – by far and away – are the biggest and have grown that network model.
“When you’re known as the best one [in the business], then people come back to you. And then you get more data on antibodies and the competitive advantage grows over time.
“It’s a capital-light business model, so not only does it grow but the growth has high returns means that the compounding effect is really powerful.”
Performance of Abcam over 3yrs
Source: FE Analytics
As the above chart shows, over the past five years, Abcam’s share price has risen by 120.25 per cent, and is trading at a high multiple, according to the manager, suggesting that its quality credentials are well understood by the wider market.
However, Kernohan said there are some quality stocks in the UK that are overlooked because they are improving or because the market doesn’t understand them.
This was the case with Marshalls, which makes landscaping products for the construction industry, and was added to the portfolio a few years ago.
“On first glance, any kind of normal quality investor would probably completely disregard that because it’s a UK domestic stock and economically dependent,” she said.
“But, actually, when you do the work, get into the business model and look at what they do, it’s got 55 per cent market share in its core landscaping product and it’s the only one in the market that can supply a range of different products, which is what its customers ultimately need for the products that they’re doing.”
She added: “So, it does actually have a significant amount of pricing power, which means it can make good margins. Then you throw into the fact that these products need to be relatively local because they are difficult to transport, so the barriers to entry are quite high and the competitive advantage is sustainable.
“And the demand profile, whilst a bit cyclical, is actually less than you might think because a lot of the products go into infrastructure projects, which are long term and visible.”
Kernohan said the company has delivered strong organic growth in recent years and has made bolt-on acquisitions that have enhanced the business.
“So, there are hidden gems out there in UK market, and quite often they’re not the obvious ones,” she said.
The manager also takes a more long-term approach to the concentrated portfolio, which holds around 35 stocks with low turnover.
“The rationale behind that is that you want the company to do the heavy lifting and doing the performing for you,” she explained. “And compounding businesses need that multi-year period to achieve that.”
And a focus on quality – while it won’t perform well in all market conditions, warned Kernohan – can help minimise the drawdowns due to how resilient the companies are.
Something which has been seen in performance in 2020.
Performance of fund vs sector & benchmark YTD
Source: FE Analytics
Year-to-date, the fund has made a loss of 9.15 per cent – in total return terms – compared with a fall of 15.87 per cent for its average IA UK All Companies peer and a 16.67 per cent loss for the FTSE All Share index.
“You never could have predicted that Covid-19 would have come along, but pleasingly the fund did outperform and the resilient holdings really came through,” she said. “But on the other hand, the markets are strong and the fund does have the ability to keep up with good markets, which is important because, in the long term, equities do generally go up.
“The one key market condition where it would perform less well and lag would be in a value rally. So, if we saw oil companies, banks, and companies which are really on quite depressed valuations at the moment rally then – given the importance in the UK benchmark – that would cause my strategy to underperform. There’s no doubt about that.”
She concluded: “Everybody has a strategy and no strategy can outperform in all scenarios. So it’s just about staying true to your strategy and explaining to your clients so that they understand that that happens.”
Performance of fund vs sector & benchmark under manager
Source: FE Analytics
Since Kernohan was appointed manager at the start of 2018, the ASI UK Equity fund has made a total return of 7.81 per cent compared with a loss of 8.62 per cent for the IA UK All Companies peer group and a 10.10 per cent fall for the FTSE All Share. It has an ongoing charges figure (OCF) of 0.85 per cent and holds an FE fundinfo Crown Rating of four.