Sector review: A mixed bag for UK All Companies

The UK All Companies sector is the IMA’s largest but performance has been wide-ranging, writes Paul Burgin

UK All Companies managers know there are tough times ahead. Even with forewarning over sovereign debts and deficits, plotting a clear route for active UK equity portfolios will not be easy.

The UK All Companies sector is the country’s largest, accounting for 19.2% of assets under management, according to the IMA’s March figures. At £98bn in size, it is more than twice the size of its nearest rival, the Sterling Corporate Bond sector.

In March, the UK All Companies sector recorded the industry’s largest gross sales. But these were offset by heavy repurchases, resulting in the industry’s biggest net outflows at £849m, most of which were retail. The poor sales performance reversed a general trend where equities had outsold bonds in the previous six months, says the IMA.

Based on Financial Express Analytics data over the past year, SWIP’s Multi-Manager UK Equity Growth fund suffered most within the sector from investor jitters. It saw outflows top £500m. The company says the figure relates to an internal move between funds for diversification. It was followed by Royal London’s FTSE 350 Tracker fund and Jupiter’s UK Growth fund.

Inflows outnumber outflows

On the plus side, inflows to the most popular funds were far larger than the biggest outflows. Tom Dobell’s M&G Recovery fund faired well, attracting just under £900m in new money over the last year. L&G’s UK Index fund and Newton’s Income fund also attracted significant sums.
Dobell remains cautious over the outlook for global growth. He is particularly concerned about growth in the UK economy in the medium term. The international economy will take time to recover from debt excesses of the last decade, creating a challenging environment for companies. His strategy is one of mitigation. He says: “The M&G Recovery fund already has a diversified international earnings profile, with a much lower reliance on the prospects of the UK economy than in previous years.”

While the fund’s focus remains on companies with recovery potential, he is avoiding those suffering simultaneously from both operational and financial difficulties.

The Standard Life Investments UK Equity Unconstrained fund has been first quartile since launch in 2005. Current manager Ed Legget took over in 2008 and has produced second quartile results since then. He admits he got the Lehman Brothers story wrong. With Barclays and RBS each making up between 4% and 5% of the portfolio, he took a beating.

Profit taking when the market was in free-fall was not a success either. Stocks sold then repurchased on rocketing yields continued to plummet. Important lessons were learned.
Legget says: “Since April and May of last year, turnover on the fund has dropped dramatically.” He has also taken time to exit some restructuring stories such as Punch Taverns.

His attention has turned to growth stocks, particularly those with strong franchises that can weather the storm and take market share from ailing rivals. He likes The Restaurant Group, owner of Garfunkels, and Galiform which emerged from the collapsed MFI group.

Industrials are taking a more central role too. Those that export to fast growing emerging markets have benefited from sterling’s weakness, yet their shares remain underpriced. “They all trade at a discount to their global peers,” says Legget.

Macro data

With reporting seasons over, many in the market are relying on backwards-looking macro data not company specific information. Under-valuations may continue for some time, he thinks. The fund has rebounded as a result of his shift in strategy. Legget has produced the sector’s best one year returns at 78.15% to the end of April.

Paul Spencer, manager of the Rensburg UK Mid Cap Growth fund, made his last portfolio changes in Q3 2009. He shifted from an overweight UK recovery position to an overseas outlook. Then, just 40% of the portfolio’s corporate profits came from overseas. Now they make up 65%, with the accent on the Americas and emerging markets.

“It was clear then that any new government would have to take aggressive steps to tackle the deficit. At best, the UK will experience anaemic growth, at worst a double dip,” Spencer says.
He believes a ‘VL’ shaped recession is likely, where the down stroke and upstroke of the ‘V’ represent the crisis and stimulus periods, whilst the ‘L’ represents moves to tackle deficits. If that proves true, Spencer says the emphasis on solid balance sheets and strong cashflows will rise.

His pessimism has played out well for the fund. It is first quartile over every period from six months to five years.

Longer-term view

In contrast, Mark Lyttleton has enjoyed less short-term success with his two UK All Companies funds. The BlackRock UK and UK Dynamic funds have slipped from second quartile over five years to third and fourth quartile respectively over one year and six months.

