At times the past 10 years has been a lively period to be a UK value investor. If nothing else, it has been instructive. As we consider our decade of managing the Man GLG Undervalued Assets Fund, we have identified four standout lessons from the past decade of running money in an unloved asset class.
Shares move more than fundamentals
The past 10 years have not been short of crises. The Brexit vote, the ups and downs of actually leaving the EU, multiple UK elections, the pandemic, surging inflation, European war and now the fastest rate hiking cycle in more than 30 years.
It is easy in these moments to be singly focused on the pervasive bearish narrative. By simply following market sentiment at the time one would believe that UK domestics were never going to be interesting post June 2016, while Glencore was uninvestable three years ago – as were Shell, BP and Centrica. Airlines were worthless in the depths of the pandemic.
Today, brick manufacturers are trading at deep discounts to their clay reserves yet are deemed avoids by brokers in light of weak housing demand.
When it feels most scary, some of the best opportunities emerge as emotions take over from fundamentals. Having experienced what feels like more than our fair share of these extremes, we have learnt that it can be highly beneficial to lean into that risk at acute moments as process dictates.
Process prevents ‘bad surfing’
Having a consistent process in these instances can help with the difficult decision to be counter cyclical. By falling back on rules, value investors can hopefully profit from those selling in despair just as a company slides materially below the value of its assets near the darkest-before-the-dawn moment.
We have learned from the weight of evidence over time to trust that a robust process can identify and consistently quantify this undervaluation. This is just as valuable at peaks as it as at troughs: having a view of fair value driven by a regular application of modelling enables investors to avoid falling in love with shares that have performed well just when the upside is most limited.
We will often find ourselves selling to eager buyers in moments of euphoria. Internally, we term this ‘avoiding being a bad surfer’: avoiding either going too early or too late to every wave and not catching any of them. Whilst none of us is any use on a surfboard, process helps us avoid that fate when it comes to making investment decisions.
Ignore the cashflow and balance sheet at your peril
As value investors, we are regularly presented with ostensibly cheap companies, often stocks that have fallen significantly in the recent past. Some of these will indeed be fantastic value opportunities. Others having halved will go on to halve again… and again. What is the best way to pick the value opportunities from the value traps?
The lesson for us is to firstly focus on the actual cash generated by the business, rather than the headline adjusted earnings that management might want you to look at. Then to build a detailed understanding of the structure of the balance sheet and the working capital.
We have learned – through sometimes painful experience – to spend more time in pages 80-120 of an annual report than in the accompanying flashy PowerPoint presentation. It is there that fragility often reveals itself in companies that are not as cheap as they seem.
If we can identify businesses with robust balance sheets, which are genuinely converting their earnings to cash, we tip the risk/reward strongly in our favour.
It is these companies that give themselves the best chance to survive long enough for corporate Darwinism to take hold in their end markets and enjoy the recovery on the other side.
Better data equals better outcomes
Fund management is more about hard work and continual improvement than it is about inspiration or talent. Although our process remains unchanged, we try to ensure our ability to execute on it is on a constantly improving path. Even a successful fund will rarely have a hit-rate above 55%, leaving plenty of errors to parse.
While it is always vital to ‘postmortem’ loss-making positions – identifying what went wrong is central to making improvements – it is important to dig deeper, something that has been enhanced by developments in data over recent years.
Modern data analytics systems can examine trading patterns and behavioural biases, allowing investors like us to identify where we fall short and help us make better risk-adjusted decisions.
The continual accumulation of proprietary data is also key as time moves on. For instance, the data we have gathered over the past decade for each UK company – tracking it through its own idiosyncratic cycle – helps us spot attractive opportunities, especially in lesser-analysed parts of the market.
The sum of these incremental improvements is much larger than any individual one appears at the time. Marginal gains matter, and they give us the conviction to continue on the same path in the next 10 years.
Jack Barrat is co-manager of the Man GLG Undervalued Assets fund. The views expressed above should not be taken as investment advice.