Much like buses, you wait ages for one and then two come along at the same time.

Avient

 

Avient is a chemical company that was formed when PolyOne purchased Clariant’s Masterbatches division in August 2000. We had looked at PolyOne in the past and were very interested in the business model. However, with a market cap below $4bn it was slightly too small for us. As the deal closed last year it gave us an opportunity to revisit.

Avient is a provider of specialised and sustainable materials which are used in a wide variety of applications, mostly in packaging (35% of sales), consumer goods (23% of sales) and industrials (17% of sales) but also in Healtcare, building & construction, transport and eletrical & electronics. The company partners with OEMs, processors and assemblers. Avient offers very specialised materials that vastly improve the quality of the end product but have a low impact on overall cost of the end product. In that respect the business model is similar to the one of Fuchs or Evonik, both of which we own in the fund, or even Food Ingredient companies.

It’s probably best to explain their input into end products with a few examples:

– Barrier technoloiges that preserve the shelf-life and quality of food, beverages, medicine and other perishable goods through high-performance materials that require less plastic.
– Leight-weighted solutions that replace heavier traditional materilas like metal, glass and wood which can improve fuel efficiency in all modes of transportation.
– Breakthrough technologies that minimise wastewater, improve the recyclability of materials and advance a circular economy.

The common theme across many of Avient’s products is the minimisation of use of materials and resources and increased recyclability of its products while operating in high growth areas. This is reflected in another revenue split the company offers:

– 15% of revenue is in sustainable solutions, which has a growth rate of 8-12%
– 15% of revenue is in healthcare, which has a growth rate of 8-10%
– 18% of revenue is in emerging regions, which has a growth rate of 5%
– 6% of revenue is in composite/5G products, which has a growth rate of 10%
– 47% of revenue is in segments that grow in line with GDP, i.e. 2-3%

The long term drivers across all businesses is the increased complexity of customers’ need in achieving their sustainability and environmental goals. Unfortunately, there is not enough recycled content for everyone to achieve their ambitions. The biggest tailwind for Avient is its capacity to use more recycled content than peers, which in turn gives its customers a higher recycled input for their products.

Avient spends 3% of sales on R&D. Through innovation and pricing Avient is anticipating a long term top line growth rate of 6.5% CAGR. Margins should also continue to expand as synergies from the merger are still to come through and due to the company’s strong pricing power: 35% of sales is generated from products that are introduced in the last 5 years and 25% of products renew once a year when pricing can be taken. This is achievable due to the imbalance between cost and quality to the end product as explained above.

The asset light business model gives Avient plenty of cash to invest in R&D and look out for other successful M&A targets which in turn will transition Avient into a higher margin and ROIC business.

We have met management multiple times and were very impressed by their drive and vision for the business. On our conservative assumptions of 6% sales growth and about 100bps margin improvement 2021-25 the shares were trading on 16.5x Y1 PE and 9.3x Y5 PE, not reflecting the structural growth opportunities over the next few years. The starting dividend yield was just below 2%. However, at around 30% payout ratio and a cash cover of 4x we believe there is amble room for a more attractive yield in the next couple of years. Net debt/EBITDA should come down to below 2x this year and the FCF yield on the shares is expected to grow to over 8% in the next couple of years. We initiated position in August at $49.78.

China Mobile

 

We have never really been enthusiastic about investing in utilities: the debt often made us uncomfortable, and regulation is frequently a tightening noose that reduces returns for investors.

Telecoms was once perceived as a high growth/tech area, but they too succumbed to never-decreasing levels of capex, which brought high levels of debt and competitive pressures that reduced returns.

Against this background, it was with some bias that we re-examined China Mobile. The company is a leading mobile telephone company in China. It is well invested and has been a leader in 5G role-out. The implementation of this technology and the geographic diversity of China suits mobile as a faster growth platform than fixed line. Capex is likely to remain high as 5G is rolled-out. Unlike many utilities, China Mobile has substantial net cash resources. While the majority of returns are likely to be from dividends, the shares look oversold and are attractive at these levels. US investors have been forced to sell the shares which has led to significant underperformance in the last year.

Despite capex to sales running above 23% since we started covering in 2007, the business has substantial levels of net cash. It appears to us that the long-term decline in operating margins has played out. Indeed, it has been remarkable, that despite the rapid increase in customers, 61% over the last 10 years, and 86% increase in revenue, that EPS is 11% lower! The operating margin was 34.6% in 2008 and 14.7% last year. The story used to be about voice, then SMS but with 4G and 5G it is all about data. There is still a transition to 4G and 5G that should prove beneficial both for revenues and operating margins over the forecast period.

Investing in China is not without risk. However, it is a domestic business, in a stable, competitive market and consequently many of the data security issues do not arise. For a business that is leading the roll-out of 5G, data will lead to a stabilisation and probable growth in ARPU (remember that!). With the PE multiple and yield both around 7%, we view the price set-back from the forced sale of US investors as an attractive entry point.

 

Graham Campbell (graham@saracenfundmanagers.com)
Bettina Edmondston (bettina@saracenfundmangers.com)

Important Information: The views and opinions contained herein are those of the author’s and may not necessarily represent views expressed or reflected in other Saracen Fund Managers Ltd communications, strategies or funds. This material is an opinion piece and intended to be for information purposes only. This material is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Saracen Fund Managers Ltd does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Saracen Fund Managers Ltd has to its customers under any regulatory system. The data provider and issuer of the document shall have no liability in connection with the third-party data. The Prospectus and/or saracenfundmanagers.com contains additional disclaimers which apply to third party data. Regions/sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.
Saracen Fund Managers Limited is Authorised and Regulated by the Financial Conduct Authority.

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How we are playing the two high growth financials on our doorstep

 

It is frequently frustrating when trying to find exposure to faster growing sections of the global
economy, that the investment that best fits is frequently domiciled in a mature economy,
rather than in an Emerging Market. Sometimes there are local alternatives, but they can be
eliminated by valuation, financial weakness, poor transparency or governance concerns. This
blog concerns two such businesses that happen to be domiciled in the UK.

