Income stalwart Adrian Frost has downplayed market concerns around ‘bond proxy’ names, but suggests the likes of retail companies face unacknowledged headwinds.
Mr Frost, who runs the £6.4bn Artemis Income fund with co-manager Nick Shenton, pointed to rising inflation expectations as one such concern.
“Normally we desist from talking about the macro, [but] Donald Trump has got 280 campaign pledges [to fulfil]. They look inflationary to us,” Mr Frost said.
“We think this is a turning point. Bond yields will continue [to rise] – they won’t go back to the quantitative easing days.”
But he departed from the line taken by some income managers who have been reviewing the ability of bond proxy stocks – those that share some attributes with fixed income securities – to endure inflationary pressures.
“It’s not just about having bond proxies; in the main, many of them are growing,” he said.
“They happen to be highly valued, but for us it’s [also] about the growth that’s expected and the chances to achieve it. In the long term, can they do what investors expect and more?”
Some retail companies that meet the bond proxy description, such as Unilever, have become a cause for concern for the managers.
“There are some really interesting things happening in the industry that are not recognised by the market,” Mr Shenton said.
He noted successful start-ups such as Dollar Shave Club – acquired by Unilever last year – and Huda Beauty had established a market presence by harnessing social media, indicating that small businesses could exert downward pressure on industry margins.
“Dollar Shave Club launched five years ago and now it thinks it has 15 per cent of the market in the US,” Mr Shenton said.
“It sold the business to Unilever, which doesn’t create these businesses but is good at buying them and scaling them up.
“The stockmarket has been very accustomed to Unilever being a safe stock that makes you feel warm and cosy and has no risks. It grows margins, but the issue is [the insurgents] aren’t making margins.
“If [Unilever] is going to grow Dollar Shave Club, its margins are going to come down. The barriers to entry for growing a brand have clearly been structurally lowered.
“These are challenges for Diageo, Unilever, Next and Marks & Spencer. We see the earnings model under some pressure – that’s not the market narrative. These are trading at all-time margins and prices,” he added.
In late December the managers held 6.8 per cent in consumer goods and 18.2 per cent in consumer services.
Elsewhere in the fund, financials made up 31.4 per cent, with “7 or 8 per cent” in banks, according to Mr Frost.
“We are not a lopsided fund that, after eight years, has to go to the cupboard and find a file that says ‘banks’ and say ‘how do they work again?’ We run a relatively diversified portfolio,” he said.
Mr Frost also claimed that, while the value rally had proved difficult for UK managers, the drivers of such momentum had limits.
“We are a commodity-based market [in the UK]. I think that’s quite a good sector position to be an active manager against,” he said.
“If share prices get to a certain point, prices are high and stimulate supply. We have got huge respect for our US team, where a lot of their benchmarks are [the likes of] Facebook and Amazon.
“There’s a lot of mean reversion that sits with commodities.”
KEY FIGURES
2.4ppt
The fund’s underweight in Diageo compared with the FTSE All-Share
15%
Estimated US market share achieved by Dollar Shave Club
