Mundy (pictured), the Investec UK Special Situations and Temple Bar Investment Trust manager, states that reading is the most productive use of an investor’s time. Hammerson, Centrica and Sainsbury’s are among the company reports currently sitting on his desk.
“We’re looking for out-of-favour companies but we’re also aiming to make sure we understand them,” he explains. “We’re very happy to say, too hard, move on.”
The eight-strong investment team will read anything, from research to blogs, and seeks to step outside the value bubble, too.
“There’s plenty written about confirmation bias – just reading the stuff that agrees with you – so you should be out there always looking to oppose the conventional wisdom.”
Normalised profitability versus discounted cashflow
Mundy’s team takes “a normalised profitability” approach to value investing. “We’re definitely not unique but, at the same time, there are value investors who have different approaches to us. Some will look more at history than the future, saying the future is hard to forecast. That’s right, but sometimes history is no guide to the future.”
The approach isn’t overly formulaic, he says. “Normalised profitability is a combination of what sales we think a company is capable of making and what profit it can make on those sales. Our work is partially informed by what the company used to make on those sales and what its competitors make.”
Unlike a discounted cashflow approach, which assumes a constant rate of growth, Mundy searches for how the trajectory of a company may change.
“There’s more precision involved in a discounted cashflow, where we’re just saying at some time in the future we think this company should make ‘x’ million of profits. You could say that’s a sort of shorthand discounted cashflow, but we’re trying to be approximately right rather than precisely wrong.
“We think a detailed spreadsheet can increase an investor’s comfort and confidence, but it doesn’t necessarily increase their chances of being right.”
Big Brexit bets
The value team invests when the gap between the share price and its assessment of fair value represents 50% potential upside.
The team is “blessed” with lots of out-offavour companies at the moment due to a divergent market of expensive and cheap stocks, he says. That covers a lot of domestic UK stocks as the country approaches 31 October, the current deadline by which we will leave the European Union.
Mundy admits the portfolio presently looks like a big bet on Brexit. “But I’d say there are a lot of investors out there who’ve got a big bet on Brexit. They’re just taking the alternative view.”
About 60% of UK portfolios are invested in domestic stocks. Mundy finds it helpful to replace the term ‘Brexit’ with ‘recession’, which is less emotive. Is Brexit likely to be more structural and long term than a recession? Possibly, he says. “But we’ll see. I think as a result of questions like that, investors are either paralysed or they’re actively selling stocks exposed to the UK economy.”
The fact that Brexiteers are in power and have effectively promised everything will be alright reassures Mundy. “If it goes badly then they’re going to have to press lots of buttons and pull lots of levers.”
Not that Mundy is shying away from a critical assessment of the current UK leadership. Boris Johnson: the beast of Brexit – a study in depravity, is among his out-of-office reading at the moment, alongside Mike Tyson’s autobiography, and books on stoicism, chess and running.
Within domestics, banks is a “pariah” sector Mundy currently favours. Temple Bar holds Lloyds Banking Group in its top 10, while UK Special Situations holds Barclays and both hold RBS.
“Investors still worry about banks but using a language more suited to 2007 than now. We think these businesses are much changed, with stronger balance sheets, less gung-ho management and stronger regulation. Those three things together mean a rerun of 2007/8 is unlikely. If anything, past experience is positive for today’s banks.”
Another theme is repair maintenance improvement on UK housing stock. Precious metals also feature, accounting for 2.9% of Temple Bar and 2.3% in UK Special Situations, due to a fear that central banks may be tempted to take greater risk when it comes to inflation during the next few years.
Retirement property builder McCarthy & Stone is a position Mundy’s built up since mid-March, having had his eye on the company since it started to disappoint shortly after its 2015 IPO. He says many investors would have blamed that on the slow-moving property market, which he doesn’t reckon explains the full situation. “It’s a classic example of a company that made it look as though they were struggling against the market because the market was not great for them. But, actually, they seem to be not operating at their best or the optimum levels for the company itself.
“There was a smaller peer who was far more profitable, and there’s no reason why McCarthy & Stone shouldn’t match their peer’s profitability as it’s a fairly homogenous sector,” he says.
“They were buying too much land without doing the due diligence on it. They were trying to get planning permission through too quickly because they were in such a hurry to build these retirement flats, and they were trying to win too many architectural prizes for how beautiful the flats looked.
“The new management team is saying that we want to squeeze every possible flat out of the planning permission, so we don’t have to win permission first time.” McCarthy & Stone now makes up 2.3% of the UK Special Situations Fund.
Buying into the Woodford overhang
The value team hasn’t been doing a lot of selling recently. “We tend to do more of our selling when we have vintages that are maturing. At the moment we’ve got quite a lot of early vintage recovery stories,” he says.
“If you did a stylised version of this, you’d constantly be selling a certain amount each year as they reach maturity, and constantly refreshing the portfolio. Unfortunately, the market isn’t conveniently stylised.”
Stocks are sold when they reach the team’s assessment of fair value or if the original investment thesis changes or proves incorrect. Cosmetics brand Avon Products was the last stock removed from the portfolio, thanks to a bid from rival Natura in May.
“It had been a very poor investment for us and it was a relief to see it bid for, as the turnaround continued to be slow.”
Capita is a stock Mundy has stuck by despite initially buying it “about an hour and a half before its final big downgrade”. “We felt particularly foolish,” he says. “We then carried on buying after the profit warning and bought quite a lot of shares. Our average buy price is now back to the current share price, so we’ve done neither well or badly but we’ve had a lot of excitement in between.” It is 5.8% of the Temple Bar portfolio and 6.1% in UK Special Situations.
Woodford’s troubles represented a chance to add more to the holding. “It still seems to be a stock other investors aren’t willing to entertain, partially because it’s had one very high-profile investor selling shares, so there’s been a perceived stock overhang. Second, the company’s been getting its house in order, doing everything it’s promised. It’s out of intensive care but still on the road to recovery, and I think investors and the market are still waiting for better news.”
From gilts to value investing
Mundy became attracted to value because of his interest in the behaviour of crowds, but the actuarial science graduate’s City career started in gilts, which he describes as “incredibly dull”.
“I did three years of my sentence and decided to apply for an MBA. The person I asked to referee was our head of equity research at the place I worked for. He said, ‘Instead of doing that, why don’t you come and work with us?’”
Mundy is happy with the path his career has since taken, even as value suffers a prolonged period of being out-of-favour. “Other styles go out-of-favour for just as long but don’t seem to get the bad press value gets.”
He is manager on the £1.6bn Investec Cautious Managed Fund, so still dips into fixed-income markets. “When we look at equity, we look at those other instruments, including the balance sheet. Sometimes you think the equity is not necessarily cheap and some of those fixed-interest assets might be more attractive, but we haven’t done that for many years.”
The IA Mixed Investment 20-60% Shares fund currently has 18.4% in the money market, 13.5% in commodities, 8.5% in Norwegian government debt and 3% in global index-linked, with the remainder placed into global equities.
“The one thing I’ve always found funny is how equity investors seem to have undue regard for fixed-interest investment,” Mundy reflects. “They always say, ‘Oh, the fixed-interest market’s telling us this,’ as though fixed-interest investors are more intelligent. I didn’t see any great difference in intelligence between the two groups.”