The Polar Capital UK Value Opportunities fund has had a reasonable start to life since it launched in January 2017, but performance over the past nine months has tarnished its previously stellar returns.
Indeed, while the fund has beaten the FTSE All Share and average IA UK All Companies peer since its launch, it has lost more than 8% over the past six months and 4% over one year.
This is at a time when the ‘value’ part of the market – oil, miners, financials and tobacco to name but a few – have been booming.
It something that managers George Godber and Georgina Hamilton are aware may have disappointed investors, but there are reasons behind it.
Total return of fund vs sector and benchmark since launch
Source: FE Analytics
They pointed to the underperformance of the mid-cap region, which has failed to take off this year, as the main driver.
“Yes there has been a tailwind for value and we would expect in the future when value is doing well to deliver a better performance versus the index, but at the moment the benefit of value has been swamped by our multi-cap focus,” said Hamilton.
She added that since September, the underperformance of the FTSE 250 relative to the FTSE 100 is larger than it was during Covid, Brexit and the global financial crisis, indicating that there is plenty of room to run.
Below, the managers explain why their fund still has a place in a balanced portfolio, reveal which stocks have been bright spots this year and highlight how avoiding environmental, social and governance (ESG) principals may lead to investing in “value traps”.
What is your process for picking stocks?
Godber: We model everything in the FTSE 350 that is large enough for us to look at. We then screen for the valuation criteria we are looking for. With the around 120 stocks that are left we meet management and do our research to get to the 60 stocks that are in the portfolio today.
Hamilton: We look for shares that are temporarily depressed compared to their intrinsic value. So we quantify the fundamental worth of a business through a detailed modelling process and we look for where a company is out of favour and there is a discount between the price and their worth.
Why should investors pick your fund?
Godber: We are bottom up, we are value and we hunt across the market-cap spectrum. We stick to this, even if our process is out of favour – and by golly has that been the case at times in the past few years. If people want balance in their portfolio and don’t want five funds all doing the same thing, then we feel that we have a place.
We always used to say that value was underserved in the UK market but has got a lot more so in the past few years. There is not many that we do what we do. We have one of the highest active shares in the sector, so it is whether people want that diversifier to their other holdings.
Performance has been poor in 2022, what has been the biggest detractor?
Hamilton: Our worst year-to-date has been M&S which is down around 40%. The thing with being a value manager is if a share falls you should want to buy more and should be more excited by it as it means it is cheaper.
But we have not changed our fundamental analysis on the net worth of Marks & Spencer. Although it has been the worst contributor to the fund this year, we think it is a really good investment.
Loads of people have tried to turn around Marks & Spencer over the years but the difference this time is that the numbers and the data do support that there is a genuine turnaround there.
Godber: It is trading on 6x earnings and a year ago, the last time M&S was at this level, it would have been forecast to make £295m in profit before tax. Now it should deliver around £500m – that is the scale of the improvement yet shares are back to where they were a year ago.
Which stocks have done well in 2022?
Godber: The best year-to-date is Serica, which owns about 5% of the UK national gas market and is a good example of how we are happy to hunt anywhere. We first saw that business when there were five people there.
This year there has been a lot of strength in the gas price, which belittles the extraordinarily good work that this management team has done in improving its asset over the past few years.
It is still on only 4x earnings, it is highly cash generative and so we think it is due a re-rating this year. Shares are up 30% or so in 2022.
Another that has done well, but is centred around the war in Ukraine, is a mid-cap defence company called Qinetiq, which we have held for a long time. Clearly the outlook for defence has got sadly better over the next one, five and 10 years.
Do you incorporate ESG into the fund?
Hamilton: Integrating ESG factors is essential in delivering our objective – long-term capital growth. Essentially we have a score that we have created ourselves, which we think gives us an edge. We expect in time others will in time bring this in-house rather than using third parties.
Overall scores don’t much help, as a meaningless number times by a meaningless number leads to a meaningless number. You have to look at it in each sub-sector.
Our score leads to exclusions to a small degree, but the main part of it is to do with position sizing and specific engagement. We have big position sizes in companies and talk to management frequently throughout the year.
Godber: It is not a theme that is going away, so you need to think about how it is going to affect your business and your customers. The reason ESG matters is because it matters to the people on the street and it is affecting purchasing decisions.
As a value manager if you are not aware of it and don’t spend enough time on it, you can get caught in hot water by being stuck in a value trap.
What is the most exciting stock in the fund?
Godber: Our biggest success going back over our entire career is JD Sport, which we started investing in in 2012. As value investors we run strict price targets and the company hit ours about halfway through last year as it had gone from being unknown to a high street name. We exited the holding in full.
More recently shares have halved, so we have been able to add that back into the portfolio and we are delighted. It is still in the foothills of the exclusivity deal that it has with Nike and there is an awful lot of room for growth in the firm’s US business.
It is the best at what it does and to get that at sub 10x earnings, but look at where it could be in three years’ time, we pinch ourselves that we were able to add it back.
What do you do outside of fund management?
Godber: I have a young family that consumes everything, although I play a little bit of golf badly.
Hamilton: I have the two best jobs in the world: being a fund manager and a mum to a toddler.