The UK shares fund managers love and loathe

Hankering for housebuilders

UK housebuilders have stormed ahead in recent years, but analysts have taken against the sector recently, arguing that the good times must come to an end. Managers say the recent re-rating is an opportunity and are ploughing onwards in the face of souring market sentiment.

Job Curtis, manager of IC Top 100 fund City of London Investment Trust (CTY), holds Persimmon (PSN), which kicked off reporting season for the housebuilders on 4 November 2015, revealing a 12 per cent rise in sales and 13 per cent increase in profit to £272.8m over the half-year to 30 June 2015. He says: "I hold Persimmon and Taylor Wimpey(TW) and they are in good shape. They've got long land banks; they bought in at attractive prices. Planning has eased a little because the government is so keen for houses to be built, and demand for houses is strong, so land prices aren't too expensive.

"This recent setback in the market is not surprising because housebuilders have done so well this year, but I think that setback is an opportunity. Persimmon is now at £18.45 and had got up to £21.30 at the end of September, so it's off about 13 per cent from its peak, and presents an opportunity. It has also committed to distribute some of its supernormal [above normal] profits back as dividends."

Georgina Brittain, manager of mid-cap trust JPMorgan Mid Cap Investment Trust (JMF), which has a capital growth rather than income focus, says: "We are still really keen on housebuilders and have added to our position. On 9 November we bought retirement home builder McCarthy & Stone (MCS). We think it is in a very strong position and it's part of a big theme in the portfolio, which is about the government commitment to home ownership, about low interest rates.”

Stephen Bailey, manager of Liontrust Macro Equity Income (GB00B888YP40), says: "A lot of froth has come off housebuilders recently and I think investors will be surprised at their resilience. It's true that the housing bull run can only continue for a few more years and in the future we won't see the returns we've seen in the past few years, but returns could surprise industry watchers."

The beguiling challenger banks

Eight years after the financial crisis, mainstream and investment banks are still nursing old bruises, with many reeling from new sucker punches at the hands of regulators. A new breed of challenger bank is making the most of their lack of reputational and financial damage to storm ahead.

Mr Bailey says: "The major disrupter we think is Virgin Money (VM). It is a stock that has just started paying dividends, but if you look two or three years down the road it could be yielding in excess of 3 per cent. It has gained 4 per cent of the mortgage market in the UK in a short space of time and is developing its credit card business beyond market expectation. It has just moved into the small- to medium-sized enterprise (SME) market."

Ms Brittain holds OneSavings Bank (OSB), whose shares doubled between listing in June 2014 and August this year after it successfully tapped into the buy-to-let market. She says: "We have several challenger banks. It's a consumer and also an SME story and about the big banks leaving a big fat gap for the challenger banks to come in and make good money and good returns."

Contentious shares: Lloyds Bank Most managers were in the 'hate' not 'love' camp for Lloyds Bank (LLOY), which has been hit with record fines for PPI mis-selling. James Henderson, manager of IC Top 100 fund Lowland Investment Company (LWI), said: "I haven't got any Lloyds at the moment. I really hope it is OK as it'd be good for the economy, but for me it's too difficult. Regulation hasn't finished yet, so the demand on how much capital it needs to hold could change again and you just don't know what return on capital it can achieve or what the returns or dividends will be." But Mr Curtis says: "I've been buying back into Lloyds, which I sold out of at the time of the HBOS deal," he says. "I think the capital position has been rebuilt and I would expect good dividend growth from the bank. "Market expectations are of a 3.3 per cent dividend yield over the next 12 months and the expectation is that it will grow from there. Lloyds has been a big disappointment for me. I thought when I first bought it that Lloyds was a conservative bank and then it decided to buy HBOS. It is trading at a price/earnings ratio of under 10 so it is cheap. But that is because it has been so disappointing. Over the years there is a lot of mistrust because of the feeling towards the banks and penalties they will have to pay. If things don't get worse from a fines point of view then, given the profits it generates, I am happy with it." But Mr Bailey says: "A lot of people are expecting bumper dividends from the likes of Lloyds bank, but regulatory risk is restricting those dividends."

