The shock EU referendum result, a low exposure to resources and an overweight in domestic-facing UK stocks have been the primary causes of Standard Life Investments UK Equity Unconstrained’s bottom-decile performance over the last year, according its manager.
Wesley McCoy, who has been at the helm of the fund since June 2015, says that a bottom-up stock-picking investing style veered the team away from making macro calls in the wake of Brexit but says that things are starting to look up for the £842m investment vehicle.
The fund, which has a concentrated portfolio of 41 holdings and holds more than half of its portfolio in mid-caps, has achieved strong total returns over five and 10 years, having more than doubled the performance of its sector average over the last decade.
While McCoy initially launched the fund, most of its track record has been driven by Ed Legget who left Standard Life Investments for Artemis last year with McCoy once again taking over the helm in June last year.
However, the fund has fallen on tough times over that time as well as over the last three and six months, falling into the bottom decile over each of these time frames.
Over the last 12 months, SLI UK Equity Unconstrained has lost 13.3 per cent compared to its sector average’s total return of 2.47 per cent. Year-to-date, the fund is down 9.19 per cent compared to its average peer’s return of 5.36 per cent.
Performance of fund vs sector and index in 2016
Source: FE Analytics
“For the first part of the year prior to the overwhelming impact of the referendum, we had a period where we had some doubts about growth which started to affect some cyclical positions that we had. We also had a period where we had an incredible v-shaped bounce back in lots of resource parts of the market.” McCoy explained
“In 2015 to the benefit of the fund, the fund was very lightly invested in resources. In 2016 you had a very strong rally in the oil price in the early part of the year and a strong rally in many commodity parts of the market and the fund was less heavily invested than traditional indices in those parts of the market.”
“A bit of a lag has started to open up a bit from that impact - both of those are macro events and this fund has prided itself on being quite stock-specific and very bottom-up focused. It hasn’t been a period where we’ve particularly called the big macro events that have driven markets, so we have lagged a little bit in the first half of the year.”
During the second half of the year, the manager says that the team’s focus on stock specifics led the fund into a large number of UK domestic positions – its biggest holdings include the likes of international packing business DS Smith, Synthomer and thermal metal process provider Bodycote.
According to the fund’s latest factsheet, it has just a 35.3 per cent weighting in UK blue-chips compared to the FTSE All Share’s weighting of 81.2 per cent. SLI UK Equity Unconstrained also has an 11.9 per cent weighting in small-caps, 2.6 per cent in unlisted companies and the remainder is held in mid-caps.
McCoy says that the decision to increase exposure to mid-caps was based on the companies themselves and not because he felt that the UK was a particularly strong economic driver for markets.
Performance of indices in 2016
Source: FE Analytics
“It was providing an area where the stock specifics were dominant over and above the macro positioning of the companies,” he explained.
“Obviously Brexit has meant that, in the UK, you haven’t really been able to avoid the macro, so you’ve had the impact of that and the sector where you will see that most profoundly is housebuilding.”
“That’s a sector with incredibly strong dynamics in terms of demand and supply but we now have the added nuance of having to consider that while looking at the wider picture. It is an entirely domestic asset that is entirely priced in sterling, which is impacted by international flows of capital.”
“Finally, a traditional benchmark is much more heavily exposed to international revenue and dollar-based revenues and, as this fund has tried not to be a macro, top down-orientated fund we’ve not thought about the positioning in that way. The instant impact of Brexit has meant that the stock-picking has really been overwhelmed by that macro positioning and that’s the context we find ourselves in.”
Despite the backdrop, McCoy says that the team has a lot of resolve at the moment and points out that the fund has behaved similarly during other significant macro events. During the financial crisis of 2008 and the European debt crisis in 2011, the fund was bottom-decile on an annualised basis but bounced back to the top decile in each of the following years.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
“We’ve had significant periods over time where we’ve focused very much on our stock-picking, but that positioning has become overwhelmed by the state of the overall world,” he continued.
“We’ve had three periods in the life of the fund where we’ve had really profound changes in the macroeconomic framework we’ve been investing in. The financial crisis in 2008, the EU sovereign crisis in 2011 and now I expect we’ll be looking back and talking about the Brexit crisis and what that caused.”
“Each time it’s forced us to go back and really think about what we’re trying to do here. Each time we’ve had to say to ourselves that we’ve set up this product to be long-term investing, thinking about stock specific ideas and how they’re changing, trying to take the best of what we can do and trying to find a concentrated way to invest.”
“In both periods we’ve had historically where we’ve had a real dislocation in markets, we’ve been able to come out of that stronger and we’ve been able to use that, adapt to that and make strong investment cases. That’s partly by trying to be focused on a time horizon we think that is effective.”
The manager points out that markets have become increasingly myopic which is opposite to the fund’s long-term investment horizon.
While it means that his fund can be hit during large-scale macro events, he says that this can lead to some attractively-priced opportunities being ignored by the broader market which could lend themselves as strong long-term positions.
“By us looking back and thinking about periods we’ve had in the past and how we’ve managed to get through those – in the two examples we’ve given, we’ve thrived in those, that’s what gives us that resolve and that real intention to try and do the same thing this time,” McCoy said.
“When we come into how the fund is positioned at the end of July, I’m really happy about this because of its concentration and conviction. There are often times when you think about your historic conviction and that causes you pain, you think about the ‘what ifs’ and the ‘should haves’ but it’s about getting back to what we’re good at.”
“We’re good at finding stock-specific ideas where we see change at that level, if we understand the context of that change and we have acknowledged that the context is different from what it was before the 23 June, the idea is then to invest with conviction in that area. What is so pleasing for me is that the areas of so many of these positions are the ones that have been really questioned by the market in the period right after Brexit.”
