A hefty 15 per cent portfolio turnover, which involved selling several underperforming stocks and topping up contrarian positions, led to JOHCM UK Dynamic fund’s stellar outperformance last year, according to the manager.
FE Alpha Manager Alex Savvides, who has headed up the four crown-rated fund since its launch in 2008, says a number of punchy calls took the fund from the bottom quartile in 2015 to becoming one of the best-performing funds in the IA UK All Companies sector last year, despite many active managers failing to outperform the FTSE All Share.
Many funds in the space struggled to achieve outperformance relative to the index last year following the plunge in sterling, which benefitted the global-facing large-cap exporters that account for a large proportion of the index.
Despite holding 58.9 per cent of the portfolio in FTSE 100 stocks – which account for approximately 80 per cent of the FTSE All Share – JOHCM UK Dynamic returned 20.95 per cent in 2016, compared to its benchmark and sector average’s respective returns of 16.75 and 10.82 per cent.
Performance of fund vs sector and index over 2016
Source: FE Analytics
“I think memories are short in the stock market. I would like to remind people that, in 2015, this fund underperformed compared to my expectations for short-term reasons, which unwound to some degree in 2016,” Savvides said.
“One of those reasons was Anglo American. One of the reasons we did well in 2016 was because Anglo American had a very good year, it was one of our top three investments for the majority of the year and, having started the year at £2.20 [per share], it ended the year at £13.
“When one of your top investments does something like that, it’s a fair tailwind.
“Having said that, there were things we did that were very important in the recovery and the outperformance of this fund in 2016.”
During 2015, the manager and his team removed a number of investments which either weren’t aligned with performance expectations, weren’t the best possible option relative to stocks elsewhere or had delivered historically and were unlikely to deliver to the same degree in the future.
The capital from these underperforming or late-cycle holdings was then allocated to newer and higher-quality, higher-conviction stocks.
“We ended up taking about 15 per cent of the portfolio out and recapitalising that 15 per cent into existing ideas. We were net sellers of stocks through 2015 and 2016,” he explained.
“That process meant that we ran five or six high conviction, larger positions at the top end of the portfolio, all of which did very well last year.
“One of the key beneficiaries of our capital allocation decision was Morrisons, where we took the position from 1.5 per cent at the start of 2016 of the fund’s assets to 4 per cent in the space of about two months. We also took out some residual positions in the consumer space to reallocate.
“It was done for the right reasons and it was done at the right time. What the management team delivered next was better than even we expected and then the share prices reacted.”
Savvides describes supermarket chain WM Morrisons as the most unloved stock in his portfolio, given that many investors are worried how rising inflation will impact the end consumer.
This, combined with the rise in e-commerce and the price war triggered by German discounters, led to a general sell-off in the sector last year. However, the manager says many fundamentally attractive stocks are overlooked because of a fixation on macroeconomics.
“I am not belittling for a minute the debate about macro and sectors and around the wider economy, their consumers and their expenditure. But sometimes, the ability to do improve an individual company far outweighs the headwinds you might face on a sector level, and I definitely think Morrisons is one of those cases,” Savvides said.
“All we have ever wanted to do is understand what the company is doing, in the context of what the wider market is doing. Analysts look at the wider context and then they want to understand what the company is doing, it’s just the other way round from that perspective.
“To cut a long story short, if you focus on what the individual company has been doing over the last few years you get a very good picture. Morrisons had a completely new management team from top to bottom, but it goes beyond that and below board-level. Whether it’s a property director, a commercial director, whether it’s a director in HR. This was a different business and it had to be.”
Morrisons has returned less than a quarter of the gains made by the FTSE 100 over the past five years due to significant losses in 2012, 2014 and 2015.
Last year, however, the out-of-favour stock rallied, returning 59.74 per cent compared to its index’s return of 19.07 per cent.
Performance of stock vs index in 2016
Source: FE Analytics
“If we look back at last year, it’s definitely one of the best things we did. I might even say that it is one of the best investments I have made so far as an investor because it has been so contrarian,” the manager said.
“It’s been very difficult but for the right reasons and I daresay it will drive a lot of value over the years if this management team stays with the company.”
Savvides says the fund’s performance was also driven by maintaining a strict sell discipline in addition to buying or topping up unloved positions.
When it comes to removing stocks from the portfolio, he focuses on a blend of factors, which include company valuation and the ongoing capabilities of management teams to grow the business further over the long term, among others.
Last year, however, he admits there were several particularly challenging decisions he had to make when it came to selling out of already lowly-valued stocks.
“I’m actually almost prouder of the positions we sold and some of the tough decisions we took to sell some assets through 2015 and 2016 that really were struggling for us,” Savvides continued.
“We sold Johnston Press at less than 70p, it sits today at 16p in the market. It has done badly for us but, having lost money, we weren’t blinded. We also sold DX group, which was a residual position, at 35p and they’re at 6p today.
“There’s a long list, it’s not just those. There were some others that we undertook which were good sales. Carpetright, the money that went into Morrisons, was sold at £4 and it ended up falling to £2. Our sells were just as good as our buys last year and I think that is a bit of a hidden story.
“It was about the strength of our conviction. Even if you’re taking those losses, you know that allocating capital elsewhere is the right thing to do. Maybe the timing was lucky in some cases, but the decisions were taken and we’re very proud of some of the things we did last year.”
Since Savvides launched the £378m JOHCM UK Dynamic fund in June 2008, it has returned 173.48 per cent compared to its benchmark and sector average’s respective returns of 82.59 and 83.8 per cent.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Over the same time frame, it is in the top quartile for its maximum drawdown (which shows the most money lost if bought and sold at the worst possible times) and for its Sharpe ratio (which measures risk-adjusted returns). It is in the third quartile for its annualised volatility.
The fund has a clean ongoing charges figure of 0.87 per cent and yields 3.42 per cent.