“The process and the portfolio construction are, if you like, your comfort blankets. If you are feeling uncertain or nervous, you can cling to the process and say, ‘tell me what to do’.”
The process Whitmore and assistant fund manager Dermott Murphy follow is based on two screens, which are designed to measure value rather than forecast future returns.
The first screen uses the Graham-Dodd long-term price earnings ratio, which is designed to provide an approximation of the average earnings power of a company over a business cycle.
It is based on the work of Benjamin Graham and David Dodd, two of the doyens of value investing who believed that, when looking at companies, five years’ worth of earnings data is much better than three years, seven is better than five and 10 years is better still.
That is not to say all companies with a low P/E ratio are good value, however. “There may be something that puts you off when you look at the stocks in depth, but it pushes you in the right direction,” says Whitmore.
The second screen uses the work of Joel Greenblatt. If one has the choice of two equally lowly-valued shares, Greenblatt’s advice was to buy the one with the best return on assets, ie the highest quality one.
Explains Whitmore: “We start at the valuation point. If it is less than 16 times 10-year average annual earnings we will look at it, regardless of what sector it is in.” He explains that this objectivity helps eliminate some of the natural biases that inevitably exist around sectors and stock selection.
While much has changed within markets in the years Whitmore has been an investor, he says the base human emotions of fear and greed, as well as the more nuanced ones such as anchoring and overconfidence, remain the same.
“We are never going to be able to resist those emotions in their entirety, and it would be naïve to think that. But the valuation screens are very objective so we are not doing any anchoring, we are not doing any forecasting and we are pretty disciplined in the portfolio construction to ensure a spread of investments, so we avoid overconfidence.
“All of these things have been built into the process to keep the fund as immunised as possible from those big buffetings.”
