JOHCM’s Clive Beagles and James Lowen share latest review of their UK Equity Income Fund

by | Jul 4, 2023

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Performance 

Markets were sluggish in May, with some of the issues noted above dominating like rising bond yields, the US Government debt ceiling and pressured commodity markets. The UK FTSE All Share was down 3.12%, the Fund underperformed the benchmark, down 4.38%. Year-to-date, the Fund is down 2.44%, whilst the FTSE All Share is up 2.12%. Following a strong start to the year, the Fund has struggled since the Silicon Valley Bank (SVB) news in February, which led to a powerful risk-off mentality across markets. Looking at the peer group, the fund is ranked 4th quartile within the UK Equity Income sector year-to-date. On a longer-term basis, the fund is ranked 1st quartile over three years, 3rd quartile over five years, 2nd quartile over 10 years and is 2nd best Fund in the sector since inception in 2004.

Banks continued to recover from March’s events (SVB / Credit Suisse), with NatWest Group and Standard Chartered up 6 and 7% relative respectively. Many small caps, including those we touch on in the next section, were also notable contributors. As well as those discussed below, Severfield (up 10% relative), Polar Capital (up 10% relative), Palace Capital (up 10% relative) and Conduit (up 6% relative) were also strong. This is the first month since the end of last year that this has been the case and is encouraging. 

First Group, despite the loss of one of its rail contracts, continued to be a strong performer (up 7% relative). 

Results (with a few pockets of weakness – as discussed below) continue to be robust, with solid results in the month from recent addition Marks & Spencer, as well as, EasyJetKeller and Conduit. As mentioned above, there are pockets of weakness, c.10-15% of the Fund. Headlam issued a weak statement which led to downgrades of c.9% for 2023, Eurocell similarly issued a weak statement and ITV’s update was sluggish. All three stocks are at or very close to all-time relative lows (ie. lower than the financial crisis, lower than Covid). Headlam trades 20% below the value of its cash, stock and properties (ie. tangible net assets); all are market leaders, two have little to no debt and all trade on c.7x depressed earnings. Currys continued to weaken, despite a better-than-expected update. Vodafone was weak as the new CEO rebased expectations, which now look credible. We had cut our position by more than 50% over the last few years, but started to add post the fall after this set of results.

The commodity sectors were also weak, particularly the oil sector as the oil price fell. 

Portfolio activity 

Several of our small caps started to perform better, and we accordingly marked positions to target weights. Kier and International Personal Finance (IPF) reached 12 month relative highs, while Tyman reached a 6 month relative high. At the start of June, Tyman was promoted to the FTSE 250, which will reduce our aggregate small cap weighting to c.17%. Despite some positive performance trends from these three holdings, the current valuation of these stocks reveals how lowly valued they remain, with Kier trading on a PE of 4x, IPF on a PE of 5.5x (and a yield of 9%) and Tyman on a slightly higher PE (9x) but on depressed earnings. During the month, Tyman had an inline trading update (which is positive given its main end-use market – US Housing – which has been weak but now looks to be starting to recover). Altogether, UK small caps remain one of the most undervalued asset classes globally. 

We have been monitoring Inchcape for a decade, but it has always been too expensive to add to the Fund. It is the global leader in car distribution, operating in markets too small for vehicle original equipment manufacturers (OEMs) eg. BMW, Mercedes, where it acts as their agent in these countries. This is a growth market because vehicle penetration in these markets is low and despite being the largest operator in this segment, Inchcape only has a market share of 1%. In the first part of the month, we added to Marks & Spencer before the share price increased after its results. We increased the weight of Drax after their recent investor day, following announcements of internally funded plans to become one of the leading players in carbon capture globally. 

We also added to Easyjet, which had solid results and saw forecast upgrades. As well as the recovery in the airline business, it is becoming clear that the recently established and separate holiday business has and should continue to be a profitable and valuable franchise.

Outlook 

Much of the debate in markets at present centres upon whether the Fed can engineer an economic soft landing; most market participants feel quite sceptical about the prospects of success, but the performance of equity indices suggests a moderately growing sense of optimism is building in that regard. The Fed’s monetary tightening phase looks to be over, but we anticipate a lengthy pause rather than a hasty reversion to rate cuts. Inflationary pressures continue to dissipate, particularly input costs, whilst consumers have proven resilient thus far, helped by strong employment markets and comparatively low levels of leverage. Elsewhere in the world, China’s emergence from its COVID restrictions has been a little softer than anticipated but will still help global growth, whilst many parts of the emerging world will begin to ease monetary policy as inflationary pressures subside. Europe and the UK will likely see modest economic growth during the rest of 2023 and a stronger 2024. 

Given this backdrop, we continue to find value on offer across many parts of the UK equity market.

Outlook 

Much of the debate in markets at present centres upon whether the Fed can engineer an economic soft landing; most market participants feel quite sceptical about the prospects of success, but the performance of equity indices suggests a moderately growing sense of optimism is building in that regard. The Fed’s monetary tightening phase looks to be over, but we anticipate a lengthy pause rather than a hasty reversion to rate cuts. Inflationary pressures continue to dissipate, particularly input costs, whilst consumers have proven resilient thus far, helped by strong employment markets and comparatively low levels of leverage. Elsewhere in the world, China’s emergence from its COVID restrictions has been a little softer than anticipated but will still help global growth, whilst many parts of the emerging world will begin to ease monetary policy as inflationary pressures subside. Europe and the UK will likely see modest economic growth during the rest of 2023 and a stronger 2024. 

Given this backdrop, we continue to find value on offer across many parts of the UK equity market.

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