The ability to prosper in difficult markets, adding important diversification and the potential for significant long-term outperformance are all reasons why investors should consider adding a value fund to their portfolio, according to Miton’s George Godber. 
Only a handful of UK funds take a value approach to investing, whereby managers seek out stocks that they believe the market has undervalued and will therefore appreciate rapidly when their long-term fundamentals are recognised.
FE Analytics shows just 58 funds in the entire Investment Association universe are categorised as taking a value approach and only 17 of these reside within the IA UK All Companies, UK Equity Income and UK Smaller Companies sectors.
But despite these funds’ relative rarity, Godber (pictured) believes they can be a useful addition to a portfolio, especially if an investor already owns a number of the more ‘usual’ funds.
Of course, one would expect the FE Alpha Manager to have a degree of bias towards this investment style as he runs the CF Miton UK Value Opportunities fund with co-manager Georgina Hamilton. But he has a number of suggestions as to why now might be an opportune time to consider buying such funds.
Value might not crash as hard as everything else
Markets have just gone through a strong sell-off, with the FTSE All Share losing around 15 per cent between 28 May and 24 August when a plummet in the Chinese stock market brought fears of global economic slowdown into sharp focus.
However, the average IA UK All Companies fund managed to protect investors’ capital better than the market and the average value fund within the sector did even better than that, as can be seen in the below graph.
Performance of sectors and index between 28 May and 24 Aug
Source: FE Analytics
Godber argues that the ‘safety checks’ carried out by his fund and other with a value style – which are designed to ensure that undervalued stocks don’t have any serious issues that could cause them to blow up – means they have the ability to avoid the worst of corrections.
“We’re not a hedge fund and we will fall. But this is where our safety check becomes important: we avoid highly leveraged stocks, which tend to fall faster than the market,” the manager said.
“I always like to remind people that we own some truly boring businesses, those making crash barriers, running funeral homes or cleaning table clothes. We will never be the fund that finds the next LinkedIn but we do find businesses that are very, very good at what they do.”
Value can ride out volatility
Linked to the above point, Godber points out that value funds can be less volatile than the typical UK fund and the wider market, as by definition they steer clear of overpriced stocks that can move up and down as investor sentiment changes.
“When I think of UK funds with the typical holdings in BP, Shell, Glaxo and HSBC, I know they will all go up and down at the same time with the market,” he said.
“Ultimately with value, what you’re trying to do is give a smoother ride than that. We like to think of the tortoise and hare – we want to be the tortoise and keep plodding along, grinding it out.”
Risk-return balance of sectors and index over 3yrs
Source: FE Analytics
Tricky markets can be a source of value
Given that value funds only buy stocks that are deemed to be priced at less than their intrinsic worth, an indiscriminate sell-off in the markets can provide them with a rich hunting ground.
“We quite like tricky markets in a way,” Godber said. “There’s two things behind that: this kind of market is about stock selection and avoiding the blow-ups; and when you get sell-offs, you can get some really good quality companies being sold unfairly because of the panic going on.”
This time around, though, things have been a little different. The manager says that aggressive market corrections will typically mean new holdings get added to the fund, but says this hasn’t been the case over recent weeks.
Godber notes that the latest sell-off mainly hit oil & gas and mining companies, which fail to pass his fund’s safety check, while the businesses he would like to add did not become cheap enough. However, he did use the sell-off to put more money into existing holdings at lower prices.
Value can lead to outperformance
A core tenet of value investing is that the price which is paid for an investment is the biggest determinant of the return that will be made from it.
Godber illustrates this sentiment with a quote from Oaktree Capital Management co-founder Howard Marks: “It has been demonstrated time and time again that no asset is so good that it can’t become a bad investment if bought at too high a price. And there are few assets so bad that they can’t be a good investment when bought cheap.”
Most UK value funds only have a short track record but those that have been around for five years or more have beaten the FTSE All Share by a decent amount and are currently ahead of the average IA UK All Companies fund, albeit by a smaller margin. It’s important to note that five years is not usually considered to be long term.
Performance of sectors and index over 5yrs
Source: FE Analytics
Godber said: “All investment styles have good times and bad times, so there will be times when value won’t be the best approach. You don’t want to be in a value fund, for example, if we’re in the middle of a tech boom but over the long term, we think value performs extremely well.”
Diversification
The manager added: “Why should consider a value fund as part of their portfolio? I think we’re doing something slightly different to the rest of the funds out there.”
“If you look at our top holdings, this is not what the top 10 of a typical UK fund would look like – and they shouldn’t because they’re not value funds. So we think value can be complimentary to the usual portfolio and has a low correlation to the rest of the sector.”
A look at the top 10 holdings of CF Miton UK Value Opportunities and the average IA UK All Companies shows how value funds look outside the most common UK names.
Source: FE Analytics
Godber and Hamilton have managed CF Miton UK Value Opportunities since its launch in March 2013, over which time it has made a total return of 58.92 per cent, ranking it second out of the 266 funds in its sector where the average gain has been 16.38 per cent. The FTSE All Share has made 9.07 per cent over this time.
Furthermore, the fund stands out on some of the other indicators mentioned by the manager in the above article as it is one of the top three funds in its sector for alpha generation, downside risk, maximum drawdown, risk-adjusted returns measured by the Sharpe, Sortino and Treynor ratios, annualised volatility and number of positive months.
CF Miton UK Value Opportunities has a clean ongoing charges figure (OCF) of 0.89 per cent.
In a coming article, FE Trustnet will take a closer look at the UK value funds that are available to investors and how they have performed over recent years.
