A fund manager’s stock picks for 2020

Freddie Lait, manager of Latitude Horizon Fund, tells ii's head of equity strategy Lee Wild when the FTSE 100 will top 8,000, stocks he backs in 2020 and the deepest value FTSE 100 share. 

Lee Wild, head of equity strategy at interactive investor:    

The election is done and dusted and there’s a significant Conservative Party majority, exactly what we’re told the markets wanted. We had the initial ‘Boris bounce’, but what is your reaction to the actual result, both in terms of what it means for market direction and asset choice?

A couple of other questions; how high can UK indices go, are we looking at 8,000 for the FTSE 100 this year?

Freddie Lait, manager of the Latitude Horizon Fund:

I think its unmitigated good news for the market. I think the risk of a Corbyn government was one of the primary concerns for the market for the last few years. You've seen business investment stalling and markets far below their global peers. 

But we're not out of the woods yet, you know, we still haven't had a Brexit, there's been new legislation put forward by Boris Johnson, which is causing the pound and the markets to fall. So, I think we're going to continue with a period of uncertainty, albeit probably with a higher level of certainty as we enter 2020.

So, I think that's very good news for the market. The FTSE itself should bounce, but it will depend on sterling because 75-80% of the FTSE's earnings are overseas, so as sterling rallies those overseas earnings are translated back. 

But I do believe 8,000 is a fair level for the FTSE 100 by the end of [2020]. 

Lee Wild:    

Mid-caps have been beneficiaries haven't they, so we talk about the FTSE 100 and 8,000, but should investors be looking at the FTSE 250 in 2020?

Freddie Lait: 

Yes, I think investors really should be focusing on UK domestic stocks. There's plenty of stocks that are in the £2-10 billion market cap, UK focused, very high-quality businesses like Howden Joinery (LSE:HWDN) or Tesco (LSE:TSCO), and things like that, where the majority of the earnings are earned in the UK. 

Those are the stocks I’d be focusing on as opposed to those overseas earnings if you're trying to play a lowering of uncertainty and improved investment outlook in the UK itself. 

Lee Wild:

In your latest market commentary, which I read with interest, you talk about “hunkering down for the winter”. That was pre the election result. Is the result forcing you to make changes to your portfolio? Is it going to happen now, or is this something that happens over time?

Freddie Lait: 

So, we broadly thought that this result was the most likely and put the portfolio together in that way in anticipation. So we've done well throughout the last few days and hopefully will in the future. The hunkering down point was really that it's been a series of bottom-up decisions. It’s more of an output than an input.

At Latitude we don't tend to make big macro decisions, believing it's much harder than making lots of little individual bottom-up decisions. And as a result of most global stock markets being quite expensive, having great success with our stock picking, and our bond picking this year, we've just cut it a little bit back, gone to shorter duration, gone into a bit more cash, fully hedged back to sterling and waiting to see when the markets give us a little bit more clarity.

Lee Wild:  

You mentioned UK assets, the FTSE 250, mid-caps primarily, so we saw a significant rally post the election, in the past few days. But how is the equity portion of your portfolio split geographically, are you switching more money into UK stocks, or are you happy with the split?

Freddie Lait:    

We're happy with the split, as I said, we've been invested like this for the last sort of 6-12 months. We have about 15% of our equities invested in the UK. But we tend to invest in very large liquid stocks, you know, mostly global in nature, some have domestic exposure, like Tesco's or some comparable businesses in Japan or in the US.

But I think we will continue to hold that sort of allocation, and we won’t be trading more into the UK market. I think it is probably due a short-term bounce, but there's still a lot of uncertainty. And we invest with a five or 10-year outlook, as opposed to one or two years.

So, the stocks we've got have benefited from this bounce and that's nice to have, but we're not going to try and concentrate our bets on that one thing.

Lee Wild: 

But I guess a lot of people will like the UK for 2020, you say you've got 15% of your portfolio allocated to it. In terms of stock picking, or stock ownership in your case, which UK stocks do you own at the moment, which do you think will do best out of this election result?

Freddie Lait: 

Looking at the larger liquid section of the market, again, which is where we tend to invest, you know, the stocks that I really think are great, Unilever (LSE:ULVR) is a big global stock, but won't enjoy a very expensive sterling. 

What you've seen is a little bit of a reset from the management team recently, the stock is trading relatively cheaply compared to recent history. I think it's just one of the highest quality consumer staple stocks in the world, with great [developed market] exposure, and great household product exposure on top of the food businesses that everyone knows. So, I think that's a really good one for the long-term investor. 

Tesco I continue to believe has gone through a great period of turnaround in the last five years, incredibly high cash flow, incredible market share and one to invest in if you've got a little bit more risk appetite. And then, for the higher risk investor, I suppose the deepest value stock in the FTSE 100 is Imperial Brands (LSE:IMB), the tobacco and vaping business. It's trading on six times earnings, it's got a near 13% cash flow yield and earnings are actually growing. So it's incredibly interesting for the longer-term investor as well. 

Lee Wild: 

But every year, there's always one standout investment strategy, one that generates knockout returns. What do you think is going to be the winning trade in 2020?

Freddie Lait:  

I wish I knew. I think the key thing to remember, and this is a bit of a broad answer, stocks themselves, good high quality stocks in our opinion, but whichever stocks suit your investment strategy, equities continue to be the best, most attractive asset class globally. When you think of what's happened to bond yields and yields on cash around the world, they're almost zero everywhere.

And that means that things like bonds are incredibly expensive, infrastructure projects are very expensive, real estate, not to mention illiquid, but within equities you can pay 15 times earnings if you're buying FTSE shares for highly liquid assets that have a good index-linked dividend yield and I just continue to believe that whatever your market weight in equities is, you should be at that across the world. 

Lee Wild:

It's a bit of a Desert Island Discs question for you now Freddie. What would be your stock pick for 2020, you're allowed one UK share and one overseas share?

Freddie Lait:  

I'm not very good at calling short-term returns, but I think next year Tesco is going to come into its own, so it’s a stock we've owned for a number of years, everybody knows it. Super high free cashflow and an increasing level of free cashflow coming out of that business. 

A lot of options around their new stores, their Clubcard Plus programmes, their farm brands, own brands business. So, I continue to believe the next three to five years will be very bright for Tesco. Hopefully 2020 will be a good start to that.

On the international stage, another retailer that we've been looking at is called Advance Auto Parts (NYSE:AAP) in America. They're a little bit like a Halfords type business in America, there's three of them in the market. The other two players have already doubled in the last couple of years, and Advance Auto Parts has been lagging slightly, as it changes its management and addresses a few of its integration issues.

But I believe that the stock is set to double earnings over the next three to five years. It's going well through its turnaround phase as well. Highly insulated from the likes of Amazon (NASDAQ:AMZN) or anyone else trying to compete, because they're heavy, bulky, service-led items. You want help with your wiper blades, things like that. 

So I think that will do very well [in 2020] and could rerate substantially. 

[Video filmed on 17 December 2019]