It is fair to say that FE Alpha Manager Nick Train’s performance relative to both his peers and the wider UK equity market has been outstanding over recent years.
Thanks to his high conviction, very concentrated approach which revolves around buying quality businesses with reliable earnings and strong franchises, both his five crown-rated CF Lindsell Train UK Equity fund and Finsbury Growth & Income Investment Trust (which are effectively mirrors of each other) have dominated their respective sectors.
According to FE Analytics, his £1.6bn open-ended fund has been a top decile performer in the IA UK All Companies sector since its launch in July 2006 with returns of 179.48 per cent, nearly tripling the gains of the FTSE All Share in the process.
Performance of fund versus sector and index since launch
Source: FE Analytics
While those returns are impressive, it is the consistent nature of that outperformance which has been so striking.
CF Lindsell Train UK Equity has never underperformed against the sector average in a full calendar year and is the only portfolio in the highly-competitive peer group to have beaten the FTSE All Share and delivered top quartile numbers in each of the last seven calendar years.
On top of that, it is top quartile and outperforming the index so far in 2015.
Given that performance profile, it is unsurprising that the CF Lindsell Train UK Equity fund has been one of the sector’s best for risk-adjusted returns and its maximum drawdown.
It is a similar story with his trust, which has been the best performing IT UK Equity Income portfolio over the last decade and has outperformed the FTSE All Share in nine out of the last 10 calendar years.
Source: FE Analytics
Regular FE Trustnet readers will be well aware that we are fans of Train and his approach, but just as a fund which has perennially struggled should be scoured over, so should one which has delivered stellar returns – especially if it has such a clear cut and unwavering strategy.
For example, Train’s portfolio (which is 70 per cent weighted to his top 10 holdings) has hardly changed over recent years and his funds have massively benefitted from his huge overweights in the consumer staples sector with th
e likes of Diageo, Unilever and Heineken accounting for close to a quarter of his assets.
“I saw Train present in January this year on his investment trust. He started off by saying that he didn’t know whether to feel ashamed or proud, but he had not bought or sold any positions over the last three years,” Ben Willis, head of research at Whitechurch, said.
The major worry now, however, is that these types of stocks have been the preferred choice for ‘tourist’ fixed income investors who have been forced out of the bond markets by central banks in search of their highly dependable and strong dividends – meaning their fortunes could be closely correlated to those of bonds.
Train himself has been quick to point out to both his unitholders and shareholders that his consistently stellar returns are unlikely to continue.
“Listen, I have been saying to my shareholders that this investment trust has beaten the market in the past five consecutive years. It has outperformed very strongly and I know, and hopefully they know, this won’t go on forever," Train (pictured) said in October 2013.
Since then, however, Train’s fund has more than doubled the gains of its benchmark and average peer.
Of course, he is classed as a long-term manager and no sane expert would recommend trying to time the market, but now that Train is heading for his eighth year of outperformance, should investors consider selling their stakes and taking their profits while the going is good?
Willis says there is little doubt that Train is a top quality manager, but adds that he is concerned about the strength of CF Lindsell Train’s outperformance over recent years given that all active funds go through tough times. He is also worried about his weighting to ‘bond proxy’ stocks like in the consumer staples sector.
“It depends on your time horizon for investment. The ‘bond proxy’ stocks he has invested in have done exceptionally well in recent years but they are now very overvalued,” Willis said.
“These companies are still likely to be good stocks over the next 10 to 20 years but the odds are stacked against them outperforming over the next two to three years, particularly within a rising interest rate environment.”
“As such, if you have benefited from his excellent performance over the last few years, and with the manager clearly signposting that this is unlikely to continue, then I would sell. It is always a difficult decision to sell a fund that could be the best performer in your portfolio – but when is the right time?”
He added: “Better to bank profits and seek opportunities elsewhere – you can always go back to the fund at a later date.”
There are already signs that consumer staples stocks could be in for a tough ride over the coming years if bond yields do gradually rise and interest rates start to increase.
Performance of stock versus sectors during ‘bond rout’
Source: FE Analytics
As the graph above shows, during the recent bond market rout when sovereign debt yields spiked, the performance of shares in consumer goods companies such as Unilever were highly correlated to traditional fixed interest assets.
Rob Morgan, pension and investment analyst at Charles Stanley Direct, agrees with Willis.
While he says investors shouldn’t fall foul of thinking Train’s portfolios are purely consumer staples (he counts the likes of Schroders, Relx, Hargreaves Lansdown and Burberry as top 10 holdings), they should realise that his recent performances are unlikely to be repeated over the coming years.
He says that if investors are planning to hold his trust for the next 10 to 20 years, they should do nothing with their exposure.
However, if investors have a shorter time frame, Morgan says they should look for other opportunities.
“As a long term ‘buy and hold’ investor (which probably applies to most people) I would keep it. The fund is well managed and contains the sort of portfolio of earnings ‘compounders’ that works best over long periods of time,” Morgan said.
“Indeed it might continue to thrive in a continuing boring, sluggish environment.”
“However, thinking more tactically, I would prefer to add to areas that have lagged right now, perhaps more cyclical parts of the market where valuations look more attractive – and wait to add to a Nick Train-style fund after it’s had a bad run.”
Hawksmoor’s Richard Scott uses CF Lindsell Train UK Equity across a variety of his client portfolios and expects to keep hold of the fund for the foreseeable future. However, he has taken profits over recent months.
“I would put Nick Train in the same stable as Terry Smith – a very high class stable, Derby winning horses rather than old nags,” Scott said.
“We continue to hold both of these managers funds as well managed exposure to some of the world’s highest quality companies, but have trimmed exposure in recent times in the belief that valuations are quite stretched in some cases.”
FE Alpha Manager Terry Smith has very similar strategy to Train on his five crown-rated Fundsmith Equity fund, as he has a highly concentrated portfolio of high quality businesses that can sustain a high return on operating capital employed and whose advantages are difficult to replicate.
As a result, the £3.6bn fund has been the fourth best performing portfolio in the IA Global sector since its launch in November 2010 with returns of 100.98 per cent, beating its MSCI World benchmark by close to 40 percentage points in the process.
Performance of fund versus sector and index since launch
Source: FE Analytics
Scott added: “In summary I would back Train (and Smith) over the long term, but it would not be surprising if the funds go through a period of duller absolute and relative performance. If this does occur it should be viewed as an opportunity for long-term investors to add to exposure.”
Ian Rees, head of research at Premier, understands why some are concerned about the outlook for Train’s style given the near term concern of interest rate rises impacting on the absolute valuations of long duration assets.
However, he says investors who hold Train’s fund or trust in a fully diversified portfolio shouldn’t necessarily be looking to sell.
“We do not consider it sensible to be purely invested in a single investment style at any time, let alone when the macro environment is undergoing such politically and economically sensitive change,” Rees said.
“If the Lindsell Train fund is held as a diversified portfolio, the current concerns should be understood and balanced. I would have a high degree of confidence that the fund will continue to perform as expected with this style, however the relative performance of the fund is unlikely to be as strong looking ahead.”
“If investor exposure is dominated by this holding, then owning a fund purely on the basis of it being a good performer may create disappointment if what they have bought is not fully understood. That is the real risk of the strategy.”
