08 Aug 2019
Callum Abbot
Portfolio Manager, JPM UK Equity Plus Fund, J.P. Morgan Asset Management
July has been a remarkable month in some ways. The England and Wales men’s cricket team won the World Cup in the most dramatic of games, Egan Bernal became the first Tour de France winner from Latin America and the highest temperature ever officially recorded in the UK was set at 38.7C in Cambridge (lovely weather to be on the underground in). It was also marked by perhaps the only predictable event in recent UK politics. Boris Johnson won the Conservative party leadership contest. This marks a small respite in what remains an extremely unpredictable Brexit end game.
The market continued to bob upwards in the month. Monetary policy remains loose, with the Fed announcing a 25bp rate cut at the end of the month. The UK equity market was also helped by the collapse in sterling, which fell 2.3% over the month against the dollar and is hitting lows not seen since Article 50 was triggered. This has been driven by Boris Johnson categorically stating that the UK will leave the EU on the 31st October with or without a deal. However, as roughly 70% of UK listed companies’ revenues are generated overseas, the fall in sterling has made those earnings more valuable to UK investors. This shows that, even in a hard Brexit scenario, the currency will take a lot of the strain off the equity market.
It is worth noting that while large cap stocks generate over 70% of their revenues overseas, for mid and small caps it is closer to 50% and 30% respectively. Further work our Market Insights team has done shows that towards the end of the cycle, which after 10 years we are probably nearer the end than the middle, large caps tend to outperform small and mid (SMID) caps. However, as the chart below shows the majority of UK equity fund managers are considerably overweight mid and small cap stocks.
This positioning is probably for two main reasons.
Firstly there are more of them! In the FTSE All Share, there are 534 SMID stocks, not to mention AIM stocks, meaning there are numerous opportunities for managers to find attractive investment opportunities.
Secondly, they are less well researched and so tend to be less efficiently priced. This is particularly true in a post MiFid II world where many brokers have rowed back how much research they produce. This means that managers doing their own work are more likely to believe that they can find an edge for a SMID stock than for some of the well-researched large cap stocks.
We are not immune to the charms of SMID cap stocks but, while most investors acknowledge SMID cap stocks are inefficiently priced, it is often glazed over that inefficient pricing can manifest as overvalued stocks as well as undervalued. This results in plenty of SMID stocks underperforming. For example in 2018 the 20 worst performing stocks were all SMID caps.
In the JPM UK Equity Plus fund we take lots of overweight positions in SMID stocks we think are undervalued but we offset these by shorting those we think are overvalued.
The result is we have plenty of gross exposure to inefficiently priced SMID cap stocks but on a net basis we have a broadly neutral exposure to SMID cap stocks and of course a full benchmark weighting to those mature blue chip large cap stocks which tend to outperform at the end of the cycle.
This positioning sets us apart from our peers and demonstrates that shorting can actually help to control some risks, rather than necessarily increasing a fund’s risk.
Burberry. In July this luxury fashion retailer showed signs it has got its mojo back under new designer Ricardo Tisci. Consumers, particularly in the vitally important Asian markets, are responding well to his new product driving strong LFL sales growth. This drove the stock up 20%. This has been a long term holding.
Aston Martin. Having gone bust 7 times in 102 years Aston Martin returned to public markets in October last year. It has been a shocking performer since relisting. In July alone, the stock has fallen 50% as a profit warning led to material downgrades. The company has cited a challenging macro environment and poor wholesale unit sales as the driver. They also acknowledged that in a downturn liquidity would be eroded and new financing, which has not yet been committed, may be required. Once again the company’s balance sheet is looking precarious.
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