Contentious shares: BP Jamie Forbes-Wilson, manager of the AXA Framlington Blue Chip Equity Income Fund (GB00B7KBNV36), is positive on BP (BP.) - but not everyone is. He says: "BP has been screamingly cheap, on less than 10 times forward earnings for over a 6 per cent yield, but it does all depend on your view of oil. Analysts tell me that even though the Saudis continue to pump it out, we need 4 per cent of oil to be replaced every year just to stand still. So we are going to see a notable reduction in supply coming on-stream, which gives me comfort that the price won't stay at these levels for a long period of time. On a two-year view I think $70 is more likely than $40 a barrel. "Does BP get me out of bed in the morning with a smile on my face? No. But it is a large chunk of the index. I'm underweight Shell (RDSA) because I think it has a good story to tell and will be interesting in two years' time, but at the moment it has a lot to do in terms of swallowing BG and sorting out what is a giant bureaucracy. Mr Curtis says: "I hold both BP and Shell and think both will continue to pay dividends. I think the Shell and BG deal is interesting and on a long-term view there are a lot of levers they can pull in terms of reducing capex. "I would slightly prefer Shell, although both are fine. BP, of course, has now reached a settlement over the Macando penalties which give more certainty, but I think this BG deal could be good for Shell." But Mr Bailey says: "I've got an issue with the affordability of BP's model going forward. It is placed closer to oil at $60 dollars rather than the current $50 and it will be increasingly difficult to pay that dividend."

Managers' top stocks

Hugh Yarrow, manager of Evenlode Income (GB00B40Y5R17), likes to invest in companies that fly under the radar but perform vital, business-critical functions for big-name companies, affording them a pricing power and competitive advantage while remaining "unfashionable".

One such business is financial software provider Fidessa (FDSA), which provides software for investment banks and trading floors. He says: "We look for businesses that sell something that is mission-critical to the customer, but not a massive part of the cost base so that the customer tends to be more focused on the quality of the product than the price.

"It is a very asset light company and doesn't need to invest loads. Its capex requirement is small and it is a people-focused business, so historically very consistently repatriated its earnings as ordinary and special dividends.

"85 per cent of Fidessa's revenue is recurring and renewal rates are more than 99 per cent, and it has been that way for a long time. The issue is that it has been much tougher for brokers and investment banks after 2008 and there has been consolidation in the market, which means fewer customers for Fidessa."

One of Lowland manager Mr Henderson's favourite stocks is Rolls-Royce (RR.). Despite Rolls-Royce becoming one of the FTSE 100's five biggest fallers in the year so far, and despite the much-discussed slowdown in Chinese growth, he believes that Rolls' Trent 1000 engines, which power the Boeing 787 Dreamliner jet, will keep the stock soaring ahead of rivals.

"I think the way people have sold down Rolls-Royce is overdone. A few years ago, it was seen as the great technology company of the UK and it now seems to be a stock that analysts love to hate.

What do we know about China? We know that the Chinese will be flying more air miles in future than they are today and will also travel a lot internally within China. They have put in big orders with Boeing for the next generation of jumbo jet.

It will be a long time before China will be making jumbos, and civil aerospace in the past year accounted for £6.8bn of sales, making operating profit of £942m out of £1.7 total. So 56 per cent of total profit came from civil. Over 60 per cent of the Boeing Dreamliner engines are Rolls-Royce engines and the order book stretches out to 2022."

But Mr Henderson finds himself diametrically opposed to market sentiment. The engine maker has issued four profit warnings in little over a year and shares have plummeted in a matter of days as a result.

Jeremy Lang, manager of the Ardevora UK Equity Fund (IE00B3WN9227), which aims at capital growth not income, is keen on Rentokil Initial (RTO). He says: "Rentokil was, a long time ago, a go-to growth stock. It promised 20 per cent growth every year, and delivered. It had a valuation that reflected this feeling of safe, predictable growth. Unfortunately, to keep delivering consistent growth, management took greater and greater risks. Rentokil had always relied on acquisitions as part of its growth, but it started to buy larger and larger companies in areas well outside its prior areas of expertise; this culminated in the purchase of BET.

"This acquisition quickly went wrong, and the 20 per cent growth record was rudely shattered. It has taken almost 20 years for Rentokil to unravel the mess.

"Only in the past year did we start to see clear evidence that management was genuinely committed and the business was being fixed. Rentokil has gone back to its roots: pest control. It has many years of patient growth ahead of it, especially in America. But the stigma of past failure still hangs over the stock, making investors nervous, and analysts sceptical."

Fund performance (% cumulative total return) compared to sector average

Source: FE Analytics, as at 12 November 2015