JPM manager achieves top returns with ‘two-dimensional’ approach to investment
Launched in May 2000, Michael Barakos’ J.P. Morgan UK Strategic Equity Income fund is ranked second out of 18 vehicles in the IMA Equity Income & Growth sector over one year to 22 February up 42.7% against an average increase of 30.6%, according to Morningstar.
Michael Barakos has managed the vehicle since February 2004, with assistance from David Allen, since August 2008.
The fund aims to provide long-term capital growth by investing in a value style biased portfolio of UK companies.
What is your investment style?
We are very much style investors, and we look to have a barbell strategy of being long value, long growth at all times simultaneously. We see value and growth as being two-dimensional rather than one-dimensional – ie the two are not mutually exclusive. You can generate outperformance long term by having both value and growth side by side.
In early 2000, we also offered single-style funds in response to investor demand.
We launched this fund originally as the J.P. Morgan UK Strategic Value fund. In 2007, we changed the name to UK Strategic Equity Income because value and income are positively correlated so this fund will always have a positive tilt to the market. Until about three years ago it was in the UK All Companies universe. Now it is in the Income and Growth universe.
What have been the key drivers of fund performance over the past year?
The biggest driver has been its exposure to value. In terms of methodology, we still run it as a value fund but we make sure it has an income tilt, which it always naturally has. Typically this has been more than 10% vs the market. At the moment it is exactly 10%. The fact value has done very well over the last 12 months has meant this fund has done very well during this period.
What shifts have you made to holdings in recent months?
The fund has had a very cyclical bias. The key to our success is we have been very disciplined and rigorous in our investing. If you go back 12 months, investing in value/income stocks was very scary, and not necessarily intuitive. The key to our success over the long term has been to hold our nerve and offer investors basically what they have bought.
By definition, a value and income fund is going to be typically contrarian in style, and certainly 12 months ago it was contrarian to have cyclical stocks. We have not changed a lot in the last few months. We still have a cyclical bias in the portfolio. However, for the first time in years we are starting to see some defensive sectors come onto our screens, such as telcos and food producers.
Unfortunately, the one we missed was water and utilities. We were right for a long time but we missed the inflexion point. They have had a very good run with the more benign regulation that came out three or four months ago. We were right to be underweight, and not hold any of them for many years. We were concerned that even though they had a very good headline yield, this was not sustainable. Whereas some of them did get the dividend cut it was not cut as much as the market expected; those stocks have done very well in the last couple of months. But we still remain out of them because we still see them as being yield traps.
How would you describe your current positioning?
Positioning is very similar to the inflexion point 11 or 12 months ago so we still have a big cyclical bias. The biggest overweight positions are financials, general retailers and housebuilders.
Even though housebuilders have gone on a phenomenal run over the past 12 months, they are still cheap and offer plenty of positive news, whereas 12 months ago it was very negative. Persimmon, for example, recently came out with its results. It had a 5% NAV write-back and is very likely to have another 10% NAV write-back in the next six months. What has happened is people over-extrapolate on the way up and on the way down, and analysts and investors have over-extrapolated on the way down in terms of downgrading their NAVs due to land write-downs.
Do you think investors should still be looking at the Equity Income and Growth sector?
I would advocate a combination of income/value over the long term side by side. Empirical evidence has demonstrated income/value investing works roughly 60% of the time.
And we know growth investing works 60% of the time. Because the two tend to be negatively correlated if you put the two styles together in the portfolio you tend to have a portfolio that works 70% to 80% of the time. So you reduce your risk-adjusted returns.
With regard to income specifically, if you look at the UK, historically the majority of returns have come from dividends/dividend growth rather than capital appreciation or market re-rating.
This is very crucial. Going forward, if you think about it intuitively, in what looks like an environment with plenty of headwinds – whether it is UK macroeconomic or regulatory issues – you can pin your hat on income.
We have a three-stage approach to investing. We identify the income out there. We then make sure the income is fundamentally sound. We simply make sure the stocks we are investing in are going to be able to sustain that dividend going forward. And the third stage is to find the catalyst that releases the value.
How will the fund develop in the next year?
I think the change going forward is the fact defensives, having significantly underperformed, particularly over Q2 and Q3 2009, are starting to look a bit more interesting on value criteria. Telcos and food producers are examples of sectors where we have been increasing our weighting in the past few months.
This is the kind of fund that does what it says on the tin. If income value works in the next 12 to 24 months this fund will do very well. If it does not work this fund will underperform the market. You are not getting a fund where the manager is trying to outperform in all kind of environments. You are getting a disciplined approach which, at inflexion points when it is least obvious, locks onto value and income returns as it should do. This is evidenced by the past 12 months numbers that show we have outperformed the competition in the income space.
