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Hole in security fence

False security?

10 August 2017

Nick Purves of RWC Partners believes the shift in growth and interest rate expectations has made 'bond proxies' look more risky.

Markets often move in cycles, depending in great part on whether fear or greed has the upper hand. Last year it was politics that provided much of the momentum in developed markets, pushing investors to sell off sterling and to buy up stocks in both the US and UK.

At the start of 2017, investors were nervous over both sluggish growth in major developed economies and political risks in the year ahead, notably a series of elections in Europe. Central banks kept interest rates at or close to historic lows, thereby signalling their own caution about the outlook. As a result, many equity investors clung to the safety of ‘bond proxies’ – companies that behave like high-quality bonds because they tend to offer predictable returns, even in the lean times.

“Value stocks didn’t do very well in that period,” says Nick Purves of RWC Partners, manager of the St. James’s Place Equity Income fund. “The first half of this year saw falling growth expectations and, over time, the market has become quite cynical that we can return to pre-crisis growth rates. Last year, markets went up because of Trump’s pledges about fiscal stimulus and tax cuts – confidence in those pledges has since waned. When interest rates are falling and people are worried, it’s the bond proxies that tend to do well, as people pay up for growth and dependability.”

Yet Purves believes that bond proxies today are a lot less secure than market sentiment suggests, because post-crisis quantitative easing has pushed the prices of many stocks too high.

“Broadly speaking, UK stocks are overvalued just now – caution is required. Our own approach is value investing and there are periods when that approach goes out of fashion, usually towards the end of a bull market, which is when sentiment takes over and valuation becomes irrelevant.”

Purves gives the examples of the technology bubble in the late 1990s and the period shortly before the 2008 global financial crisis.

“On those occasions, the fund’s conservative approach meant it missed out on short-term gains, but was then rewarded in the ensuing correction,” says Purves. “More recently, we have entered a period of central bank-driven asset price inflation. As a result, we have sold holdings that we consider to be fully valued and have increased cash levels in order to take advantage of future opportunities.”

Safety exit?

Purves only focuses on UK-listed stocks. While the global profile of the FTSE 100 means he can still gain plenty of international exposure, he tracks the UK outlook closely. At present, he sees plenty of unknowns ahead.

“We can’t see how the Brexit negotiations are going to go, but we do see real signs that the UK economy is slowing – real wage growth has gone sharply negative and inflation almost reached 3% in June,” he says. “The Bank of England reckons that a 15% currency depreciation translates into 3% inflation but is only temporary. If nothing changes from here, it could be that inflation drops back down towards zero. It takes time for price pressures to come though, partly because the retailers were hedged against currency movements and so didn’t put up prices immediately. It could take another year or so for Brexit inflation to feed through fully.”

The UK retail sector is one that Purves is especially focused on. Store-based sales have been declining in recent months, but Purves believes that mainstream food retail will continue to benefit from its distinct distribution model.

“Many retail chains have big fixed cost bases, and small changes to revenues have a very marked influence on profitability,” he says. “On the stock market, retailers have been very weak. But I don’t think you’ll see the same problems in food retail because the product is incredibly bulky, which means that the distribution costs of fulfilling online are much, much higher – distribution points need to be much closer to the customer.”

Several food retailers saw their share prices slip when Amazon’s purchase of Whole Foods was announced in June, but Purves doesn’t believe Amazon is automatically going to erode supermarket profits any time soon. He currently holds both Tesco and Morrisons in the fund.

“The real change in food retail is how the stores are used – the back of the store might be used for internet fulfilment in the future,” he says. “Tesco is as much a logistics company as a retailer and it can adapt.”

In January, Tesco acquired Booker, a cash-and-carry group, for £3.7 billion. Booker supplies hundreds of convenience stories, and owns both Londis and Budgens.

“We were nervous at the acquisition price and the fact it would distract attention at Tesco from the core work of engineering recovery – improving operating margins and so on,” says Purves. “But we came away from the meeting with the CEO comforted to the extent that what they’re buying is effectively within their scope of competence – the best deals are where most of the synergies come from cost savings and where you’re sticking to core competencies.”


RWC Partners is a fund manager for St. James’s Place.


The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The opinions expressed are those of Nick Purves of RWC Partners and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any strategy. The views are not necessarily shared by other investment managers or St. James’s Place Wealth Management.


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