A deterioration in the quality of balance sheets and weaker-than-expected operating cashflows from overseas means the UK equity market is fraught with risk, according to Georgina Hamilton, co-manager of the top-performing CF Miton UK Value Opportunities fund.
Hamilton and her co-manager George Godber, who is an FE Alpha Manager, use a disciplined value approach to investing within their highly-popular fund. 
However, as they focus on companies that are generally unloved by the wider market, the duo implement safety checks on each of their stocks to make sure they are not buying into potential value traps.
Worryingly, given that global growth has weakened and we are seven years on from the global financial crisis, Hamilton warns that the number of FTSE All Share stocks that fail their ‘safety checks’ has increased dramatically.
As a result, the manager says she and Godber are focusing on downside protection now more so than ever.
“The risks have definitely increased,” Hamilton (pictured) said.
“We have seen eight FTSE 100 companies cut their dividends this year and many are still paying their dividends out of debt – so we don’t think that trend is over at all. The risks are generally much higher than they have been, which is no surprise given where we are in the cycle, but balance sheets tend to be in much worse shape.”
She added: “You’ve just got to be careful.”
Following five years of almost unabated gains, the UK equity market has shown clear signs of weakness over the past 18 months of so.
According to FE Analytics, the FTSE All Share has made just 2.93 per cent since January 2014 and has had a maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible times – of 11.73 per cent over that time.
Performance of index since Jan 2014
Source: FE Analytics
Concerns surrounding the UK equity market have only increased this year due to macroeconomic headwinds such as China’s slowing growth and the uncertainty surrounding its economy, falling commodity prices and the possibility of higher interest rates in the US.
These trends have only really affected the FTSE 100 index rather than small and mid-cap stocks, though, as the blue-chip index is far more internationally facing.
As a result, that’s where Hamilton says the major risks lie.
“There are a few reasons for that and one of those is because FTSE 100 companies are more exposed to overseas. Operating cashflows have been weaker than expected from overseas and companies have generally been doing more share buy-backs,” she said.
Nevertheless, given the FTSE 100 has made just 0.01 per cent and is some 9 percentage points behind the more domestically orientated FTSE 250 index in 2015, many value managers are upping their exposure to mega-caps.
Performance of indices in 2015
Source: FE Analytics
One of whom is FE Alpha Manager Alex Savvides who, like Hamilton and Godber, has a genuine multi-cap approach within his JOHCM UK Dynamic fund.
“It just so happens some of my most interesting ideas at the moment are in the FTSE 100 and they are right at the top end. You will get small-cap returns from mega-cap stocks over the next three years and if you are not in them, you will miss out,” Savvides told FE Trustnet last month.
However, Hamilton and Godber run a very different type of value fund compared to many of their peers.
While CF Miton UK Value Opportunities is made up of two tranches – ‘bargain assets’ (stocks trade materially below their intangible asset base) and ‘cheap value creators’ (stocks whose value creation is materially underappreciated by the market) – they have a safety check to make sure they are avoiding value traps.
These checks include rigorous analysis of retained cash generation to determine if a company has the time horizon to realise its intrinsic value and therefore filter out companies that aren’t in a sustainable funding position.
Consequently, unlike many value funds, CF Miton UK Value Opportunities has no exposure to bombed-out commodity companies which have led the rally since August’s ‘Black Monday’ sell-off. In fact, apart from certain stocks like EasyJet and Royal Mail, the fund has no exposure to the FTSE 100.
“All of the utilities companies have failed our safety check and there are a couple of pharmaceuticals and supermarkets – so it is not just mining and oil companies,” Hamilton said. “Yes, the oil and mining companies are certainly failing our safety checks in a quite spectacular way, but it is quite broad brush.”
“The way we see it is that while there are opportunities in the current market, there is also elevated risk. We just need to need to focus on stock selection and have to be discerning about each share.”
As a result, the managers hold the large majority of their portfolio (73 per cent) in the FTSE 250, Small Cap and AIM indices. On top of that, Hamilton and Godber currently run 7 per cent of their portfolio in cash.
CF Miton UK Value Opportunities has been one of the best performers in the competitive IA UK All Companies sector since its launch in March 2013.
FE data shows it has been a top decile performer in the sector over that time with returns of 55.72 per cent, meaning it has more than doubled the gains of the FTSE All Share in the process.
Performance of fund versus sector and index since launch
Source: FE Analytics
However, it is the fund’s capital preservation characteristics that Hamilton is most proud of. According to FE Analytics, for example, it has had the best risk-adjusted returns (as measured by its Sharpe ratio), lowest annualised volatility and lowest maximum drawdown in the 265-strong peer group since inception.
This may come as somewhat of a surprise, given the fund has historically held the majority of its assets in the lower end of the FTSE All Share.
“We see risk in a very different way to most. A lot of people think of big as safe and small as risky. However, we see cheap stocks with good balance sheets as safe and expensive, unfunded large-caps as risky,” Hamilton said.
Given the managers’ process and strong risk-adjusted returns since launch, it comes as little surprise CF Miton UK Value Opportunities has quickly turned into one of the most popular offerings in the UK growth space.
Its AUM, combined with the managers’ other FP Miton Undervalued Assets fund (which is soon to be integrated into CF Miton UK Value Opportunities), is now more than £600m. However, to make sure performance isn’t hindered or their style isn’t affected, Miton have a plan to close the portfolio – like they did with their top-performing UK Multi Cap Income fund.
“The capacity for the fund is £1.2bn,” Hamilton explained.
“I don’t think there is any way we could run more than that. If we have to address the size before that, but Miton as a group have a good history of closing funds before they become too big. I think that is right because I don’t think we would be able to perform as we have done if we were to run more than that.”
CF Miton UK Value Opportunities has an ongoing charges figure of 0.89 per cent.