Post the Covid outbreak last March, shares in Prudential collapsed. We had the business on
our radar for a while and welcomed the simplification of the business model, divestment of
non-core areas and focus on growth in Emerging Markets. We initiated a purchase at 730p.

Since then, Prudential has announced the demerger of Jackson, their US business, further
increasing their exposure to Africa and Asia. Consequently, the share price has rallied strongly
due to the investor reassessment of their prospects. However, we consider the valuation now
stretched and the yield too low. We sold the shares at 1484p in April 2021.

 

 

Conversely, we sold the holding in HSBC in March 2020 at 480p. While a supporter of the
long-term focus into Asia, we were concerned over the implementation of a new business
strategy at a time when key management was not in place. While talking a good game,
corporate actions were slow and the capital buffer did not provide us with the comfort we
desired.

Rolling on 12 months, HSBC feels like a rejuvenated company. There is an impressive
combination of Mark Tucker as Chairman, new CEO Noel Quinn and Ewen Stevenson as CFO.
Post a Zoom meeting, I had a feeling that things were happening. Costs are under control,
management is being streamlined and relocated to where the business is located. Capital is
sufficient with CET 1 ratio at 15.9% (target range 12% – 13%). But more importantly, it seems
as if management is finally playing to its strengths: growing wealth management in Asia and
withdrawing from underperforming areas, such as France.

The business is a major beneficiary of rising interest rates, with the loan to deposit ratio
currently only 63% and there is scope to reduce the asset intensity (Risk Weighted Assets) of
the business through further disposals. The Tangible Net Assets of the business is $7.75, or
around £5.57p in GBP.

 

 

Exposure to HK and China poses many risks and opportunities. However, with many of our
concerns now resolved, trading at around a 19% discount to TNAV, with scope to grow
dividends and repurchase shares, this was an attractive opportunity and we reinvested at
452p.

 

 

Further details available on request.

Graham Campbell (graham@saracenfundmanagers.com)
Bettina Edmondston (bettina@saracenfundmangers.com)

Important Information: The views and opinions contained herein are those of the author’s and may not necessarily represent views expressed or reflected in other Saracen Fund Managers Ltd communications, strategies or funds. This material is an opinion piece and intended to be for information purposes only. This material is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believe to be reliable but Saracen Fund Managers Ltd does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Saracen Fund Managers Ltd has to its customers under any regulatory system. The data provider and issuer of the document shall have no liability in connection with the third-party data. The Prospectus and/or saracenfundmanagers.com contains additional disclaimers which apply to third party data. Regions/sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.

Saracen Fund Managers Limited is Authorised and Regulated by the Financial Conduct Authority

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Update on the latest changes to the Global Income & Growth Fund…

During January we initiated a position in 3M in the TB Saracen Global Income & Growth fund.  We had looked at 3M in the past but preferred to hold on to our position in DuPont where we saw value creation from the spin-off of various divisions.  The latest was Nutrition & Bioscience, which merged with IFF at the end of January.  In the run up to this, DuPont shares saw a strong rise (+17% in the first two weeks of the year).  It reached valuation levels which we thought were not justifiable anymore, namely 31x 2021 PE with a dividend yield below 1.5%.

 

DuPont

 

It was time for us to dust down our 3M template.

3M is a direct competitor to DuPont in many areas like automotive, electronics and construction.  What has drawn us to 3M is the strong margin profile, cash generation, return on invested capital (close to 20%) and an uninterrupted 62-year history of dividend growth.  Combined with its leading position in its fields and high investments in R&D (6% of sales) and capex (5% of sales), 3M attracted a premium to peers in the past.

However, this has evaporated in recent months.  The rational in the market was that it had done better during 2020 than in previous downturns and would therefore not see the usual early cycle rebound in 2021.  We disagree.  The main reason it has outperformed peers operationally during the pandemic is the strong demand for its face masks.  The company also managed to cut costs further than expected.  Going forward, we would expect areas not exposed to face masks to recover meaningfully as economic growth picks up.  We have already seen good signs of improvement in the auto aftermarket and home improvement areas as well as tentative signs in elective surgery.  Additionally, we expect demand for face coverings to remain high for at least another year.  Many of the cost savings will be recurring and we expect margins to further improve, moving 3M well ahead of DuPont and other diversified chemical companies.

In short, we expect 3M’s operational performance to pick up during 2021 and 2022.  We also expect the shares to close the discount to their peer group.  Below 17x 2021 PE and with a 3.4% yield we saw a great entry point into this high-quality name.  We sold our holding in DuPont to finance the purchase.

 

3M

 

3M ROIC

 

Graham Campbell (graham@saracenfundmanagers.com)

Bettina Edmondston (bettina@saracenfundmangers.com)

 

Important Information: The views and opinions contained herein are those of the author’s and may not necessarily represent views expressed or reflected in other Saracen Fund Managers Ltd communications, strategies or funds. This material is an opinion piece and intended to be for information purposes only. This material is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Saracen Fund Managers Ltd does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Saracen Fund Managers Ltd has to its customers under any regulatory system. The data provider and issuer of the document shall have no liability in connection with the third-party data. The Prospectus and/or saracenfundmanagers.com contains additional disclaimers which apply to third party data. Regions/sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.

Saracen Fund Managers Limited is Authorised and Regulated by the Financial Conduct Authority.

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Update on the latest addition to the Global Income & Growth Fund…

During November we initiated a position in RELX in the TB Saracen Global Income & Growth fund.  We have owned RELX (or Reed Elsevier as it was known then) in the past and have followed the company for years.  It has remained on our Wish List due to its sustainable revenue growth, cash conversion, progreesive dividend payments, good balance sheet and strong ROIC.  The sectors where RELX operates have long-term attractions.  Within its four divisions it is exposed to academic research and the publication of high end journals (STM), Risk & Business Analytics, Legal Analytics and Exhibitions.  The Data Analytics side in particular offers strong growth potential, due to the ever more complex world we live in and the need of companies to have a greater understanding of their customer base.

