The key to running a successful UK growth fund is to avoid large cumbersome stocks, maintain a relatively cautious attitude and adopt a bottom-up stock-picking approach, according to Newton’s Paul Stephany.
The manager’s Newton UK Opportunities fund has outperformed its IA UK All Companies sector average and FTSE All Share benchmark between him taking the helm on 13 February 2013 and the end of May 2015. The fund has provided a return of 37.27 per cent over the period, including dividends reinvested.
Performance of fund vs sector and index over manager tenure
Source: FE Analytics, performance with dividends reinvested between 13 February 2013 and 29 May 2015
He partially attributes his performance to having a low degree of sector and stock commonality, which he believes is a far lower-risk tactic than jumping on the bandwagon and buying into stocks that many UK investors cluster into.
“Sector selection has certainly played a part; for example I’ve been underweight1 the mining sector and the oil & gas sector since I took on the fund. That proved to have been the right thing as commodity2 prices have fallen dramatically.” he said.
He also highlights his aversion to HSBC – currently the second-biggest company in the UK.
“The bank is often viewed by investors as resilient and a big dividend yielder and as such you often see it in UK funds. However, I’ve never owned it. I think it can be adversely impacted by increased financial regulation and in my opinion its growth prospects are limited.” he explained.
“I won’t invest in something just because it’s a big position in the index – I’d much prefer to have a bigger position in the shares I like. I believe not owning HSBC or Royal Dutch Shell, two large components of the FTSE 100, will stand us in good stead, as it frees up money for me to take positions in smaller, more nimble companies.”
“I’m happy to take on the relative risk this involves: it is where fund managers can add value.”
Stephany, who has also managed the Newton UK Equity fund since September 2014, attributes his ability to seek out nimble companies to his previous role as lead manager on the Newton UK Smaller Companies fund, which he first took over in March 2011.
As such, the manager and his team adopt a bottom-up stock-picking approach in his Newton UK Opportunities fund. The £401m fund is able to invest in companies of all sizes and in any industry, and has the freedom to invest without referencing a benchmark or index.
Among his biggest high conviction positions at the moment is Playtech – a software company that serves a number of online gaming companies. It is currently Stephany’s largest holding.
“Examining company specifics are hugely important. I’ve spent a lot of my career investing in smaller companies where having forensic analysis skills is crucial,” Stephany explained.
“I have experience in looking at the accounts and ask probing questions when I’m in company meetings and speaking to analysts. I tend to look more at the cash generation of these businesses, the strength of its model and so on. All this allows me to get into the investment nuts and bolts of a company”.
However, Stephany hastens to add that the team doesn’t ignore the macro by any means and also uses long-term observable trends, known as Newton’s ‘themes’, to shape his portfolio.
“This perhaps differentiates us from a lot of our rivals,” he said. “It prevents us from focusing too much on short-term company results and allows us to take a step back and look at the bigger picture”
“For example, at the moment we’re cautious about retailers that aren’t strong in the online area, as well as the banking sector due to our concerns over regulation. Therefore, it is by using this top-down process and broad themes that have pushed us in this direction”
Their stock selection process has proven successful, especially considering that the fund has outperformed while also maintaining a cautious investment approach.
“My experience in smaller companies has naturally led me to be a conservative investor. I’ve seen a lot of things go wrong and I’ve built up a set of rules, which has helped me to identify warning signs. Those rules can be applied not only to smaller companies but to larger ones too.” he said.
“Identifying the top-down views should not be looked at in isolation. The mining sector is a good example; many of my peers are investing large portions of their funds in mining due to their belief China has a great economy and will continue to deliver fantastic GDP growth. However, you can get your fingers burnt if you buy into the wrong company.”
Stephany says that he is particularly pleased with the outperformance of the fund, considering the market has risen significantly under his tenure. However, he adds that aiming to protect client’s money could lead to times of underperformance in the future.
“When we look at a business we ask ourselves whether its credentials are good, whether the business model makes sense and whether it can perform in different economic conditions. These factors are much more important than short-term results, which sometimes can be poor for perfectly valid reasons,” he admitted.
“What’s pleasing is that despite taking a more cautious stance in general in the fund, we have still managed to outperform. For example, the housebuilding sector has had an absolutely fantastic run but it doesn’t fit in with our view of the world so we were not invested in that area. Yet we were able to find enough company specific ideas in other areas of the market to offset missing out on that performance.”
Newton UK Opportunities is currently yielding 2.24 per cent.
[1] Having less invested in a company/region/sector, than a comparative index.
[2] A raw material or primary agricultural product that can be bought and sold.