There’s something ever so slightly evangelical – maybe even Pentecostal – about the way some investors (and fund managers) embrace a ‘style’ of investing. The preachy tones of growth managers (just feel the heat of disruption and the energy of momentum) is rivalled by the broad church ‘sense and sensibility’ of the value brigade, who inevitably focus on more cautious ideas.
The challenge for value managers is that the original gospel – laid out by investing prophets such as Ben Graham, Warren Buffett and academics like Joseph Piotroski – has mutated over the decades as the nature of investing has changed. Back in the pre-war period and immediately after the Second World War, there were many ‘deep value’ stocks that ticked all the boxes for those investors looking for a Graham stock, with loads of cash and assets set against a miserly share price.
But as the post war boom dragged on, those dirt-cheap stocks melted away and investors started redefining their core beliefs, with Warren Buffett, the Sage of Omaha, in particular taking the lead. He suggested that what was really needed was to take Ben Graham’s ideas about investing in the business – not just the shares – and turn it into a more comprehensive way of understanding the strength of a business, its balance sheet and its profits and loss account, whilst also including its economic moats which act as a barrier to market competitors entering the market. As a result, Berkshire Hathaway (BRKb.N) – his investment vehicle – has changed and mutated and ended up looking rather more like a private equity style diversified industrial.
Growth knocks even 'quality' value
But even this mutated form of value investing – buy good quality, cheaper businesses rather than dirt cheap value traps – has run up against a bigger problem. In recent years, markets have turned aggressively bullish and as a result have bought into the shiny, boosterish enthusiasm of the growth Pentecostals. In simple terms, growth stocks (high valuations, lots of positive earnings momentum) have comprehensively beaten value stocks. The chart below is from Standard Life Aberdeen and illustrates that growth has outperformed value for 12 years since 2006.
But every broad trend eventually meets its Waterloo and there are now some grounds for believing that more value-orientated stocks might outperform. Only a few weeks ago for instance, the well-respected equity strategy research team at Morgan Stanley put out a note which suggested that growth stocks might have a tough time, in Europe, in the next year or so. They argued that profit ‘margin pressures appear to be rising [which] should be good for our relative overweight call on value versus growth, as these [value] stocks should be less vulnerable to a derating in the event that margin pressures start to bite, or maybe even benefit from the causes of inflation to some extent. We may already be seeing some of this play out as a net 16% of value stocks beat estimates during the third quarter earnings season while a net 8% of their growth peers missed estimates’.
Where to invest for value?
The challenge is that if you do believe that value investing is about to make a comeback, where to invest? Most fund managers say they are in some way value focused, but its obvious to me that this is largely a myth. The vast majority are really what I call ‘growth at a reasonable price’ enthusiasts, who are mid way in style terms between growth and value.
More importantly, many funds are so diversified across dozens, if not hundreds, of stocks that one is left wondering whether they are just closet index trackers. Fund managers with a strong and coherent investment philosophy are few and far between, especially if they have a portfolio that is very concentrated in just 20 to 50 stocks.
To me, that concentration on stocks is a key defining measure – does the manager have the courage of their convictions to invest in only the very best ideas? That’s what Warren Buffett now argues for and it seems to me that concentration (risk) is the true measure of real ‘alpha’, providing a real difference against the benchmark beta.
A Hidden Gem inspired by Buffett
Enter my first Hidden Gem candidate – the CFP Sanford DeLand UK Buffetology fund. This is a unit trust that is avowedly very different and has grown in size quite substantially over the last few years. Its manager is Citywire AAA-rated Keith Ashworth-Lord. He is hardly my typical shrinking violet who hates market coverage, and he has picked up a few awards for being an alpha manager.
But what I like about his fund is that it is avowedly different and unique, with a tight portfolio of 25 to 35 stocks, all focused on an internal investment style that is called business perspective investing. This is all very Buffett – it means a focus on measures such as a high return on equity, on strong cash flow and reasonable valuations. And so far, at least, this approach seems to be paying off – using data from the fund through to the end of October, the one-year return has been 20%, and the five-year return 111%.
The fund was launched back in March 2011. Looking down its list of top holdings one instantly recognises a long list of favourite value stocks – businesses such as Games Workshop (GAW) and Craneware (CRW) as well as more growth orientated businesses such as AB Dynamics (ABDP) and Bioventix (BVXP). One could be forgiven for thinking that is more of a mid- to small-cap focused fund, where the opportunities for value investing is huge. But the manager refutes this charge and points to the 13% of the portfolio invested in mega caps and a further 30% in large caps over £1 billion. I’m not entirely convinced by this line of argument, observing that just under half of his invested portfolio is in mid- to small-caps.
I also like the way that the manager will switch to cash if needs be – the fund was running cash at around 16%. Again, this is what true alpha fund management is about. Take the profits and wait for value to come knocking at the door. This will always be a more volatile fund, based on a distinctive philosophy but for UK exposure I think it’s absolutely worth including on your watch list.
Let me know your own Hidden Gems!
Highlighting Hidden Gem funds will be a regular feature of this weekly column. I think the unit trust industry is too dominated by huge asset managers, boasting monolithic internal processes which suck the life out of clever investment managers. I also have a contrarian aversion to any fund that advertises itself too heavily, preferring the unloved manager who toils away in difficult, hard-to-understand markets where risk levels are higher but upside opportunities more likely. So, in sum, what am I looking for in my hidden gem?
- A lower market profile.
- An independent manager, not affiliated to the one of the main houses;
- with a distinctive investment philosophy;
- in a market niche;
- who has produced more than decent returns over some time periods.
If you’ve bumped into a fund that you think ticks the box, let me know in the comments below! I’ll dig around inside the fund and see if it’s worth highlighting.
Any opinions expressed by Citywire or its staff do not constitute a personal recommendation to you to buy, sell, underwrite or subscribe for any particular investment and should not be relied upon when making (or refraining from making) any investment decisions. In particular, the information and opinions provided by Citywire do not take into account your personal circumstances, objectives and attitude towards risk.