2017 was supposed to be the year value investing came back to the fore, after years of painful underperformance versus growth stocks. That held, but only for a very short amount of time.
Market dynamics did change, but not for the better from a value investor’s perspective. As John Bennett, manager of the Morningstar Bronze Rated Henderson European Focus Trust (HEFT), explains: “We’ve gone from a growth beating value market to an all-out momentum market.”
For many, though, this remains an opportunity. The Morningstar Silver Rated Schroder Recovery Fund has been a victim of value’s poor recent performance. But co-manager Kevin Murphy points out there’s 100 years’ worth of data that shows the cheapest companies outperform over the long term.
And some believe the worm will finally turn. Graham Bird, manager of Gresham House Strategic (GHS), notes that value tends to outperform during periods of monetary policy tightening. When policy is loose, investors’ cash tends to flow into risk assets, pushing up momentum strategies and growth companies, he adds.
“Now, we’re getting back to a cycle where interest rate rises are back on the agenda. I think that’s quite an interesting point in the cycle. I think value is going to come back into favour.”
As a result, we took a look at the holdings in some of the best rated UK funds run with a value bias using the Morningstar X-Ray tool to find out which companies might benefit.
BP (BP.)
One of the FTSE 100’s two oil majors, BP is a prized asset for its yield, which is forecast to stay well above 6% for the foreseeable future. While many had previously – and some still do – questioned the sustainability of this dividend, it’s taken steps to remedy that.
Morningstar analyst Allen Good notes that the reduction of its cash flow break even level to $50 per barrel of oil ensures the dividend’s safety in the event of an oil price decline. Further, the share buyback announced means it’s now effectively paying a full-cash dividend once again.
Good gives the stock a three-star rating, suggesting it’s fully valued at around 475p. But sellside analysts are more bullish, with both UBS and Barclays rating BP a ‘buy’. Barclays’ 675p price target suggests upside of 42%.
Since hitting a near eight-year high a month ago, the share price has pared back over 10%.
BP is owned by five of our screened funds, accounting for 8.59% of M&G Recovery’s portfolio and 6.37% of Jupiter UK Special Situations’.
HSBC (HSBA)
Banks are a feature on this list, with the next two also from the sector. UK and Hong Kong-focused HSBC is held by four of our funds, including heavily by M&G Recovery at 8.19% of the portfolio, Investec UK Special Situations at 7.48%, and Schroder Recovery assigning 5.72%.
The company is in the midst of a restructuring, which Morningstar analyst Derya Guzel says is progressing well. However, her fair value estimate of 690p suggests the stock is slightly over-valued at 749p today.
Guzel thinks HSBC will benefit from higher interest rates more quickly than peers due to the short-term nature of trade finance loans. “However, we think the transactional nature of the business will limit net interest margin expansion.”
With a yield of just above 5%, Ian Forrest, investment research analyst at The Share Centre, recently picked it as one of his top stocks for 2018. He says its “pivot to Asia” strategy is already showing through, with around 70% of profit coming from the continent.
Royal Bank of Scotland (RBS)
RBS has been one of the worst-hit banks on the misconduct side. While Guzel thinks the worst is over, fines and restructuring costs will continue to weigh on profits in the near term.
At a fair value of 300p, RBS is a three-star stock despite the share price still being lower than it was two years ago. The government still owns a 71% stake in the troubled lender, which will continue to hold the share price back.
Guzel sees scope for profitability to improve, with RBS still possessing a strong retail and commercial banking presence. However, Vince Cable, leader of the Liberal Democrats, recently suggested the Treasury may not be able to offload its shares for another decade.
RBS accounts for just over 5% of the portfolios of Schroder Recovery and Investec UK Special Situations.
Lloyds Banking Group (LLOY)
A favourite of UK investors, high-street lender Lloyds is also a top pick for many fund managers and analysts. Indeed, Guzel has a four-star rating on the stock, with a fair value estimate of 84p suggesting potential upside of 25%.
Broker Barclays has a similar target price, noting a potential dividend yield of over 7% next year.
While HSBC is pivoting towards Asia, Lloyds remains a pure play on the UK economy, with 95% of its assets based here. That’s held the share price back and it’s one of the worst performers in recent months and years.
“While the current economic and political outlook could affect its operations more than others’, we believe Lloyds can weather any short-term volatility,” says Guzel. Return on equity continues to improve, supported by declining operating cost and stable NIM and loan-loss provisioning.
Lloyds is a favourite for five of our funds and all have a similar allocation. Artemis UK Special Situations has the largest stake, followed by Fidelity Special Situations.
Royal Dutch Shell (RDSB)
In a similar vein to BP, Shell is another with a yield of over 6%. Like its oil major peer, its payout looks safer now. Shell’s also now stopped paying its scrip dividend, further underlining management’s confidence.
Good prefers Shell to BP, with a four-star rating on the stock. Its fair value estimate of £27.50 suggests it’s undervalued at £23.19 currently. He reasons that the market continues to discount Shell’s potential, adding it “remains one of our best ideas in the sector”. Like BP, Shell’s shares have slipped over 10% from a multi-year high.
The stock is held by four of our funds, with Investec UK Special Situations having by far the largest position at 7.49% of the portfolio.
