Steve Davies has halved his Jupiter UK Growth fund’s cash weighting over recent weeks as he has felt more comfortable buying into the equity market on the back of more attractive valuations.
There had been a growing sense of anguish among market experts over the summer months as many expected a pick-up in volatility – which had been at ultra-low levels – because, following a sustained rally through 2012, 2013 and the early parts of 2014, there were concerns that equities were fully valued.
This anticipated correction duly happened during September and October as a result of various headwinds such as geo-political tensions, slowing growth in the eurozone, the end of quantitative easing in the US and the Ebola outbreak, causing the FTSE All Share to fall close to 10 per cent over six weeks.
Performance of index between Sep and Oct 2014
Source: FE Analytics
Davies, who has worked on the UK Growth fund with Ian McVeigh since 2007 (becoming co-manager in January 2013), was one such manager who had started to worry about the state of the equity market and began to build a more cautious portfolio as a result.
However, following the sell-off, he is now far more positive in his outlook.
“I think the outlook is pretty decent,” Davies said.
“If you were to look where we are on the spectrum, valuations aren’t as bombed out as they were in early 2008 or 2012, but if you were to compare it to the start of this year, they are more attractive. I think there is scope for decent returns over the coming years.”
“Valuations are a bit fuller than they were in 2012, but I think there is the potential to see decent profits and earnings growth from here.”
Due to his more bullish outlook, the manager has brought his cash weighting down to currently 5 per cent and says he is looking for more opportunities over the coming months.
“Our cash balance had been quite high as back in March it was at around 10 per cent. We saw limited upside to share prices and the IPOs had come to the market at stretched valuations – we just felt the market looked overstretched,” he explained.
“We do like to use our cash. If we feel nervous we would much rather use it than just buy defensive companies.”
“We also pushed it back up to 10 per cent in September when the result of the Scottish referendum looked like it could have gone either way and we sold down some of banks which would have been very affected. We also put our cash reserves in dollars rather than sterling.”
“Now, however, while we are not fully invested, we are not as defensive.”
That’s not to say Davies is getting carried away, however.
He has warned FE Trustnet in the past that the major headwind facing UK investors is the upcoming general election. He currently runs a portfolio geared towards a recovering UK economy, holding companies which derive the large majority of their earnings domestically rather than from overseas.
However, with a growing uncertainty over the outcome of the election, he says he is ready to rotate the portfolio if there is a change to the current political status-quo.
“The big question is the UK election. I think that we will be spending just as much time looking as polling data as we will do looking at P&L [profit and loss] data. The UK economy looks good, but as the Scottish referendum showed, politics can weigh on markets and therefore we won’t be afraid to raise our cash weighting again.”
He added: “We just are aiming to make sure the fund is indifferent to the potential outcomes.”
According to FE Analytics, Jupiter UK Growth, which currently stands at £1.2bn, has been a top decile performer in the highly competitive IMA UK All Companies sector since Davies has co-run the fund with returns of 38.08 per cent, beating its benchmark – the FTSE All Share – by more than 15 percentage points.
Performance of fund vs sector and index since Jan 2013
Source: FE Analytics
This complements the fund’s longer-term numbers.
Our data shows it has been beaten the FTSE All Share in seven of the last 10 discrete calendar years; turning in top quartile returns in 2004, 2005, 2009, 2010, 2012, 2013 and is again top quartile in 2014.
It has taken full advantage of rising markets, but underperformed in the tougher markets of 2007, 2008 and 2011. Nevertheless, it still boasts top quartile returns over one, three, five, seven and 10-year periods.
Source: FE Analytics
Davies attributes that return profile to his and McVeigh’s bottom-up analysis.
“I think our fund is quite unusual as we have quite a substantial weighting to large-caps but we are still active. Most funds are either one or the other, not both,” he said.
For example, while FTSE 100 stocks make up the bulk of the portfolio, the managers have nothing in widely held stocks such as the oil majors, mega-cap pharmaceuticals or Vodafone at the moment. Instead, the managers count less-popular companies such as retail banks, insurers and media stocks as top 10 holdings.
This active approach is reflected in the fact that the fund has been top quartile for its alpha generation, relative to its benchmark, and its information ratio over 10 years.
Davies says he and McVeigh have a disciplined process for picking stocks.
“We spilt the fund into two buckets. The first are ‘recovery’ names, which are companies that have been written off and deemed un-investable by the wider market, which gets our antenna’s twitching.”
“Recovery stocks will have had a big fall in their share price, which is almost always followed by a fall in profits.”
He says that currently banks such as Barclays, Lloyds and RBS fall into this category. However, he won’t just buy stocks which look cheap and is currently avoiding Tesco, which has had a torrid time of it in 2014.
Performance of stock vs index in 2014
Source: FE Analytics
He added: “We must see a catalyst for change [in our recovery holdings], such as a change in management for example.”
The second bucket is growth, according to Davies. These are companies with high barriers to entry and have predictable business models. He admits that to find quality companies like that they have to pay up for them – so he follows the growth at a reasonable price (GARP) approach for that portion of the portfolio.
His growth bucket currently includes the likes of BMW and Experian.
Davies and McVeigh set a two year target price for each stock they pick – including both their recovery and growth companies – which they say gives them a clear view of the return expected from each position.
Jupiter UK Growth has clean ongoing charges of 1.04 per cent. Though not strictly an income portfolio, it does throw off a small yield of 1.1 per cent.
