Sue Noffke, head of UK equities, Shroders

UK equities

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Managing equities in the context of news and current affairs

Sue Noffke, head of UK equities at Schroders, and manager to the Schroder Income and Growth Fund, says the UK equity market holds some good value companies for the long-term investor.

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As investment uncertainty prevails, Sue Noffke explains why investors should now focus on fundamentals and process.

The world, or the decade 2020 so far, has certainly had to cope with a lot. We’ve seen political unrest between the US and Iran, continuing Brexit disruption in Europe, devastating fires in Australia, floods in the UK and now the global Coronavirus pandemic. 

So what’s an investor to do? Based on my 30 years as a fund manager and having faith in a long-established investment process, I believe it’s a case of keeping calm and carry on.  

While there is continued uncertainty over both the short- and long-term impact of coronavirus on the global economy and business, for investors who can still take a long term view of the situation, assessing the fundamentals can help give perspective to the situation. 

In this respect, the investment trust structure has several advantages. Alongside gearing and revenue reserves, there is the fixed capital structure that is very much an aligned long-term view. There’s no distraction from money in, money out; there is the ability to overwrite stocks within the portfolio; write covered calls to generate extra income; or gain overseas exposure when, in each case, the environment is right. 

Inefficiency provides opportunities

Underpinning all of this is the belief that markets are inefficient and that inefficiency provides opportunities. So taking advantage of any adverse sentiment to buy out of favour stocks by focusing on the long-term fundamentals.  

Idea generation is all about trying to spot opportunities when they present themselves; it’s understanding the universe that you are looking at, and it’s trying to see why a stock might be out of favour – asking whether that is an opportunity or is it reflecting the fundamentals?  

Focus on key investment drivers

In terms of key drivers, accounting is vital. Accounting helps avoid the blow-ups by paying attention to cash flow and the balance sheet; ensuring diversification across the value and growth spectrum; and having a valuation discipline. It’s about assessing peers, looking at history and asking lots of questions about whether it is different this time.  

Strategic positioning is probably one of the critical differentiators for stock performance; so looking at the sustainability of the profits of a business, looking at the threats from the disruption to stress test holdings and new ideas. Management and governance are also vital to assure the delivery on strategy and to make sure that shareholders benefit from that.  

There are also macroeconomic driver considerations. These considerations help understand and inform the cyclicality, as well as the upsides and downsides in an absolute sense, to changes in the macro drivers. 

When to sell

Sometimes a change in the investment thesis is beyond your ability to change or control, in which case you have to sell and move on. Sometimes it’s much more about a judgement on the valuation. It might be high because it’s anticipating a significant upswing, in which case can you test and verify that? Can fundamentals back the valuation or has it just been caught up in a wave of some flavour of the month? If so, is that something you want to run with? 

Other red flags include signs of deterioration. Sometimes frequent or expensive acquisitions, especially when it’s not part of the stated business model, can be hiding some level of decline. Other signs include a deterioration in ESG performance; failure to respond to disruption; and questions on the sustainability of the dividend. For an income fund, the dividend is key. There’s no point in just selling when it’s already discounted in the price as you’ve suffered the capital deterioration. It’s much more about stress testing how sustainable that dividend is going forward; not just this year or this half-year, but in the next couple of years.  

Weaker and deteriorating balance sheets are also a sign because the combination of operational and financial leverage can be toxic, particularly in a downturn. And that’s the critical reminder that long investment experience in markets tends to leave you with. 

Looking ahead

Clearly, the coronavirus pandemic is going to have an impact on stock markets and investment performance going forward. Questions we now need to ask are to what level it will impact on trade, and to what extent the market is going to look through that? How will the impact of liquidity support from central banks play out? It’s also essential to take into account that the UK equity market is not all about the UK economy, so it does matter what international markets are doing. All of these things are issues to think about and to explore.  

As we move forward, diversification by style certainly gives opportunities to perform in several different market opportunities. So holding the right balance of value and growth stocks gives the flexibility to pick up on different market environments and opportunities. 

Revenue reserves is a further tool for investment trusts, particularly those that have an income focus. In terms of Schroder Income Growth, the fund has been able to maintain dividend growth at times that dividend growth has been very hard to come by within the market. While we’ve not been afraid to dip into revenue reserves to ensure continued dividend growth to investors, we have also repaired and rebuilt. So a fix the roof while the sun is shining approach to prepare for whatever the market throws at you in the future. Hopefully, these preparations will now help sustain and support as we move forward.

Despite the uncertain investment environment ahead, investment trusts must continue to provide investors with capital growth and grow income in real terms. By using a combination of experience and focusing on investment process and fundamentals, we hope to continue to do that, regardless of whatever environment we happen to be operating in the world.  

Sue Noffke, is a Manager of the Schroder Income Growth Fund and Head of UK Equities at Schroders.