The Janus Henderson Cautious Managed Fund delivered a positive return of 0.7% over the six months to 31 January 2018 (source: Morningstar, A class accumulation shares, net of fees, in sterling terms). Brexit continued to negatively affect the UK equity market, which drifted sideways through the period, significantly trailing very strong overseas markets. As a result, the fund lagged its more globally invested peer group, the Investment Association (IA) Mixed Investment 20-60% Shares sector, which returned 2.3% over the period. Gilt yields hit lows of 0.9% in Jun 2017 and 1.0% in late August, before rebounding, reaching 1.5% by the end of the period (Thomson Reuters Datastream, as at 31 January 2018). Gilt yields are inversely correlated with bond prices and the rise in yields reflected a sell-off in bond markets that benefited our defensively positioned bond portfolio.
Ascribing all movements in the UK equity market in 2017 to the state of Brexit negotiations might be exaggerating events, but not by much. It remains the key influence on sentiment, particularly for international investors who, by and large, represent the marginal buyers and sellers. While most of the period saw UK equities underperform world indices, in keeping with perceived difficulties over Brexit negotiations, there was a brief respite in December. At that time, Brexit talks finally started to progress and agreement was reached to move on to stage two of the negotiations. Sterling at least did find some poise through the period, beginning to recover lost ground, especially against the weaker US dollar.
Individual stock disappointments held back the fund’s performance over the six months under review. In our view, there remains an extraordinary skittishness among many investors at the moment, which encourages them to sell any share where they see disappointing trading news. Our biggest disappointment was Capita, the support services provider, where the new CEO issued a profits warning and proposed a rights issue. Babcock, another company in the same sector, but operating in different and, we believe, more robust areas, fell in sympathy. BT Group and Greene King are examples of stocks we hold within the equity portfolio, where forecasted earnings have drifted downwards only modestly, but where their share prices have fallen significantly. We are not alone in experiencing these seemingly unjustifiable moves, but our willingness to buy out-of-favour stocks for their longer-term value can lead to periods of underperformance when the market favours companies seen as reliable growers, over those that may perhaps represent good long-term value.
We are of the opinion that the tide may finally be turning towards more value-biased investment strategies, such as ours. Not only did we see much stronger performance from stocks such as Kingfisher, the home improvement retailer, EasyJet and Tesco, but fund’s best performer over the half year period Ladbrokes Coral, saw its share price rise by more than 30% after a takeover bid from rival GVC Group. All of these stocks have been out of favour for some time in the market. It is the move back to respectability that we are looking for, and positive news such as this gives us hope that our investment rationale can play out over time. Elsewhere, Victrex, the specialty thermoplastic producer, continued its strong progress, while our avoidance of companies operating in the consumer staples sector was beneficial, as these ‘bond proxies’ underperformed.
The bond portfolio benefited from our defensive positioning during the six months under review, positioned with low duration (leaving the fund less adversely exposed to any rise in interest rates) and a relatively large exposure to inflation-linked bonds. We also kept a high cash balance, which helped to reduce volatility. We are optimistic that he long-anticipated rise in bond yields seems to have begun. Bond yields have an inverse relationship with prices, so we will consider adding to the bond portfolio once yields rise to more sensible levels.
We bought bonds in Next and Sainsbury’s, retailers with arguably robust balance sheets, and invested in a bond issued by Vodafone. Within the equity portfolio, we have maintained our strategic positioning of having relatively little exposure to ‘expensive defensives’, sectors such as consumer staples and utilities, in favour of what we believe are attractively priced stocks with greater exposure to domestic markets. We sold out of the fund’s holding in Unilever, taking advantage of the stock’s rally following the aborted bid approach from Kraft. We reinvested the proceeds from the transaction into WPP, a world leader in advertising and marketing services, which we believe will benefit from consumer goods companies needing to increase their marketing budgets to boost stalled sales growth momentum.
