Although UK equities have extended their rally over the summer months, risk appetite among investors remains limited given a spike in Covid-19 cases, the reintroduction of some restrictions and continued Brexit uncertainty.
Incredible valuation dispersions
The pandemic and ensuing global recession have been historic in their impact. Looking at the market, this uncertainty has translated into a very one-sided consensus. Investors’ focus has been very narrow and primarily on companies with superior long-term growth potential, seemingly irrespective of near-term uncertainty and unquestionably irrespective of valuations. This has proved a challenging backdrop given our strategy’s contrarian value focus and has created incredible valuation dispersions.
Attractive opportunity set
During such periods, investors typically lose sight of valuations. This leaves a vast number of less fashionable parts of the market incredibly unloved and therefore very cheap, while conversely some areas are priced for perfection with little room for disappointment.
No one can predict with accuracy what will happen over the next year in terms of the evolution of the virus, and the speed of economic recovery, but investing in companies with attractive valuations has proved a rewarding strategy over the long term. We see no reason why this should change going forward.
The number of value opportunities we are finding, particularly at the smaller end of the market cap spectrum, is highlighted by the 11% gearing in the investment trust. At the margin, we have been adding to cyclicals. This is mainly because we have more balance sheet certainty post-lockdown (as most businesses are operating again) and the valuations of selected cyclicals like premium car distributor Inchcape and provider of residential property services LSL Property Services did not reflect improving fundamentals and self-help initiatives.
However, given the uncertainty ahead, the portfolios remain well diversified, with significant exposure to resilient businesses in areas such as health care, government outsourcers, telecoms, infrastructure and utilities.
While relative performance has improved when the market is upbeat and people are more positive about opening up and restrictions being eased, the strength and resilience of the underlying businesses we own should provide some protection should we be faced with a second wave of the virus or the economic impact be worse than anticipated.
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