We delayed purchasing shares for two reasons. Firstly, we wanted to fully understand the risks attached with regards to a shift in business model in the STM division from subscription only to open access.  Secondly, our apprehension was based on the valuation of the shares: we required a greater certainty of the risks on our earnings forecast.  In our proprietary Worst Case modelling the potential downside risk was too big.  However, after various contacts with the company in recent months we are much more reassured about RELX’s positioning and the outlook for academic journals.

Most importantly, we feel that the appointment of a new divisional CEO in February 2019 led to a change on RELX’s side of the contract negotiations. Since then, we have seen one big dispute with the Dutch universities settled and we expect the two main outstanding contracts in Germany and the University of California to be settled in due course.  It also became apparent in our conversations that a move to open access will not have a negative impact on margins.

The perceived risks have impacted valuation in recent years and led to some derating of RELX.  In addition, in 2020 the Corona virus has adversely impacted the Exhibition division but it is our belief that the demand for physical exhibitions will return farily quickly and strongly once restrictions are lifted. The rollout of vaccines means that 2021, especially H2, should see a much better growth and margin profile than 2020.

During this crisis RELX has experimented with virtual exhibitions and the uptake has been surprisingly positive.  This could be seen as an extension to the existing business, which again could help contribute to a rerating of the shares.

Conclusion

At Saracen we like to buy high quality businesses at attractive valuations.  With our increased comfort in RELX’s strategy, especially within STM, we felt that RELX shares had reached a buying level in recent weeks with a renewed sell off resulting in the 2021 PE ratio slipping below 17x.  At the same time the dividend yield is a solid 2.5% and the company has avoided a dividend cut during 2020.

Additionally, the ROIC profile remains strong at  close to 20%.   We initiated a 1.5% position, which we will increase on any share price weakness.

Graham Campbell (graham@saracenfundmanagers.com)

Bettina Edmondston (bettina@saracenfundmangers.com)

Important Information: The views and opinions contained herein are those of the author’s and may not necessarily represent views expressed or reflected in other Saracen Fund Managers Ltd communications, strategies or funds. This material is an opinion piece and intended to be for information purposes only. This material is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Saracen Fund Managers Ltd does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Saracen Fund Managers Ltd has to its customers under any regulatory system. The data provider and issuer of the document shall have no liability in connection with the third-party data. The Prospectus and/or saracenfundmanagers.com contains additional disclaimers which apply to third party data. Regions/sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.

Saracen Fund Managers Limited is Authorised and Regulated by the Financial Conduct Authority.

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Graham Campbell and David Keir discuss the effect of the COVID vaccine on equity markets…

We have written extensively about the current valuation extremities within equity markets and the long period of under-performance of ‘Value’.

In our recent Quarterly review, we highlighted several potential catalysts that could occur in Q4, namely; the US Election, a likely stimulus package from the new administration, perhaps more from Europe too, maybe a Brexit deal and potentially a vaccine to Covid as several Phase III Trials read out, that would prove more positive for this style of investing.

We believe that yesterday’s news regarding a COVID vaccine will prove to be the turning point in markets that we had been waiting for.

As the chart above highlights, Value did perform incredibly well yesterday.  Highly rated stocks fell (but in our view remain over owned and expensive), Value rallied dramatically from a low base (but remains under owned and still very cheap).  We think there is much more to go from here.  We expect this to be the start of a long-term trend in which price is again considered when valuing a business.

In our last quarterly, we also questioned the consensus regarding bond yields being lower forever and implications that a steepening yield curve would have on stocks and sectors.  As the chart below highlights, the yield curve is now the steepest it has been in almost 3 years.  This is good news for depressed financial shares but also bad news for long duration assets such as widely held and expensive technology shares.

Our fund remains cheap, trading on 14.3X 2021 PER and yields 3.8% (source: Bloomberg).  There has been no style drift and the fund remains very much in the “large Cap value” space.   We have repeatedly stated that many of our holdings are materially undervalued and despite many outsized moves yesterday, this remains the case.

We thank our investors for their patience, but believe that this is the turning point we have been waiting for.  As the chart below highlights, Value shares have a lot of catching up to do…

We would be delighted to speak with any clients who wish to discuss this further.

Graham Campbell

David Keir

November 2020

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The Saracen team discuss the importance of ESG, the impact on portfolio construction and performance and our approach…

ESG has become the buzz word in investing over the last few years.  It seems everyone is talking about it and ever more people are trying to find out about it.  Just look at the following chart of “ESG” and “ESG investing” searches on Google:  

 So, what’s Saracen’s ESG approach?  First up, we are not turning into an ESG house nor we are not jumping on a bandwagon.  But we would like to highlight the following points in this blog:  

  • What is the purpose of ESG research 
  • How does ESG impact portfolio construction and performance? 
  • How do we apply this at Saracen?  

Why did a company like boohoo, which was rated so highly, unwind?  Why do so many technology businesses score so poorly on governance, yet don’t get called out for it? We want to make sure we understand our ESG data and don’t fall in whitewashing traps!  In this blog we will highlight some of the vagaries in reporting systems, but also emphasise the importance of due diligence by the Analyst in spotting and interpreting potential issues. 

We will use lots of examples across our fund range throughout and also give our reasons for holding shares in the oil & gas and tobacco sectors, which are often shunned by others.  

What is the purpose of ESG research?  

We see ESG analysis as a natural extension to our fundamental research.  It provides another risk overlay that highlights potential problems or solutions within a company that might not be captured in the financial analysis, e.g. the reputational or brand risk for a business not adhering to social responsibility factors, or raising the governance issues such as nepotism.  Another aspect would be the negative impact in culture of not having equal opportunities, whistle-blower policy, high staff turnover and so on.  Successful companies tend to set high, but fair standards and fully accept both the economic and moral rationale for implementing ESG targets.  When managers drag their feet or are unwilling to move forward constructively, they are often hiding other issues which are likely to negatively impact the long-term growth of the business.   

