Manager discusses growth, value and the pro and cons of running 30-stock fund
It is a long time since focus funds were the must-have product launch for asset managers but, despite their low profile today, there are portfolios out there quietly producing the numbers.
One such is the £91m Ignis UK Focus fund run by Ralph Brook-Fox, which has produced top-quartile returns over one and five years to 16 August 2010. Brook-Fox caught up with Asset TV to talk through his thoughts on growth, value and the pros and cons of running a 30-stock portfolio
What makes your approach and fund different to the competition?
It is hard to generalise, but I like to think we have a stock selection process that is tried and tested and has been honed over a number of years. We have a very experienced team of people, and we the resources to ensure we can invest in areas such as technology as well.
You claim to have a quality bias in your stock selection. Is that always right in all market conditions?
When we say we tend to have a quality bias, it is because within our stock selection framework we are looking for winning characteristics. Winning characteristics are things we think are good predictors for stock outperformance over the short and medium term. So that is what we mean by quality bias. But at the same time I am anxious to emphasise we are very pragmatic. In this fund in particular we are looking for performance to be delivered by each stock on a six-month timeframe. So at times that means the quality can be out of favour and we need to broaden.
You hold between 25 and 35 stocks in the portfolio. Some people might see that as risky.
I would not put it that way. The reason we hold 25 to 35 stocks in the portfolio is because we have focus in this fund. Studies have basically shown once you move beyond about 30 stocks in a portfolio, the benefits of diversification rapidly dwindle.
For example, if you move from 30 to 60 stocks, studies we have performed show your tracking error only drops by 10 to 15.
The reason we have a concentrated portfolio is to make sure we have got as much focus as possible to maximise the potential to outperform.
Having 30 stocks and keeping to that discipline means there is always a competition for capital going on in the portfolio, which means you are always focused on the best ideas. When we get a new holding coming into the portfolio where we expect decent returns, we have to find an existing position, which is to basically make room for it. That may even mean we are actually selling stocks while some upside is left on the table.
What have been your best-performing stocks over the last six months?
One of the common attributes among some of our successes has been the growth characteristics. This is an environment where the market has been on the hunt for growth. This was the theme we identified some time ago and indeed is a trait that has always run through the portfolio. For example, we have had stocks such as Rolls Royce, SABMiller and Standard Chartered. These stocks have global exposure. We also had some good domestic exposure deliver for us.
We held Serco over the period, which is a UK-based outsourcing company, and you will find as government budgets are under pressure, that is a great opportunity for the private sector to do more in the public sector space.
It has not just been about growth. On the value side of the equation, we have had Lloyds Bank, a somewhat controversial name but one which has delivered for us in the short term.
Despite all the travails in the banking sector, what we have now is a much more consolidated space. A lot of the foreign competition is gone and there is actually decent opportunity to widen margins. So as I am sure many people will know, the spreads people are paying on mortgages are substantially greater than they were paying historically. The other positive attribute is the impairment profile, the losses they have taken, for example, on foreclosing on properties, has been much lower than people were anticipating.
Do you prefer organic growth, or do merger and acquisitions come into play for you?
Organic growth is always a winner for me. If companies have strong organic growth and can demonstrate it over a number of years, that is a very attractive attribute. Growth will be scarce over the next decade, particularly in Western markets, so any companies that can demonstrate growth are going to be highly rewarded.
A number of the stocks we hold in the portfolio are very good cash generators, and this is going to be an attractive attribute in future.
Also, where we can trust the management teams and where they have a good track record, M&A is the icing on the cake. It can take organic growth and push the overall earning lines into double-digit territory.
What positions have not worked so well for you?
It has to be said, our view for a while has been a high degree of caution with regards to the UK consumer. We all know last year the consumer was propped up by mortgage rates that came down. Real personal disposable incomes meant, provided you stayed in work, you actually did not have that bad a recession. Also, unemployment numbers were not bad either. We think that environment is going to get very tough from here.
That said, we did have a couple of stocks in the form of both TUI Travel and Travis Perkins, which we think are good companies and good stock-specific stories where we were hopeful they would be able to outperform the difficult macroeconomic situation they were likely to face, basically through self-help.
Post the Greek scenario and the Budget austerity in play in the UK at the moment, we have had to revise that view. And while we think they are good companies, we think the chances of them delivering the performance on our stated six-month time horizon has diminished somewhat, and so it is appropriate to redeploy the funds into stocks that are going to deliver sooner.
What have you added recently?
Growth has outperformed value and is now highly rated on that basis. Our focus has been looking through the value space to find names where value has become so apparent as to offer opportunities.
We have rebalanced the portfolio back a little. One name that fits would be National Grid, where there was an unexpected rights issue recently, which caused some indigestion in the marketplace. But we think the rights issue was for good reasons and the underlying business is sound. The underperformance the stock has seen has provided an interesting entry point.
The other stock we have added, which is in the sort of lower-grade high-value category, is Glaxo. This is because it is a stock that has been trading on a single-digit P/E and an attractive yield.
As the market hunts around for yield and value on a temporary basis, the stock can do well. However, with both those positions I would say they are not the sorts of stocks we anticipate holding that long. There is a tactical opportunity to exploit the growth/value divergence opening up in the marketplace.
Are you tempted by BP at these levels?
We have a residual position in BP. We did have a bigger position and we chopped it back. Unfortunately we did not chop it back quite soon enough, but at least we got out at high levels as the scale of the disaster became apparent.
We have held on to our residual position because we think the sell-off is overdone, and there is an opportunity for bounce back now the relief well is in place. That said, it no longer fits many of our winning characteristics and on that basis I would be surprised if it is still in the portfolio in a few months time.
Things apparently do not look bright for the UK as an economy. Why should anyone consider investing in UK equities?
If you look at equities, interest rates are going to remain low for a very long time. So the returns you are going to get on cash are pretty pitiful.
From the UK angle, when you look at the make-up of the UK equity market, it is much broader than just the focus on the UK economy. In fact, over two-thirds of earnings of the UK market come from overseas.
Even within the UK, we think there are opportunities because with austerity comes opportunities for the private sector to do more in the public space.
