Henry Dixon, fund manager of Man GLG Income, sits down with interactive investor’s collectives editor Kyle Caldwell to discuss the cheap valuations on offer in the ‘unloved’ UK equity market. Dixon details how he is investing in a rising interest rate environment, names two stocks he’s finding plenty of value in, and explains why he is a fan of the banking sector, using the recent turmoil to up his stake in his favoured play.
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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 Henry Dixon, fund manager of the Man GLG Income fund. Henry, thanks for your time today.
Henry Dixon, fund manager of the Man GLG Income fund: Thank you for having me.
Kyle Caldwell: A notable trend for a number of years now has been UK fund investors venturing overseas for income, which has seen a lot of money go into global equity income funds, and a lot of money has come out of UK equity income funds. What are your thoughts on that trend and how would you try and convince someone to back the UK today for equity income?
Henry Dixon: Yes, absolutely. I think the exodus for UK assets has been well documented and consistent. And that's clearly, on one hand, a huge shame. But if you look forwards now, you would say the relative value metrics are outstanding, really, versus history, so if you look at relative value on earnings, and certainly the dividend yield on offer now is well in excess of other global markets, even other good value markets globally.
So, I think the value is becoming quite apparent. And it is not until investors start to see that value being rewarded that maybe they might respond to it, but I think it is pleasing when we look at last year, in a year where it was so brutal for vast proportions of the asset spectrum, almost the entirety of the asset spectrum, that the UK market actually registered a positive return and the fund managed to slightly beat that. So, I think that's very rewarding, and it should give people pause for thought, in a slightly higher interest rate environment, that value does have a part to play.
The other thing that's important, if you look at M&A trends and compare them globally, it's certainly the case that probably [one] of the most active markets in the world right now for M&A is the UK market. And I think that's corroboration of value from businesses, from trade buyers, from private equity. And there is now a reasonable amount of evidence building that the value is not maybe just being spoken about by UK fund managers, but it is also being rewarded by investment with better performance and then also corporate activity.
Kyle Caldwell: That better performance, particularly over the past 18 months or so since interest rates have started going up, that's been driven by the fact that certain value sectors have performed well, the likes of the oils and the miners. Do you have exposure to those areas and what other companies have fared well for the fund?
Henry Dixon: Yes, absolutely. Certainly, if I think about 18 months ago, we were exposed to both oil and mining. I felt at the time that mining was, if you like, a less controversial part of the portfolio because it was deemed to be part of the solution, not necessarily the problem. Metals such as lithium, cobalt, copper, these were all clearly going to be part of, if you like, the new economy that we looked to.
And it was certainly a cheap sector 18 months ago. We sought to move on from mining quite clearly [in the] middle of last year, towards the end of last year. The rationale being that we'd started to see some cost creep, started to see some slight change in investment intentions. And if you start to see some more supply creeping on, that can have detrimental effects for the prices of commodities, and I think that has started to play out now.
Oil was a harder decision certainly 18 months ago. It was a very tarnished sector. But we absolutely saw a sector that was trading, in many ways, under the wrong name. It was ultimately a gas sector, not an oil sector, and we thought gas had a part to play in energy transition. And we saw huge value 18 months ago. We've actually, in similar fashion to mining, but not quite as much, it's still a reasonable sector, we've been keen to take some money out of the oil sector lately. Just because, 18 months ago we had unbelievably good value, we had fantastic free cash flows, and critically we also had good momentum because of where the oil price was. Now, clearly the oil price today doesn't provide you with that momentum.
If I think about other areas that have really benefited from interest rate rises, we shouldn't underestimate the sea change in interest rates. I think it's transformed the competitive dynamics of a few sectors because in so many places you saw new entrants who weren't really playing by the rules of capitalism, which is when you start to lose money, you think about stopping.
In an era of free money and zero rates, they were happy to keep funding losses, which was very difficult for certain incumbents. So, I think about the demise of Bulb Energy, for example, being the rise of Centrica (LSE:CNA). When a big competitor like that has to leave, that's a huge moment, and it can be a powerful moment. And then another area that's been very good over the past 18 months would be non-life insurance. I think of names such as Beazley (LSE:BEZ). But a lot of capital made [its] way into their market in an era of zero rates because [of] trying to get an excess return. But as rates have risen, a lot of that capital is left, and I think that's very important, and that's really made the company able to capitalise on great pricing, great volumes, and the shares have responded very well.
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Kyle Caldwell: So, where are you finding the best value opportunities at the moment? Are there any sectors that you'd highlight, and what have been the most recent purchases for the fund?
Henry Dixon: The mining sector has been very weak. A lot of the excitement over China reopening last year was probably slightly misconstrued. I thought it was going to be more service-based excitement rather than fixed-asset investment. But you'll see a name such as Anglo American (LSE:AAL), down the best part of 30% this year, trading at a level now I think would be impossible to replicate that asset base for the current price on the screen. Very strong balance sheet, net debt EBITDA certainly below one, valuation modest, seven, eight times earnings with a yield there, so I think we're quite keen to buy into that weakness.
I think another area that we've been quite keen to push against some of the negativity that has played its way out in the market with regards to consumer trends, we added Associated British Foods (LSE:ABF) to the portfolio, which is the owner of Primark, but it also has ingredients divisions, so Twinings Tea, and it also has a commodity-based business as well.
