Alex Breese, the manager of the Neptune UK Special Situations fund, remains a strong supporter of financials, holding 25% of his fund in the sector.
The manager says he likes stocks in “areas that are out of favour with the market, as that is where you get valuation anomalies.”
“At the start of the year we were skewed towards the most beaten up and depressed companies,” he says.
“The fund was significantly overweight in cyclicals, such as consumer discretionary, financials, real estate and IT, and to achieve that, we sold more defensive areas such as consumer staples.”
He adds there is significant recovery still to come in financials. “Financials were so out of favour and they were the worst performing sector in the bear market, so they have got further to go.”
Breese also favours real estate. One of his holdings is Hansteen, who he describes as a “vulture-style property fund.”
“Hansteen’s management say they are seeing some of the best property opportunities of their careers,” he says. “They are buying assets from distressed sellers at 50% below replacement cost. Yields are very high, and over time, property prices will come back.”
Breese bases his stockpicking approach on management quality, as well as detailed understanding of cashflow and balance sheets.
He says he will trade-off quality for valuation. “For a medium quality company, I want a bigger discount to intrinsic value,” he says.
Whilst he is optimistic on the outlook for the British market, Breese is moving back into higher quality companies. “We have had a strong rally in cyclicals, and valuations have risen a lot. But moving into a low growth environment, we will see a shift back into quality.”
Breese says Neptune were unusual in taking a positive stance on the market at the beginning of the year. “Sell-side analysts and economists were dramatically reducing their expectations on earnings and GDP growth. We felt there was a lot of negative expectation priced into the market,” he says.
“Companies were very scared and began aggressive cost cutting,” he says. “Now, as we start to see stabilisation, this combination of cost reduction and inherent operational gearing means any slight improvement leads to a dramatic rise in earnings.”
Breese says this led to companies consistently beating earnings expectations throughout the mid-year reporting season.
Breese says the market will continue to rise over the next four to eight months. However, he is not predicting a strong economic recovery. “We do expect improvement, but in a low growth environment rather than a strong rebound,” he says.
Breese also anticipates an uptake in M&A activity. “Management teams of listed companies do not buy at the bottom,” he says. “They need confidence in the economic outlook. Now we will see them starting to make decisions.”
“There are lots of companies with decent cash piles out there, and valuations are still suppressed, making mergers attractive,” he says.
“And with the low value of sterling, it is a great time for European or American companies to look at acquisition opportunities in Britain.”