“Although larger cyclical companies are enjoying their day in the sun, we believe that it is the growth companies with growing dividends that will increase their shareholder returns over the long term.”
One of my investment mantras has always been that the world does not necessarily get better or worse, it just gets different. 2016 was most certainly a different year for the global macro environment and UK equities were not immune. The impact on the AXA Framlington UK Select Opportunities Fund should be compared to my annual relative performances over the past 30 years. During that period I have outperformed the FTSE All Share in 22 years, including 15 with an excess return of more than +4% against the FTSE All Share Index1.
Last year was amongst my worst in relative terms, up there with 1988 and 19972. The investment backdrop in 2016 was fairly similar to those two periods, in that it featured both heightened economic and political uncertainty. This environment also witnessed a swift market rotation that benefited larger companies but also negatively impacted the small and medium-sized companies. How I handle these challenging periods in terms of my investment style is something I am frequently asked by investors, the media and younger colleagues at AXA Investment Managers
My answer is quite simple. There are rotations in markets – and it is true that they have been brutal over the last few months – but I believe you cannot accurately predict these on any regular basis and it is therefore unwise to try. Instead, I try to forecast which companies can grow their earnings, cash flows and dividends consistently. I then select those firms and management teams that can adapt and cope with change, be it geopolitical, economic or market led. This is where I believe I have added value over my 35-plus years of experience in managing money and where I will hopefully continue to do so over the coming years.
A bad Brexit! – H1 2016
For the 12 months ending 31 December 2016, the Fund returned +4% vs. +11%3 for the relative comparative benchmark, the FTSE All Share Index. As mentioned above, UK larger companies, particularly those generating a high proportion of their earnings from overseas, significantly outperformed more domestically-oriented small and mid-cap companies in 2016. Paradoxically this was pretty much a reverse of 2015 when the Fund delivered +9% in absolute terms, outperforming the relative benchmark by +8%3.
The Fund posted poor performance in H1 2016 (-9% for the Fund vs. +4% for the benchmark3). The Fund’s underweight allocation to large international companies was the main detractor of performance both before and after the Brexit vote. Larger stocks in the FTSE 100 Index, the largest 20 of which generate more than 75% of their revenues outside of the UK, performed well after referendum on 23 June 2016, chiefly due to the devaluation of sterling. However, medium-sized FTSE 250 companies, which typically generate around 50% of their revenues within the UK, suffered. The Fund’s higher-than-benchmark allocation to FTSE 250 companies (40% vs. 16% for the Index) was a big factor in the fund’s disappointing returns over this period.
Within the Fund the best performing stocks were a pre-merger Betfair and plastic packaging company RPC. The worst performer was, somewhat ironically, Paddy Power Betfair – after its merger last March the company entered the FTSE 100 Index and succumbed to significant profit taking. At a sector level, being underweight financials helped relative returns. Healthcare stocks also performed well. However, being very underweight consumer goods stocks (i.e. not owning any tobacco companies which accounted for 6% of the FTSE All Share Index) and defensive fast-moving consumer goods (FMCG) companies, such as Unilever, turned out to be the biggest negative influence.
An ongoing recovery – H2 2016
The Fund recovered much of the ground lost in the first half of the year and outperformed in the latter half of 2016 (+15 % vs. +12% for the benchmark3ranking it 38th percentile in its IA sector over the period). While some of the strongly performing larger companies fell in price from elevated valuations, particularly within the ‘bond proxy’ sectors (i.e. consumer goods, utilities and telecoms), we have seen a strong rebound from more domestically-focused UK firms. Several of our top FTSE 250 holdings such as RPC, Rightmove and Auto Trader recovered in the second part of the year. On the negative side the rebound in commodity prices, and hopes of a new era of reflation, supported a value-style rally led by mining and banks. We are heavily underweight these two sectors which were the biggest detractors in the second half of the year. This was partially offset by good stock selection in industrials with Ashtead, Weir and Rotork; these stocks all benefited from President-elect Trump’s commitment to a significant infrastructure investment programme in the US.
2016 relative performance
Long-term investors not short-term traders
There has been very little activity in the portfolio. Its one-year turnover has remained low at just 4%. We did not change positioning in an attempt to guess the binary outcome of the ‘Brexit’ referendum and the US election results. We have maintained the Fund’s long-term approach and structural biases. This means we have continued to focus on growth-oriented businesses, remaining overweight in small and medium sized companies, industrials and consumer services, and staying underweight both the financial and commodity sectors.
