Companies are continuing to trade strongly and valuations look highly attractive

We are continuing to see the majority of our portfolio companies trading strongly and delivering updates either in line with forecasts or surpassing them, despite the challenging economic backdrop.

Asset manager Man Group is a good example. The company reported $1.1bn of inflows in the first quarter, which was slightly ahead of expectations, and a significant proportion of these flows went into the company’s absolute return strategies, which command higher margins, so this is positive for earnings. The company pays an appealing dividend yield of 6.5%, which is covered twice by free cash flow, and it has £700m of net cash. It is on an attractive valuation, with a price-earnings (P/E) multiple of 12.5x (falling to 8.5x for estimated earnings in 2024), and is well positioned for future growth.

Morgan Sindall is a construction company that operates in areas where we see particular opportunity, including infrastructure, social housing and urban regeneration. It reported record results earlier this year. The stock is on a dividend yield of just under 6%, which is covered 2.5 times by free cash flow, and, unusually for the construction sector, the business has maintained average daily net cash of £256m on the balance sheet over the past year. Morgan Sindall is on a P/E multiple of less than 8x and we believe it has very healthy long-term growth potential.

Another strong performer is NWF Group, which is a distributor of fuel, food and animal feed. It released an update in March saying May’s full-year results are likely to be ‘significantly ahead’ of expectations. The stock is on a dividend yield of more than 3%, which is covered 2.5 times by free cash flow. NWF is expected to have net cash of around £5.5m (excluding leases) when it reports in May and is attractively valued on a P/E multiple of around 9.5x.

We believe UK equities remain significantly undervalued relative to other developed markets. Simon French, Chief Economist at broker Panmure Gordon, calculates that even after adjusting for the varying characteristics of different markets, UK companies are at a discount of around 18% to their peers listed elsewhere.

Our view that UK companies look very attractive at current valuations has been borne out by a recent increase in merger and acquisition activity. This included Deutsche Bank agreeing to buy the broker Numis, which we hold in the fund, at a 72% premium to the pre-deal share price.

Looking ahead, we believe the second half of the year could offer all the ingredients for a robust performance by equities. The Bank of England is forecasting inflation will begin to fall sharply and we are likely to be nearing the end of the rate-hiking cycle.

In our view, the first announcement that rates are to be held as they are, or even cut, will act as a positive catalyst for markets and encourage investors to focus once more on company fundamentals. A consensus also appears to be emerging among investors that the dollar will weaken over the next year or so, translating into stronger sterling. This is likely to benefit domestically focused UK companies, particularly small and mid-cap stocks.

In this environment, and with valuations at current levels, we believe that the quality dividend-paying companies in our portfolio present a highly attractive opportunity, particularly since small and mid-cap companies are likely to be at the forefront when investor confidence returns.

Sid Chand Lall 05/05/23

Risk Warnings

Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Our funds invest for the long-term and may not be appropriate for investors who plan to take money out within five years. The fund will be exposed to stock markets and market conditions can change rapidly. Prices can move irrationally and be affected unpredictably by diverse factors, including political and economic events. The fund invests in smaller companies which are typically riskier than larger, more established companies. Difficulty in trading may arise, resulting in a negative impact on your investment. The fund invests mainly in the UK therefore investments will be vulnerable to sentiment in that market which may strongly affect the value of the fund. In certain market conditions some assets may be less predictable than usual. This may make it harder to sell at a desired price and/or in a timely manner. All or part of the fees and expenses may be charged to the capital of the fund rather than being deducted from income. Future capital growth may be constrained as a result of this. Dividends paid by companies are not guaranteed and can be cancelled, which may impact the fund’s ability to deliver an income to investors.

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