Schroders’ Gibbs looks for growth in cheap mid caps
Schroders’ high conviction manager Nathan Gibbs has consistently outperformed his sector peers across the market cycle by targeting small and medium-sized stocks.
Gibbs, who has managed the Schroder Japan Alpha Plus fund since its launch in 2000, has been highlighted by Trustnet as one of its Alpha Managers, performing well against peers in both rising and falling markets.
The £107m Japan Alpha Plus vehicle is ranked second in the IMA Japan sector over one year, up 11.4% to 23 August compared to the sector average of 2.4%. Over three years the fund is down 2.4% compared to a sector average decline of 6.9%.
Gibbs also manages the Clerical Medical Japanese fund, which is the top performer over one year, up 12.3%.
What type of stocks do you favour?
Both funds are run in exactly the same way. The Schroder Japan Alpha Plus fund is a highly concentrated portfolio with 30-35 stocks. We are looking for the best ideas we have gathered internally from our own research to put into this fund. There is a significant overweighting to mid and small caps within the fund.
There are lots of people looking at large caps in Japan, some of which are great, high quality stocks, but the chance of finding a significant mispricing in a very large stock is less. We are not interested in micro caps because it is difficult to hold larger positions in these stocks.
We want to be in equities for growth but I am looking to buy that growth very cheaply so the fund typically has value characteristics, and this is reinforced by adding to positions.
When we hold a stock and it underperforms, if I still think our original view was correct then we add to that position. We make sure the weightings do not get diluted as stock prices move.
Adding to underperforming stocks within the fund reinforces the value characteristics quite strongly.
We are not interested in sector weightings. We are much more interested in the individual stock risk, and what the risk of those individual stocks is in combination with one another. I do not mind if I am holding a few stocks in the same sector if I think they are not correlated with one another, or they are driven by different things.
What has driven outperformance?
Early in 2009 a lot of cyclical economically-sensitive stocks looked very cheap. We do not spend a lot of time trying to form a macro view that is different from the consensus, but we do ask whether the prevailing macro view in the market is currently reflected in the stock prices. In the first quarter of 2009, it seemed to me the cyclical stocks were not pricing in any recovery at all, whereas we felt the recovery in some parts of the economy was already underway. The data was already there but it was not reflected in the stock prices.
For example, stocks in areas like machinery and machine tools have had a big impact on fund performance over the last 12 to 18 months.
Other areas that have done well are some of the stocks we held in 2008 that underperformed and then rebounded extremely strongly. By making sure we kept the weighting high in these underperforming stocks, we added more value as they rebounded.
For example, we have held a big position in Nippon Electric Glass, which makes glass for LCD screens, for the last two years. There are only three companies worldwide which do this well, so Nippon Electric Glass is in a very strong market position.
In 2008, investors became very worried about the short-term outlook, and the stock underperformed dramatically. We were adding into that decline, and then it outperformed equally dramatically throughout 2009, and was a big contributor to the overall performance of the fund.
Coming into 2010, there has been a broader range of stocks contributing to outperformance as a lot of those cyclical stocks were repriced during 2009 and some of the small caps have also rebounded.
Both 2008 and 2009 were extraordinary years in terms of the market conditions. In 2008, everything was sold off and in 2009, lots and lots of things rebounded. But in both years there was not much focus on individual company valuations.
In 2010, the market environment in Japan and elsewhere is starting to look more normal. Investors are looking at individual company valuations and the prospects for individual companies. The performance differential between stocks is now starting to be more significant, and as stockpickers we like that. This is an environment we want and in which we should do well.
A period like 2008 and 2009 where all the stocks move in the same direction all the time is often harder for stockpickers. We reflected that by having a poor year in 2008 and a very good year in 2009.
How is the portfolio positioned?
The portfolio remains positioned for a rising market and a recovering economy. We do not expect huge economic growth in Japan but we expect gradual incremental improvement in things like the labour market and consumer confidence, with deflation beginning to ease over the next one or two years. In the very short term, this has been overridden by fears of a slowdown as a result of the stronger currency. This has meant the portfolio has done less well over the last one or two months.
The portfolio remains pro-cyclical, although I have made a gradual move away from some of those cyclical areas like machinery stocks, shipping and steel – all of which did well last year – into slightly more domestic areas. These include railway companies, transportation and domestic retail. This is simply because the story on the cyclical stocks is now better known. We look to where we have non-consensus views.
Our view on cyclical and economically-sensitive stocks early in 2009 was very non-consensus. The consensus gradually caught up with that view, and those stocks have performed. I think if there are surprises, they are more likely to be seen in the domestic economy because expectations are so low. Any improvement will result in significant earnings growth for some of these domestic companies, such as retail, transportation and railway companies. This is where I am now gradually moving the portfolio.
Do you think investors should still be looking at Japan funds?
Yes, but I think the current concern primarily around currency and the political situation has also impacted on sentiment over the last few months. The currency policy of the Government and the Bank of Japan is almost non-existent at the moment and this is hitting sentiment, although to be honest we did not expect them to do very much anyway. The currency is becoming more of an issue in the sense that policymakers seem incapable of addressing it sensibly. Four or five months ago I would probably have expected now to be in a situation where Japanese monetary policy looked relatively loose compared to the rest of the world. But actually we are not in that situation. The rest of the world has not tightened policy and Japan has stayed the same, so we are actually seeing the yen strengthen as a result of this.
The upside is still there and nothing that has happened over the last few months has affected our mid- to long-term view of earnings growth in Japan, which I think still looks good. Market valuations are the same or cheaper than they were before so I am still quite happy, though I accept sentiment has been badly dented over the last few months. But all the things we were interested in - the improvements in the domestic economy, growth in the rest of Asia, and Japan’s ability to export to meet that growth in China and Asia - is still absolutely in place.