We view a low ESG score as a potential warning sign that can lead to us either not purchasing a share or selling a holding where we feel the risks are not appropriately recognised by management.  

We don’t invest based on the highest ESG ranked companies, we view it as complimentary to our other research. We hope to record improvementwhich we expect will lead to better operating performance and ultimately a higher rating on the shares.  We maintain a strict valuation discipline to our investment decisions.  ESG provides greater depth to the discussion, to highlight businesses that are embracing environmental, social and regulatory change and flagging the risks surrounding others who prefer a less open and responsible analysis of their actions and behaviour.   

Once businesses set targets for omissions, energy usage etc, management are typically incentivised to meet them.  If we can identify businesses that have the products or knowledge to help them improve their performance, then both parties stand to benefit from their collaboration. 

Let me explain this with a few examples.  

We recently purchased Wienerberger it manufactures bricks, concrete, roofing and pipes.  On first glance this is a highly energy intensive company with a high carbon footprint.  To be fair, its Environmental rank is relatively low, albeit improving.  During the past five years, Wienerberger has worked towards its Sustainability Roadmap 2020 and markedly reduced its energy consumption and CO2 emission while at the same time increasing the use of recycled materials.  The company is also making more products that will help its’ customers improve their energy efficiency; 35% of products have been developed in the last five years.  There is much more to come.  There is no doubt that Wienerberger’s Roadmap is making a positive impact on the environment and the company.  These initiatives also had a positive impact on financial returns, such as gross margins, which expanded by almost 400bp over the last five years in part due to reduced energy costs and CO2 permit costs.  In our forecasts we see further margin upside potential, which in turn should lead to higher profits, valuation expansion and ultimately to a superior return for our portfolio and clients.   

It is a similar case for Heidelberg Cement, who as the name says, produces mostly cement.  Again, a highly energy and CO2 intensive business.  Many investors ignore the shares due to the perception that the cost to offset CO2 emissions are prohibitive for Heidelberg.  However, the company is trying to get back on the front foot – they have set ambitious targets to reduce carbon per tonne and they have identified measures they can implement which don’t require significant capital outlays, e.g. reduce the clinker component in cement which would actually lead to a reduction in cost and an increase margins.  If Heidelberg can make this transition successfully, in a costeffective manner and faster than peers, we would expect investors to re-visit the sector and the shares to re-rate.  

Many ESG credentials depend on a company’s manufacturing footprint and impact on society.  It is also important to evaluate the impact their products have on their clients: there is growth in helping customers meet their ESG targets.  Take Schneider Electric for example, which is highly ranked in its own right being a Corporate Knights Global 100 Most Sustainable Corporation and was recognised for actions to cut emissions and mitigating climate risks.  Schneider is a manufacturer and supplier of hardware and software that increases automation and improves energy efficiency.  In effect, Schneider’s products are used to reduce their clients’ carbon footprint.  Over time, the demand for these energy efficiency products should lead to market share gains and higher returns for shareholders.  

We are often asked why we own tobacco shares.  Are they not a lost cause in times of ESG?  Again, we would like to point out that we support a change in business culture and a path towards a better company and society, not necessarily the status quo.  The best example here is our investment in Philip Morris International (PMI).  Its valuation – like the rest of the sector – suffers from the negative impacts smoking has on society.  What is not yet reflected in valuation or ESG scores are the structural changes PMI has gone through in the last 10 years which culminated in the launch of IQOS 5 years ago.  It’s PMI’s goal to replace cigarettes with the smoke-free products.”  This reduces the risk to smokers compared to a traditional cigarette and to passive smokers.  Overall, the impact on society would be enormous if every smoker moved to IQOS.  Although this won’t happen, the trend is encouraging.  The company has invested heavily over the last 10 years and it is miles ahead of competition.  IQOS is not classified as a combustible tobacco product, so taxes are lower.  This has a positive impact on margins, ROIC and in turn should lead to higher valuation and better returns for our clients.  One unquantifiable aspect of the new strategy is the reduced litigation risk for PMI.  

Another sector that is shunned by ESG investors is oil & gas.  Even here we can detect changes, that will contribute to a better society.  We currently own shares in Wood Group in our UK funds, which prior to the purchase of Amec Foster Wheeler in 2018 was predominantly an oil services business.  Today upstream oil and gas accounts for only around 35% of revenues and the group now has significant business in alternative energy sources such as wind and solar and are developing promising services in areas such as carbon capture and hydrogen.  All of this means that Wood Group should now be at the heart of the energy transition process away from fossil fuels over the long run and a leader in ESG in the oil & gas sector.  The shares have been friendless in recent years, but we now see a period of recovery ahead, driven by their increased exposure to faster-growing environmentally friendly services.  Wood is now ranked at the top end of its peer group by both MSCI and Sustainanalytics, giving further credibility to their ESG credentials. 

We mentioned that we like to support companies on their way to become ESG leaders in their field.  Danone is already highly ranked for its plant based dairy business and it is the first listed company to adopt the “Entreprise à Mission” model, which incorporates ESG factors into its Articles of association.  But its water business has many red flags when it comes to ESG (sustainability of sourcing, packaging, carbon footprint).  At the start of the year Danone announced a €2bn investment programme that will combat all these issues.  In the short term, this means a hit to margins.  But we believe in the long term it will set Danone apart from the competition and will increase its brand value and reputation – something that will be reflected in valuation over coming years.  

ESG analysis has also helped us to avoid some higher risk companies, which would have looked interesting on fundamental analysis alone.  Again, let me demonstrate this with a few examples.  

We used to own a healthcare company which we discovered, owns a luxury hotel and vineyard.  This was often used by management despite the location being in a country far from the Head Office.  This raised many questions with regards to Corporate Governance and management focus.  While we raised our concerns with management no action was taken and we decided to sell our investment.   

