An investment strategy that focuses on high-quality companies and is well diversified across investment styles and sectors should stand UK equity investors in good stead when the ‘skies clear’, according to JP Morgan fund manager James Illsley.
‘Don’t ask me about coronavirus – I haven’t got a clue frankly,’ he told delegates at a Citywire conference. ‘. . But what I can tell you is something about the UK equity market. I can tell you where we start from – one of an extremely undervalued asset class.’
He compared the yield on UK equities at around 5% to the yield on 10-year gilts at less than 0.5%. ‘If you look at that gap through time there’s only one time in history that it’s been higher – that was World War I. That tells you something about the fear factor that’s going through the UK equity market, and to an extent that is also reflected in other global equity markets.’
Illsley, one of four managers named on the JPM UK Equity Core fund, sees relative value in the UK market versus overseas equity markets. ‘The UK equity market is a low beta, defensive market so we tend to trade at a discount through time,’ he said. ‘But look at where we are today – a 30-year relative low – well below the average discount though time. That is a once-in-a-generation opportunity to buy UK equities versus international equities.’
He believes a marked improvement in the underlying fundamentals of the British economy seen prior to the spread of coronavirus will remain after its demise.
‘We will suffer through this time period, but when we come out the other side – as we inevitably will – those fundamentals will still be in place,’ he said. ‘We’ve got rid of some the uncertainty of Brexit. We have a stable government for the next five years with an intent to boost fiscal spend. A lot of those uncertainties that were holding us back, once this latest uncertainty is out the way, will still be in place.
‘So, if nothing else, in two to three months if you feel prepared to add to your equity allocation just try to remember these facts – we are a cheap market with an underlying improving economic outlook and at the same time there’s a lot of pent-up demand for UK [equities] as and when the clouds lift and the skies clear.’
Smoother ride
Illsley and his co-managers expect to see a slew of earnings downgrades as companies assess the impact of the virus on their businesses but believe its impact on long-term economic growth is likely to be limited in magnitude.
They remain focused on identifying robust equity investments – high-quality businesses with prudent capital management delivering high returns on capital – and paying the ‘right price’ for them.
‘In old terminology, we want to build a portfolio that is better value, better quality and better momentum than the market,’ he said. ‘The good news is that all three of these investment processes work through time. The bad news is if you’re a value manager today you probably haven’t had any alpha for the last ten years. If you were a growth manager in the tech bubble you got burnt, likewise in the financial crisis.
‘But if you combine these three styles, which tend to perform at different times, you’ll get higher alpha and importantly much better risk-adjusted returns – you get a smoother ride.’
In running JPM UK Equity Core, the managers take small overweight positions in good businesses that are attractively valued whose outlook is improving, whilst taking small underweight positions in stocks with inverse characteristics. One position that has recently served the fund well is an underweight in cruise operator Carnival, which contributed to returns as concerns grew over the impact of the pandemic on demand.
‘We are still continuing to do exactly what we set out to do more than ten years ago when we launched the fund – sector bets are close to neutral and most of the risk is taken at a stock level,’ added Illsley. ‘The result is consistently adding alpha, a high hit rate, low risk and we’re offering this at 33 basis points all in.’
