Value funds are looking increasingly attractive given changing market dynamics, according to Darius McDermott (pictured).
The managing director of Chelsea Financial Services says that investors have a greater chance of generating higher returns on cheaper holdings, despite the fact that value investing has been largely out-of-favour over recent years.
“Value investing has been a thankless task for quite some time now. Cheap has just got cheaper. But now may well be a good time to invest in this style – as long as you're prepared to be patient,” he said.
Performance of indices over 3yrs
Source: FE Analytics
“In the short term, global growth doesn't look likely to rebound strongly, nor interest rates likely to rise markedly. In this environment, companies that can simply grow faster than the market are very attractive, so good growth stocks could continue to be popular and outperform.”
“But the power of the value factor over time should not be underestimated and, 10 years into a value bear market, when it still feels a really uncomfortable choice, the contrarian in me can see opportunities ahead.”
As such, McDermott lists five of his favourite value funds in the below article:
Artemis UK Special Situations
This £1.2bn fund has been headed up by FE Alpha Manager Derek Stuart since the turn of the century, who was then joined by co-manager Andy Gray in 2014.
The fund aims to hold companies with simple and sustainable business models that are able to generate cash, but have fallen out of favour due to a shortcoming within the firm.
However, the managers believe it is important that the firm has recognised its underlying issues and is in the process of resolving these before they buy into it. Examples of the fund’s current holdings include BP, BT, GlaxoSmithKline and Informa.
“Run by Derek Stuart since launch, this is an unconstrained, multi-cap fund with a mid and small-cap bias,” McDermott said.
“Derek looks for hidden value. By focusing on stocks’ scope for re-rating and longer-term earnings, he views ‘problem investments’ as potential opportunities.”
Over the manager’s tenure, the fund has provided a total return of 468.9 per cent, outperforming its sector average and benchmark by 389.13 and 383.32 percentage points respectively.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
The fund has also managed to outperform its average peer over one, three, five and 10 years, while value investing has been out of favour.
In terms of risk metrics, it has delivered a top-quartile maximum drawdown (which measures the most potential money lost if bought and sold at the worst times) and Sharpe ratio (which measures risk-adjusted returns) since its launch, although it does have a bottom-quartile annualised volatility.
Artemis UK Special Situations has a clean ongoing charges figure (OCF) of 0.81 per cent.
JOHCM UK Dynamic
JOHCM UK Dynamic is £311m in size and has been managed by FE Alpha Manager Alex Savvides since 2008.
The fund has a concentrated portfolio of 41 holdings, all of which are chosen by Savvides on the basis that they are changing or improving their processes. He opts for those he believes are most likely to succeed while also boasting the highest cash-based valuation support.
As a result, the portfolio consists of holdings that the manager believes to be high quality, under-researched and unloved.
“Virtually undiscovered by the broader investment community, the fund benefits from an effective investment process, a strong manager and a stable company environment,” McDermott explained.
“Alex invests in UK companies that are undergoing substantial positive change that is unrecognised in the current share price, thereby benefiting from a recovery in the business.”
Since its launch, the fund has provided a total return of 114.22 per cent, more than doubling the performance of its sector average and benchmark over the same time frame.
While the fund has performed well over the longer term though, it has provided a bottom-quartile return over the last year, which could be attributed to the fact that value investing has been particularly out-of-favour recently due to heightened market volatility.
Over five years, the three crown-rated fund has provided a bottom-quartile annualised volatility and maximum drawdown, which means it might be best suited to investors with a higher appetite for risk.
JOHCM UK Dynamic has a clean OCF of 0.74 per cent and yields 3.42 per cent.
Jupiter UK Special Situations
Next on McDermott’s list is the £1.3bn Jupiter UK Special Situations fund, which has been managed by Ben Whitmore since 2006.
The fund aims to outperform its FTSE All Share benchmark by 2 to 3 per cent per annum over a market cycle and the manager does this through the use of two main quantitative screens, which measure how undervalued a stock is relative to its long term history and how attractive it is based on its low valuation versus high capital return ratio.
“Ben is a true value manager who believes that company earnings forecasts are difficult to predict with any accuracy,” McDermott said.
“As such, he focuses on buying enduring companies that are cheaply valued.”
Examples of the fund’s largest weightings include BP, Relx, BAE Systems and GlaxoSmithKline, although the manager is also able to hold small positions in Europe and the US as well as the UK.
Whitmore is also unafraid of holding larger amounts of cash at certain times during the cycle as he accepts that his value approach will not deliver an outperformance in all market conditions - currently, the three crown-rated fund has a 7.97 per cent cash weighting.
Over five years, the fund has provided a total return of 53.23 per cent, compared to its sector average’s return of 37.52 per cent and its benchmark’s return of 30.91 per cent.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
The fund, which has a clean OCF of 0.77 per cent, also has a top-quartile maximum drawdown, annualised volatility and Sharpe ratio over five years.
L&G UK Alpha Trust
Launched by Richard Penny in 2009, this £161m fund has a portfolio of 49 holdings across the market cap spectrum, ranging from less than £50m in size to up to £10bn.
The investment vehicle is also able to hold small weightings in regions outside of the UK and currently has small positions in Ireland, Israel, the US and Australia.
“Run by a straight-talking manager who describes himself as a “tight-fisted Yorkshire-man” when it comes to his investments, this market capitalisation agnostic fund looks for bargains in all corners of the market and particularly where the manager believes it is inefficient,” McDermott said.
As the name suggests, the fund aims to generate high levels of alpha through its concentrated and multi-cap approach – over one, three and seven years it has delivered an above-average alpha generation, although this is lower than average over the last five years.
The manager combines both deep value and strong growth strategies when building his portfolio and will focus on management, return on capital, cash conversion, predictability and growth.
While the fund is able to invest anywhere across the size spectrum from micro-caps to mega-caps, Penny is only able to allocate a maximum of 30 per cent to companies that are less than £25m in size.
The fund has outperformed both its sector and benchmark over one, three and 10 years although it has underperformed over five years.
L&G UK Alpha Trust has a clean OCF of 0.88 per cent.
The final fund on the list is Schroder Recovery, which is managed by Nick Kirrage and Kevin Murphy.
McDermott said: “[This is] a true deep-value fund that invests in the cheapest and most unloved companies in the UK. Investors need to have a high tolerance for volatility, as this fund is liable to be at the bottom of the performance tables one year and top the next.”
While the fund is indeed in the bottom decile for its annualised volatility over the managers’ tenure, it has provided a top-quartile Sharpe ratio over the same time frame due to the fund’s strong performance.
Since July 2006, the £705m fund has provided a total return of 122.4 per cent, outperforming its sector average and benchmark by 54.74 and 57.13 percentage points respectively.
Performance of fund vs sector and benchmark under Kirrage and Murphy
Source: FE Analytics
The managers look for companies that have fallen on hard times and whose ability to recover has been underestimated by the market. Some of the fund’s largest holdings include the likes of RBS, BP, GlaxoSmithKline and Anglo American.
The Square Mile research team, who has awarded the fund an ‘A’ rating, said: “Although the managers are relatively early in their careers, they have a sound appreciation of the dangers that this type of investment can entail and they understand the requirement for a committed approach to an investment process such as this.”
Schroder Recovery has a clean OCF of 0.92 per cent.