Another example is a Chinese staples company we researched in the past.  On a PE basis the company appeared attractively valued.  However, during our ESG analysis it became apparent that most of the members of the management board were related.  Furthermore, the CEO and other members held private businesses which in turn transacted with the staples company.  We could not clearly identify if these transactions were made on an ‘armslength’ basis.  As in the previous example, it raised all kinds of red flags and it reduced the Social Governance score dramatically.  We refrained from investing in the company as a potential accounting fraud risk was too high.  The shares subsequently tumbled and never really recovered, greatly underperforming the Chinese and global staples sector. 

How does ESG impact on portfolio construction and performance? 

As mentioned above, we use ESG analysis as another risk overlay to our research process.  It determines if we invest in a company and to what extent.  A low but tolerable ESG score will result in a lower portfolio position, just like any other increased risk metric would lead to a smaller position. For our clients, this means additional downside protection and risk minimisation.  It can also highlights businesses, which over the next few years might become ESG leaders in their field, but where the market has not yet given the company any credit for their transformation 

How do we apply this at Saracen?  

Since 2011 we included socially responsible investment factors in our company research templates.  As the debate about sustainable investing and ESG factors has evolved, so has Saracen’s process. 

There are numerous ranking systems and even more definitions on ESG.  How does one compare system A to system B?  How come a large company like BASF gets 44 out of 100 with RobeccoSAM but 84 out of 100 with Sustainalytics? Similar for Unilever: 100 from RobeccoSAM and 54 from Sustainalytics. (Source: Bloomberg).  The issue is that often these rankings are based on tailor made questionnaires, which leave room for objectivity and can’t be easily compared between providers.   

At Saracen we require data that we can verify and is as objective as possible.  We settled on a detailed score card from Bloomberg, which in turn is based on publicly available information, mostly in annual accounts, sustainability reports and ESG policies. 

Every company is ranked on each of the ESG pillars and is given an overall score.  This is imbedded in our analysis and discussion on any investment. 

The score card is detailed (and this blog is not the place to explain the intricacies), but we are more than happy to talk interested clients through our analysis process and we are always here to answer any questions you should have.  

As always, at Saracen we pride ourselves at being open and transparent with our clients and hope our application of ESG should be just as well understood as our investment approach.   

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David Keir and Graham Campbell share their musings on the tentative signs of recovery in ‘value’…

Normally we spend a lot of time in May and June hitting the road and meeting investors face to face.  We always find it insightful to hear how our clients view life and markets and normally share these perspectives in our “View from the Road” blog.  With most clients currently working from home due to the impact of Covid-19, we thought we would do a special “View from the Garden” blog focusing on the tentative signs of a recovery in “Value”.

We briefly provide our latest thinking on why investors should consider increasing their allocations to “value” and more specifically to the TB Saracen Global Income and Growth fund.

Value is a winning strategy

Our starting point is that buying good businesses at attractive prices and not overpaying for illusory growth appears a sensible approach.  As the chart below highlights, it has worked well for over 100 years. However, it has not delivered over the past 10 years now and many investors have given up on the strategy.

Source:  Kennedy Centre for Research

Value performance headwind

The sustained outperformance of, in our view, fully valued quality and growth stocks (which is highlighted in the chart below) has gone on for much longer than we expected.  While we have some sympathy that investors will value defensive and growth attributes when economic growth is declining, the divergence is nevertheless extraordinary.  What we have found surprising is that value stocks, until recently, have continued to underperform during the market collapse, despite having materially underperformed in recent years.  There would appear to be no market conditions where value outperforms!

Value managers are losing assets, mandates and their jobs.  The consensus view is that the increasing importance of ESG will only exacerbate this trend.  Over time, and because of the long-term continued outperformance of growth and investor style drift, there are now very few truly value-orientated portfolios in the global segment.

Valuation must surely matter

The other notable feature of equity markets has been the absence of any discussion on valuation when assessing many businesses that are covered in the Quality or Growth segments.  It seems a strange approach to ignore the price you pay, when considering an investment.  Similarly, if there is an attractive price to buy a share, there must also surely be a price when it is overvalued and should be sold.  It seems like the industry has forgotten, or more likely, conveniently ignored any Sell Process to allow managers to retain shares, when they intuitively know they are expensive: but there is safety in numbers!

Growth versus value outperformance reached a record on 15 May 2020 – was this the peak?

The current underperformance of value is now so extreme that on the 15 May, growth’s outperformance of value hit an all-time high (see the chart below).  We believe that this disparity is now simply too big for investors to ignore and note the significant improvement in value performance since then.

Catalyst for value to outperform

So, value is cheap and under-owned and has never traded at such a big discount to quality and growth.  The debate is about a catalyst for this trend to reverse!

The sharp and severe recession caused by the impact of Covid-19 may provide the stimulus for a long-awaited change in market leadership.  Value usually outperforms post recessions.

A combination of the steepest recession on record with unprecedented monetary and fiscal support should help the recovery and increase investors willingness to rotate into value stocks.

Bear markets end with recessions, they do not begin with them!

In addition, many investors own the same, expensive shares, which are proving in many cases to be no less cyclical than other lowly rated sectors.

TB Saracen Global Income and Growth Fund

The whole ethos of the fund is to buy global leading businesses that have the potential to grow over the long-term but be disciplined in the price that we pay and when to sell.  Our “pragmatic” value style has clearly been out of favour (particularly over the last couple of years) given the markets disregard for valuation metrics.  However, our process has not changed and the given the lack of middle ground, the fund has never had a greater value bias.   As the Morningstar style chart in the table below highlights, there has been no style drift here!  SGIG only invest in companies that we consider as undervalued.

The fund remains very differentiated in the global equity income peer group and attractively valued both against the peer group and the market – currently trading on 14X 2021 eps and yielding over 4%.

