Franklin UK Opportunities A Inc, AA-rated manager of the fund, is not battening down the hatches in preparation for the end of quantitative easing.
‘I suppose the challenge for the market in the short term is the ongoing debate about interest rates and when we will see the Bank of England (BoE) raise rates,’ he said.
‘That is one thing people have been grappling with, alongside the strength of sterling, which has been a considerable headwind. Many companies have investments overseas so that has been another challenge for the UK market.
‘There are these challenges out there but it’s fair to say we are positioned for that outlook.’
Russon is watching closely to see whether the stabilising but fragile UK economy can stand on its own two feet without central bank stimulus.
‘My personal view is that the GDP data has been reasonably robust, but the broader economy is dependent on a high level of support from central banks. [BoE governor] Mark Carney refers to escape velocity, but the question is whether markets can survive without their support. In my view, that will be a challenge.’
However, the manager is heartened by the strength of the UK housing market, which he said is good news for the consumer.
‘The strength of housing has given the consumer recovery a lift and the consumer is in better health than 24 months ago. However, he added that the advent of rate rises which the Bank of England is keen to stress will be gradual would be the next test for the consumer.
Accordingly, some of the stocks most beneficial to the fund in the past year were retail names. These have profited from the consumer recovery story, for example Next, which Russon said had executed very well.
Russon joined Franklin Templeton last April from Newton Investment Management, where he ran the Newton UK Opportunities fund. He has been co-managing the £93 million Franklin UK Opportunities fund for around a year, which was renamed from the Franklin UK Select Growth fund on 30 September 2013.
Over 12 months to the end of June the fund returned 12.4%, narrowly underperforming the Citywire UK Equity sector return of 13.6%.
It is highly concentrated into just 37 stocks and each ‘has a meaningful impact on performance’.
To mitigate macro risks, a large chunk of the portfolio is made up of globally diversified stocks in the pharmaceutical and utilities sectors. These are not particularly sensitive to what the domestic economy is doing, and are generally cheaper than growth stocks, he said.
‘Our focus is on non-economically sensitive companies with balance sheets that are not too highly geared, so they can ride out more difficult environments,’ Russon said.
‘If you look at cyclical areas, people are paying a higher multiple for future growth. Obviously, if that growth does not transpire, you have risks of downgrades, which are less of a risk in defensive parts of the market.’
Last year, the fund experienced the perils of holding politically sensitive stocks when Centrica, the parent company of British Gas, was hit by the fallout from political posturing over energy prices.
‘We got caught out by the political moves and Labour’s pledge to freeze energy prices. The political risk was detrimental to the portfolio,’ Russon said.
‘The position was reduced to mitigate the impact, but I still think there is value in the shares. They just have to ride out the political environment in the short term.’
However, he still holds a handful of what he deems structural growth companies, including Compass Group, his ninth largest position, which provides contract catering at sporting and leisure events.
‘There is an element of cyclicality to their business as they are exposed to the fortunes of the corporate entities that they serve. It’s a very underpenetrated market and there is a structural growth driver to the business. These are companies you will pay a higher valuation for but you still have a very strong balance sheet and strong total return,’ he said.
Elsewhere, Russon said none of the recent rash of flotations in the UK market had tempted him because valuations were overhyped.
‘Internet companies are on very rich valuations, which I find very hard to justify. You are paying for an awful lot of hype,’ he said.
‘Quite a lot of the high profile names are at a lower price, still a long way from a price that I would find interesting. They are not valuations I would feel happy putting into the portfolio.’