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Why investors should look beyond their usual UK funds

03 May 2016

‘Safety in numbers’ is a sentiment that most people will understand but when it comes to investing, it can ultimately lead to a negative outcome. With this in mind, JP Morgan Asset Management’s Jonathan Ingram says investors should look beyond the most obvious hunting grounds when seeking UK funds.

 
Investors should broaden out their UK equity exposure from the popular funds that are the mainstay of many portfolios and look to complement them with those that can add a differentiated approach and new stock ideas, according to JP Morgan Asset Management’s Jonathan Ingram.

Investor herding (or the tendency for a small group of funds to attract the lion’s share of inflows) is not a new trend in the asset management world but Ingram – who co-manages the JPM UK Dynamic fund – argues that this behaviour can ultimately prove damaging to the end investor.

If we look at the IA UK All Companies sector, for example, close to two-fifths of its £157.3bn total assets are managed by the peer group’s 10 largest funds. Half of these are trackers and the other five are generally run by well respected managers.

 

Source: FE Analytics, as the end of March 2016

However, Ingram explains that large funds (with their growing assets) bring a number of issues that should make investors think twice before committing all their UK allocation to them.

Not least of these is the fact that larger funds find it hard to establish a meaningful position in smaller companies, which have the potential for higher growth rates albeit with more risk, as they would own too much of the business. If small companies were behind some of the fund’s earlier track record, there could be question marks over whether they can repeat this performance.

“Ultimately, if everybody goes into the same fund then it will become too big and large funds make it structurally harder for the manager to outperform smaller funds,” Ingram said.

Furthermore, most of the largest funds in the IA UK All Companies sector have a relatively fixed approach to investing. In the case of trackers, they simply mirror the index while the active funds often stick to one style of investing, such as focusing on income stocks or looking for value opportunities. 

Given this, Ingram argues that it can be beneficial for investors to add smaller, more nimble funds to their portfolio – especially if they have a differentiated investment style that brings something new to the table.

Ingram’s £164.5m JPM UK Dynamic fund, which he co-manages with John Baker and Blake Crawford, holds five FE Crowns for superior performance in terms of stockpicking, consistency and risk control over recent years.


 

As the graph below shows, it has achieved a second-decile total return of 249.95 per cent between its launch in 2000 and the end of March 2016, outperforming its average peer and its FTSE All Share benchmark by a significant margin in the process.

The manager explains that these returns have come about on the back of a unique process that focuses on three criteria of value, quality and momentum. Due to its unconstrained approach, the fund offers multi-cap exposure (it has more than 30 per cent of its assets in mid-caps and 8 per cent in small-caps) and exposure to the JPM behavioural finance team’s best ideas.

Performance of fund versus sector and index since launch

 

Source: FE Analytics. Total return in sterling, with income reinvested, between 18 Oct 2000 and 31 Mar 2016

The team, which comprises 49 members, uses quantitative screens to narrow down potential holdings. A value screen identifies stocks with attractive valuations on traditional measures such as the price/earnings ratio, a quality screen looks for profitable businesses with sustainable earnings and disciplined management teams and a momentum screen seeks positive momentum in earnings and share prices.

Through this process, the team aims to remove emotion from investing and assess companies through an objective and repeatable process, rather than one that could be influenced by subjective factors such as how polished company management is.

“We've looked at what we think drives share price returns then really focused in a disciplined fashion all our fund managers and analysts on these factors. We've built an investment process around understanding behaviour and have a framework that allows us to make good, rational decisions,” Ingram said.

“Our job as fund managers is to outperform the index so if you distil that right down we’re looking to predict which share prices are going up and which are going down. It's not to take a judgement call on how 'good' one company might be versus another.”

“Great companies aren't necessarily great performing share prices and vice versa. We therefore analyse the behaviour of people who have the potential to make share prices move in one of three ways.

The first, he explains, is because company management does or says something – such as raising earning expectations, making a good acquisition or cutting their dividend – that prompts a reaction from investors.

“A management action will cause the share price to move, one way or the other, so we have to understand company management and their behaviour,” he said. 

One way the manager looks to gain a deeper understanding of company management is to determine how conservative or overconfident they are. Given the team’s approach, they are more interested in using “meaningful measures” to gauge this rather than basing it on subjective factors such as the firmness of the CEO’s handshake; one way they do this is to look at how aggressive a firm’s accounting practices is compared with its peers.


 

“Take airline companies, for example. They all buy the same aeroplanes but some depreciate those over 15 years while others take the same plane and say they can get 20 years out of it. One of them is right and one is wrong – we won't know for 15 years or 20 years which but we can look at them together and say one has more conservative tendencies that the other,” Ingram (pictured) said.

“Therefore, it might mean that if they've guided they'll do 10 per cent profit growth this year, that might also be a conservative estimate and they'll deliver 11 per cent and the share price will go up. The reverse could be true for more aggressive companies.”

A second factor that can move share prices is the irrational behaviour of other investors and the process therefore looks to exploit this. One area of particular interest is for investors to sell otherwise attractive companies after some short-term bad noise while holding onto those that are down in the belief they can make their money back.

“What we're really trying to capture is the underlying behaviour inherent in most of us to try and avoid saying we were wrong,” Ingram explained.

“Take a hypothetical situation: if you buy a stock for £100 and it goes up to £120 then some bad news comes out, emotionally you'd find it easy to sell and say 'oh well, I've made 20 per cent, '. What investors aren't so good at doing is making an investment at £100 and holding it when it goes down to £95 and then bad news comes out, because we have to admit we got it wrong. People hold onto it and maintain that it will go back up.”

“That gives us some interesting dynamics on the types of companies we want to own because we do an analysis essentially of the experience of the shareholders in a company and that can help inform our view as to whether we're likely to have sellers or buyers in the future. Clearly, we want to own the ones that others will want to buy.”

A third factor that can move share prices is the analyst community. While JPM’s behavioural finance team does not pay attention to the buy, hold or sell recommendations of analysts, they do take stock of the changes in their views.

Like most people financial analysts exhibit “herding tendencies”, according to Ingram, and tend to feel more comfortable if their forecasts are similar to everyone else’s. This can mean that good news about a company is overplayed while signs of bad news are relatively ignored.

However, if the team notices small change in analysts’ opinion they believe there is often the potential for this to herald more significant good or bad news to come. This gradual shift in news flow around a stock can highlight an investment opportunity.

“If we see analysts start to change their mind on a company, often it's the start of a more gradual shift to their ultimate conclusion," the manager said.

In a coming article, we will see how this process is put into practice by highlighting a number of stocks that differentiates JPM UK Dynamic from the ‘typical’ IA UK All Companies fund.

 

The above article was prepared in partnership with JP Morgan Asset Management and should not be taken as investment advice.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.