While investors were deserting UK domestic stocks, Citywire A-rated Matthew Tillett was filling his boots. His Allianz UK Opportunities fund had just 14% in domestic names in the fourth quarter of 2015 – a figure that climbed to 28% by the EU referendum in mid-2016 and to 38% by the start of 2018.
‘UK domestics might be in the dog house, but they have commanded 35-40% of the fund for the past year,’ he said. ‘That’s a pretty big statement when you consider that many UK names are international businesses with little domestic exposure and just 25-30% of FTSE All-Share revenue is domestic.’
Tillett is a contrarian, value-driven investor, looking across the market for genuinely mispriced opportunities.
A recent analysis of share price performance by Allianz Global Investors, which he joined as a research analyst in 2006, reveals how starkly UK domestics have underperformed over the past two years: while the FTSE 350 index has risen by almost 20%, domestic stocks have fallen by 6%. Sterling’s depreciation (by 10% against the dollar and 16% against the euro) accounts for only part of the divergence.
Consumer cyclicals – such as housing-related firms and retailers that benefit from discretionary consumer spending in buoyant economic conditions – have performed the worst, losing almost 15% over two years and trailing the index by more than 35%.
‘It’s striking how dreadful consumer cyclicals have done,’ said Tillett (pictured). ‘You might think this reflects a deteriorating earnings profile in the wake of a weaker UK economy and consumer. There certainly have been some high profile profits warnings amongst these companies, but many have held up surprisingly well.’
A valuation de-rating explains much of the underperformance: the median price-to-earnings (P/E) ratio for consumer cyclicals has fallen from 16 times at the beginning of 2016 to a multiple of 13, although there is a wide range with some high street retail and leisure companies languishing well below 10. Over the same period, the P/E ratio for the overall market has risen modestly from 15.5 to 16 times.
Measured but bold
Tillett describes his approach as ‘measured but bold’ – measured in the sense that it is underpinned by a strong valuation and risk discipline, and bold because when he decides to invest, he does so with conviction.
The portfolio is relatively concentrated with just 41 holdings, and the manager typically deploys a minimum 1.5% of assets when he first invests in a company. With a focus on absolute return, he looks for a company to return at least 10-15% per annum over a typical three- to five-year holding period before including it in the portfolio.
‘If you really want to really deliver good long-term returns you have to do something different and the way I do that is by being very opportunistic,’ said Tillett, who bought DFS in August last year shortly after it issued a profits warning.
‘Financial markets are reasonably efficient, but sometimes they get things really wrong, and usually when they do there is herding behaviour in the market when everyone becomes very negative about a sector or company.’
Combining such behavioural anomalies with rigorous analysis of the long-term drivers of shareholder returns allows Tillett to unearth ‘really great opportunities’ at both a sector and stock level.
The fund had relatively little exposure to commodities before the oil price crash of 2014/15, but buying on weakness saw the fund’s exposure increase to well over 20% during 2016.
Tillett still likes energy, but has taken some profits recently, though mega caps BP (BP) and Royal Dutch Shell (RDSb) are amongst the fund’s largest positions on the strength of improvements to their business models and rising returns from their assets. Small caps Faroe Petroleum (FPM) and Serica Energy (SQZ) are also amongst holdings.
Compelling stock ideas for Tillett are often recovery situations such as Capita (CPI), the unloved outsourcing company that he started buying towards the end of 2017.
Electronics and technology business Laird (LRD) was in a similar position last year and has gone from ‘bumping up against its covenants constantly’, as chief executive Tony Quinlan put it, to agreeing a £1 billion private equity takeover. Tillett doubled his money on the company, having bought in last year during a rights issue to repair its overstretched balance sheet.
The same cannot be said for Mothercare (MTC). Tillett had held the shares for a number of years, but sold them at a loss at the end of last year.
For every loser, there has been a clutch of winners though and the fund has achieved top quartile performance over one, three and five years with lower volatility than its peer group average. Its 10-year record is less impressive, ranking in the third quartile out of 187 UK equities funds with a total return of 81.8%.
Tillett took over the fund in July 2013, replacing Jeremy Thomas who had run it for five years. Under him it has generated a 30.5% total return, ranking 43 out of 233 UK Equities funds tracked by Lipper. Since 2016, after Thomas left the company, Tillett has also worked on the Brunner (BUT) investment trust, helping fund manager Lucy Macdonald with UK stock selections for the listed global portfolio.
At £75 million Allianz UK Opportunities, can grow a lot bigger before it loses the nimbleness necessary to exploit the opportunities he sees.
While he expresses concern about current equity market valuations globally and the risk of central banks like the US Federal Reserve raising interest rates too quickly, he believes his hunting ground remains fertile.
‘The risk of a policy error – something that derails markets – is higher than before,’ he said. ‘For me, that means being a bit more cautious about the stocks we’re buying and holding a bit more cash [currently 6% of assets]. While there might be volatility ahead, the UK is more nuanced than the US and wider global market; there’s more absolute value here.’
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