The current UK political situation surrounding Brexit is piling more pressure on fund managers trying to identify value opportunities, according to Allianz Global Investors’ Simon Gergel. 
Gergel, head of the UK equity team at Allianz and manager of the £511m Merchants Trust, said the lack of clarity over negotiations between Theresa May’s government and the EU is complicated further by the lack of support for her negotiating stance from her own party.
“Fundamentally, we are value-based investors so we spend a lot of time trying to understand what companies could be worth and, clearly, if there are any changes in the environment or political risk or other risk we need to take account of that.
“But by having a view on what we think companies are worth we can see when share prices might get out of line and take advantage of that.”
While markets rarely offer much certainty or clarity for investors, since the EU referendum of 2016 the public’s expectations for a deal have oscillated between a soft Brexit – representing a closer relationship with the bloc – or a hard Brexit and a clean break from the EU.
Gergel (pictured) said: “We’re essentially trying to keep a very broad view and diversify the portfolio because there are significant but unpredictable risks out there and it’s hard to have much certainty about what might happen.
“We want a portfolio that can perform pretty well in most environments which means you need a combination of domestic companies but also a large holding of international-type businesses, less affected by what happens in the UK.”
He added: “The other thing we’re trying to do is identify where there are anomalies – companies that might be treated like a UK domestic company but are actually global businesses.”
One of the recent acquisitions in the Merchants Trust has been construction company Keller, which focuses on ground engineering works and a “global leader in new pipe engineering business”.
“Keller is a good example,” he explained. “If it was quoted on a stock market elsewhere it would probably be on a higher rating because of its global spread and there are few of those situations.
“As we go through the next few months and as investors start to take one view or another about soft Brexit or a hard Brexit you might find opportunities to react to like we did in 2016 after the referendum, even though we didn’t predict it.
“So, we’re keeping a close watch on share price moves and whether that throws up any opportunities.”
Indeed, the UK remains one of the cheaper major markets, said Gergel, and should be much more resilient to Brexit risk than many investors believe because of its exposure to overseas earnings.
As such, he said in the event that a hard Brexit turns sentiment against UK stocks there will probably still be a lift from weakened sterling.
Other recent additions to the portfolio include broadcaster ITV, which he said is increasingly becoming a content-generating business rather than one reliant on advertising income.
Another is wealth manager St James’ Place, which the manager said “unusually for a company growing very fast, has a good dividend yield”.
One area that the manager has recently bought back into is the tobacco sector and Imperial Brands, in particular.
“It’s interesting because we didn’t have any tobacco companies for over a year and haven’t owned Imperial for five years because we felt there were many risks out there that weren’t priced into the shares,” he said. “But we have felt that actually the market is pricing in the risk from next generation of tobacco products and e-cigarettes and they’re actually well-positioned in that.
“Tobacco shares are now priced at a sensible level that offers a good return while we were more cautious a year ago.”
Performance of stock over 1yr
Source: FE Analytics
However, one area that Gergel said the team behind Merchants Trust were finding little value was consumer staples such as goods companies, which were quite expensive generally.
The manager is hunting up and down the market capitalisation scale for opportunities, given that 65 per cent of the trust is held in FTSE 100 stocks and a further 27 per cent of the portfolio in FTSE 250 names.
“Keller is pretty small, Imperial Brands is a big company,” he said. “We still like many of the mega caps although we have been taking money out – particularly of the oil companies.
“Two years ago you couldn’t give them away they were very out-of-favour had dividend yields of 8 per cent and many investors felt they weren’t sustainable.
“We took quite a different [approach]. We thought they were sustainable and – in any case – we saw tremendous value. Those shares have been extremely good performers as the oil price has recovered. We still think they’re good value and still own some.”
However, while there are many opportunities for value investors in the current environment – particularly given the most recent sell-off in markets – it remains a difficult time for the investment style, according to Gergel.
“We’ve performed well despite being a value investor rather than because of being a value investor in the past two or three years as actually many of the value type of companies have been quite poor performers,” he said.
“Normally, when rates are rising and economies are recovering that’s quite a good environment for value. But if you follow the global markets you’re looking at the likes of Amazon.com, Apple and Google have been the phenomenal share price performers and driving world markets and those aren’t value stocks in any sense of the word.”
While Gergel remains hopeful that the cycle could turn and begin to favour value strategies, there remains a growing number of opportunities.
“We don’t just buy every company on a low valuation, we’re very selective,” he explained. “We try to find companies where we think the business is genuinely sound.
“These tend to do well in an environment where the valuation is an anomaly rather than reflecting a difficult outlook.”
Performance of trust vs sector & benchmark under Gergel
Source: FE Analytics
Since Gergel took over the trust in April 2006, it has returned 98.16 per cent compared with an 87.64 per cent gain for the benchmark FTSE 100 index and an 83.97 per cent return for the average IT UK Equity Income trust.
The trust is trading on a discount of 2.3 per cent to net asset value (NAV), is 16 per cent geared and has ongoing charges of 0.58 per cent, according to the Association of Investment Companies (AIC).