Banks may have gone from being compelling investment opportunities to “value traps”, according to LF Miton UK Value Opportunities manager Andrew Jackson. 
FE Alpha Manager Jackson recently sold two banks from his £406.7m portfolio and trimmed his holding in a third after a number of factors cast a shadow over his outlook for the sector.
As the chart below shows, the shares of banks such as Lloyds Banking Group and Royal Bank of Scotland have yet to recover from the global financial crisis, owing to their position at the epicentre of the events that shook markets in 2008. This has led many to see them as value opportunities but Jackson thinks this might not be the case.
Performance of stocks vs index since 1 Jan 2008
Source: FE Analytics
In his review of the third quarter, the manager said: “In light of falling interest rates and trading statements which generally encouraged analysts to reduce their earnings estimates, the fund’s investments in the banking sector were reduced through disposals of shares in Lloyds Bank and Royal Bank of Scotland, and a reduction in the exposure to Standard Chartered Bank.
“Although the sector has the air of being of value material, the interest rate environment, increased capital requirements and lack of loan demand all suggest this sector is becoming more and more a value trap than value opportunity.”
Banks weren’t the only stocks that LF Miton UK Value Opportunities exited in 2019’s third quarter.
The manager sold supermarket giant Tesco and plumbing and heating products distributor Ferguson as he “perceived the easy money had been made and ideas with greater potential had been identified”.
He also sold brewer Greene King on the view that it was “a fully priced bid which was unlikely to be exceeded”; some of the proceeds of this disposal were put into Marston’s, another brewer where the manager sees potential for change at the corporate level.
One of notable event of the past month was the outperformance of the value investing style, which has severely lagged growth for much of the decade since the global financial crisis. This was prompted by the Federal Reserve’s move to cut interest rates following a run of disappointing economic, financial and political news from across the globe, reversing the increase it made in late 2018.
Performance of UK value and growth stocks in Sep 2019
Source: FE Analytics
Jackson said that it remains to be seen whether this brief resurgence in value at the index level becomes anything more substantial and noted that the general bearishness environment has tended to push investors in perceived safe havens like government bonds and ‘bond proxy equities’, or quality-growth stocks with reliable dividends and strong fundamentals, during 2019.
“As evidenced by the near-uninterrupted decline in bond yields around the world, investors remain very cautious as they reflect upon anaemic economic growth and political discord within and between many regions of the world,” the FE Alpha Manager said.
“With the weight of money apparently favouring stability and predictability, even more than is usual, the corollary is that value may be more readily unearthed where there is volatility and change even if that opportunity is often found in close proximity to its less appealing close cousins of value trap or, worse, capital destroyer.”
He added that his approach is designed to limit the influence of short-term shifts in sentiment towards one investment style or another and instead finding companies that will strengthen over the long term.
The lowly priced shares that make up the hunting grounds of most value investors do include companies that display volatile price movements as investor expectations about them rise and fall in respond to short-term newsflow, But Jackson instead seeks out business that are “trying to increase the absolute level and reduce the variability of operating performance so that they may find favour with investors and enjoy a lasting re-rating”.
“If we pick our investments correctly, recoveries of this nature should have a higher degree of permanence, be somewhat isolated from wider economic and financial cycles, and deliver rewards with an outsized ratio to the consequences of a miscalculation,” he explained.
However, Jackson noted LF Miton UK Value Opportunities’ portfolio will not be immune to wider macroeconomic or political events, even though he has built up from a bottom-up perspective.
With the fourth quarter of the year being one where volatility can often be higher and with events such as Brexit casting a shadow over markets, the manager also considered how the fund could behave under certain broad scenarios.
“Under a full risk-off scenario with attendant rush to bond proxies, the fund might underperform in light of its underweight exposure to stocks which have exhibited these traits in recent months,” he explained.
“If there is some element of clarity surrounding Brexit, the fund’s overweight to domestic activity should prove beneficial both for the health of our investee companies and from returning investor interest to the UK equity market.
“Because of the extended uncertainty on that same issue to date, further lack of clarity may not carry the same attendant risks from investor interest but one might start to question the resilience demonstrated by the UK economy to date.”
Performance of fund vs sector and index under Jackson
Source: FE Analytics
Jackson has managed the LF Miton UK Value Opportunities fund since 1 July 2016, over which time it has generated a total return of 44.02 per cent. This puts it in the IA UK All Companies sector’s top quartile and is higher than the gain made by the FTSE All Share (although the fund has no benchmark).
It has an ongoing charges figure (OCF) of 0.89 per cent.