Collins Stewart comments on fund selection in British waters

Friday 23 July 2010

• The UK stockmarket is not necessarily a representation of conditions within the UK economy

• Nick Mcleod-Clarke of BlackRock UK Income believes that over 80% of FTSE 100 revenues are earned overseas

• Some fund managers see the best value in companies with an actual UK focus

• …others are taking significant positions in internationally diversified companies

• We ensure that the amalgamated performance of our preferred managers is not wholly dependent on one particular segment of the market

Commenting on Fund Selection, Justin Oliver, Co-Manager of the Collins Stewart Select Funds said:

When speaking with our third party UK fund managers, one message comes through loud and clear; the UK stockmarket is not necessarily a fair representation of conditions within, or the outlook for, the UK economy. One must always be careful of managers “talking their own book” and thus, in this instance, trying to put a positive spin on the UK equity market at a time when many investors might be looking at their exposure with trepidation given the poor state of UK public finances. However, all things considered, these arguments do appear to have some merit.

Nick Mcleod-Clarke, one of our favoured managers who runs BlackRock UK Income, believes that over 80% of FTSE 100 revenues are earned overseas. If one invests on a fundamental basis – as we do – and if one accepts that economic growth in Asia and the developing world is likely to outpace that of the western world in the years ahead – as we do – then it may be that the UK stockmarket offers a significant attraction for global investors. At the very least, one should not be put off the UK stockmarket simply because UK economic growth might lag other parts of the world. Consider the revenue streams of the largest UK equity index constituents. According to BlackRock, HSBC earns over 65% of its revenue outside of the UK, Vodafone generates 85%, BP and Shell over 90%, while Glaxo generates 95% of its revenues overseas.

The UK stockmarket is undoubtedly home to many global industrial leaders who are not heavily exposed to the UK domestic economy and whose operating performance is being boosted by sterling weakness. Indeed, from this perspective, one could argue that further falls in the value of the pound could be a positive driving force for the UK stockmarket, particularly at a time when many countries would like to embark on a policy of competitive devaluation.

While the disconnect between the UK stockmarket and UK economy is well appreciated in the fund management community there is, as ever, disagreement on how investors might best capitalise on this fact. Fund managers such as Mark Costar at JO Hambro and Adrian Frost of Artemis have highlighted that, while UK domestic conditions may remain challenging, this has been more than discounted by certain share prices. Consequently, the best value may be found in those companies which have an actual, or perceived, UK focus. Given consensus views, investors have shunned the likes of Severfield-Rowan (engineering/construction), Northgate (commercial vehicle rental) and Speedy Hire (rental services), despite the fact that they are all clear leaders in their field and in many cases are trading at a discount to their tangible assets.

Yet, other managers – most notably Neil Woodford at Invesco, as well as Nick Mcleod-Clarke – are consciously underweight businesses that are overly exposed to the UK, instead taking significant positions in well capitalised internationally diversified operators that offer good earnings visibility. In this regard, pharmaceutical stocks – Glaxo and AstraZeneca – are particularly favoured.

As we have emphasised in previous articles, we firmly focus on blending funds, with the aim of ensuring that the amalgamated performance of our preferred managers is not wholly dependent on one particular segment of the UK stockmarket. Thus, while we believe that a UK stockmarket exposure does not necessarily expose investors to the UK economy per se (in fact quite the opposite), one must consider that this might present different investment opportunities to different managers. Some might be attracted to the value seemingly inherent in the domestic parts of the market which have been shunned. Others are focussed on those sectors which are felt to be most exposed to international revenue streams. An appreciation of a manager’s positioning and appropriate fund blending thus remains an extremely important consideration when looking to capitalise on this fact.