While Brexit negotiations continue to mire the outlook for UK equities, opportunities are emerging in the domestic stock market for investors willing to look past the political noise, according to Jupiter Asset Management’s James Clunie.
Clunie, who oversees the £1.5bn Jupiter Absolute Return fund, pointed out that the lack of clarity over the final Brexit outcome has led to some investors avoiding UK stocks.
He explained: “The UK is in chaos; uncertainty over Brexit continues to ratchet up and market participants – alongside politicians, it seems – have no clear idea what form Brexit will take.
“Investors, faced with this environment of extreme Brexit-induced uncertainty, seem to have come to the general conclusion that in its current state the UK is ‘uninvestable’.”
There has also been a noticeable impact on the UK stock market since the EU membership referendum in June 2016, with the FTSE All Share lagging its international peers.
Performance of indices since EU referendum
Source: FE Analytics
As the above chart shows, the FTSE All Share has underperformed the broader, developed markets-focused MSCI World index, making a 22.02 per cent return against the latter’s gain of 43.34 per cent.
The Jupiter manager – whose process aims to exploit inefficiencies in global equity markets –said UK valuations relative to Europe have plunged more recently as sentiment towards the economy remains negative.
“While this knee-jerk reaction to extreme Brexit uncertainty is understandable, we have to consider what our job as investment analysts and managers is exactly,” he said.
“For me, the answer is clear: it’s to take calculated risks under conditions of uncertainty.”
Clunie added: “If uncertainty is so high that it’s terrifying, then actually that’s just a slight extension of what is the bread and butter for investment analysts and managers – to take calculated risks when you’re not sure what will happen next.
“So, it should be business as usual, just in a slightly heightened sense.”
While others have taken UK and Brexit-related risk completely off the table, said Clunie, his fund has instead taken a different approach.
“First, we analyse each of the companies we’re interested in in its own right – ignoring the geopolitics,” said the manager. “We then get an idea of whether we’d want to be long or short of the stock if there wasn’t all the Brexit and parliamentary confusion and noise.”
After this process, the manager considers what could go wrong and what impact a change in the political landscape could have, resulting in a number of scenarios.
“We can then look more closely at the stocks we want to own,” he said. “If we know for a particular stock that there are some scenarios where we’ll lose money, but in most scenarios we’ll likely make money in the long term, then that’s a buy. And vice versa with the shorts.”
As such, the manager has gently been adding UK domestic stocks to the portfolio on ‘bad days’ when the market has fallen.
Clunie said one example of its approach is outsourcer Serco Group, which looks very cheap on its valuation model.
Performance of stock over 10yrs
Source: FE Analytics
“It’s not going bust, the balance sheet is OK, and they’ve been winning lots of contracts recently including their largest ever a few weeks ago,” he said. “Analysts have also been upgrading earnings forecasts. Overall, it appears relatively cheap to us with good news and upgrades.
“Of course, there is potential for headwinds, notably around fears it could lose public sector contracts were a change of government to happen, but we are otherwise positive.”
Another example is brickmaker Forterra, which has positive fundamentals but looks cheap relative to the market.
“Regardless of who is in charge of Britain, we will still likely build houses – whether they’re private or social housing, it doesn’t concern a brickmaker,” he added.
As well as adding to UK domestics in the ‘long’ portfolio, Clunie has been short-selling into sharp rallies following the return of volatility last year.
“Although not certain, we think we have entered a bear market, with high asset prices and draining liquidity,” he said. “In these conditions, sharp ‘up days’, which we have witnessed in the past few months, are not uncommon. These up days can provide opportunities for short-selling.”
Indeed, investors put off investing in UK equities by Brexit uncertainty could be missing out on such opportunities, according to Clunie, and would be better off sticking to tried-and-tested processes.
“Far from being uninvestable, UK equities can offer plenty of opportunities to the fund manager who continues to employ the same tools they have always used to analyse companies,” he said.
“Only then, should the impact of Brexit on the company’s fortunes come under scrutiny.”
The Jupiter manager added: “In short, Brexit should probably not be the first test of a company’s eligibility as a potential investment, rather a secondary consideration once a firm’s overall health and prospects have been assessed.”
Clunie’s Jupiter Absolute Return targets an absolute return over a three-year rolling period independent of market conditions.
Under Clunie – who took over management of the fund in September 2013 – Jupiter Absolute Return has made a 13.6 per cent total return while the average IA Targeted Absolute Return fund is up by 12.06 per cent (although the sector is home to a range of strategies).
Performance of fund under Clunie
Source: FE Analytics
“The manager has used the same strategy since 2009, which he exported from Scottish Widows to Jupiter in 2013,” noted analysts at FE Invest.
“He perfectly understands its strengths but also its weaknesses, meaning that he can limit the risk in the portfolio if he believes the strategy can’t perform. It happened several times in the past and the capital loss has been small in those periods.”
Jupiter Absolute Return has an ongoing charges figure (OCF) of 0.84 per cent.