Global equities continued to make progress during July, with the FTSE 100 index rising by 1.2% over the month. Despite Spanish yields rising to all-time highs, volatility levels in equity markets remained subdued, well below the levels associated with periods of elevated risk in recent years. A possible explanation for this was a speech from Mario Draghi, who said that the European Central Bank (ECB) would do ‘whatever it takes’ to support European economies and that the euro currency as a whole was here to stay. The market took these strong words well. So it would seem we that we may be moving towards the final stages of the European sovereign debt crisis, assuming Mario Draghi stays true to his statement and promotes the right policy for greater stability in Europe. Against this background the Absolute Insight UK Equity Market Neutral Fund (‘the Fund’) continued to deliver positive returns, rising by 0.44% (gross of fees, in sterling terms).
With macro concerns on the back burner and negative data having less impact for the time being, corporate earnings were the focus in July, as we saw a huge raft of numbers being rushed out ahead of the traditionally quiet August period and start of the Olympics. It is difficult to draw too many conclusions from the share price reactions, other than that it was the more defensive stocks which were sold down as there was little to surprise in their statements. BT was a good example of this, with quite a sharp sell-off on a weaker revenue outlook in the global services division. The division is small and impacts sentiment more than it should, so the share price recovered subsequently. We have seen similar reactions from Serco, Imperial Tobacco and GlaxoSmithKline where initial falls proved short lived.
In terms of geographical exposure, Europe was a source of weakness and it is clear that the unusual weather this year has affected retailers and construction companies. The reverse was true in the US, where very warm and dry conditions resulted in a decent recovery in construction activity. Within the Fund we favour companies which are more exposed to US construction. One example is Wolseley, which supplies plumbing, heating and bathrooms and had a decent set of numbers, but exposure to France offset strong US performance, so small downgrades followed the statement. Given the broader market has experienced net downgrades we elected to stick with Wolseley, especially given that our short hedge, CRH, is more exposed to state spending in Europe.
Keller, a specialist in ground engineering solutions, had strong numbers over the month and won a significant contract in Australia, leaving the market to anticipate upgrades and recovery. Given that margins halved through the downturn this recovery should be substantial. We have hedged a long position in Keller with Balfour Beatty, where the short-term potential looks more limited. Our long position in RPS, which provides health, safety and environmental risk consultation services to energy companies and governments, performed well. This was on the back of strong results and a small acquisition which should bolster their Australian business.
Pace, a set-top box manufacturer, also had a good update with initial signs that the new finance director, Roddy Murray, is driving improved cash flow and margin performance. Investors are wary of Pace as its earnings have proved volatile in the past, so currently ascribe the stock a very low valuation rating. However, this means that if the finance director can drive more consistent earnings performance the stock should have plenty of scope to re-rate upwards.
We have maintained gross investment levels at 80%, and this has proved right through the recent bout of eurozone stress. However, volatility could easily pick up again in August so we will continue to monitor it closely. In terms of activity we have only made small adjustments to positions through July. It has been interesting to note that the degree of stretch between cyclical and defensive companies is very high, both in terms of performance and valuation. As a result we have moved some money away from defensive companies which have done very well, in favour of companies where we believe there is scope for catch up in both share price and valuation. One example is a reduction in our long position in Compass, a specialist in food catering and supporting services, with money being redeployed into Imperial Tobacco.
In summary, we continue to hedge factor risks (sector, style etc.) very carefully, which is enabling us to maintain our gross exposure level. Clearly risks remain high, however, and a euro breakup cannot be ruled out. That said, policy makers do seem more willing to do what is necessary.
Please note the value of investments and any income from them will fluctuate and is not guaranteed (this may be partly due to exchange rate fluctuations). Investors may not get back the full amount invested.
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