Annual Report 2017

Investment Strategies

Regional Equity Strategies

US Equities

We manage the US Small and Mid Cap Equity (SMID) strategy from JOHCM’s Boston office. The investment philosophy centres on the belief that sector-based investing is the optimal way to identify long term winners, with important advantages in return and risk.

We have identified some key beneficiaries of Trump’s policies at the sector level, particularly within defence and infrastructure. These stocks were among the prime beneficiaries of Donald Trump’s election, as many expected the administration to increase spending on the country’s decaying roads, bridges and related projects. The 2017 Infrastructure Report Card, released by the American Society of Civil Engineers, awarded the country a grade of D+, clearly indicating room for further improvement.

Although the so-called ‘Trump trade’ subsided early on in 2017, the topic has remained on President Trump’s agenda. Among our related holdings in this segment are Terex, a Connecticut-based manufacturer of construction and transportation equipment, Jacobs Engineering, a Texas-based provider of construction services, and Martin Marietta Materials, a North Carolina supplier of construction materials, including granite, gravel and cement.

President Trump has also been a vocal advocate of greater defence spending, with additional support from the House and Senate Armed Services committees. More recently, concerns have centred on North Korea, which conducted several missile tests in July and August 2017, sparking widespread international condemnation. Rhetoric has been heating up in the region, with countries like the US, Russia and China contributing to the conversation.

In addition to worries about conventional warfare, scrutiny has been mounting on the recent proliferation of cyberattacks. For instance, computers from Ukraine to the US were hit by ransomware attacks in late June, while another ransomware attack targeted governments, hospitals and companies in Europe in May. In that vein, the portfolio holds Booz Allen Hamilton, a Virginia-based government cybersecurity consultant. Although it is technically not in the industrials sector, we view this information technology name as a compelling play on defence.

Strong stock selection across a number of sectors led the strategy to outperform meaningfully over the period. Leading the way were the portfolio's industrials holdings, with the above-mentioned Terex being the clear stock winner. The construction equipment manufacturer has a solid backlog and a promising turnaround plan that is currently under way. Staying with the sector, Old Dominion Freight and HD Supply also made notable positive contributions. The consumer staples and telecommunications sectors were also happy hunting grounds, with Cogent Communications' share price buoyed by results in the September quarter as the company delivered a solid quarterly earnings report and Moody’s lifted its ratings outlook to positive. Elsewhere, the share price of health care provider Centene benefited after plans were announced to offer coverage in areas without other Affordable Care Act options.

The only material performance headwind originated in the information technology sector, where stock selection impeded performance. Here, travel technology company Sabre was the standout individual laggard. Its share price sold off after it reported mixed fourth quarter results and a disappointing full year forecast that reset expectations.

Despite some setbacks on health care reform, we still expect US policies on taxation, regulation and infrastructure spending to change. However, we may not see the resulting positive impact on corporate earnings estimates or stock prices until 2018, regardless of what Congress is able to enact in the remainder of 2017. Yet, US consumer sentiment remains high and the market has proved to be remarkably resilient.

Financial conditions are still constructive, and credit is not yet a major concern. Bank results are highly sensitive to potentially faster US growth (through potential tax reform and infrastructure spending), normalising interest rates and valuations that remain low relative to history and earnings potential.