Plenty of macro clouds, but here’s why now is attractive entry point

Sue Noffke, head of UK equities at Schroders, points out that while there are macro risks, not least the prospect of a recession in 2024, now is a great opportunity for investors to enter the market given that valuations are at low levels.

In particular, there’s one area of the market where Noffke is finding plenty of value opportunities. She names one holding that’s been topped up and one that she is keeping an eye on.

Noffke, manager of Schroder Income Growth Ord (LSE:SCF), also tells ii’s Collectives Editor Kyle Caldwell that gearing levels on the investment trust are pretty much at their maximum amount, and that she has been increasing her own personal investment in the portfolio she manages.

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Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Sue Noffke, manager of the Schroder Income Growth investment trust. Sue, thanks for coming in today.

Sue Noffke, manager of Schroder Income Growth investment trust: Delighted to be here.

Kyle Caldwell: As we head into 2024, there's a lot of doom and gloom associated with the UK stock market. Some commentators are predicting that a recession will take place in 2024. What are your thoughts? Are these fears of a recession overblown?

Sue Noffke: Probably not. There are plenty of clouds on the horizon, but there are always. Most of the time, glasses are half-empty as well as half-full. And at the moment, the glass is definitely half-empty with lots of talk about recession. I would note that if we were sitting here this time last year, people were also predicting a recession. It hasn't come. It's not to say that it won't come. What we have seen is a very rapid response from central banks to a higher inflationary environment. And that carries risks, undoubtedly.

What we are also seeing is a reaction within the economic data to show that those rapid rises in interest rates are having an effect on cooling economic activity, the labour market. So, the medicine is working and the question is do central banks over-tighten? I think we're at the peak of interest rates and I think the lags in their impact will continue to constrain activity a bit. There may be a technical recession, which is two consecutive quarters of negative GDP activity, but it would only be pretty shallow.

I think there is enough in valuations not to get too pessimistic. I talked about valuations. What I mean by that are price earnings ratios, dividend yields, numbers that you can really hang your hat on to give you a base level. I think this is an attractive entry point for many investors in the market, regardless of what the mood music is at the macro level.

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Kyle Caldwell: Of course, UK equity funds, they've been out of favour for a number of years now, pretty much since the Brexit vote. So, could it be in 2024 that these low valuations will finally start to draw people back to the market?

Sue Noffke: I would hope so, because valuations are really important. They are the most important driver of investors’ future returns. Much more than growth. That's also important, but your entry point is a key determinant. So, if you're buying low, you give yourself the best opportunity to make positive returns. If you're buying high, you've really got to get that growth to deliver and surprise to the upside. So, in terms of what can change, you're right that we've seen negative flows.

There are a number of initiatives that could start to change that. But I think what we've seen around global markets is there's only been one game in town and that's US equities. And even within US equities, it's been the Magnificent Seven, those large hyper-scale tech stocks. If we see any crack in that or an ability for people to think, I want some diversity in my portfolios at an asset allocation level, that could just stop the outflows from UK equities. The reasons are very similar if you look at Europe and Asia-Pacific as well. So, if you just stop that magnetic draw into US large-cap tech, I think other markets have a chance.

Kyle Caldwell: In terms of valuations for the UK market, within the investment trust you manage, where are you finding the best value opportunities?

Sue Noffke: At the small- and mid-cap area. So, these have been de-rated for almost three years now. And these are areas that have driven fantastic returns for investors over multi-year periods. So, over 25 years through to the end of 2021, the FTSE 250 area of the market, what we call the mid-caps, had kept pace with the S&P 500 over the same period. So, it's a good starting place.

They've de-rated now to extraordinarily low levels compared to their own history and really attractive levels within the broader market. So, the yield gap has closed in. I'm able to find many mid-cap stocks with the same yield characteristics as I'm looking at for larger-cap stocks. And the price/earnings ratio has also compressed to really attractive levels. So, I'm as overweight in that area for the trust as I've ever been.

Kyle Caldwell: So, in terms of more recent portfolio activity over the past couple of months, has it been that area where you have been increasing exposure to, and have any new holdings been introduced?

Sue Noffke: There have been a couple of holdings introduced to the portfolio as well as topping up some of our pre-existing holdings. So, one stock that we have topped up would be defence services provider QinetiQ (LSE:QQ.). It's in the mid-cap area and it's de-rated down to about 11 times through to 2 March 2024. For an international business that's growing organically with the potential, with a strong balance sheet, to do supplementary bolt-on acquisitions.

We know that geopolitics has reared its head in an ugly way around the world in the last two years, and I think that's going to stay with us. They focus on cyber-security as well as getting forces battle ready and doing a lot of tests and evaluation. So, I think that's a pretty exciting value opportunity within the portfolio. What we also do is keep a watch list, or a subs bench of stocks, where we've done the work, but we're waiting for the right opportunity to present itself.

One such stock would be Cranswick (LSE:CWK), which won't sound terribly exciting when I tell you what it does, which is bacon, sausages and breaded chicken. But it is a fantastic operator within its market. It's well invested. It's taking a lot of share. It's supplying McDonald's in McCrispy Burger. And it has fantastic growth opportunities. It's also been de-rated in that two to three-year sell of Smid companies, from what was about a 20 times price earnings multiple down to about 15, and we think that is a great opportunity to buy into a long-term growth opportunity. So that one has gone into the portfolio recently.

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Kyle Caldwell: One of the differences between investment trusts and funds is that investment trusts have the ability to gear, so they can borrow to invest. Given that the valuations for the UK equity market are cheaper than usual, have you been increasing gearing levels to take advantage?

Sue Noffke: Yes, we're not quite fully maxed out, but we're pretty much at the maximum. We've got a £30 million facility that has been renewed. We averaged 12% gearing through last year, and at the end of the fund's year, which is the end of August 2023, we were over 13.5% geared. So that's putting our money where our mouth is.

Kyle Caldwell: And finally, a question we ask all fund managers, do you have skin in the game?

Sue Noffke: Yes, I do. And I took the opportunity when the trust was trading at a double-digit discount last month to top up holdings.

Kyle Caldwell: That’s great to hear. And, Sue, thank you very much for your time.

Sue Noffke: Thank you.

Kyle Caldwell: That's it for this episode of our Insider Interview. I hope you enjoyed it. Please like, subscribe and comment, and hopefully I'll see you again.