We believe we have significantly improved the quality and long-term growth prospects of the Fund through our portfolio upgrade in March – when we were able to invest in high quality businesses such as American Express, Danone, Fuchs Petrolub, Prudential and Rockwell at very attractive valuations.  We did a portfolio upgrade of similar magnitude in Q1 2016 which aided performance significantly.  We strongly believe that several of our holdings are materially undervalued.

Conclusion

The global economy will recover.  There is no reason to believe this time will be different. The combination of the steepest recession on record with unprecedented monetary and fiscal support should boost economic activity.   This is usually a positive scenario for ‘Value’ investors!

Value has begun to perform in recent weeks.  We firmly believe that this is the (long-overdue) beginning of a more sustainable trend, as earnings and valuations once again take centre stage.

There are still many outstanding opportunities in high quality businesses that are trading at attractive prices.  Investors may not yet be convinced that the trend has turned, and ‘value’ is back, but more appear to be considering the possibility and are interested in blending their portfolios to capture some of the potential recovery.

We believe that the TB Saracen Global Income and Growth Fund with its attractively valued portfolio of global leading businesses is well positioned to recover lost ground should investors refocus on valuation and market leadership changes.

Stay safe and many thanks for your patience and continued support.

David Keir (david@saracenfundmanagers.com)

Graham Campbell (graham@saracenfundmanagers.com)

Co-Managers, TB Saracen Global Income & Growth Fund

June 2020

 

Important Information: The views and opinions contained herein are those of the author’s and may not necessarily represent views expressed or reflected in other Saracen Fund Managers Ltd communications, strategies, or funds. This material is an opinion piece and intended to be for information purposes only. This material is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Saracen Fund Managers Ltd does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Saracen Fund Managers Ltd has to its customers under any regulatory system. The data provider and issuer of the document shall have no liability in connection with the third-party data. The Prospectus and/or saracenfundmanagers.com contains additional disclaimers which apply to third party data. Regions/sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.

Saracen Fund Managers Limited is Authorised and Regulated by the Financial Conduct Authority.

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David Keir, CEO, discusses valuation anomalies in the market…

We have written at length over the past 12 months on valuation anomalies, where share prices appeared to diverge from the underlying prospects for a business.

We highlighted the ratings of the so-called quality shares or the “bond proxies” which appeared at odds with company fundamentals.  The prevailing wisdom was to simply own these shares forever, irrespective of valuation.

Catalysts to change are typically only obvious in hindsight, but a combination of an amelioration of macro-concerns and disappointing Q3 results led to the underperformance of many of these quality shares as investors reassessed their fundamental prospects.  We now get much less push back on our long-held view.

Despite the pull-back, quality shares remain expensive – as they are in the 96th percentile of valuation (source: Morgan Stanley) – and it is still too early for us to consider them attractive for investment.

The other major anomaly, in our view has been the outperformance of the US market pre-dominantly led by the FAANG shares – Facebook, Amazon, Apple, Netflix and Google.

The chart below looks at the performance of the US market versus European markets since 1950 and highlights its significant outperformance over the last 10 years.  It has reached well over a two standard deviation event, which is incredibly rare (<5% probability).  The chart looks similar for the US against most other global indices.

US equities at 70-year high versus Europe

Clearly a massive driver of the US’s outperformance has been the growth of technology shares, which has not been replicated within Europe.

Nevertheless, the scale of relative outperformance has reached levels that appear to us as being within ‘bubble territory’.  In the chart below we consider the original FANG shares and include Apple and show the performance against the S&P 500 over the 5 years.  It is noteworthy that  the bubble is being inflated by the largest shares in the biggest and most liquid stock market in the world.  Anomalies persist frequently for small and mid-cap. companies, which either have poor analyst coverage or where they can achieve explosive growth from a low starting point.  However, it is rare that big businesses can achieve this, partly due to the their already high market shares, but also as a result that companies are rarely able to achieve supernormal returns indefinitely: they tend to attract competition or regulators!

To put this into context Apple, Microsoft and Google now have market capitalisations over $1,000,000,000,000 (trillion) and Amazon is close to joining the club!  To justify these valuations, we must conclude that investors believe that their prospects to grow are still bright and remain underappreciated by investors.

FAANG stocks are driving the US market higher

Our holdings are not driven by any benchmark considerations.  We try to build a portfolio of global leading businesses, with double digit margins, strong balance sheets, attractive valuations and supportive dividend yields, with a capital preservation focus.  Consequently, we only own cheap shares in the fund and have a strict sell discipline.  We have no exposure to any of these FAANG shares.

Like “peak quality” in summer 2019, we currently get lots of pushback on our view that these shares are discounting a lot of good news and that there are better opportunities in other geographies and sectors.

We are frequently told that it is indeed “different this time” and not a repeat of 2000.  The FAANG businesses are embedded into our daily lives and have massive and sustained growth ahead of them.  We are told that these shares will grow into their current ratings and will remain the “must own shares” given the current anaemic global growth rate.

We have no doubt that the FAANG’s are currently great companies.  The debate we have with such investors is about investment process and at what valuation point will they consider selling these shares?  We also see the long-term risks posed by global anti-trust regulators and tax authorities given the current lack of regulation and tax paid.

Our view is that there is significant optimism in the share valuations and investors who perhaps  have one eye on the benchmark, are dispensing with their sell process in order to continue owning these highly rated shares.  This can persist for some time, but we don’t believe it’s different this time.  If the best way to generate returns is to calculate the value of a business and buy it at a significant discount, then owning overvalued and over-owned shares is playing with fire.

While many of these businesses have currently strong market positions , it would be naive to suggest that technological change will not bring new competitors or that returns may fade as the business matures, or regulators become more interested in competitive practices.

We have no idea about the catalyst for a change in market leadership – as ever these will only be obvious in hindsight.  However, we would make the following observations.

