Europe, Japan and the UK are the three main areas that Thesis Asset Management has been adding to since the start of the year.
The firm has halved the cash weighting in some of its portfolios since January following the market correction in the first quarter of the year, with 1 per cent added to each of the three markets.
“The recent pull-back is an opportunity to put part of our cash balances to work in the equity markets,” Thesis research analyst Ryan Paterson said.
“Valuations look pretty attractive on a relative basis for those three markets, especially when you compare them to the US.”
He noted that while the US, and in particular the S&P 500, deserves to be trading at a higher multiple thanks to better earnings over the past few years, there are now better valuation opportunities elsewhere.
Taking the UK first, Paterson said the market presents one of the most attractive valuation opportunities over the longer term of any market.
“Many of our peers are very underweight in the UK and therefore a weighting close to the benchmark is a differentiator,” he said.
Indeed, the UK has been the most unloved market for some time, according to the Bank of America Merrill Lynch Global Fund Manager Survey.
Additionally, the FTSE All Share has underperformed the global equities MSCI World benchmark over the last decade by 60.39 percentage points with much of this occurring in the past four years.
Performance of indices over 10yrs
Source: FE Analytics
While political risk may lead to further volatility in the UK in the short-to-medium term due to the uncertainty surrounding Brexit negotiations, in the longer term a recovery is likely, the Thesis analyst noted.
This is likely to be most profound in the “unloved domestic stocks” and in those that look attractively-valued to overseas competitors, leading to more mergers & acquisitions (M&A)
“Some highly valued champions may be takeover targets due to sterling weakness, being immediately earnings accretive to a foreign purchaser,” he said.
In the UK, the Thesis team are backing the £131m RWC UK Focus run by John Innes, which since its launch in December 2010 has returned 103.04 per cent – a second quartile performance in the IA UK All Companies sector.
Currently the fund has key overweights in the travel & leisure, insurance, oil & gas and mining sectors.
“That is where we would like to be positioned as we are later cycle and can get a bit more inflation come through. Those commodity stocks should continue to do quite well in this environment,” Paterson said.
“The manager’s got a long history and we like this fund because it is a high conviction portfolio of around 30 stocks. He takes quite large active positions with an active share at 72.5 per cent so he has taken some big benchmark bets.”
The fund, which makes up 7 per cent of the Balanced portfolio, is the newest of the five UK funds in the vehicle alongside Invesco Perpetual UK Strategic Income, Montanaro UK Income, JOHCM UK Dynamic and Aviva UK Equity.
Another area the team have topped up this year is European equities which makes up 5 per cent of the Balanced portfolio. Despite some concerns, it also offers attractive value, Paterson said.
“Europe is growing faster than previously and is not on such a high valuation as the US,” the analyst noted. “It has had its wobbles recently but some of the underlying data is still pretty strong with PMIs in expansionary territory, some of the slack coming out of the economy and unemployment beginning to fall.”
While some political risk remains with the ongoing Brexit negotiations as well as an anti-euro coalition government in Italy, it is “much less of a concern than it previously was” last year following market-friendly election results in France and Germany.
Concerted global growth is also likely to be supportive, he added, with the region closely-linked to the fate of the world economy.
In the region the team have a longstanding position in JPM Europe Dynamic ex UK, an unconstrained fund which invests in attractive value, quality and momentum stocks.
However, a newer position has been added in the five FE Crown-rated Oyster Continental European Selection managed by FE Alpha Manager Michael Clements.
Performance of funds vs sector and benchmark over 3yrs
Source: FE Analytics
“The investment philosophy is to focus on high quality companies with a strong competitive edge and solid balance sheet, either suffering from short-term pressures, or selected as longer-term recovery plays,” Paterson said.
Both funds have outperformed the IA Europe ex UK sector and MSCI Europe ex UK benchmark over the past three years, returning 37.09 per cent and 41.04 per cent respectively.
The final area the team have added to is Japan, where the near 4 per cent allocation is split evenly between the actively-managed JOHCM Japan fund and exchange-traded fund DBXT JPX-Nikkei 400.
A well-known boost for the market has been the reforms of Japanes prime minister Shinzo Abe, which has included promoting more shareholder-friendly policies among companies.
“They are paying dividends and not just sitting on the cash like they used to which is driving return on equity. It is a great story that has more room to run,” Paterson said.
Additionally, he noted: “Japan presents an attractive valuation opportunity relative to other markets, especially considering its rate of earnings growth. It is a geared play on rising global GDP.”
It has been a key overweight position for the team for the past two years due to attractive valuations and high-quality companies trading on low price-to-earnings multiples.
To take advantage of the corporate governance shift, the team use the passive fund DBXT JPX-Nikkei 400, which filters out companies on a number of metrics.
“It looks at the company’s return on equity, its three-year operating profits and its size, and certain qualitative criteria such as the appointment of independent outside directors and reporting and disclosure standards,” Paterson said.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
Meanwhile, JOHCM Japan focuses on small- and mid-cap areas of the market that are often under-researched by sell-side analysts and overlooked by investors.
The fund has been a second quartile performer over the last decade, returning 147.62 per cent, although it has struggled over three- and five-year periods, sitting in the bottom quartile of the IA Japan sector.