There are the likes of Steve Russell’s CF Ruffer Total Return fund and Sebastian Lyon’s Trojan fund in the mixed asset space, but asides from exceptions like FE Alpha Manager John Wood’s JOHCM UK Opportunities fund in IMA UK All Companies, there are very few on show in pure equity sectors.
One portfolio that constantly has the downside in mind – and is under the radar of most investors – is the £350m Kennox Strategic Value fund.
Headed-up by Charles Heenan and Geoff Legg, the global fund was launched in July 2007.
According to FE Analytics, it has been a top decile performer in the highly competitive IMA Global sector with returns of 77.85 per cent over that time, more than doubling the gains of the sector average in the process.
Performance of fund vs sector since July 2007
Source: FE Analytics
However, unlike most of its rivals funds, its strong relative returns haven’t been generated during the recent bull market. In fact, it underperformed the sector in 2013 and 2012.
Legg and Heenan’s outperformance has come when the large majority of their peers have struggled.
Our data shows that Kennox Strategic Value returned 6.38 per cent in the crash year of 2008, while the IMA Global sector fell 25 per cent.
Performance of fund vs sector in 2008
Source: FE Analytics
Its performance in falling markets means the fund has the best maximum drawdown in the sector since its launch, which measures how much an investor would lose if they bought and sold at the worst possible time, of just 13 per cent.
The sector’s maximum drawdown is just shy of 40 per cent over that period.
Legg and Heenan say their risk-averse attitude is a direct result of the fact that they have significant personal holdings in the fund. They target an absolute return in rising markets, but relative outperformance in falling markets.
“Everything we do within the portfolio is how we would want to run our own money,” Legg (pictured) said.
The portfolio, as its names suggests, is put together with a clear value style. The team only holds a small number of quality companies, which must have cash on the balance sheet and low levels of debt.All of the holdings tend to trade on a P/E ratio below that of the wider market. They also prefer to buy companies that pay a dividend.
Although Kennox Strategic Value has a relatively low yield of around 2 per cent, a recent FE Trustnet article highlighted it as one of the very best from a dividend sustainability point of view.
The managers have a low turnover, at around 15 per cent a year, and build up cash in the portfolio to high levels if they aren’t finding enough opportunities.
They had a high weighting to cash in the lead up to the 2008 crisis for example, and ominously have an 18 per cent position at present.
“The cash weighting is pretty high at the moment, but that isn’t a reflection of a macro view. We aren’t necessarily saying the market is going fall tomorrow,” Legg said.
Legg and Heenan are among a number of fund managers that have a high cash weighting at the moment.
Concerns over valuations and increasing headwinds including the end of QE tapering in the US and growing geo-political risks have all contributed to the concern among experts.
While Legg says the fund’s cash exposure is entirely a product of the team’s bottom up analysis, he admits that now is a good time to be cautious from a macro point of view.
“I’m the last person you want to ask about the macro. I’ve got my opinions, of course, but who’s to say they are better than anyone else’s,” Legg said.
“We always envisage what will happen in a falling market and build a portfolio around that. The market does feel artificially high at the moment and you can hardly call it a rational market when interest rates have been this low for so long.”
“QE has been a huge experiment and no-one seems to agree on whether it will work, the only thing people agree on is that nobody knows how you actually end it.”
“In this sort of environment, however, we don’t mind returning 18 per cent when the market is up more than 20 per cent, just as long as you don’t get caught out when the market does fall.”
Legg says the current cash weighting is very similar to the level it was at in 2008, which was one of the major reasons they were able to outperform.
He also attributes their positive returns that year to holding attractively valued companies which had struggled in 2007 and avoiding tech and financials; two areas he says the team will never invest in due to the latter’s high level of debt, and the latter’s low levels of sustainability from a business model point of view.
Though the fund has performed well, it isn’t a popular choice with retail investors and is only held by one fund of funds in the IMA universe: the Turcan Connell Growth Portfolio.
Rob Morgan, pensions and investment analyst at Charles Stanley, says Kennox Strategic Value is one he has looked at in the past and while he thinks it is an interesting, active and unconstrained approach, investors shouldn’t expect it to never lose money.
“It is one I have come across before and though the managers will be able to find ways to protect capital, as they are in the IMA Global sector, they will have to have at least 80 per cent of exposure to the market at all times,” Morgan said.
Though the Kennox fund returned close to 7 per cent in 2008, it did lose more than 4 per cent in 2011. However, it was still top quartile that year as a result of the sector falling 10 per cent.
Performance of fund vs sector and index in 2011
Source: FE Analytics
Legg says there are other ways he and Heenan are trying to defend capital, one of which is their sector positioning.
Their largest sector weighting is energy, which makes up 23 per cent of the portfolio, and they count the likes of Statoil, Royal Dutch Shell and Encana Corp as top-10 holdings.
The reason they have such a chunky weighting to oil companies is their attractive valuation he says, adding that the demand for energy around the world is only going to increase.
“If you look at the different market cycles in the past, it tends to be the likes of financials and tech companies that dominate the index on the way into a downturn, and then coming out the other side, it is energy,” he said.
“They are obviously flawed companies over the long-term, but on a five to 10 year view, our need for energy is only going to increase.”
Kennox Strategic Value has an ongoing charges figure (OCF) of 1.17 per cent.