He has run three main strategies over the past six to nine months when the last major portfolio changes were made. The first is based on the cyclical recovery not being fully priced in.

Lyttleton is confident travel and leisure stocks should recover as the economic outlook brightens.

The second concentrates on high quality and high growth stocks on a three-to-five-year view. Lyttleton says: “At the moment, the market is not distinguishing between them.”

The third strand has been disappointing. Defensive stocks should have done what they normally do when markets, economies and sentiment are under pressure. This time round, they have lagged and pulled down Lyttleton’s performance. He says: “They have performed poorly because they are less exciting. They should have done better than we thought.”

But he is not about to reorder his portfolios to chase short term gains. He believes that defensives will come through this year, adding rather than detracting from his overall stance. “We can live with this in the short term,” he says.

Q&A: Active vs Passive

The UK All Companies sector may be large, but that does not mean all performance is good. Across standard time frames provided in the Lipper data, the sector average trails the FTSE All Share index, a key benchmark.

Cost and underperformance issues have attracted significant investors to passive funds. Of the sector’s 10 biggest funds, half are trackers. They represent £13bn of a total £30bn in assets within the best sellers list.

Rob Page of Ignis Asset Management says he was surprised when the fund group investigated adviser attitudes to passive funds.

Q. What research did you do and why?
A. We do lots of IFA research, mainly for business planning which occasionally throws up some interesting results. I am not anti-passive funds, I hold ETFs and trackers myself. But we wanted to find out what IFAs thought and whether there will really be an explosion in passive investment post-RDR when commission bias is removed.

Q. Why were the results such a surprise?
A. Although the survey base was small, the results were not what we expected. We thought there would be more of an emphasis on passives post-RDR, but the results do not bear out the expected explosion.

Most of the consultants expect a wall of money to come in as advisers seek low-cost beta funds for parts of their portfolios. They think there will be a polarisation between high quality alpha players and the low cost trackers. Our results show the passives can expect good flows, but not as much as forecast.

Q. What does this mean for future advice and allocations?
A. Two-thirds of advisers expect their passive allocations to remain the same. Over 9% expect it to drop. They are concerned about how passives are perceived as lower risk. Many feel that clients do not fully understand the concentrated risks in big stocks you get with FTSE 100 trackers, for example. Also, the guys that will struggle post-RDR will be the quasi closet trackers. Those who charge 1.5% but aim to outperform the benchmark by only 1% will suffer.

But there will be cases where passives are justified. North American equities managers find it hard to outperform the S&P 500, making that market an obvious passive target market. We will repeat this research to dig deeper into the context and uses of active and passive funds.

Adviser View: Justine Fearns, AWD Chase de Vere

Advisers like:

• Choice – diverse range of funds, strategies and styles
• Long track records of the strongest managers
• Active managers can take action in a downturn, passives cannot

Advisers dislike:

• A lot of underachievers and closet trackers
• Concentration of holdings and risk if mixing different funds

Justine Fearns at AWD Chase de Vere thinks advisers need to inspect their UK All Companies portfolios carefully. The growing number of Opportunity and Special Situations funds has increased the choice of strategies.

The best performing managers must demonstrate how they work and how they can deliver long term results. Investors may have to revise their selections as many managers are not suited to all conditions, although Fearns warns about switching funds too regularly.

For long term results, she has two recommendations; the M&G Recovery fund and Newton’s UK Opportunities fund run by Ben Russon. Both are first quartile performers over five years.

Fearns says: “Do they sound boring? They probably are for some but key for us is that both have a good name behind them, have very strong investment processes, excellent fund managers and teams.”

She says that unlike many competitor funds, both offer complementary portfolios. Investors could easily hold both and still diversify within the British equity space.

The Newton fund is concentrated, holding no more than 50 stocks. Those selected must have good cash flows and strong management. The current theme of ‘all change’ at a global level has been complemented by a newer ‘low end spend’ theme, reflecting economic reality and that all consumers are counting the pennies.

The M&G Recovery fund ‘has been around for years and years’, says Fearns. She says manager Tom Dobell’s philosophy has changed very little over time. He looks for unloved companies with strong management teams in place to maximise recovery potential. He works with two corporate restructuring experts, working mainly in the smaller cap arena.