Later in the period, we acquired a position in British American Tobacco (BATS) after a notable price fall. We have avoided BATS due to what we saw as a relatively high valuation, but the price now looks more reasonable to us. We switched from British Land into Land Securities, both real estate investment trusts, and trimmed AstraZeneca while topping up GlaxoSmithKline in the healthcare sector. In both of these cases, the relative valuations and prospects of the latter stocks had improved. A further purchase was made of Randgold Resources. We believe a holding in this gold mining operation can be justified on its fundamental prospects alone. In addition, the recent poor price performance of bullion and growing concern over the inflation outlook (gold can br viewed as a hedge against the impact of inflation) makes this a sensible addition to the portfolio. We took profits from our position in Novae, the insurance business, after it received a bid, and in Carnival, the cruise operator, a long-term holding that has now materially increased in value.
For all the challenges we are growing confident that our patient approach is beginning to bear fruit. Inflation, interest rates and bond yields are now starting to rise as the global economic recovery matures, a trend that both our bond and equity portfolios are set up to benefit from. We believe that the UK, covering both domestic stocks and sterling, has been oversold and offers compelling value compared to international markets. Following such a prolonged period of underperformance by many UK companies, pressures for change are building. Whether via internal reorganisations, share buybacks, the sale of specific underperforming divisions or indeed whole companies, boards and management teams are now looking at ways to address their lowly share prices. Self-help – the ability to make positive internal change – is very likely to be the key to improved stock performance at a time where valuations globally are arguably high. We continue to believe that the UK, with its low valuations relative to other regions, low investor expectations and opportunity for improvement, represents an attractive opportunity. The Janus Henderson Cautious Managed Fund currently offers a historical yield of 3.3%* (as at 31 January 2018) and, in our view, is well placed to benefit long-term investors seeking the potential for income and capital growth.
*Source: Janus Henderson Investors as at 31 January 2018. Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Any stocks mentioned in this article are intended for illustrative purposes only. References made to individual securities should not constitute or form any offer or solicitation to issue, sell, subscribe or purchase the security. If you invest through a third party provider, charges, performance and terms and conditions may differ materially. This commentary is intended as a summary only and potential investors must read the prospectus, and where relevant, the key investor information document before investing.
Bond proxy: An equity perceived to pay safe and predictable income, with a low level of volatility – characteristics that are more commonly associated with bonds. Bond proxies are typically found in the utility, consumer staples and pharmaceutical sectors. They might be added to a portfolio to imitate bonds, hence their name.
(Low) duration: Duration is measured in terms of the weighted average of the cash flow for an individual bond, or portfolio of bonds, which includes interest payments (coupons) and final the repayment of borrowed money, expressed as a number of years. The larger the figure, the more sensitive it is to a movement in interest rates. If a bond or portfolio has a low duration relative to the market, it less sensitive to any change in interest rates.
Inflation-linked bonds: A bond where the coupon and principal payments are adjusted in line with the rate of inflation, such as the Treasury inflation protected securities (TIPS), issued by the US government. Inflation-linked bonds are also known as index-linked bonds, or ‘linkers’.
Real estate investment trust: An investment vehicle that invests in real estate, through direct ownership of property assets, property shares or mortgages. As they are listed on a stock exchange, REITs are usually highly liquid and trade like a normal share.
Hedge: Consists of taking an offsetting position in a related security, helping to limit or offset the probability of overall loss in a portfolio. Various techniques may be used, including the use of derivatives.
Inflation: The rate at which the prices for goods and services are rising in an economy. The Consumer Price and Index (CPI) and Retail Price Index (RPI) are two common measures.
Share buybacks: The repurchase of shares by a company from existing shareholders, thereby reducing the number of shares outstanding. This gives existing shareholders a larger percentage ownership of the company. It typically signals optimism about the company’s future and a possible undervaluation of its shares.
Domestic stock: A company that generates the largest proportion of its earnings from local ‘domestic’ markets.
Historical yield: The historical yield of the fund reflects distributions declared over the past 12 months as a percentage of the mid-market share price, as at the date shown. It does not include any preliminary charge, and investors may be subject to tax on their distributions. Past performance is not a guide to future performance and the level of any income received may go up or down over time.
Value investing: Value investors search for companies that they believe are undervalued by the market, and therefore expect their share price to increase over time.
Volatility: The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility.
Bid approach: An offer from one party to purchase part of all of a business. Any such bid usually comes with a premium – an offer in excess of the prevalent value of the company.