How UK value funds are beating the market

It feels as though things might finally be looking up for the beleaguered UK equity investor. Rate cuts may be on the way, the economy has exited recession and the likes of commodities and financial shares have enjoyed strong starts to the year. That may explain why the FTSE 100 has hit a series of record highs in recent weeks, bringing some attention back to an unloved market.

Portfolios have had their own successes in turn, with the average fund in the Investment Association’s UK All Companies sector now up 10.6 per cent over a 12-month period. But it’s notable that, continuing a trend we observed at the start of the year, funds with a value tilt have been generating especially strong returns.

Ninety One UK Special Situations (GB0033063636) is already up by around 16 per cent in the year to date, with other names such as Artemis UK Select (GB00B2PLJG05), JPM UK Equity Value (GB00B235SZ61) and Invesco UK Opportunities (GB00BJ04KP99) also enjoying a rich run of form.

With the economy looking in better shape and some more cyclical sectors maintaining an allure, the strong performance of such funds might seem hard to resist. The sector has a long pedigree of established value managers with different approaches, all of which are worth bearing in mind.

Sectors

Much as financials and energy shares are still prominent in the FTSE 100 and often seen as mainstays of a typical value portfolio, the leading UK value funds out there don’t necessarily rely on these companies.

Most do tend to have a decent chunk of financials exposure, with the latest factsheets showing Artemis UK Select has a 35.8 per cent allocation and the average fund in our sample having around a quarter of its portfolio in the sector. Invesco UK Opportunities, however, bucks the trend with a mere 16 per cent weighting.

Funds that have gone big on the energy sector, meanwhile, are actually fairly rare: Invesco UK Opportunities is something of an outlier here with its large allocation, exposed to the tune of 15.1 per cent, with M&G Recovery (GB00B4X1L373), typically seen as something of a ‘deep value’ fund, sitting on a 12.4 per cent allocation.

Others are much less enamoured of the sector, however, with Alex Wright’s investment trust Fidelity Special Values (FSV) and Invesco UK Opportunities having less than 7 per cent tied up in these shares. Such funds are therefore not the most obvious play on any uptick in the energy industry, or even a renewed commodities supercycle.

Aside from these areas, Ninety One UK Special Situations has a big bet on consumer discretionary shares, with nearly a third of the portfolio in the sector. Artemis UK Select, the second best-performer from the cohort, has roughly a quarter of its assets in that particular sector, but the other funds have much lower allocations, ranging from around 13 per cent to just 6 per cent. A couple of funds, JPM UK Equity Value and Polar Capital UK Value Opportunities, are excluded from this particular analysis because they break out their sector exposures differently.

Some other points are worth noting. One is that not many of these funds have explicitly loaded up on healthcare names, although M&G Recovery does have a notable 12.4 per cent allocation.

Some names, such as the Fidelity fund and Man GLG Undervalued Assets (GB00BFH3NC99), have fairly big bets on industrials. Meanwhile, a couple of funds, Fidelity Special Values and M&G Recovery, have a strikingly high level of exposure to shares listed overseas, with each having just 80 per cent of their portfolio in UK-listed stocks. As such, some unexpected names crop up in the portfolios, including Roche (FR:ROG) making an appearance among the top 10 holdings for FSV.

Turning to other preferences, the funds vary notably by which parts of the FTSE All-Share they tend to hunt for value in. Artemis UK Select has three-quarters of its portfolio in large-cap stocks and just a fifth in mid-caps, with JOHCM UK Dynamic (GB00B4T7HR59) taking a similar approach.

Investors who think there is good value to be had in the beaten-up FTSE 250 might consider the likes of Polar Capital UK Value Opportunities (IE00BD81XX91), which has half of its portfolio in the mid-cap space.

Big bets

There is always plenty of debate about what represents good value, and that is reflected in some of the big bets made by the different funds. It’s notable that Ninety One UK Special Situations still has a large position in Rolls-Royce (RR.), which has made a return approaching 200 per cent in the space of a year.

Those worrying about value funds backing high-flyers might also raise an eyebrow at the presence of 3i Group (III) in Artemis UK Select’s top 10 holdings.

The Artemis investment team made a case early this year that a “virtuous cycle is evident” for 3i’s flagship asset, European retailer Action, noting: “Growing sales are allowing Action to invest more in keeping its prices low, thereby deepening its advantage relative to its peers and driving further growth in footfall through its stores.”

Some pretty obvious concerns do linger with 3i, however, ranging from the sheer size of its Action position to the fact the trust’s shares trade on a premium of around 40 per cent to portfolio net asset value (NAV).

As the table shows, other funds look somewhat more conventional in the companies they back most heavily, from the banks to the energy majors and GSK (GSK). Not all portfolios have notable positions, however. Fidelity Special Values and Polar Capital UK Value Opportunities, for example, have no weighting making up 5 per cent or more of their portfolios.

Of course, some funds do diversify more widely than others: the Polar Capital fund has less of its portfolio wrapped up in its most prominent holdings, with 29.6 per cent of assets in the top 10 holdings versus an average of just under 40 per cent for the wider cohort. In short, the funds on offer for value investors still vary notably by composition and approach.