Tesco profit warning shows vulnerability of defensives, Steve Cordell says

Steve Cordell, manager of the Cazenove Absolute Target Return fund, a pick of Citywire Selection, is moving away from defensive stocks following the release of better manufacturing data.

Profit warning rattles investors

Steve Cordell's Cazenove Absolute Target Return fund gained 1.5% in January, lagging the broader index's 2.7% rise.

With many of last year's worst performing sectors such as metals, autos and miners, posting double-digit returns in January, Cordell believes the shock of Tesco (TSCO.L)'s first profit warning in 20 years made many investors reticent to add further risk into the market.

Food retailers were the worst performing sector in January, falling 18.5%, and Cordell said: 'We had commented last month that defensive stocks looked expensive relative to cyclicals and they were vulnerable to rotation on the back of better economic data.

'Add in the shock of a profit-warning from the UK's poster-child of earnings reliability, and investors needed little more encouragement to shift from their defensive stance.'

Looking to increase cyclical exposure

Cordell has been looking to increase his exposure to cyclical stocks, meaning those whose fortunes are closely tied to the wider stock market, after they got a major boost from better-than-expected global manufacturing data this month, although he remains wary of paying too high a price after such a strong monthly rally. 

'The speed of the move up in some shares leaves us wary of chasing the market too far from here, but we suspect set-backs will be modest while many investors are still sceptical,' Cordell said.

Defensives worst performers

The worst performers were generally defensives, with Morrisons (MRW.L) down 26 basis points following the Tesco profit warning, and GlaxoSmithKline (GSK.L) falling 12 basis points after disappointing trials of its respiratory drug Relovair.

The fund's short book – those stocks the fund predicted to fall in value – lost 4% in the month, with Cordell admitting disappointment at missing the Tesco profit warning, but benefiting from the 14% fall in the share price of mobile phone firm Ericsson, which added 11 basis points of performance to the fund.

'We are moving towards a pro-cyclical stance, but the speed of some moves leaves us wary of chasing overbought stocks. Unless the data compels us, we shall probably await a better moment to move fully to the next stage of the cycle,' Cordell said.

Since Cordell took the reins of the fund from Tim Russell on 1 June 2011, the fund has posted a positive return of 5.64% compared with the Alt Ucits Long/Short Equity Average return of -4.62%.

Citywire Selection verdict:

Performance has progressed well since Steve Cordell took over in June 2011, so the fund is no longer under review. He has taken advantage of opportunities in Europe to diversify short positions, notably in cyclical areas, and we are pleased with how the pragmatic approach is evolving.