Oriel UK manager Patrick Barton said he has been forced to take refuge in cash as current equity valuations ‘do not allow any margin of safety’.
Barton has sold down a number of his largest positions, viewing them as too expensive. At the end of June, his IWI Oriel UK fund had a cash weighting of 8.6%, more than double the level the fund has had over the past five years.
The £58.1 million fund is a concentrated portfolio of 25 ‘unappreciated’ stocks, which means Barton has to be rigid in his sell discipline. He has cut back on top 10 holdings, including drugs giant GlaxoSmithKline, Associated British Foods, Compass Group and BP.
But the manager said his actions are not a call on the market but simply a way to protect the portfolio from downside risk.
‘We do not have any near term views with anything. We do not know what is going to perform in the next 12-18 months. It means you get yourself in a muddle if you run it [the fund] that way. If the stocks do well, you do ridiculously well. If not, you can have 15 stocks doing well but you underperform because the other 10 are your largest positions.’
Although the fund tends to sell down positions that breach the 6% portfolio weighting level, Barton said that ‘the main impetus for the money we have run this year has been valuation’.
‘Valuations have moved from very attractive in 2009, 2010 and 2011 to valuations that do not allow any margin of safety,’ he said.
‘Although we may still like the businesses and like the management, there is no particularly good reason to hold 6% rather than 4%.
‘In the space we occupy, the higher quality end of the spectrum, I am struggling to find opportunities to put cash to work [in stocks that will provide] a long term return that exceeds 8%.’
Over the year to the end of June, the Oriel UK fund has returned 13.3%, narrowly underperforming the 13.6% delivered by the UK All Companies sector average.
Over three years it has returned 40.2%, compared with 32.2% by the sector average. Meanwhile, the estimated historic yield was 3.1%.
Although the fund has narrowly underperformed in the past year, the manager said he would rather take a little bit of pain than buy into stocks in excess of the cost of capital.
‘At a 6-8% return I can find lots of things but my sense would be that is not the right way to go. I would rather set up a liquidity position for a period of time and it hurt a little bit rather than put the money to work at economics that did not make sense.’
Looking ahead, Barton has said that weakness in foreign currencies such as the dollar is ‘the biggest threat to the fund,’ because the strong pound caught UK managers by surprise, affecting overseas earnings and trade competitiveness.
Associated British Foods, which at the end of June was the fund’s fifth biggest holding, at 5%, said sterling strength had hit the translation of sales and profits from overseas businesses.
This could cost the firm £50 million this year on an adjusted earnings-per-share basis.
A number of other major holdings such as WPP, GlaxoSmithKline and Compass Group have also warned on the impact of sterling strength.
Barton is passionate about his concentrated style. He says this allows him to really know what he is invested in and to concentrate on the positions where he has the most conviction.
While some investors assume that the fund would be volatile compared with a more diversified fund, he maintains the reverse is true because of the high quality, low debt companies he invests in.
At £51 million, the fund is smaller than many of its peers in the UK All Companies sector. Barton would like it to be bigger, although he already keeps an eye on capacity and said he would stop taking new money if he felt the distinctive style of the fund was being compromised.