Value investing has had a renaissance in the UK over the past few years as previously unloved areas such as banks, miners and oil companies have rocketed higher on a macroeconomic backdrop that includes rising interest rates, geopolitical tension and sticky inflation.
This has been beneficial for funds such as JOHCM UK Equity Income, which specialises in picking up high-yielding (and therefore often underpriced) companies.
It has been a top-quartile performer in the IA UK Equity Income sector over one, five and 10 years, and beat its average peer over the past three years, where it slipped slightly to the second quartile. It has also beaten the FTSE All Share benchmark across all these timeframes.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
There are pros and cons to good performance, however. On the one hand, co-manager Clive Beagles said stocks that had been mainstays “started to perform their way out of the fund having been in the dustbin for a number of years”.
This could inadvertently be a problem as the rhetoric surrounding the UK market in recent times has been that, with an increase in merger and acquisition (M&A) deals, a shrinking pool of stocks makes it harder to find compelling companies.
It is even more important for a fund such as JOHCM UK Equity Income, as the manager uses a yield threshold to ensure all his holdings are delivering the income his investors demand.
But he is unconcerned.
“People always ask me with all this M&A aren’t you going to run out of new ideas? Well no because the world changes and different types of stocks appear in our universe,” he said.
“The set of [potential] companies evolves and changes depending on what falls in and out of favour with the markets. It could be the macroeconomic picture, people worrying about structural change, management messing up, or all of the above.”
An example of this shift is the fund’s newest position in Schroders, the asset management giant, which entered the fund this yearn for the first time since the portfolio was launched more than 20 years ago.
“Asset management companies have clearly fallen out of favour with the market as everyone is worried about fee pressure and flows,” said Beagles, but Schroders is an even more specific case.
Richard Oldfield was appointed the new chief executive, replacing Peter Harrison, whom Beagles worked with many years ago when both were at Newton Investment Management. This change could be for the better, he argued.
“We quite like the new direction of the new chief executive who seems to be more focused on not just costs but rolling back some of the company’s ambitions,” said Beagles.
“Schroders had chased a lot of the fashionable new areas in the past three to four years whether it be ESG [environmental, social and governance] or private equity and actually maybe it needs a strategy that focuses more on the core credentials that Schroders is good at.”
He noted the cost-income ratio had got “a bit out of control” under the old management, which had led to the company’s share price multiple dropping, putting it on his and co-manager James Lowen’s radar.
Another name the managers are conducting a lot of work on is Whitbread, the owner of the Premier Inn franchise.
“It used to be in the very highly rated bucket as a growth compounder and was often on high teens type multiples but because it is perceived to be a UK domestic consumer spending kind of name, it has been quite heavily de-rated in the past six months on the negativity around the UK,” Beagles said.
“It is now yielding 4% which is at the lower end of our yields but that is very unusual to see the company sitting on that yield.”
The stock is trading on a discount to the value of its property assets, while its expansion into Germany is also unappreciated. Although he admits the firm has “taken a lot of losses” so far, “no one seems to be giving them any chance of the Premier Inn franchise working in Germany”.
“There are a few reasons why it might be interesting. We haven’t completed our research yet but if it were to make its way into the fund that would be two stocks we would have bought that we’ve not owned before,” the JOHCM UK Equity Income manager said, noting that would be “a good thing”.
It is in stark contrast to four years ago, when he said the fund had become “stuck” with the types of companies it could hold.
“Probably in the past three or four years there has been less of that happening. We have been slightly stuck with a universe heavily populated with financials, commodities and unloved domestic stocks. In the past 12-15 months we have begun to see a bit more change again,” he noted.
One area yet to receive any love from the manager, however, is healthcare, where the fund has a 0% weighting. AstraZeneca – one of the two main players in the UK market – is a “good company” but is too highly rated to fit into Beagles’ criteria.
GSK – formerly GlaxoSmithKline – is cheap enough but as yet the JOHCM UK Equity Income manager has not seen fit to dip into the pharmaceutical space.
“GSK has had lots of issues. It had too much debt, its cashflow wasn’t very strong and it didn’t have a great deal of growth in its pipeline,” he said.
While “all of those have improved a bit” and it is “definitely more of a candidate than it was historically”, he is nervous around its main market: the US.
“Drug prices in the US are still broadly twice as high as they are anywhere else in the world and you have quite an interventionalist, controversial health secretary being appointed,” he said, referring to Robert F. Kennedy Jr.
“GSK is not richly priced don’t get me wrong, but we still feel there is a lot of opportunity elsewhere. But it is definitely a candidate in a way that it probably wasn’t a couple of years ago.”