Favoured stocks - looking at the Buy side

Thursday, 7th March 2019 09:53 - by David Harbage

One question that is often asked by private investors is,”Do fund managers like the stock?” In trying to answer this teaser, the writer has looked beyond what might be considered the consensual view on a company share to investigate a particular institutional investor or two through perusing the prime investment vehicle they manage.

It is not difficult to see what the equity research houses are recommending on individual company shares, as plenty of financial websites publish the institutions’ name, view and often fair value or price target. Such views from the ‘sell side’ of the industry carry a natural bias to be positive in their stock recommendations, in the hope of courting fees from any future corporate action, although the same analysts might express a less complimentary opinion in a face to face conversation. By contrast, discovering what the ‘buy side’ or the investing institutions are thinking or doing in respect of a particular company stock is not such an easy exercise.   

On the basis of a reasonably liquid (able to trade easily), and therefore efficient, market represents the balance of buyers and sellers at any one point in time, the price of a security can be viewed as being fair. However, while some share prices might seem to be stable and rarely move by much more than a few percentage points, most (and especially smaller companies), will be much more volatile than that predicated by business specific news flow as investors move large positions prompted by a variety of reasons. Often a significant disposal of stock may simply be to meet redemption requests from investors, rather than anything sinister which the fund manager anticipates.

Some institutions can be perceived as passive, rather than active, investors – in particular the index-tracking funds of Blackrock, Vanguard and, closer to home, Legal & General. There are also some fund managers who could be viewed as quasi-trackers, because their portfolios seem to replicate a benchmark (the index or other objective which a fund seeks to outperform) and take few significant ‘bets’ against it – for instance a UK equity investing fund typically owning large positions in the likes of Royal Dutch Shell, HSBC, BP and the FTSE100 index’s other large businesses.          

For the purpose of this blog’s exercise, we will not be investigating which UK company stocks these passive fund managers favour – as their very large stakes will owe more to index size than a subjective view on the merits or otherwise of such stocks. The likes of Blackrock (the owner of i shares exchange traded fund products and the world’s biggest manager of stock exchange assets, if not money) will possess large holdings in most listed assets; owning £7.5bn worth of HSBC shares (equating to a 6% stake) and £5.7bn of BP (representing a 5.2% stake). In similar vein, Vanguard and Legal & General boast £5.2bn and £4.9bn positions respectively in Royal Dutch Shell, equivalent to stakes of almost 3% each on the energy giant’s share register.

Turning to more active fund managers, it is as interesting to see which stocks they dislike - by reference to owning very little or none of a significant constituent within their benchmark index or universe of investment – as the ones they choose to own. An example of this would be to discover that a particular fund manager has deliberately chosen to exclude certain industries or index-significant businesses from his or her portfolio. The £4.8bn Woodford Equity Income fund, managed by Neil Woodford, whose benchmark is the FTSE All Share (an index that includes all companies listed on the main market of the London stock exchange) only owns three constituents of the FTSE100 index, which overwhelmingly dominates the UK equity universe: Imperial Brands (representing 7.1%, it was the portfolio’s largest exposure as at 31 January 2019), Barratt Developments (the second largest, at 6.8%) and Taylor Wimpey (eighth largest, being 2.9% of the fund).         

In addition to these overweight (compared to the fund’s benchmark) positions, investors might be interested to take a look at the Woodford Equity Income portfolio’s other large holdings. This open-ended fund offers a contrarian (as compared to many of its peers) investment strategy, featuring high exposure to domestic firms, which restrained its relative performance last year but could yet prove beneficial in 2019. Taking a look at Neil Woodford’s other high conviction ideas, as at 31 January 2019, the afore mentioned fund held large positions in the £3.8bn market capitalised stock Burford Capital (6.1% of the portfolio), the US$1.25bn Theravance Biopharma (4.4%), £1.5bn Provident Financial (4.3%), unlisted security Benevolent A1 (4.0%), £1bn IP Group (3.1%), £700m New River REIT (2.8%), US$1bn Autolus (2.6%) and £1.5bn Countryside Properties (2.5%). In total, those twelve constituents – which range dramatically from cash generative, seemingly undervalued traditional industries through to the as yet unprofitable, cutting-edge technology pioneers - represent 27.3% of a portfolio which features just north of 100 constituents.

There are other UK equity fund managers who are known for their concentrated, limited stock portfolios – where, akin to many private investors, they seemingly have neglected or chosen to ignore the generally accepted principles of risk-reduction via diversification. However, joining most market observers who are curious to see where such fund managers are placing their not insignificant ‘bets’ the author notes that 0.7%, of the Woodford Equity Income fund is invested in the £200m market capitalised Crystal Amber Fund which is an AIM-listed activist investing predominantly in small and medium sized UK equities “where it identifies opportunities to enhance long term shareholder value through active engagement with companies”.    

As at 31 January 2019 the net asset value of the Crystal Amber fund was assessed to be 217p per share, of which its largest 5 constituent companies represented 77.2% of its worth and its 10 largest share holdings accounted for 86%. Now, institutional funds don’t get much more concentrated than that – and the reader may be keen to learn where Richard Bernstein the investment advisor is ‘placing his chips’. The five biggest positions by value are:

£850m market cap Hurricane Energy (where Crystal Amber own a 5.1% stake) whose forecast earnings for the year to 31 December 2020 would put the stock on a PE ratio of 6.2x, after seeing profits on its oil assets eventually arrive; the Sell side unanimously like the stock with 6 Buy recommendations on view.

£500m market cap Northgate (Crystal Amber own a 6.5% stake) whose forecast earnings for the year to 30 April 2021 would put the stock on a PE ratio of 8.2x, after seeing profits on its fleet of vans in the UK, Ireland and Spain rise 6% in that year, and offer a prospective dividend yield of 5.1%. Brokers also like this stock, with 5 Buy recommendations and 1 Hold view published.

£160m market cap FairFX (Crystal Amber own a major 21.1% stake) whose forecast earnings for the year to 31 December 2020 would put the stock on a PE multiple of 11.6x, based on strong, both organic and via acquisition, c.30% growth in profits next year. The Sell side provide limited, but positive coverage of this stock via 2 Buy recommendations on view.

£145m market cap STV Group (where Crystal Amber own another big 19.8% stake) whose forecast earnings for the year to 31 December 2020 would put the stock on a PE ratio of 7x, after seeing a 12% pick-up in profits from its Scottish digital and broadcasting interests. Featuring a dividend yield of 6%, brokers seem to like this stock too, with 3 Buy recommendations published.

£435m market cap De La Rue (Crystal Amber own a 5.4% stake) whose forecast earnings for the year to 31 March 2021 puts the stock on a PE ratio of 8.9x, after seeing profits from its printing activities advance 3%, with another supportive dividend yield of 6%. The Sell side proffer mixed opinions on the stock, with 1 Buy and 1 Hold recommendation currently on view.

Readers who are interested in ‘drilling down’ into collective funds to discover other fund managers’ favoured selections can readily make progress via factsheets (produced by open-ended fund groups and investment trust managers, usually on a monthly or quarterly basis) and company reports on investment trusts and companies, which can typically be accessed via the fund’s website or from an intermediary. One should take note of how successful the past performance has been of both the share, or unit, price as well as the underlying net asset value. Mindful that past performance is not a reliable guide to future returns, and being aware of changes in management of the fund – both in group style and in personnel – have fun!

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.