It’s difficult to ignore the headwinds facing the high street right now, not least the growth of online shopping and stifled demand as a result of Brexit uncertainty.

But in every sector there are always winners and losers – and retail is no different. In spite of the threats facing UK retailers right now, a number of fund managers believe there are still investment opportunities to be considered.

“Negative sentiment led to a largely indiscriminate sell-off of retail shares in the final quarter of last year, but we believe success stories can be found even in troubled sectors,” explained Eustace Santa Barbara, co-manager of the Marlborough Special Situations fund.

He highlights sportswear retailer JD Sports as his top pick in the sector.

“What a business like JD Sports demonstrates is that when companies work hard and get the formula right there is still money to be made in retail.”

Santa Barbara notes that JD Sports continues to benefit from the ‘athleisure’ trend, where sports clothing and training shoes are worn for everyday life. He also likes that the company has expanded its presence internationally and gained a foothold in the US after acquiring the Finish Line chain last year.

“Management have a strategy of consistently investing in shops, customer engagement and brand relationships and the company is reaping the benefits. In the high street and online, JD Sports’ popularity continues to grow,” the fund manager explained.

Spotting the winners

Tony Yarrow, manager of the TB Wise Multi-Asset Income fund, notes that if a number of headwinds facing UK retail subside, the sector could positively surprise.

Firstly he points out that real disposable wages in the UK, which refers to the amount each person has left over to spend after outgoings, roughly doubled from £2,300 a year to £4,700 between 1979 and 2009. Since then, this figure has stayed flat.

“Wage growth hit a low in 2014 but has since been rising. However, this growth has been offset by a spike in inflation, mainly caused by the effect of a weak pound on imported goods. The pound stopped falling months ago, and wage growth is accelerating, so there may finally be more money available to spend,” he said.

While uncertainty created by Brexit has dampened demand, Yarrow adds that any reduction in the level of uncertainty, particularly if this is not accompanied by a further decline in sterling, could usher in a period of significantly higher retail demand.

During the Christmas period, the fund manager notes that a polarisation in performance within the sector was exposed.

“We believe in 2019 the outlook for the ‘winners’ in the retail space will improve. The fact that their weaker peers are going under is a further tailwind,” he added.

Yarrow and his colleagues look for talented and experienced management teams that understand what their customers need and continue to deliver it. For example, this could be a product which can’t easily be bought over the internet or a balance sheet that is strong enough to take the company comfortably though several years of challenging conditions.

He cites Shoe Zone as an example of a ‘winner’, even though it has been unloved by investors over the past few years. He says a solid period of trading over Christmas caused the market to realise “it had thrown the baby out with the bathwater”, causing the share price to rise in January and February.

Cautious outlook

Gervais Williams, who manages the CF Miton UK Multi Cap Income and UK Smaller Companies funds, currently has a low exposure to retailers.

Although a number of UK-listed retailers saw share prices recover in January and February, he is concerned that trading conditions could deteriorate from here. In addition, unemployment has the potential to rise.

Although retailers have benefited from sterling strength during the early part of the year, which has brought import costs down, he believes the path ahead looks challenging for the sector.

“We don’t think the direction of travel will get a lot easier, so we have very few retailers in our portfolios,” he concluded.