Sunniva Kolostyak: Welcome to Morningstar. For many months now we have gone through a period of high inflation and increased interest rates. So, how have funds reacted to this? Today, I'm joined by Daniel Nilsson from the manager research team.
Daniel, you've looked at how UK value funds in particular have reacted to this sort of environment. What are the headlines?
Daniel Nilsson: Yeah. So, we've seen a number of themes over the last couple of months. One, we've seen a lot of growth companies who in the past have been able to raise capital at cheap funding levels have been really hit hard with the increase in interest rates. In the past, if they had a profit downgrade or missed expectations, they were able to then raise more capital and keep the show on the road. But the market has really been hitting hard those companies who have had profit downgrades and no longer to access capital at those cheap rates that they got accustomed to. So, that's one theme we've seen in the market. Another one is we are seeing value managers start to move more towards financials and banks which I'll get onto a bit later.
SK: So, let's start with smaller companies funds. How have you seen those react?
DN: Yeah. A fund we recently met with is the Artemis UK Smaller Companies Fund. So, they're a valuation-conscious manager, look for, I guess, bottom-up, strong balance sheets, market leaders, good cash-generative businesses. So, that's been one that's really come into its own across 2022 and had some really strong outperformance over the index and the peer group. So, in such an environment the fund did increase positions in companies with strong balance sheets and market leaders who really benefited from those disruptors being forced out of the market, which I mentioned earlier. They were unable to get access to cheap capital and their really strong market leader positions held up really well.
SK: You also mentioned financials. Why has this been the space that value funds have moved into and what type of value funds have you seen?
DN: Yeah. So, one we met with recently was the Fidelity Special Situations Fund. So, they're quite contrarian in nature. Banks really have been a position that a lot of UK fund managers have been underweight for a sustained period of time now really. But with the increasing interest rate cycle in the UK, which we've seen over the last 12 months, there's been a real, I guess, misunderstanding of what that's meant for the earnings for these banks and their net interest margins. So, the Fidelity fund has been focusing more on those interest rate-sensitive banks like AIB and NatWest who have had a really dramatic change in their earnings profile. So, that's been one trade we've seen come to the fore, and they're at its most significant overweight they've ever had to banks. But in contrast to that, we saw them actually reduce their weight to house builders over the last 12 months quite considerably. They were a bit worried about concerns with momentum in the residential market will slow and they've cut exposure to areas more susceptible to a slowdown in economic activity.
SK: Any other funds that have done the same thing?
DN: Yeah. So, the Man GLG Undervalued Assets Fund is another one we had a recent review with. That fund has been managed by Henry Dixon since inception with Jack Barrett since 2013 and really looking for cash generated businesses that can show positive earnings momentum. I guess given the increasing interest rate environment, the more onerous cost of capital, they've seen a remarkable change in the dynamics for many different industries. And one they've highlighted is the real estate sector. So, they think that's going through one of the largest fundamental changes they've seen in the history of the sector. And really within this sector, they're looking for companies with unaggressive starting yields, low leverage, development potential. So, they've still got exposure to the area, but being selected in their name, so looking at companies like Grainger and British Land, for instance.
SK: Well, Daniel, thank you very much for coming here today. For Morningstar, I'm Sunniva Kolostyak.
