Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Ed Legget, manager of the Artemis UK Select Fund.
Hello, Ed.
Edward Legget: Good morning.
Wall: So, over the last year investors in U.K. equities have not done too badly. If you manage to avoid the blip post the referendum result, actually equities have come up quite a lot. Year-to-date, they are up about 8%. I suppose the big question is, how long can this rally continue?
Legget: Well, that is a big question. And I think, clearly, if you look over long term, equities have been a good place to be. The cash flows have come off companies. They are valued at a much lower level than other asset classes because of the volatility inherent within them. And as a result, over the long term, you pick up those cash flows and generally make better returns out of investing in equities. But clearly, there will be individual years and time periods where returns aren't so good.
I think if we look back over the last year, as a U.K. equity investor, you've benefited significantly from the fall in sterling. And the companies quoted in the U.K., the majority of their profits in absolute terms actually come from outside of the U.K. So, that's been a big tailwind for investors, which has actually meant that the stock market went up post the referendum rather than down.
Wall: And that sterling windfall, that sterling boost, how much longer can we expect that to continue? Because if that's what's driving the market, we saw recently, even today, with the inflation news, if the pound rises, then of course, the FTSE falls.
Legget: Indeed. And there's been a very strong correlation. Particularly, since the referendum result this is very much in the news and in investors' focus, and the two are very interlinked. Depending on people's views of the outcome of the Brexit negotiations will drive people's views of the long-term prospects of the U.K. economy, which will drive people's views of sterling, which will in turn drive people's views of the prospects for the companies within the stock market relative to each other.
So, today, in the fund we run, we are actually pretty neutral versus the market on sterling, i.e., we have got significant positions in domestic companies which roughly match the index and I think probably versus most of our peers that is quite different. And if I look at sterling today, I think there's a reasonable chance that in, certainly, on a one to two-year view, as there's a bit more clarity, the sterling actually strengthens from here.
And as we go through the second half of the year, it's going to be very interesting. Because if you look at the sterling/dollar rate, actually, having been an enormous tailwind for companies over the first half of the year, the companies that make money in dollars, in the second half of this year at current rates it's going to be quite a big headwind. And that will change the relative earnings progression of different companies.
So, if you've looked over the last year, if you've been an overseas earning company and you've done nothing in terms of growing your business, when you translated that back into sterling, it looks like you are growing at 15%, 16%, which – everyone gets the bonus at the company and all looks great. But in reality, your business has made no progress at all. And then as you come through the second half of this year, if you're a big dollar earner, you've suddenly got a 4%, 5% headwind.
And so, we see the scope for the relative valuations of overseas equities and domestic equities potentially to start to narrow and is quite stretched at the moment given the uncertainties caused around the referendum.
Wall: And you did touch on it there. But I suppose the question is, with so much of uncertainty out there how do you invest as a U.K. equity manager? You mentioned that having that particular focus on domestically-focused stocks, are there any sectors in particular that will lend themselves to this style of investing?
Legget: So, we've got some domestic holdings. We've got many U.K.-quoted stocks that do things overseas in terms of their business. If we look at the U.K., clearly, the U.K. domestic holdings, many of them are linked into the U.K. consumer spending in some form or other given that's such a big part of the economy today. And for us, that's part of the market where there are big structural changes happening. So, how do we not pick a company that's maybe having problems cyclically because the U.K. consumer is under a bit more pressure, but also isn't having problems structurally as well.
So, if we look in the domestic holdings we own, we've principally got positions in financials. So, we like life assurance, in particular, big yields, the pressure for individuals to save for their retirement, et cetera, is driving, we think, quite attractive growth there. We also like housebuilders. The desire to own a house, the barriers to entry in that industry are going up. We're not particularly bullish on house prices, but the returns are very high, the yields are high and you can see that in the numbers. If you've seen from the Persimmon, Redrow, et cetera, they are all reporting very strong progress. So, those would be two sectors we'd like in the U.K.
Elsewhere in retail, in leisure, it becomes harder. A stock we've been buying recently would be Lookers, a car dealer; ticks every box. The things people think they don't want, big-ticket consumer item, concerns about PCP finance, concerns around diesel, concerns around imports from Europe into the U.K.
But underlying, structurally, we think that market is consolidating quite quickly. It's quite difficult to disintermediate through the internet as you got to get your car serviced which is where they make the majority of their money. And we can buy it today on 7 times earnings. It's trading around its property value. The value of the properties is worth the value of the whole company and pick up a 4% yield and we think it will be a lot bigger in five years' time than it is today and there is deep value there. The catalyst is potentially harder to see. But where there's value is where there's opportunity.
Wall: Ed, thank you very much.
Legget: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