The chart below looks at the market concentration in the US market over the last 25 years.   It highlights a couple of very interesting points.  Firstly, the top 5 companies now represent 18% of the total market capitalisation of the S&P.  This is unparalleled, even in the 2000 tech bubble where the top 5 represented 16%.  Secondly, like 2000, there is a growing divergence between the top 5 companies and their share of net income – i.e. the market capitalisation is a result of a re-rating of the shares as opposed to growth in net income.  We do not believe this is sustainable!

Growing divergence between the largest companies in the S&P and their net income contribution

We detail the valuation of the top 5 constituents of the S&P in the table below.  We observe the lofty PER’s particularly on Amazon, Apple and Microsoft – which has re-rated from 9X to 30X in the last 8 years!  We also note the lack of dividend yields on offer.

FAANG stock valuations

 

Year 1 PER

Dividend Yield
Facebook 21X 0%
Amazon 68X 0%
Apple 24X 1%
Alphabet 24X 0%
Microsoft 30X 1.2%

Source: Bloomberg (17 January 2020)

We like to buy companies that can grow but are completely focussed on the price we pay.  Our current holdings in the technology sector look very attractively valued and have supportive dividend yields.  They also will benefit from many of the growth drivers of the FAANG stocks.

SGIG current Technology holdings

  Year 1 PER Dividend Yield
Cisco 15.0X 2.9%
Corning 16.3X 3.0%
eBay 12.7X 1.6%
IBM 10.4X 4.9%
Intel 12.7X 2.2%
Sabre 18.6X 2.5%

Source: Bloomberg (17 January 2020)

The following chart looks at the relative performance of the technology sector versus its earnings.  Whilst similar but not yet as extreme as 2000, the relative performance has significantly outpaced earnings in recent years.  For example, at the beginning of 2015, the consensus 5-year earnings growth for Google – now called Alphabet – was 18%.  Today that figure has dropped to 15%, yet the shares have re-rated by over 40% over the intervening 5-year period.

Technology sector relative performance has significantly outpaced earnings

Apple shares were up an astounding 85% in 2019 having re-rated by over 50% over the last five years.  We need to remind ourselves that Apple is a primarily a hardware company that earns most of its profits from selling high quality but expensive mobile phones and is clearly prone to product cycles.

We note with interest that the market capitalisation of Apple is now close to topping the entire Australian market!!

Apple market capitalisation versus the entire Australian market

Whilst these trends can persist, share prices must follow earnings over the long-term.  Earnings will have to increase materially, or the share prices will fall.  We suspect it will be the latter.

It is impossible to disaggregate the key drivers of the current outperformance of the FAANG stocks.  It may be a combination of low interest rates, low economic growth, the relentless shift to passive investing, the development of the ETF market and benchmark driven investors being forced to own some of the shares given their weight in the index.  Or perhaps we need look no further than the  liquidity provided by the Federal reserve balance sheet, highlighted in the graph below, which is flowing to the largest and most liquid names at the top of the S&P 500.

US Federal Reserve Balance Sheet Expansion

The dynamics of outsized US market performance and the extreme valuation of some of the largest companies in the index ties in with our research and portfolio positioning, which suggest that there are better opportunities for investors in other sectors and global markets.

So, what do we expect to happen from here?

Our central case is that global economic growth persists.  If this occurs, we would expect the market leadership to change and market concentration to expand to more attractively valued parts of the market given the significant valuation differential.

The less palatable outcome is a significant market correction caused by a growth scare or inflation shock which will affect all parts of the market but particularly the expensive growth stocks.  We would then get a proper understanding of how much of the current bubble is being driven by excess liquidity and ETFs.

We have seen this movie before, and it didn’t end well.  Owning expensive shares in the hope that you can sell them to someone else at a higher price, is not a game that we would encourage any investor to play.    Especially not in companies which are massively changing our daily lives but are not regulated and arguably don’t pay their fair share of tax.

Many thanks for your continued interest and support.

David Keir (David@saracenfundmanagers.com)

Graham Campbell (graham@saracenfundmanagers.com)

Co-Managers, TB Saracen Global Income & Growth Fund

Important Information: The views and opinions contained herein are those of the author’s and may not necessarily represent views expressed or reflected in other Saracen Fund Managers Ltd communications, strategies or funds. This material is an opinion piece and intended to be for information purposes only. This material is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Saracen Fund Managers Ltd does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Saracen Fund Managers Ltd has to its customers under any regulatory system. The data provider and issuer of the document shall have no liability in connection with the third-party data. The Prospectus and/or saracenfundmanagers.com contains additional disclaimers which apply to third party data. Regions/sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.

Saracen Fund Managers Limited is Authorised and Regulated by the Financial Conduct Authority.

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The Global team take us through their December portfolio activity…

  • 2 new holdings – eBay and Samsonite 

At Saracen, we take a long-term view and try to avoid trading wherever possible.  However, we have been active during December, adding two new holdings in businesses that we have followed for years and where the recent share price movements have provided an attractive entry point; namely eBay and Samsonite. 

eBay appeared on our proprietary screen following its Board’s decision to pay a maiden dividend earlier in 2019.  eBbay was the original online marketplace, starting more than 20 years ago as a simple place for buyers and sellers to connect. Over the following two decades, eBay evolved into one of the world’s largest e-commerce platforms with #1 or #2 market positions in most geographies (ex-China) – a global marketplace facilitating nearly $90 billion of transactions between over 180 million users and 25m sellers across 190 countries.

It may surprise readers that 90% of all products sold are not at auction (sold at fixed price), 80% of products sold are new and 70% ship within 3 days (mostly for free and no subscription required).

There is a lot going on at eBay now – Activist investors Elliott Management (4%) and Starboard Value (1%) have built stakes in the company and made some recommendations to the board about what to do earlier this year.

Their general thesis is that there is a massive conglomerate discount in the eBay share price.  With StubHub tickets and the classifieds company in the portfolio, there is a view that these businesses would be worth much more to someone else and selling them would give management more time to focus on the company’s core offering which is the marketplace.

