I visited the London Value Investor conference last month and interviewed some of the best speakers (listen to the interviews here). But what exactly is value investing? I’d highlight four points, first outlined by pioneers such as Benjamin Graham and Warren Buffett in the US.
Firstly, investors are frequently wrong and buy the wrong stocks at too high a price, then underprice other great businesses when sentiment turns sour. Secondly, investors are also very bad at focusing on the right fundamentals or numbers. They look at shallow measures, such as the share-price chart or simplified earnings, rather than digging deep into the balance sheet or understanding how a business truly works.
Thirdly, investors frequently over-diversify and invest almost randomly across markets, rather than picking a tight bunch of stocks they understand very well. And finally, investors, by overpaying for some stocks, leave no margin of safety if things go wrong.
However, these insights can be interpreted in various ways. For some, value means dirt-cheap stocks, such asRussian or Japanese ones, where the share price might be below total cash and the price/earnings ratio in low single digits. For others, this is contrarianism gone mad. They’d rather focus on reliable, high-quality stocks in sound markets where governance is superb – great business franchises rather than obviously cheap stocks. Into this latter category falls the SF Metropolis Value fund (total expense ratio: 1.45%).
The fund launched in 2011 and has £50m in assets under management. The managers – Jonathan Mills and Simon Denison-Smith – are ex-management consultants who both spent many years running successful private businesses. As their wealth grew, they became more interested in the art of managing money. They started off with a share club, and then attended one of Buffett’s Oklahoma sessions – also known as “Woodstock for value investors”.
They decided to apply his methods to their own portfolios, and those of their share club colleagues. In their first 12 months (to the end of May 2009), the fund – which was private at that point – was up by 19%, while the FTSE All Share had fallen by 23% (in total return terms). They packed in their day jobs and became full-time managers.
If you look down the key holdings table (below), you’ll see a curious bunch of stocks for a value investor. Former tech leviathan Cisco once dominated the S&P 500 before the dotcom meltdown. It fell out of favour and is now viewed by many investors as cheap. But it’s still a tech stock, as is second-biggest holding Samsung. Until very recently most value-orientated investors wouldn’t have touched tech. But Metropolis uses Buffett’s way of thinking about valuing a business franchise to come up with what they think are reasonably priced world-class businesses.
Ryanair (the fifth-largest holding) is a classic example. For them it’s a profit-making machine in the unfashionable airline sector. It can undercut almost every other rival and use its superb balance sheet to scale up.
As the performance data below show, the fund has not always beaten its benchmark, but it could be a very interesting investment for the future. It is tightly focused on a small selection of global equities where the management team sees genuine value. The managers also have a well-considered management process, which may offer protection if global markets get choppy.
Here’s how they sum it up: “We only invest in companies we understand, only in high-quality companies, only in companies with low levels of debt, only in companies with good managements and only when there is a margin of safety. Then we put these carefully selected stocks together in a portfolio which minimises risks further [by] being as global as possible, by holding cash if we cannot find anything that meets all of our criteria, by building our positions slowly and finally by having a strong sell discipline.”
Of course, the value sector has underperformed in recent years compared with growth stocks. But some experts – including Fleet Street Letter’s Charlie Morris – think its time in the sun may be nigh. If so, this looks like a good fund to invest in.
| Key holdings | % of fund |
|---|---|
| Cisco Systems | 7.50% |
| Samsung Electronics | 6.90% |
| Berkshire Hathaway | 6.70% |
| Sanofi | 6.40% |
| Ryanair | 6% |
| Performance data | Metropolis Value Fund | MSCI World GBP TR |
|---|---|---|
| 2011 (Apr–Dec) | -1.20% | -7.40% |
| 2012 | 6.60% | 11.60% |
| 2013 | 17% | 25.70% |
| 2014 | 7.40% | 11.50% |
| 2015 | 12.10% | 5.50% |
| 2016 to 31 May | 4.20% | 3.70% |