And again, it was a case of the valuation was very low, the shares had been poor. So, you're looking at 12 times earnings, very strong balance sheet. Again, you had 10% or 15% of the market cap in cash. So, hopefully it's a recurring theme of areas of the market have done badly, maybe sentiment is negative to them, but in all instances we think we're buying into good franchises certainly, great balance sheets so these businesses have time to maybe weather a difficult point in the cycle, and hopefully as that cycle eases, I think you can see a situation where share prices can make some headway.
Henry Dixon: We certainly wouldn't want to own all of a sector. We feel we can own some of the cheapest elements within a sector rather than having a broad base of a sector, and it's certainly an emotive sector now given events this year. From our perspective, our excitement in being invested is that we see a lot of the issues that maybe were part and parcel of the global financial crisis not being present. And I think, interestingly, we see valuations that at times, in places now, are just as cheap as they were even at the nadir of the global financial crisis, where you had no idea about the share count, you had no idea if the businesses were going to be profitable. But today you have a lot of profitability. You have valuations on price to book that marry up with points in time in the global financial crisis, and based on earnings, it's a huge disconnect versus the wider market at a time when a huge amount of these earnings and their excess capital is making its way back to shareholders in the form of dividends and buybacks, which paves the way for total returns of sort of mid-teens. It is certainly a slightly controversial area of the market. It's a part that we are overweight. But, as ever, you tend to find some of your best returns come from those controversial areas. I think about the position we took in the oil and gas sector 18 months ago, that was very unpopular, very controversial at the time, but did pave the way for good prospective returns.
Kyle Caldwell: As you alluded to, the banking sector has been in the headlines of late. There are a couple of US banks that fell into difficulty. Did this change your view on the sector, and what are your thoughts on fears out there that this could be the makings of a 2008 banking crisis all over again? Why is it different this time?
Henry Dixon: I think there are quantifiably four differences today with 2008. First, there just has not been the level of lending growth in our sector versus in the run-up to the global financial crisis. Loan books almost tripled in size in the five years preceding 2007. And when you have that level of loan growth, you can see the elevated probability of bad debt, [and] poor lending decisions, so that's not a feature.
I think you'd also point to capital ratios being twice to three times higher than they were in 2007. And, critically, liquidity ratios being some 10 times higher, so that's to say the amount of money central banks [have that] can cover any deposit outflows. I think that's important. And again, I would just come back to valuation, which during those fearful months and weeks got back to lows we haven't seen since the global financial crisis, so it feels different.
The other difference is I think the regulators move very quickly and decisively, which maybe didn't happen in the global financial crisis. I think to have these mergers over a weekend draws a good line in the sand, [and] does it quickly. And those types of events do really help not let fear and contagion bleed into the wider sector.
And then also historical parallels with what's going on. If you go back to the mid-1980s there was a significant number of US bank failures. In any given year, you might have a bank failure almost every day. And that didn't disrupt the wider economy, didn't disrupt wider markets, nor the banking sector. So, as we marry all that together, we have to be watchful. The key things for us are certainly [to] think about deposit trends, liquidity. Those are the two things that we're absolutely monitoring. But while being watchful, with this level of valuation support, [it] is still an area that we're prepared to back.
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Kyle Caldwell: And when there was that volatility back in April, was that a potential buying opportunity, did you add to those two bank stocks that you've got in the top 10?
Henry Dixon: Yes. We found it easier to add to HSBC, maybe than some of the domestics. The reason for that is relative valuation versus the global financial crisis, and I also think that the SVB deal by HSBC will prove to be a good one. When you pay £1 for well over £1 billion of tangible asset value, it could quite definitely prove itself to be a very good transaction. And then also, if I look [at] the prospective returns, a few of the cash returns are certainly paid out domestically. I think about NatWest Group (LSE:NWG), which has been a very good performer, but I think we're coming to the end of its excess capital return, whereas I think we've absolutely got the capital return ahead of us at HSBC, so that was why we wanted to visit that on the weakness.
Kyle Caldwell: Valuation, it's a very important part of your investment process. So, when that valuation rises and becomes more pricey, how do you determine whether to sell a company, or do you run your winners?
Henry Dixon: Good question. I think sell discipline is vital. We are very price target-orientated, so certainly it wouldn't be a case of we run our winners for the sake of it. We'd have to have very good new information to run our winners. In general, I make the observation that people are probably better at buying shares [than] necessarily knowing when to sell shares. And we certainly look very hard at what happens after we sell a share. And it can be the case, and typically is the case, that the shares we sell do go on to outperform. But what's vital is that we rotate into ideas that outperform that further. So, with that in mind, it's vital that you have a good bench of ideas and robust competition for capital within the fund, outside the fund, at all times, and you're constantly trying to optimise a portfolio with the most upside, best liquidity. And it's that competition for capital that is vital to ensuring that.
Kyle Caldwell: And finally, do you personally invest in Man GLG Income fund?
Henry Dixon: Oh, absolutely.
Kyle Caldwell: Henry, thanks for coming in today.
Henry Dixon: Thank you, Kyle.
Kyle Caldwell: That's all we have time for today. You can check out the rest of our Insider Interviews on our YouTube channel where you can like and subscribe. Hopefully, see you next time.
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