The Board listened, and StubHub is being disposed of for a blow-out $4bn price to Viagogo (NB eBay bought StubHub for $310m in 2007).  The great news for SGIG is that the activists also agitated for the payment of a dividend, which has now materialised.  Income funds such as ours can now consider buying the stock for the first time!

eBay ticks all the boxes we look for in SGIG – it is a high quality business that should be able to sustain attractive returns on invested capital, it is a global leading platform that offers long-term growth (underlying marketplace growth from the continued shift of shopping online plus $1bn opportunity from sellers promoting their own items and $2bn revenue opportunity from the  launch of new payment platform in H2 2020 once the current deal with PayPal expires), the margins are strong, the Balance Sheet is robust, the valuation is attractive and the business is very cash generative.

The starting dividend is on the low side for SGIG, but the dividend is currently 5X covered by cash.  This dividend could be grown significantly over the 5-year forecast period.  With the shares trading on 12X Dec 2020 and a year 5 PER of 7.6X, we think these shares are very cheap and have bought a position for the fund.

Samsonite is the largest luggage company globally with a very diversified geographical footprint (39% North America, 35% Asia, 21% Europe and 5% Latin America) and has diversified further in terms of brands through M&A (e.g. the acquisition of Tumi in 2016).  

The shares have fallen by more than 50% since April 2018 as the business has been impacted by the US/China trade war and specifically the 25% tariff imposed on luggage which is made in China and sold in the US.  In addition, the continued fears about a global recession and disruptions in Hong Kong and France have impacted investor sentiment.  However, these factors should get better in the next couple of years!

The investment case hinges on continued growth in global travel & tourism, which tends to grow slightly above global GDP.

Samsonite is well placed to participate in global growth rates of 3-5% and gain market share, which should result in 5%-7% top line growth. Operating margins are currently depressed predominantly due to the tariffs but will recover mainly as sourcing for the US market is moved outside of China.

We believe that Samsonite is a great fit for SGIG. It is emerging market listed, a global leader in luggage, very well diversified by geography and increasingly diversified in products.  The shares trade on an attractive multiple of trough earnings (14.6X PER 2020) and a year 5 PER of 8.4X supported by an attractive dividend yield of 3.7%.

Feel free to contact us if you have any questions regarding the recent activity in the fund.

Many thanks for your continued support.  We wish our investors a very Merry Christmas and best wishes for 2020.

David Keir (David@saracenfundmanagers.com)

Graham Campbell (graham@saracenfundmanagers.com)

Co-Managers, TB Saracen Global Income & Growth Fund

Important Information: The views and opinions contained herein are those of the author’s and may not necessarily represent views expressed or reflected in other Saracen Fund Managers Ltd communications, strategies or funds. This material is an opinion piece and intended to be for information purposes only. This material is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Saracen Fund Managers Ltd does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Saracen Fund Managers Ltd has to its customers under any regulatory system. The data provider and issuer of the document shall have no liability in connection with the third-party data. The Prospectus and/or saracenfundmanagers.com contains additional disclaimers which apply to third party data. Regions/sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Saracen Fund Managers Limited is Authorised and Regulated by the Financial Conduct Authority.

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David Clark shares his thoughts on what the market can expect following the Conservative landslide last week…

So now we know.

The Conservative Party has won a substantial majority and Labour and the Lib Dems have been put to the sword.

Sterling has predictably rallied and there have been some positive moves in a number of UK stocks since Friday given that a large portion of risk has now been nullified.

UK exporters should benefit.

The City will remain open for business and those companies that have been putting off any decision to come to the market will now be dusting off their plans and moving forward. The utilities sector may well experience a relief bounce as the threat of state sponsored theft recedes and larger, liquid stocks have rallied as the notion of employee trusts (which had very little to do with actual employees) is consigned to the bin.

We can expect the likes of Financials and Housebuilders to do well as will sundry other stocks who are would be beneficiaries of Mr. Johnston’s spending splurge.

At Saracen, we had positioned our UK portfolios for a Conservative victory, though the scale of this has taken us somewhat by surprise. We would expect our holding in Premier Miton to perform well as it has more gearing to an upward movement in UK equities than other listed UK asset managers, in addition to our holdings in stocks such as Ibstock, MJ Gleeson and Galliford Try. Alpha Financial Markets will be relieved that their client base will continue to operate within a business-friendly environment. We have a significant exposure to domestic earnings as well as having low exposure to non-sterling dividends and earnings. Stronger sterling is helpful for our strategy and we have recently added to our exposure in UK smaller companies which, up until now, have been in the doldrums. In addition, we have a large exposure to UK financials and would expect gilt yields to rise from here while banks and others rally.

In Scotland, it was a good night for the SNP. Ruth Davidson, the former Scottish Conservative leader had said that she would go ‘skinny dipping in Loch Ness’ if the SNP won 50 seats. It looks as if she (and we) will be spared that but it was a close-run thing. The usual rhetoric around Indy Ref 2 has begun already in earnest and Nicola Sturgeon has concluded, to no one’s surprise, that the SNP have a ‘clear mandate’ for it. This, despite the fact that 54% of Scotland voted for non-SNP candidates.

Beyond the stock market reaction, the Conservatives have pledged to get Brexit done by the 20th January 2020. That now seems very likely indeed. However, that does not mean that the Brexit risks have all dissipated. I’m afraid we are just getting started here. Now the real work begins with the negotiation of trade deals, the terms of trade and I would bet my bottom dollar that we have not heard the last of the issue concerning the Irish border. It is very difficult to say how the next round of Brexit negotiations will affect individual stocks. Whatever the terms of trade end up being the only certainty is that those companies who habitually import and export goods will see an increase in bureaucracy and almost certainly longer lead times for the movement of goods. Companies will have to adapt.

Boris has confidently said he would expect all these matters to be successfully resolved to everyone’s mutual satisfaction by the end of 2020. That’s a big ask and the jury remains out.

David Clark, Co-Manager, TB Saracen UK Alpha Fund & TB Saracen UK Income Fund

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