This year has been brimming with opportunity and rife with risk for value managers like Ian Butler. The stock market sell-off in March allowed him to add defensive names at knock-down prices to a portfolio typically populated with cyclicals. However, global lockdowns and the inevitable economic downturn has made stock picking even trickier.
‘Only 40-45% of value stocks outperform when value is doing well – most value names turn out to be value traps,’ said Butler, who runs the JP Morgan UK Equity Value fund with Thomas Buckingham. ‘This year more than ever has been difficult to navigate – we’ve had to do a lot of extra analysis.’
In the first quarter, when markets were caught in the grip of the coronavirus pandemic, they focused their energies on leverage and liquidity profiles to determine which companies may not survive. They sold a handful of holdings in the oil services, retail and leisure sectors. ‘They had high leverage and are most exposed to the effect of lockdowns,’ said Butler.
The stock market rout meant they were able to find value in more defensive names such as supermarket giant Tesco and power station operator Drax. They also topped up existing positions in cyclicals such as housebuilders – they own most of them – as the market priced in an ‘overly bearish’ outlook.
This summer they have bought Kingfisher, owner of B&Q and Screwfix, which beat market expectations in the second quarter, and bookmaker William Hill, which is now the largest sportsbook operator in the US. They believe the market has underestimated both the demand for home improvements that benefits Kingfisher and the potential upside of William Hill’s overseas expansion and both remain cheap stocks despite recent outperformance.
Once the managers have identified where value is in the market, they look to avoid stocks with very poor quality and momentum characteristics. They are wary of companies with low levels of return on invested capital and return on equity, poor capital discipline and low quality earnings that don’t turn profits into cashflow quickly or efficiently.
Areas that have been performing well for the fund include diversified miners and non-life insurers. They are among its most significant sector overweights with positions that are 4.9% and 2.6% greater than the FTSE All-Share index.
Rio Tinto, BHP and Anglo American all feature in the fund’s top ten and have been benefiting from favourable supply and demand fundamentals that have pushed up metal prices. ‘Chinese demand is returning on the back of ongoing [fiscal] stimulus and at the same time there are supply constraints due to Covid and some operational issues,’ said Butler.
General insurance holdings include Direct Line, Britain’s biggest car insurer, and fellow motor insurer Hastings, both of which have proven resilient in the face of Covid-19.
In early August, Direct Line reinstated its dividend and announced a special dividend to compensate investors for the cancellation in April of its final dividend for 2019, while Finnish insurer Sampo and South Africa’s Rand Merchant International made a successful bid for Hastings at a 47% premium to the company’s share price before they announced their interest. ‘That shows the value in the sector,’ added Butler.
In the year 2030
Royal Dutch Shell and BP are among the top ten holdings of the JP Morgan UK Equity Value fund and Butler expects to see a revolution in the energy sector in the next decade.
Last month [August], BP said it wants to have 50 gigawatts of renewables such as wind, solar and hydropower in its portfolio by 2030, up from 2.5 gigawatts at present and more than the total current renewable capacity in the UK. ‘The sector is pricing in a bearish outlook because of the oil price but these companies are incredibly cashflow generative with strong balance sheets and many levers to pull,’ said Butler.