What does it take to outperform in today’s volatile market? Ian Fraser asked leading fund managers how they have altered their portfolios to cope with the fallout from the subprime crisis and the likely UK downturn
Given the importance of experience, we have only spoken to fund managers whose funds emerged relatively unscathed from the last bear market – which ran from 2000 to 2003. Some of these fund managers, for example Fidelity’s Anthony Bolton, even managed to ride out the previous bear market with aplomb. His Fidelity Special Situations fund was up 29.79% in the three years to August 2002.
Spotting major macro trends ahead of the pack is critical to riding out market turbulence. Indeed it can be the decisive factor in ensuring that, when markets go pear-shaped, a fund is able to remain in positive territory. Most of the fund managers whose funds put in a strong performance during the last bear market —including Derek Stuart at Artemis, Nigel Thomas at Axa Framlington and Tim Steer at New Star — had the prescience to reconfigure their portfolios ahead of the credit crunch biting last July.
Nigel Thomas, manager of the Axa Framlington UK Select Opportunities fund, sold out of his last UK bank holding – Lloyds TSB – in two tranches in April and September 2007. He says: “The fund entered the credit crunch last July very light on UK financials, especially banks, and very overweight in global infrastructure and capital goods firms, as well as overweight in energy (including oil & gas, power generation and distribution, and oilfield services).”
Thomas expects to maintain his current stance for the foreseeable future: “Our worries over stagflation persist and the woes of US subprime continue to reverberate around the globe. The hangover from the credit crunch could persist for most of the current year.” He predicts that at some stage either in late 2008 or early 2009 he may become more positive towards UK financials. “I have an active radar list and within the next two to three years I might return to market weight in financials.”
Currently, however, Thomas is overweight in stocks that are poised to benefit from rising demand for capital goods in Eastern Europe, the Middle East, Asia, Australasia and Latin America. “We expect to see continuing heavy capital expenditure for mining equipment, oil and gas (including liquid natural gas), aerospace, transport infrastructure, nuclear and particularly power generation in these parts of the world.” This explains why his top ten holdings include Weir Group, Hunting, BP, BG, International Power, National Grid, Rolls Royce and Meggitt.
During 2007 Thomas also took a shine to consumer goods group Unilever, partly because it is poised to perform well in emerging markets, has sold off slow-growth businesses such as Birds Eye and Findus and has overtaken Procter & Gamble as the world’s number one in deodorants. “This is the first time I have owned Unilever since I started my investment career in 1979. Until now, I’ve always seen it as a branch of the civil service.”
Thomas also has a penchant for palm oil companies and holds both New Britain Palm Oil, based in Papua New Guinea, and MP Evans. “New Britain has gone up 70% since its IPO on December 17,” says Thomas. “Palm oil is in demand because it can be used to replace trans-fats and is increasingly being used in toiletries and personal wash products across south-east Asia and China.” Unusually for this sample of fund managers, he also stuck with a select band of retailers including Tesco and Dunelm Mill.
Generally Thomas says that at times when banks are reining in their lending it is advisable to avoid operationally and financially-geared companies.
“It’s impossible to predict how long or how deep the current downturn will be.” However he points out that even during the recession/depression of the 1930s, John Maynard Keynes was able to remain in positive territory though the astute rotation of his portfolio.
Derek Stuart, manager of Artemis UK Special Situations since launch in March 2000, became bearish about the prospects for UK equities and Britain’s economy ahead of many of his peers, selling out of small-cap stocks and buying into large cap stocks in defensive parts of the market.
The fund remains overweight utilities, bus companies, telecoms and oil & gas, and large caps but very underweight in financials, mining and industrials. A focus on energy and resources provided his fund with a safe haven during the worst of last year’s subprime-related squalls.
Yet Stuart is already excited by some of the opportunities that are being thrown up by the downturn, including “distressed” companies in housebuilding, property and financials. On the back of falling interest rates and a recent raft of director buying in companies these sectors, Stewart detects value in all three sectors and has in recent weeks being making selective purchases. He says: “Even though I am cautious on the economic outlook and the market outlook, I’m actually very confident about the stock selection opportunities in 2008.”
Anthony Bolton agrees that the current market turmoil is throwing up some interesting buying opportunities for fund managers but acknowledges these will only suit “brave investors who are willing to run against the pack”. He detects opportunities in sectors including property — a sector into which he started buying again late last year — media and pharmaceuticals.
At times like these, Bolton believes it make sense to tilt a portfolio towards larger, well-financed companies in non-cyclical businesses — those whose fortunes are not linked to the state of the economy. “Both media and pharmaceuticals have been out of favour for a long while and look cheap versus history.”
Generally Bolton is gloomy about the harm that subprime contagion could do, or indeed is already doing, to the wider UK economy, and he does not subscribe to the decoupling theory – the notion that emerging markets will be unscathed this time around.
“Personal expenditure is certainly under pressure in the UK and it is now clear that property prices are falling. While the first phase of the crisis for banks such as Northern Rock was about funding, the second phase could be about arrears.”
However, he expects to become more optimistic about market prospects later this year, when he believes the market consensus will become still more bearish. “Things won’t be this bad forever and I expect the turning point to come some time this year.”
Sanjeev Shah, Bolton’s successor as manager of Fidelity Special Situations, is already scouring the market for unrecognised growth opportunities that are reasonably priced, what he calls “hidden jewels”, and companies that are likely to be taken over, such as BG and Alliance & Leicester.
He says: “A number of interesting openings have emerged in the financial sector following the recent market volatility.” This has driven him to boost the fund’s holdings in HSBC (he likes its growing business in Asia) and Alliance & Leicester (he sees it as a takeover target and believes the shares were overly marked down following the Northern Rock debacle). However he has been unwinding his positions in oil and gas, predicting that an economic slowdown is going to dampen demand for commodities.
Traditional defensives, such as tobacco, beverages and utilities, are out of favour with Shah. He sees these sectors as expensive on a ten to fifteen year basis. “I prefer to buy growth at a reasonable price in areas like media or technology than buy expensive defensive companies.” But how bearish is Shah overall? “I think the probability of a US recession is rising, and that remains supportive of the larger-cap, defensive bias in the fund over the short- to medium-term.”
Some fund managers got their portfolio reconstruction in early
Jayesh Manek also repositioned his fund ahead of the subprime crisis. Early last year the Manek Growth Fund went underweight in banks and overweight in oil and gas, oil services, technology and telecoms, in addition to moving a portion of its portfolio into cash. The revised mix has turned out to be resilient in the current downturn, with the fund becoming one of the UK’s top performers over the past 12 months.
Manek has used index futures to help protect the fund from recent stock market falls and has also fully exploited the Manek Growth Fund’s ability to invest up to 20% of its portfolio in overseas stocks. The US and India are his two favoured non-UK markets.
Manek says: “Our US holdings include Apple Computer, Research in Motion, which makes the Blackberry, and Intuitive Surgical, which produces robotically assisted minimally-invasive surgical implements.” He is confident such companies as poised to benefit from surging demand from emerging economies, including India and China.
“I am confident the fund is well-positioned for the current market scenario, which I expect will run for the next three to six months. After that, I think that some of the worst-effected stocks including some of the housebuilders, property and financials are poised for a strong recovery.”
“I am basically bearish about the next three to six months but am definitely bullish about the two to three years after that. A lot of future growth will be fuelled by the emerging markets, which I believe will provide companies in the UK, Europe and US with their next phase of growth.”
While he has mostly avoided retail Manek has been a holder of Game, the retailer of computer games.
This article on fund managers responses to the credit crisis was published by Citywire on 14 February 2008