Market pessimism over the impact of Brexit has created some interesting opportunities from a valuation perspective, according to Franklin Templeton’s Paul Spencer. 
UK stocks have lagged their international peers since the EU referendum in June 2016. More recently, however, there have been some constructive developments as negotiators announced that a deal over the transition period has been struck.
As such, the UK market may currently be pricing in too much pessimism over the impact of Brexit, which is set to take place in a year’s time, creating some interesting valuation opportunities.
FE Alpha Manager Spencer (pictured), lead manager of the £990.5m Franklin UK Mid Cap fund, said while the fund does employ a bottom-up stock selection process, it also considers the macroeconomic environment.
He said: “The vast majority of fund managers like to say they’re stock pickers, but you need an element of top-down analysis as well because it would be naïve to suggest that what is happening at a macro level doesn’t have an impact on the portfolio construction.
“Essentially, we do take a fairly broad macro approach, which then frames the bottom-up stockpicking.
“For example, when the prospects for the UK economy post-Brexit are uncertain there‘s likely to be some winners and losers.”
The level of uncertainty in the UK market and its impact on valuations has created some interesting entry points from a valuation perspective.
Spencer said: “Until recently, we were very underweight UK-facing companies, for instance, but given the prices in these areas have been very weak we’re now slowly rebuilding our domestic exposure.”
Performance of stock since EU referendum
Source: FE Analytics
Indeed, a more recent addition to the portfolio has been pub company Greene King, which he described as “an interesting example of a contrarian value play”.
He said: “It’s a very well-established UK pub company that is being impacted by a number of well-rehearsed headwinds, but we feel that these negatives are being overly discounted in its valuation.
“In previous cycles, we’ve done very well by taking some pretty big contrarian positions, for example housebuilders in 2008.
“We’re willing to take early calls on stocks, but it’s not as though we’re moving the whole portfolio into this particular part of the market.”
He added: “We think we can entirely justify taking some early calls on stocks that are out of favour in order to build potential upside for the next couple of years.”
Elsewhere, Spencer has maintained its weighting towards real estate sector – which represents 9.26 per cent of the portfolio – where stock selection has focused on more specialist areas of the market.
The fund has a holding in Unite, which is a student accommodation provider and “clearly very specialist” in its nature.
“They’ve performed terrifically well for a very long time and it’s a longstanding holding in the portfolio,” the manager said.
“Student accommodation is benefitting from a number of structural headwinds, including a lack of quality supply and robust demand. Unite are the best operator in this space and we remain positive on its prospects.”
Other holdings include real estate investment trusts Tritax Big Box – which invests in large distribution centres and should benefit from the shift of retailing from high street to online – and Derwent London, which invests in London office properties.
“What’s interesting with Derwent is we think the market is painting a far more bearish outlook about the valuations of London office space than will probably turn out to be the reality,” said the Franklin Templeton manager.
Performance of stock over 1yr
Source: FE Analytics
“They’re trading at a 25 per cent discount to book value, yet even now there’s evidence in the actual physical market that these types of properties are changing hands at or around book value, so we expect that discount to narrow over time.”
Spencer said the mid-cap space continues to throw up interesting investment opportunities despite its perception as a higher risk part of the market.
Last year the Franklin UK Mid Cap fund delivered a total return of 26.43 per cent compared with a gain of 18.24 per cent for the benchmark FTSE 250 (ex IT) index.
Spencer explained: “There have been some horrendous performers in all parts of the market and the mid-cap [sector] is no exception, but having a high threshold on potential investments markedly improves your chances of success.”
However, the Franklin Templeton manager said mid-cap stocks is “structurally a more attractive part of the marketplace”.
“Usually you’re getting companies which are exhibiting stronger growth and that’s partly down to the fact they’re less mature businesses, in terms of their business model evolution, although you’re getting strong corporate governance with it,” he said. “There’s also a lot less analyst coverage so there is more opportunity to add value with your own proprietary research.”
Spencer said mid-cap strategies can often complement an investors’ large-cap exposure and are not mutually exclusive.
He said: “Much of the time I‘ve been running the portfolio, I get the recurring question: ‘Are mid-caps going to outperform the large-caps, or are large-caps going to outperform mid-caps?’
“I think people need to stop worrying about either/or and consider an investment in mid-cap and large-cap are actually complementary to each other. They can absolutely work together – and give you a good UK core.”
Spencer joined the three FE Crown-rated fund in 2006 and manages the strategy alongside Mark Hall and Richard Bullas.
Performance of fund vs sector & benchmark under Spencer
Source: FE Analytics
During Spencer’s tenure the fund has generated a total return of 329.01 per cent compared with a 203.52 per cent gain for the benchmark and a 100.84 per cent return for the average IA UK All Companies sector peer, as the above chart shows.
Franklin UK Mid Cap has an ongoing charges figure (OCF) of 0.82 per cent.