Ask any UK investor what keeps them awake at night, and the chances are the answer will be two-fold: Brexit and the bear. More than eight years into the current bull market, it is not unreasonable to worry that we might be near the top. But beating the bear that everyone fears is lurking around the corner is hard, if not impossible to do.
You certainly don’t want to be too late as the initial down-leg can be scarily quick, but getting out too early will also hurt. You could move into cash, but the final stages of the bull market are often the most profitable for investors. No one likes to leave too much on the table.
Perhaps the most sensible way of “beating the bear” is to be a bit braver for a little bit longer, while making some allocation to cash in the name of capital preservation and keeping some dry powder.
What about beating Brexit? The slow and tortuous negotiations are casting a long shadow over the UK economy. The outlook isn’t very sunny for sectors of the stock market that are focused on the domestic economy. From consumer confidence to car sales, the dwindling value of real household incomes as inflation rises means investors focused on the UK market have their work cut out for them.
Nevertheless, many of the fund managers I speak to have still been able to find investments that can run up the down escalator.
A good example is Old Mutual’s Dan Nickols, who manages the top-performing UK Smaller Companies Fund. While he has upped the international earners in his portfolio, he is also backing UK companies with a strong story to tell, and particularly those that could benefit from industry consolidation.
His fund contains both structural growth players and consolidators that are scooping up smaller operators and capitalising on cost synergies. Names include Fever-Tree, the Aim-listed drinks brand, Breedon, the construction materials group, Biffa, the waste management company and Conviviality, the independent drinks distributor.
The well-worn investment playbook since the Brexit vote has been to target companies with overseas exposure to take advantage of sterling weakness, while steering well clear of UK domestic cyclicals. But a company doesn’t have to be listed on the FTSE 100 to have a high international exposure. The IPO pipeline remains strong.
Alastair Gunn of the Jupiter Distribution funds recently bought DP Eurasia, the Domino’s pizza franchisee for Russia and Turkey, which is growing fast and valued at a discount to the other successfully listed Domino’s franchisees around the world. Of course, this one comes with an added topping of political risk.
Another example is Global Ports Holding. The world’s largest cruise terminal operator is reaping the benefits of the growing popularity of this form of holiday with tourists worldwide.
Brexit-related uncertainty and the challenging domestic backdrop mean UK investors need to be smarter about how they invest, according to Alexandra Jackson of the Rathbone UK Recovery Fund (soon to be renamed the Rathbone UK Opportunities Fund). She says some of the best structural growth themes to invest in can be found in the UK with a lot of interest around gaming and litigation finance.
Another fund manager who has long favoured online gamers is Leigh Himsworth, manager of the Fidelity UK Opportunities Fund, who holds GVC Holdings — an online gaming company that benefits from international earnings.
One of his long-term investment themes is technology — specifically how the internet is evolving — which he accesses via IT securities and gaming companies.
If gaming companies sound too racy, you could look for companies that benefit from the uptick in inflation such as discount retailer B&M. Consumers trade down when prices are going up and B&M offers groceries and non-food items on a seasonal basis at a widening gap to supermarket prices.
Another route is to focus on companies with domestic earnings in the non-discretionary spending space. Motor insurers fit the bill and are in the midst of an upcycle for pricing.
Cyber security is rising fast up the boardroom agenda, justified by the growing number of cyber attacks in recent months from WPP to Equifax. Ms Jackson points to £570m market-cap GB Group as “the tech business you’ve never heard of that helps prevent fraud through identity assurance”. Mr Gunn owns NCC Group in this space.
Professional investors are also focused on unearthing businesses that could benefit from self-help. TP-ICAP, the company born out of the merger of Tullett Prebon and ICAP inter-dealer brokers, will be a beneficiary of rising volatility. This might be at record lows thanks to our QE-flooded world, but could rise as the tap is turned off and we set off on the path towards monetary normalisation.
Then there is FTSE 100-listed Micro Focus which has acquired a chunk of Hewlett-Packard’s software businesses, where it expects to more than double operating performance. Other examples include engineering company Melrose that has applied the private equity model of “buy — improve — sell” to many underperforming industrial businesses, and ITM Power, which is using hydrogen to power fuel cells.
Finally, consider companies that have structural growth opportunities regardless of what happens at the Brexit negotiation table.
UK housebuilders have a well-rehearsed investment case: a massive under-supply of housing, with no quick supply response. Even if interest rates rise in November, they stand to remain subdued for some time — and the government has helpfully thrown in a further £10bn of Help to Buy funding, news of which added £1bn to the combined market capitalisation of builders including Barratt, Persimmon and Taylor Wimpey in a single day. However, the effect of any post-Brexit labour shortages has to be factored in, and housebuilders are also exposed to any falls in house prices or transaction volumes.
As such, an arguably more Brexit-proof play could be the government-backed PRS Real Estate Investment Trust, which develops suburban family homes close to good schools which are then leased via the private rented sector. The Homes and Communities Agency provided some funding during its recent IPO, and its business model benefits from its scale and use of fixed price contracts. Income-hungry investors will be enticed by the 5-6 per cent yield target.
As Benjamin Franklin once said, out of adversity comes opportunity. In other words, roll with the punches.
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