The recent spike in inflation expectations has been enthusiastically welcomed by value investors, who are hoping it will cause a shift in asset flows away from the growth businesses that have dominated the market over the past decade and into the underpriced stocks they favour.
Yet while the low-inflation environment has been cited by many value managers as the reason for their medium-term underperformance, a handful have managed to beat the market despite the unfavourable macroeconomic conditions.
Gary Moglione and the team behind the Seneca Global Income & Growth Trust can count themselves in this group.
The trust has made 139.8 per cent over the past decade, compared with gains of 79.07 per cent from the FTSE All Share and 54.41 per cent from the IT Flexible Investment sector.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
Seneca Global Income & Growth is a multi-asset trust that invests in other trusts and directly in equities. It aims to return CPI + 6 per cent per annum, while paying an attractive yield. Moglione said that what separates it from its more “vanilla” peers is its bottom-up “distinct value-based process”.
He added that the reason for taking this approach is, to him, fairly obvious.
“The top-down influence is very strong in most people's asset allocation, but I can't find evidence to say we are expert forecasters,” he said.
“Some people are right, some people are wrong. I can't see any concrete evidence that trying to predict the future and what central banks, governments and politicians are going to do works.
“You can have an opinion on the future, but there are millions of variables that can affect that outcome.
He added: “We do it from the bottom up. If you use a chart of CAPE [cyclically adjusted P/E] versus the next 10 years’ returns, the correlation is incredibly strong.
“To us, the best way to decide asset allocation is building from the bottom up. You're not trying to guess or predict, you're looking at valuations, and you've got solid evidence to back up the strong correlation between valuations and future returns.
“It goes back to buy low, sell high.”
By his own admission, Moglione said that the trust’s value bias should have pushed it into the bottom quartile of its sector over the past 10 years, but instead it has floated to the top.
There are three main reasons for this. First is the trust’s exposure to small- and mid-caps, with the manager pointing to multiple studies showing this area of the market outperforms over the long term. Second is the asset allocation, which involves taking each universe, giving all of its stocks an equal weighting, then looking back 30 years to see how it compares historically across numerous valuation metrics.
Third and arguably most important is good stockpicking. The enormous disruption that has taken place over the past decade has been cited as another major reason for the value style’s underperformance over this time. As a result, Moglione and his team have a number of processes in place to detect value traps.
These include taking a conservative or pessimistic view on companies’ earnings expectations to build a safety buffer into valuations, focusing on strong balance sheets and forcing managers to defend their stock or asset picks to the rest of the team.
The analysts also use an EVA (economic value added) model and compare it with the ROIC (return on invested capital), which tends to lead them to businesses that are growing rather than declining.
Yet Moglione said that owning businesses that are growing does not make him a growth investor.
“The perfect environment would be a growing company in a growing sector, but as you know, you can't get them on cheap valuations,” the manager continued.
“But take an example like Purple Bricks. The cheapest stocks are normally the ones that are structurally challenged, but Purple Bricks is the challenger in the estate agency space.
Performance of stock since IPO
Source: FE Analytics
“Last year it was trading at a low of 30p because of the lockdown, but it was offering viewings throughout, so the valuation was compelling.
“Ideally, we would have the highest growth stocks in the highest growth industries, but we have a strict valuation policy. If these stocks are available within our valuation range, great, if they are not, we can't invest.”
The MSCI World index has now rebounded past its pre-coronavirus levels, even though many countries remain locked down, leading to concerns that investors are getting ahead of themselves. However, Moglione remains optimistic about the future, pointing out that his value-based process helps him to avoid the over-heated parts of the market. He added there are still plenty of areas that look cheap – and you don’t have to look too far to find one of the cheapest.
“Pre-Covid, the UK was trading on a significant discount due to Brexit and rightly so,” he explained.
“That Brexit cloud has now been removed and the deal has been done. Some people are unhappy about it, but at least it provides some clarity on what's going to happen going forward.
“And the UK now leads in vaccinations with only a few countries ahead of it. So last year the UK was probably one of the worst places if you were looking on a short-term basis, but it's now actually one of the best.”
And although the UK market has surged since the November vaccine announcements, Moglione believes this is just the beginning.
“If you look at the UK versus the rest of the world, that rally is just a small tick at the bottom of a long-term structural decline,” he continued.
Performance of indices over 10yrs
Source: FE Analytics
“The UK is not going to be uncompetitive versus the rest of the world forever, it doesn’t have these Brexit black clouds hanging over it anymore. So yes, markets have done well, and yes, our portfolio has done particularly well. But there's still a long way to go.”
Seneca Global Income & Growth is on a discount of 1.79 per cent compared with 1.72 and 0.13 per cent from its one- and three-year averages. It is yielding 3.78 per cent and has ongoing charges of 1.6 per cent.