A ‘value’ manager’s view on the market sell off

Clive Beagles and James Lowen, managers of the JOHCM UK Equity Income Fund, have highlighted what they believe are exceptionally attractive valuations among companies in their portfolio.

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  1. Rob Morgan

During the recent market sell off, ‘value’ managers – those targeting cheaper stocks whose prospects they feel are overlooked – have endured a particularly challenging time. As a consequence, funds such as JOHCM UK Equity Income have been notable laggards. The fund, part of our Foundation Fundlist of preferred funds for new investment across the major sectors, adopts a contrarian approach that focuses on finding under-appreciated but fundamentally strong businesses capable of providing an attractive stream of income through their dividends.

The prevailing negative sentiment among investors has boosted defensive stocks (relatively speaking) in areas such as consumer goods, while areas more exposed to the impact of the measures taken to limit and reduce the number of people contracting the COVID-19 virus have borne the brunt of falls. This includes economically sensitive areas where the fund has some exposure such as energy and mining.

The fund’s managers, Clive Beagles and James Lowen, characterise this as “an expensive flight to safety” and “the wrong reaction”, pointing out that these sectors were already historically very cheap compared with growth-orientated areas before the onset of Covid-19. They suggest central banks have limited scope for stimulus, but that governments will probably step up much further in terms of supporting people and businesses. They therefore believe that while the coronavirus will cause, “a soft patch economically,” the impact should be finite and that economically sensitive areas will ultimately rebound.

As well as the general shift to perceived safety, two stocks in the fund have been specifically affected by the virus. Bathroom and kitchen product manufacturer Norcros has warned of supply chain issues from its China suppliers, while Easyjet has suffered from the widespread grounding of passenger flights. In both cases the managers have chosen to add to their positions, feeling that the businesses are robust enough to withstand a considerable downturn and ultimately benefit once things return to a more normal state. The duo avoid highly indebted businesses, so they have so far avoided the largest casualties of the crisis.

BP and Shell remain two of the largest positions. Their share prices have been under pressure from the public disagreement between Saudi Arabia and Russia and the subsequent decision by both countries to ramp up oil production, which led to a fall of around 30% in the oil price to the low $30s a barrel. Mr Beagles and Mr Lowen feel it is unlikely the spot oil price will remain this low for a significant period of time, and what matters most to big energy companies is average prices over time. They suggest that with the fall in demand from the coronavirus, it may well stay there over the summer months, unless Russia has a change of strategy, but the cost structure of the global industry suggests a return to the $45-55 range at some stage in the medium term.

The managers are taking heart from what they feel are now exceptionally attractive valuations among companies in the portfolio. If the virus is not contained or slowed down by the onset of warmer weather, or a workable medical treatment, they envisage a year of, on average, no earnings growth among UK companies rather than the 7-8% previously assumed. Even if their economic prognosis proves to be too optimistic, they believe that valuations now provide “ample downside protection”.

In their view, the best metric to look at in times like these is ‘price to book’, which measures the value of a company’s shares in relation to its net assets. That’s because it assesses companies according to the sum of their parts rather than taking a view on earnings. Mr Beagle and Mr Lowen assert that the price-to-book value ratio of the fund’s portfolio is at its lowest ever level and it is below 1x for only the second time in the fund’s 15-year history, the only other occasion being the six months leading up to March 2009.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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