Since the FTSE bottomed in early March, the investment world has been split down the middle: on the one half you have the sceptical camp, composed of the likes of Neil Woodford, who don't think the recovery rally is the real deal and have chosen to stick with defensive stocks such as pharma, utilities and tobacco. On the opposite side of the fence sit investors like Richard Buxton, head of UK equities at Schroders, who have placed their bets on cyclical stocks.
Those in the Woodford-camp have dubbed the bounce "a dash for trash", but is Mr Buxton's camp that is laughing right now. Defensives have underperformed in the upturn, whereas cyclicals have soared.
Mr Buxton, who manages the Schroder UK Alpha Plus Fund, a UK All companies fund which has more than doubled investors' money since its launch in 2002, does not buy the trash argument and goes so far as to term it an "emotive and nebulous" catch-all phrase.
"Managers that have underperformed this year are branding the upturn in cyclicals as a liquidity bubble, which is not justified. This is not a 'dash for trash' - it is a very genuine rally from levels that priced in an Armageddon scenario. We could never get our forecasts low enough to justify just how far these shares fell - no matter how gloomy we were."
While he concurs that some stocks have bounced unjustifiably given their weak balance sheets, he says these are not the type of companies that he has held within the Schroder UK Alpha Plus fund, a concentrated portfolio of best ideas seeking to deliver an attractive absolute return over the long term. Mr Buxton, who designed the mandate for the fund, has instead focused on companies such as Next and Home Retail. "Despite being heavily shorted stocks, these companies boast good management and solid balance sheets - they were sold down to ludicrous valuation levels," he says.
A 'gentle trimming'
That said, Mr Buxton admits that cyclicals have now outperformed to such a degree that some stocks are starting to look expensive. In response he is "gently trimming" back some of his cyclical holdings and recycling money into more defensive holdings such as Shell, Tesco and GlaxoSmithKline. "I have also bought some Centrica but it’s not because I am very defensive and hence buying utilities. It's because there is an individual stock story here - I think you can make 30 per cent over the next couple of years and yet this is a low-beta stock."
Despite rebalancing his portfolio, Mr Buxton is convinced that the surprise in the first half of next will be a buoyant where cyclicals and financials still lead, while defensive stocks continue to lag. "While I am toning down the beta in my portfolio in anticipation of greater volatility, I remain pro-cyclical and pro-financial," he says.
In time Mr Buxton expects the cyclical-defensive binary to disappear, and says the market will begin to distinguish more between those companies that can genuinely grow revenues and those that can’t, and so determine which stocks are worth paying more for through re-ratings. He also foresees more merger and acquisition (M&A) activity as things get tougher and there is need for greater consolidation - but says this time it will be funded through equity, rather than debt.
"As we move away from the cyclicals versus defensives debate, the new reality will be that with interest rates staying low and economic growth sluggish - we need to find companies that can genuinely grow. It will become a more stock specific market," he says.
| RICHARD BUXTON CV |
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Richard Buxton joined Schroders in 2001 and was appointed head of UK Equities in 2003. Prior to this he was a UK equity manager at Baring Asset Management from 1990 following one year at GRE Asset Management. His investment career commenced in 1985 at Brown Shipley Asset Management as a fixed income and equity investment manager. He has degree in English Language and Literature from Oxford University. |
Betting on banks
While the Schroder UK Alpha Plus Fund suffered from its exposure to banks going into the financial crisis - the fund lagged the FTSE All-Share over the course of 2008 - Mr Buxton has stuck to his big position in Barclays. He has also recently increased his position in Lloyds and says there is a likelihood of him building his position in Royal Bank of Scotland, all in the belief that there is a healing process underway for UK banks.
"We expect 2013 to be the first year of normalised banking earnings - by then we expect banks to have rebuild profits and balance sheets and regulators to have decided the caps on leverage and the liquidity buffers required. We think when all of this is in place banks will be making a 15 per cent return. If they are making this on whatever you think the book value will be then, we think the market will pay at that stage a premium to book value that will be at least as high as it was when they were making 20 per cent plus return on investment but with massive leverage, lower capital ratios and no liquidity buffer. This is going to be a very attractive investment," he says
Going forward
While Mr Buxton's fund has been one of the top performers in the UK equity space up well with performance up well over 40 per cent in the year to date, he is not surprised that investors are wary of putting their money back into the stock market. "Sentiment is very negative because we had a horrendous experience in 2008 and early 2009, we came very close to the financial system seizing up and we have had a decade in which you made no money of equities. Everyone can see the mess we're in and we know there is a lot of pain to come - consequently it has been a very mistrusted rally and a lot of people are not in it."
But while he expects growth to be sluggish, and believes the UK economy is unlikely to have a strong 'V-shaped' recovery given the economic headwinds, he does believe the stock market will do reasonably well next year. That's because of low interest, and because the FTSE is as much about what's happening overseas as it as reflection of the state of the UK.
But Mr Buxton does expect a lot of volatility: "We will have thrills and spills along the way as we move out of a banking crisis and monetary recession - the more Dubai-type things. It will also be very volatile in the UK in the run-up to the elections, as tax becomes a four letter word. We will twitch with every policy announcement, every opinion poll - it will get bumpier - but the market will grind upwards."
