As a group, the team builds this fund purely from the bottom-up, paying little attention to the benchmark, FTSE All Share index. It follows an investment strategy wherein the emphasis is squarely on evaluating a stock's quality and price attractiveness. They
target companies with solid fundamentals - such as a sound business strategy and an experienced top management to execute it - selling at an attractive price based on the likes of PE ratios and dividend yield. Such a selection process has an inherent tendency to preclude pricey and momentum issues and can lead the portfolio to out-of-favour areas.
That is certainly the case now. Based on the ongoing price weakness and valuation anomalies, the team is selectively building this large-cap value fund's exposure to the beaten-up financials and consumer services sectors. In fact, the fund's position size in consumer services is triple that of the Morningstar UK Large-Cap Value Equity category and financials is nearly double the peer group average. Interestingly, HBOS, which has suffered over the past year's turbulence in UK banks, is the only one of the Big Five banks this team does not own. The lack of a position in HBOS is, in our opinion, testament of this team's quality conscious approach as the fund has avoided the 71% decline HBOS has suffered over the past year; this fall makes it the worst performing bank of the Big Five.
Recent performance is very much in line with this positioning. Returns over the last three and five years to August 2008 are fourth quartile in the Morningstar category. This is due partly to the fund’s appreciable overweight in crisis-stricken financials. The outsized consumer services position also didn’t help matters, nor did the light weighting in materials, which is one of the few sectors to have delivered positive results of late.
But bear in mind this underperformance is a consequence of the team sticking doggedly to its well thought out price- and quality-conscious knitting. It bargain hunts among price weakness, buying into areas dowsed with negative sentiment. At present, the team stands by its tough choices and waits patiently for its bets to come good. This is precisely why shareholders in this fund must bring a long-term mindset and a willingness to ride out stretches of underperformance such as we’ve seen lately. And, for such risk-tolerant, patient investors, we think this fund has merits. For investors seeking more even-keeled equity-income exposure, however, it's likely to be unsatisfactory.
