Standard Life Investments UK Equity Income Unconstrained manager Thomas Moore, August 2016
19th August 2016 - UK companies seek to reassure: a fund update from Thomas Moore, manager of Standard Life Investments UK Equity Income Unconstrained, which is on the Chelsea Core Selection
“The immediate market reaction to the EU referendum result was a rotation out of small and medium sized domestically-focused companies into larger stocks with an overseas profile”, he said. “This reflected investor concerns over the sharp fall in sterling and the effect that uncertainty might have on UK corporate and consumer spending. The result was a significant divergence in valuation between UK and overseas-facing companies.”
“However, while the current uncertainty may result in an economic slowdown (and some macroeconomic data suggests this is already underway), we have been encouraged by what we have heard from the management of many of the companies in which we invest. From company visits and statements, the picture we are getting is one of limited or no short-term impact on domestic activity. Close company contact is critical at all times, but especially during periods of market stress. It gives us the opportunity to filter out much of the background noise and get to the heart of what is happening at the corporate level. Our full coverage of the UK market puts us in a good position to capture opportunities created by market dislocations.”
The UK's financial sector
“The financial sector was hit hard in the immediate aftermath of the referendum, with widespread expectations of a sharp deterioration in mortgage and consumer activity. Pleasingly, Virgin Money, the ‘challenger’ bank we hold in the portfolio, has reported no evidence of changes in customer behaviour. Furthermore, while acknowledging that uncertainty has increased, the bank could point to the quality of its mortgage and credit card books as evidence that it is well placed to deliver returns in a weaker economic environment.
“Similarly, specialist financial services group Close Brothers reported little direct impact from the referendum so far. Announcing solid financial year-end results, the company highlighted the strength of its funding and capital position, as well as its prudent approach to underwriting. As with Virgin Money, Close Brothers’ recent comments reaffirm our view that it has a robust business model that should prove resilient in the face of heightened uncertainty.”
The wider market
“It is not just financials where customer activity appears to have emerged relatively unscathed. Certain housebuilders, retailers and travel companies have also issued upbeat statements on activity trends. While Tui, another of our holdings and the world’s largest tourist operator, acknowledged a likely fall in profits due to translation effects from the sharp fall in sterling, it is confident travel patterns will be little changed. This is not the extreme negative scenario that was priced in immediately following the vote.
“Overall, although the prospect of a medium-term impact on domestic activity cannot be ruled out, what we are hearing from companies should at least allay fears of a sharp collapse. As a result, there are signs that the knee-jerk reaction to the referendum that saw investors shun UK-focused companies en masse is beginning to unwind. For example, the FTSE 250 Index, which was initially hit particularly hard, is now back around pre-referendum levels. As well as reassuring comments from companies, this is being driven by a growing realisation that some defensive stock valuations were at extreme levels, the UK political backdrop has greater clarity and global economic data has been broadly stable. We believe this is good news for many of our holdings.
“In the fund, we prefer companies with strong dividend growth prospects based on advantageous market positions, high free cashflow yields and solid balance sheets. We retain our belief in stock picking as the most successful way of delivering performance over the long term. Periods of market stress tend to generate valuation opportunities, as investors focus on economic or political concerns rather than corporate fundamentals. While this can be painful for stock pickers at the time, share prices ultimately respond to cash flows and the dividends that underpin them, providing the scope for a healthy rebound once a clearer picture of the political and economic outlook emerges.”