SLI UK Equity Unconstrained and SLI UK Equity High Alpha funds take top and number three spots over the past 12 months to 12 April
Fund manager Ed Legget has had an impressive year with his two IMA UK All Companies funds – Standard Life Investments UK Equity Unconstrained and Standard Life Investments UK Equity High Alpha – both generating remarkably strong returns.
The £181m SLI UK Equity Unconstrained vehicle is the top performer in the UK All Companies sector with a return of 103.8% over 12 months to 12 April, compared to a 48.7% average, according to Morningstar.
The £52m SLI UK Equity High Alpha fund is ranked third out of 301 vehicles, up 89.2%.
Legget has managed the UK Equity High Alpha fund since October 2006 and UK Equity Unconstrained since April 2008.
The SLI UK Equity High Alpha fund aims to provide a balance of long-term growth with some income by investing in a relatively concentrated portfolio of shares of companies listed on the UK stock market. The fund also invests in UK smaller companies.
The SLI UK Equity Unconstrained fund aims to provide capital growth over the longer term by investing in UK equities. The fund typically holds a concentrated portfolio of stocks and is actively managed by the investment team.
What is your investment strategy?
It is based on Standard Life Investment’s ‘focus on change’ philosophy which believes when expectations on earnings, the economy or management strategy change share prices move relative to the market. We are looking to identify where we have a difference to the consensus on what is happening with companies.
We might, for example, have a view on a new management team coming into a company and their ability to improve the operational performance depending on the time horizon, level of conviction and materiality of the change in the potential performance of the company.
This would dictate how big the overweight or underweight of our position would be. Then as the market comes round to our view the overall position would decrease as our difference to the consensus reduces.
What are the reasons for such strong performance in both funds over the last year?
In Q4 2008 through to Q1 2009 investors lost sight of the fundamental drivers of company valuations. There was a panic and flight out of risk assets and equities. Within the equity market there was a flight towards defensive companies such as tobacco and utilities, which ended up trading at a very large premium to the market historically.
At the other end anything which was cyclical and had any debt the markets panicked about and there was not any price for those stocks.
So you could buy companies with sound franchises in industries which were clearly going through a very sharp downturn on P/E ratios of 1, 2 on trough earnings at the same time.
In a normal downturn the market starts to look through the recession and into the potential recovery on the other side as interest rates are cut. This time round you just got an opportunity to buy companies on earnings trough multiples at the same time.
The moment the stock market and debt markets opened up to new issuance the prospect of banks coming in and taking the keys to companies – which I do not think was every that likely anyway – was dramatically diminished.
As a result you saw a very big re-rating of those companies and this was something we took advantage of in both the funds. By their nature they are both quite concentrated and active funds.
There was a massive opportunity to materially outperform the market by moving into sectors which were out of favour for sentiment reasons, rather than any rational analysis of the earnings prospects and dividend paying potential of the companies.
What shifts have you made to holdings in recent months?
In recent months at the margins I have moved a bit more overweight UK domestics, including housebuilders, construction, retailers, travel and leisure.
These are areas where we are starting to see significant value emerge but on the whole investors are very negative about the prospects for the UK economy, consumer and government spending.
While we are not hugely over bullish about those prospects either. We think those concerns are probably a) overstated and b) very consensual. It is a bit like going back 12 to 14 months ago when everyone was very bearish on the world and lost sight of valuations.
We think you are seeing a similar opportunity in some of the more UK-focussed names, although the returns available will be less than they were this time last year.
Companies like fashion retailer Next are making significantly more money today than they made in 2007, which was probably the height of the UK consumer boom. So there are winners emerging in many of those sectors, which are currently out of favour.
EasyJet is another one, Restaurant Group, the owners of the Garfunkel’s and Frankie and Benny’s chains, and Chiquitos have both been strong performers in terms of profits. In the construction sector Galliford Try is a stock we are big fans of at the moment.
How will the funds develop in the next year?
From the companies we are seeing it is pretty clear the world is getting better quite rapidly across lots of different end markets. Companies are taking a lot of costs out and hence we are seeing very big profit upgrades across the FTSE 350.
I think this will continue for the next six, nine to 12 months as sell-side analysts catch up with both the recovery in sales and the operational gearing which companies are showing. Against this backdrop I think the FTSE 350 market will continue to edge higher and within this the funds will still be focused on more cyclical areas.
So we will be hopeful those areas will continue to outperform the FTSE 350 with some very high conviction individual stock ideas on top of this as well.
What is your outlook on the UK All Companies sector?
I do not look at the sector but the FTSE 350 market. You could quite easily see this market go up on a year view by another 10 to 15% capital gains with dividends of 3% to 3.5% on top of that. With both funds we hope stock selection and market positioning would allow us to outperform that level.
We do see value starting to appear in the UK. I think potentially the catalyst for people’s perceptions to change on the UK will come after the election.
It does not really matter whether it is a hung parliament or if it is Labour, the Conservatives or Liberals.
It is more a question of once you get the certainty of what government is in place and where the cuts will fall and the tax rises will come through.
You will then see people change from being very short term with regard to investing in the UK to taking a more medium term view of how the economy might recover.
You are already seeing signs with recent unemployment figures better than expected showing jobless claims falling, and even the budget deficit, which is very high, is starting to undershoot expectations.
We are starting to see a number of factors, which while still an outlook of lower than average economic growth across the next two or three years, are definitely on an improving trend on a number of levels.
This could also lead to a sharp rally in sterling, which would benefit the domestic names.
