When markets, or whole sectors within them, are drifting up and down with the tide on the back of large-scale macro events it is a tough environment for these managers to perform in.
Manager skill
But when individual companies are rewarded for their strengths rather than being punished by factors out of their control, stock picking fund managers would argue this is a time when identifying individual companies with particularly attractive attributes means they will outperform.
Companies which are disliked by the market can be music to the ears of stock pickers. It may be because the company has been through a troubled period, or it may be simply that it has been unfairly punished by wider sentiment issues.
John Wood, manager of the JOHCM UK Opportunities fund, is a classic example of a fund manager who hates momentum-driven markets. In such an environment he will typically build up his cash position and ride out the market, waiting for his opportunity to be rewarded for his stock-picking skills.
When markets become more rational, Wood’s talents come to the fore once again as he continues his long-term track record of picking solid, well-managed companies in growth niches which reinvest wisely to create sustainable, compounding returns.
Quality shines through
Wood’s view is that that markets consistently underestimate the value created by such companies. He runs a concentrated portfolio of what he views as high quality companies which can generate predictable and growing cash flows and which have strong balance sheets.
George Godber, who runs the Miton UK Value Opportunities fund, says buying stocks at intrinsic value is an approach which does work over time.
He adds: “We’re active and very unconstrained, which means we’re in some weird and wonderful stuff. There are two types of stocks we target: those where you’re getting a pound for 50p, and those where the business can trade above its asset value through stable cash generation.”
Stocks in the first category are typically under-researched and unloved, says Godber: “This is the Benjamin Graham school of investing. Stocks don’t often get down there unless the market sees something wrong, as we’re seeing with supermarkets at present. But you can get real lay ups, for example Vodafone was down there for a long time. There’s usually an element of fear or some cyclical issue.”
When re-rating works
Godber highlights Aer Lingus as a good example of a value stock pick he has got right.
“When it had its IPO the government kept a lot of the liabilities. It has £340m in cash and planes worth £700m, with a market capitalisation of £874m. Shares have gone up, so this is a real pound-for-50p story. It also has hidden assets – it has 26 slots at Heathrow. So there is a way to unlock value.”
Godber also invests in stocks using what he describes as the Warren Buffett approach, which can encompass companies such as funeral businesses which will always trade irrespective of market conditions. “They can become more loved, and can get re-rated.”
Selling when the going is good
Value investors must also have a price target, Godber adds. “You have to be disciplined and strict on target prices. We had to sell Vodafone which remains a good company, so it can be a tough balance.”
One of the beauties of the fund management industry is that there are many different approaches. Some will always adopt a macro-driven, top-down view, and for some this can reap its rewards. But if markets continue to perform in a more rational way, rewarding individual companies rather than being driven up or down by macroeconomics and sentiment, we should see some of these stock-picking fund managers starting to be rewarded for a process which focuses on the fundamental analysis of individual stocks.
If they get their stock picks right, we could well see some of them rising to the top of the performance charts.
