Moore (pictured), whose skew towards small and mid-caps has helped his fund achieve top-decile returns in its IMA UK Equity Income sector over a one, three and five year period, believes the best opportunities remain in stocks outside of the top-20 by market cap. He says multi-billion pound UK funds are automatically more likely to invest in mega caps because of liquidity constraints, arguing their views on the matter should be taken with a pinch of salt as a result.
“Apparently 2014 is the year to rotate away from small and mid-caps and into the mega caps, but it’s very telling that many of the portfolio managers who are talking about opportunities in large caps are those whose past case has always been for the FTSE 100,” said Moore.
“The reality however is very different. So far this year it’s been the top end of the FTSE 100 that have had earnings mishaps. It’s been a minefield for managers with a structural bias towards the FTSE 100, with food retailers such as Morrison taking a massive hit, as well oil majors such as BG and Shell.”
Performance of stocks and indices in 2014
Source: FE Analytics
“We’ve already had significant earnings downgrades of 4 per cent for the FTSE 100 this year and it’s not even three months old. We’ve seen downgrades even in things like AstraZeneca and GlaxoSmithKline, which are very popular stocks.”
“These are companies that are less attractive from a total return point of view, with their best days behind them. That’s why I’m looking elsewhere.”
FE data shows that small and mid-cap companies have led the UK market rally over the past five years. Moore’s Standard Life fund has benefitted from its skew to them over the period, though effective stock picking in the bottom half of the FTSE 100 has also been a big driver of performance.
Performance of fund, sector and indices over 5yrs
Source: FE Analytics
The manager questions why large-cap focused equity income funds are referred to as “core holdings.”
“Why are they core? Because they have a bias towards companies with little growth potential and significant pressure on their earnings?” he said.
“I’m not saying outright avoid the FTSE 100, and we have found some that buck the trend.”
Moore has currently added to his positions in Sage Group and Reed Elsevier, and also has a major weighting to the likes of HSBC and Legal & General.
Moore says it’s his priority to keep the size of his fund manageable, to ensure that he can cash in on opportunities across the market cap spectrum. He explains that his exposure to small, mid and large caps has been relatively consistent since he started running the fund in 2009, which he says should make inflows more manageable for him.
“Ever since we started running the fund our small cap position has been between 5 and 15 per cent, with the FTSE 100 range between 33 and 55 per cent,” he explained.
“This isn’t an all-out small or mid cap fund, but a multi-cap fund. For that reason, I don’t think fund size will be a problem for some time to come.”
According to FE data, Standard Life UK Equity Income Unconstrained has seen inflows of £228m over the past 12 months alone, pushing total assets to £386m.
Among the UK equity managers who have recently talked up opportunities in UK mega caps include Clive Beagles, who runs the £2.5bn JOHCM UK Equity Income fund; Richard Buxton, who runs the £1.2bn Old Mutual UK Alpha fund; and Leigh Harrison, who runs the £2.6bn Threadneedle UK Equity Income fund.
It’s important to note that smaller funds also favour large caps at the moment, including Hugh Yarrow's £44m Evenlode Income fund. Yarrow was recently tipped by Premier’s Simon Evan Cook as a possible heir to Neil Woodford’s throne in the UK Equity Income sector.
Moore acknowledges the need to refresh his portfolio in order to maintain his consistent outperformance. However, rather than skewing his portfolio towards ‘cheaper’ mega caps, instead he is looking to stocks with indirect exposure to emerging markets.
“One of the key themes at the moment is emerging markets which is very sentiment driven,” he said.
“The fact remains that GDP will be superior to the developed world, and we’ve been using the falls to rotate into stocks that have been adversely affected. At the same time, we’ve been rotating out of domestic names that have done so well for us, such as Whitbread which is now trading on 24.6 times earnings.”
“When we look at what stocks have the potential to surprise it’s those with emerging market exposure that are attractive.”
Moore has recently been building a position in Inchcape for example – an automotive distributor listed on the FTSE 250.
“Two thirds of this company’s profits come from Asia and emerging markets, which hasn’t been seen as a good thing recently,” the manager explained.
“It has had very strong UK domestic sales, but because it’s associated with emerging markets it’s been de-rated relative to its sector. Even short-term noise over Ukraine has had an effect.”
Performance of stock and indices over 3yrs
Source: FE Analytics
“Inchcape is on a P/E ratio of 13.8 times and 12.7 times for 2015. It also has strong potential for dividend growth,” he added.
Moore has also recently upped his exposure to the travel and leisure sector, via Tui Travel.
Gavin Haynes, managing director of Whitechurch Securities, says he understands Moore’s views and favours his multi-cap approach. However, he doesn’t think it’s fair to automatically write-off mega caps.
“There are arguments on both sides – on one hand it will be the growth areas that will continue to do well if the economic recovery continues, and there are major headwinds to the big blue chip sectors like financials, energy and pharmas,” he said.
“That said, the price you pay is very important. The FTSE 100 is on a 40 per cent discount compared to the FTSE 250, and is also yielding much more. The gulf in valuation is the largest it’s been for some time.”
Haynes says he expects mega caps to outperform in the case of a market correction, which is becoming an increasing possibility in his view given the stellar performance of equities since the summer of 2011.
Standard Life UK Equity Income Unconstrained Income has clean share class ongoing charges of 0.91 per cent, and is available on Trustnet Direct. It is currently yielding 3.24 per cent.
