Man GLG’s Dixon: My three biggest fears for markets in 2015

Henry Dixon, manager of the GLG Undervalued Assets Fund, believes there are three major concerns that should be at the forefront of investors’ minds as we enter the final stages of 2014.
The manager of the £220m fund, which was launched a year ago and has achieved top decile returns since inception[1], said the rollercoaster year for equity markets could well be repeated next year if certain scenarios materialise.
Dixon, whose fund has returned 7.8% versus the IMA UK All Companies sector average of 2.1% since launch a year ago[2], is focusing on investing in companies which have strong balance sheets, preferably with net cash positions, in the face of three major risks for markets.
He said continually poor liquidity, the tumbling oil price, and China’s unwinding property market bubble could all derail equity markets in the New Year.

1. Liquidity

“With the end of quantitative easing (QE) in the US and the severe reduction in banks acting as market-makers in a post Financial Crisis world, there are signs of a material drop-off in liquidity in certain markets,” Dixon said.
“This can inhibit the true price discovery of certain assets and lead to extreme volatility, particularly in certain small-cap equities and some areas of the high yield credit market.
“Whilst action from the Bank of Japan and the European Central Bank (ECB) could well mean there is more central bank liquidity in markets next year than this, it is our view that this defers the problem of inflated asset prices rather than solves it.
“Thus we feel it prudent to place a greater emphasis on liquidity as defined by daily trading volumes and also by placing an extreme importance on a strong balance sheet at the company level, with emphasis on net cash.”

2. Oil price fallout

“The high yield bond market could come under stress given its dependence on energy and mining companies for coupon payments, following sharp falls in the price of oil,” the manager said.
“The commodity has now fallen more than 25% in a year[3] and we look to be coming to the end of a commodity super cycle. It is not hyperbole to say this could be the sub-prime of today.
“Indeed in our view, there appears to be an asymmetric risk/reward in many oil-related names, and we have recently reduced our positions in Royal Dutch Shell and Dragon Oil, and sold our holding in Ithaca Energy, while taking advantage of the low oil price to add to our holding in TUI Travel.”

3. Chinese Property

“A well flagged issue, but with house prices now falling in every region across China it has the possibility of materially affecting the Chinese economic story and precipitating a material slowdown in Chinese (and consequently global) GDP growth,” Dixon said.
“We do not believe a systemic global banking risk exists from Chinese bad debts, but we think the risk that Chinese growth trends down materially from current market expectations is statistically likely.
“This is certainly not being factored into earnings estimates or valuations of either the miners or the engineers that are geared to Chinese growth.”
Relative attraction of equities over bonds
However, while markets face potential headwinds, Dixon said the recent flight to safety which has taken core government bond coupons back near record lows means the relative yield attraction of equities versus fixed income is more pronounced than at any stage over the last 95 years.[4]
“Only twice before (March 2009 and December 1940) was the yield gap close to the current level, and in both instances the next twelve months were characterised by materially above average returns,” he said.[5]
“We are extremely cognisant of the risks that have got us to this extreme. However, we believe this level of relative dislocation throws up some attractive opportunities.
“Within our overarching value framework we are exposing ourselves to idiosyncratic stories, rock solid balance sheets, attractive absolute valuations and developed market consumer cash flow which is now growing at its most sustainable rate since the late 90s.”[6]
 
[1] Source: Lipper Hindsight, 15/11/2013 to 14/11/2014, Acc C GBP share class
[2] Source: Lipper Hindsight, 15/11/2013 to 14/11/2014, Acc C GBP share class
[3] Source: Thomson Reuters ICE Brent Crude Oil Front Month to 25/11/2014
[4] Source: Lazarus Partnership, Bloomberg
[5] Source: Lazarus Partnership, Bloomberg
[6] Source: Lazarus Partnership, Bloomberg