Taking over the management of any investment portfolio in the spring of 2020 would have been interesting timing, but taking over a cyclically-positioned UK equity fund on 30 April 2020 was very interesting timing indeed.
At the time, the VT Garraway UK Equity Market Fund included exposure to banks, oil companies and insurance companies – exactly the types of companies that suffered in the wrath of pandemic-induced uncertainty. But pandemic aside, these are not the types of companies I believe to be attractive investments.
In 2017, when I joined Garraway Capital Management, I brought the TM Global Equity Fund, which I had been running since 2012, with me. As this portfolio has historically held a significant number of UK companies, and since I had experience running UK equity portfolios, including mid and small cap stocks, I was pleased to be given the opportunity to take over the VT Garraway UK Equity Market Fund and work with the departing manager to ensure a smooth handover.
Avoiding value traps
The way I see it – areas such as banks, oil and gas firms and insurance companies are structurally challenged, even though optically, on a PE ratio basis, they may seem cheap. Their earnings are erratic, they have little to no growth, and ultimately, they are value traps.
My first task on taking over the fund was to go through the holdings list and remove many of these types of names, while retaining a core list of investments that tallied with my way of investing, such as JD Sports Fashion. The economic backdrop in the second quarter of 2020 was such that companies with weaker balance sheets; in a weaker financial position, were unlikely to prosper. So, the rotation out of companies such as BP, Standard Chartered, and Legal & General was fairly speedy. In their place, we invested in the UK listed companies already featured in the VT Garraway Global Equity Fund and a number of other UK companies I already knew well.
These included Reckitt Benckiser and Unilever. I also increased the weighting in Diageo, which is now in the fund’s top ten holdings, and added further quality UK companies not held in the global fund, such as Fever Tree Drinks and London Stock Exchange Group. These two companies are benefiting from a global shift towards premiumisation and indexation respectively.
Over the course of the year by moving capital into highly cash generative businesses poised to benefit from structural shifts in the economy and with positions of market leadership that present sustainable barriers to competition, the sector allocation in the portfolio changed too.
At the end of April 2020 when I took over the fund, exposure to technology was around 2%. By the end of November, this exposure had built to over 17% and includes investments in Sage and FDM, which I go into more detail on below.
The fund now has more exposure to mid and small-cap areas of the market too – at over 40% of the portfolio, compared with 30% at the end of April. At this end of the market cap spectrum I am invested in companies such as FTSE 250-listed FDM, which recruits and trains university graduates and returning military personnel then matches them with companies offering contracts in areas of skill shortages in the UK and abroad. This is a capital light business, so return on capital is high and it fulfils the same criteria as the large cap stocks I invest in. Another example is FTSE All Share-listed Treatt, which supplies ingredients to the global flavor and consumer goods market. The key to its success is that while its ingredients make up a small component of most end products, they are very important to the overall taste, texture or smell and, ultimately, the customer satisfaction. This means Treatt has strong pricing power.
Positioned to weather the storm
As a global equity manager who also runs a UK equity mandate, I see the same structural trends making strides in the UK as in the US and Europe. The deflationary and highly regulated environment is challenging banks; the long-term funding of liabilities (particularly in a world faced with an increase in extreme climate events) is of huge concern to the insurance sector; and the adoption of zero carbon targets and the transition to cleaner energy across the globe is sorely testing the oil and gas industry.
Happily, some strong global growth themes are also evolving, with the UK companies I’ve mentioned poised to capitalise from them. We expect the positioning of the VT Garraway UK Equity Market Fund, since we rotated out of the challenged sectors mentioned above, to make it an all-weather portfolio. While it will not fully participate in ‘value rallies’ such as the one seen through the end of 2020, the Fund will capture much of long-term market upside, and crucially, protect investors’ capital during periods of weaker market returns. This approach should produce strong, consistent results, much like those seen in the Garraway Global Equity Fund.
Malcolm Schembri, Fund Manager
A version of this article originally appeared in Citywire WM on 14 January 2021.