Over the past year we sold Inmarsat, Wolseley, Next, Majestic Wine, B&M, Poundland, Travis Perkins and Synergy Health (which was taken over by Steris), all for fundamental reasons. We also initiated new positions in Evgen Pharma, Worldpay Group, Amryt Pharma, Ascential, all four of which made an IPO this year, as well as Zegona Communications and Smith & Nephew. The Fund contains now 64 holdings.
RPC, our largest holding, recently reached more than 7.5% of the Fund after delivering high returns in 2016. We have started to take some profits to limit the risk impact of this single stock. But the business continues to grow its market share across Europe in the rigid plastics market, both via organic growth and market consolidation. It also continues to innovate in collaboration with its customers which are mainly FMCG companies (to which we are not directly exposed) – Unilever, Heinz and L’Oreal for example.
Going forward
The economic outlook for 2017 is very uncertain. Donald Trump had been elected the new US president, the US Federal Reserve has increased interest rates and a ‘hard’ Brexit is now expected as immigration controls dominate concerns in the single market. In addition, France and Germany will have their own elections to contend with. In all, it appears that stocks prices are likely to remain volatile for the time being.
In the UK, the devaluation of sterling has been more of an advantage to internationally-driven companies than to high-quality, reliable domestic firms. These currency tailwinds can provide an antidote to short-term, relatively low earnings growth but not a long-term solution. Although larger cyclical companies are enjoying their day in the sun, we believe that it is the growth companies with growing dividends that will increase their shareholder returns over the long term. In addition, M&A activity is likely to accelerate with UK assets looking increasingly attractive to overseas buyers given the fall in sterling and the historically low cost of corporate debt. The Fund has had two takeover approaches for the holdings of Brammer and E2V in the fourth quarter of 2016, and we expect more corporate activity in 2017.
1 Nigel Thomas Track Record Composite Fund over 30 years: Performance gross of fees with income included in GBP. All funds Equal Weighted Composite ABN Amro UK Growth 31/12/86 to 30/04/2002, Solus UK Special Situations 31/12/1995 to 31/03/2001, ABN Amro UK Select Opportunities 31/03/2001 to 30/04/2002 and AXA Framlington UK Select Opportunities 09/09/2002 onwards. For the period 30/04/2002 to 06/09/2002 a proxy return (FTSE All Share TR) has been used whilst Nigel Thomas was on gardening leave. Comparative benchmark: FTSE All Share Index. Past performance is not a guide to future performance.
2 1988 was a volatile year following the Black Monday of October 1987 and 1997 also featured an uncertain environment in the UK and globally.
3 Performance net of fees, GBP ZI Acc share class. Comparative Benchmark: FTSE All Share. Past performance is not a guide to future performance.
The AXA Framlington UK Select Opportunities Fund is a multi-capitalisation, unconstrained-from-benchmark equity portfolio based on the stock picking skills of the lead manager, Nigel Thomas.
The Fund is subject to a number of risks including concentration risk and liquidity risk. The value of the Fund may go down as well as up and you may not get the full amount invested back.
For more information about the AXA Framlington UK Select Opportunities Fund visit the featured fund website.
Fund Key Risks
Concentration Risk: as this Fund may, from time to time, hold relatively few investments, it may be subject to greater fluctuations in value than a fund holding a larger number of investments.
The value of investments, and the income from them, may go down as well as up and you may not receive back the full amount invested.
Liquidity Risk: some investments may trade infrequently and in small volumes. As a result the Fund Manager may not be able to sell at a preferred time or volume or at a price close to the last quoted valuation. The Fund Manager may be forced to sell a number of such investments as a result of a large redemption of units in the Fund. Depending on market conditions, this could lead to a significant drop in the Fund’s value and in extreme circumstances lead the Fund to be unable to meet its redemptions.
Further explanation of the risks associated with an investment in this Fund can be found in the prospectus.
Before making an investment, investors should read the relevant Prospectus and the Key Investor Information Document, which provide full product details including investment charges and risks. The information contained herein is not a substitute for those documents or for independent advice.
