The managers take a deep-value approach to investment, looking for companies that are cheap compared with earnings and also on the quiet phase of their earnings cycle, limiting their universe of possible investments to those with very little downside. They say they are finding very few opportunities in the current environment after a year of rising markets, but the oil and gas sector, usually seen as a more cyclical and risky area, is the exception.
The team have bought Statoil to add to holdings in Shell and BP, and the sector now makes up 14 per cent of their fund.
"Energy we think is interesting," Heenan said. "Portfolio management for us is about building balanced portfolios that will do well in bull and bear markets."
"Energy has not kept up with this market. It has been the forgotten sector and that’s interesting. Statoil is still under 10 times earnings and it has a 5 per cent dividend yield."
"I think Statoil is a unique asset to have that much of the Norwegian shelf."
"We follow the analyst Russell Napier who sits on our advisory board and he has written that from the bottom of the four great bear markets in the last century, energy was the best sector."
Data from FE Analytics shows that the oil and gas sector has lagged behind the broader world market during the recovery over the past two years.
Performance of sectors over 2yrs
Source: FE Analytics
Many investors have maximised their gains by moving into the financial sector, which has been leading the rally, but Heenan says it is far too risky for their long-term style.
"Financials do the worst in tough markets," he said. "We have never held a bank. We find them very difficult, they are just too leveraged."
"It’s in the nature of a bank that it has huge amount of leverage. Plus asset managers are very momentum-based."
"That’s difficult for us with our style – we don’t like high-beta assets."
"One of the nice things about not benchmarking is we can just avoid a whole sector. Obviously the problem is you have to accept different performance either in a good or bad way."
"There will be financials-led markets we won’t keep up with. QE has supported the financial services sector – we try to avoid peak earnings and we are discounting those earnings."
Kennox Strategic Value has been growing rapidly over the past year, reaching £210m. Its largest shareholders are private wealth managers and charities, organisations that share the managers’ long-term risk-averse view, they say. The managers themselves own 8 per cent of the fund.
The fund is only open to investments of £20,000 or more, but it is moving into platforms, increasing its availability.
It will shortly be on Cofunds, while it is already available on Transact and may eventually appear on Nucleus.
It is most often compared to the funds run by Ruffer, which take capital preservation as their chief priority.
Despite being an equity fund, it made money in 2008, ending the year up 6.38 per cent while the IMA Global sector fell 24.32 per cent. It also produced top-quartile returns in 2011, while in 2012 it made exactly the sector average and this year is slightly behind so far.
Over five years it is still ahead of the average global fund, with returns of 90.11 per cent to the sector’s 81.67 per cent. However, the managers do not benchmark themselves against this collection of funds, the majority of which are trying to do very different things.
Performance of fund vs sector over 5yrs
Source: FE Analytics
Heenan explains that outside of the energy sector there are few stocks showing up as interesting to them.
"We are not finding enough on low enough P/Es and that aren’t on peak earnings," he said.
"There have been times when we were finding a huge amount of opportunities in Japan. What we are seeing is valuation screens showing up commodities, emerging markets and other areas we are not willing to invest in."
The manager says that emerging markets are too volatile at this stage of their development.
"Things happen far too quickly [in investment]. We think emerging markets are very interesting in the longer-term but I am very concerned it will take time for the sector to turn."
"In the longer term these economies are very interesting. We think growth will be higher volatility. The danger is it’s going to take a year or two of consolidation: the automatic stabilisers are much lower in these economies."
"The services economy is much smaller than in the West and they are more exposed to trade, so high beta on the global economy."
"We also aren’t interested in the US, you have peak profits in the US, so we weren’t showing up US companies except some industrial companies that did show up as interesting."
Apart from Statoil, Heenan and Legg have bought only five stocks in the last 18 months, which they say is "punchy" for them.
Another was Western Union, which they bought in January at just over 14p a share. It is now at 18p.
"One of my favourite stats is that it has approximately a billion dollars a year free cash-flow and capex of just $50m, so the amount Tesco [another holding] would spend on one big store is what they spend in one year."
The managers explain that it is four times the size of the nearest competitor, while banks and financial services companies are unlikely to be able to muscle in on its business, because its customers are largely those who cannot afford a bank account and need cash in hand.
"The valuation story is that they cut one of the channels from the US to Mexico because they wanted to protect market share in that market; that is to say cut margins to protect market share," Heenan said.
"The market price went down 30 per cent straight away because they did it in a way where they said straight out third and fourth quarter numbers would be down. So we picked it up at five-year lows."
"When the opportunities come, it’s counter-cyclical to short-term earnings. I like this company because it is so different to the other companies in the portfolio, with different profit drivers."
Heenan retains a cautious outlook on the global recovery, warning that the crunch will come when central banks eventually raise rates, which he does not see on the horizon.
"The global economy will only really know if this recovery is stable or not if interest rates rise. You cannot say you have normality when interest rates are at 0.5 per cent," he said.
"It’s very dangerous to say everything is fine. We will only know once that happens."
"People are always optimistic about equities on the back of equities performing very well; it’s very dangerous to change your investment style because of a change in sentiment.”
Ongoing charges on the fund are 1.58 per cent.
