Buxton: Equity Opportunities in Defensive Areas

Holly Cook: For Morningstar, I’m Holly Cook. I’m joined today by Richard Buxton, he’s manager of Schroders UK Alpha Plus fund. Richard, thanks for joining me.

Richard Buxton: Not at all.

Cook: So ahead of the recent UK general election, you vocally were saying that you were expecting to see a Conservative majority government. How do you feel about the coalition government we’ve ended up with and what do you think will be the impact for UK investors?

Buxton: Well, yes, you’re absolutely right, I got that one wrong—to the extent that I did think that the Tories would win enough to get a majority—but as it’s panned out I think it’s actually an even better scenario than that would have been, because clearly as a country we face some huge difficulties in tackling the fiscal deficit, and the fact that we’ve got a coalition government that seems to be pretty united at this stage in terms of its ability and desire to tackle that means that we’ve actually got a majority of the voting public that have voted for the people who are going to have to push through the tough measures, so at the moment, you know, early days, but I’m pretty constructive on that.

Cook: And in the market recently, we’ve seen an awful lot of turmoil, the European sovereign debt and the ‘flash crash’ on Wall Street recently, how confident do you feel about the investing environment in the UK?

Buxton: Well it’s a difficult time to be confident because of the scale of the difficulties we’re facing and the volatility that you’ve mentioned. But at the moment it’s very much split between, sort of, the public against the private sector, because if we look at what’s going on in the private sector we’ve actually got some pretty strong surpluses within the corporate sector. Results are continuing to beat expectations, you’ve got some very strong balance sheets, strong cash flow, companies putting through above-expectations dividend increases and this is all pretty supportive. And yet, as you say, there’s a lot of focus equally on the public sector finances, and the fiscal deficits, and the European sovereign debt crisis, and clearly the numbers and very large and quite scary. And this is why I’ve said all year that I thought we would trade in a very wide range in Footsie terms—5,000 to 6,000 or thereabouts—because whenever the market’s focussing just on what’s going on in the corporate sector, it will tend to rise; and then whenever it’s thinking about, ‘cripes,’ how bad things are in the macro environment for the public sector, then there’ll be very sharp, savage sell-offs.

I think you’ve got to take a two/three year view and ride through this, accepting that policy makers will ensure that interest rates stay sufficiently low to offset the fiscal tightening, and that whatever’s necessary in terms of debt rescheduling, bailout, buying time for those countries to get their house in order will eventually happen.

Cook: So what would be your outlook for the UK market over the next 12 months or so, and are there any particular areas where you see opportunities?

Buxton: Well I continue to think it is going to remain volatile, we are going to be stuck in this trading range—quite a wide range—through the course of this year, but I don’t think we’re going to just give up all of 2009’s gains and reverse. And I can see opportunities right across a whole range of different sectors in the market, but again very much having to take a two/three year investment time horizon.

I can see opportunities in some of the more defensive areas of the market, stocks like Centrica, which I hold, where there’s very much a self-help management story of change within their business. Within more cyclical areas, you know, you can’t get a more cyclical stock than British Airways but I think things can’t get any worse for this company and it’s extremely cheaply valued. And across a range of stocks that I regard as the sort of engine of the portfolio at the moment, that will continue to grind out growth more or less irrespective of what’s going on in the UK economy. Stocks like Rolls-Royce or Unilever—with a lot of developing and emerging markets exposure, Experian, Burberry, these are names that I think will continue to deliver very attractive returns in the medium term. So across a whole range of areas I think you can find opportunity.

Cook: Now, as manager of Schroders UK Alpha Plus you steered the fund through one of the most bullish markets that we’ve had in history during 2009, early 2010. You not only outperformed the market but your peers as well. Are there any particular portfolio decisions that you’re either particularly proud of or disappointed in?

Buxton: Well I think, it was a very good year in 2009 but let’s put it in context. The portfolio suffered in the back end of 2008 as I didn’t anticipate how bad things were going to get, and the fall of Lehman, and so on.

The conviction to stick with shares that fell very heavily to valuation levels, that we just couldn’t get our earnings forecasts lower enough to justify the share price, was difficult but with hindsight I’m very pleased that we did do that. I’m pleased that we toned the beta of the portfolio down through the second half of 2009, precisely because I felt that it would be more volatile in the course of 2010. Things that haven’t gone as well: clearly, when you are trimming positions as they’re rising, inevitably you leave stuff on the table and you look back and say “gosh, I could have held on and made more.” And equally, adding to positions, and particularly through the early part of this year, there are some cyclical names I’m buying today. And it is a very gentle, slow process because it is investing for a two-to-three year time horizon but you accept that the early purchases, probably at valuation prices, you could have done better. But as I think, as I say, on a two-to-three year basis you will make money out of them.

Cook: Given the opportunities that you mentioned earlier, it doesn’t sound like you’re battening down the hatches so much. You’re fairly optimistic going forward, is that fair to say?

Buxton: It is. I’m not expecting huge returns out of the equity market this year. After an enormous gain in 2009, it would be no surprise if you had pretty modest returns this year. But I don’t think it’s going to be a substantial negative return. As I say, given the strength of the corporate sector and the valuation opportunities that I can see in the companies that I own, I do think that I’m pretty optimistic on a two-to-three year view for those companies I’m invested in.

Cook: That’s very nice to hear some positivity there. Richard, thanks very much for joining me.

Buxton: Not at all, thanks.

Cook: For Morningstar, I’m Holly Cook, thanks for watching.