The fund’s objective is to grow the capital value over the medium to long term. It can invest anywhere in the world in shares the managers consider to be undervalued relative to their long term earnings potential.
At least 80% of the fund (excluding cash) is invested in companies that have suffered a setback in either the share price or profitability but where there are solid longer-term prospects. Derivatives may be used for efficient portfolio management or to reduce risk.
Nick Kirrage and Kevin Murphy established the UK value strategy over 15 years ago. The duo co-head the Global Value Equity team, which launched the Schroder Global Recovery fund in 2015.
Kirrage, along with Simon Adler and Andrew Lyddon, are the named managers on this fund. In addition, there are six further experienced managers and analysts in the value team who actively contribute to investment research and stock selection.
Investment philosophy & process
The core philosophy is that companies which trade at a significant discount to their intrinsic value offer strong prospects for share price appreciation over the long term. The managers aim to identify unloved stocks, buy early when there is greatest potential upside, and patiently wait for a rerating.
The team believes it has a competitive advantage with its distinctive 4-point process comprising informational, analytical, organisational and behavioural elements. This starts with valuation screens to narrow down the universe to around 500 stocks worldwide.
Each week, team members select a company on which to conduct in-depth research, dissecting the report and accounts and making their own adjustments. A model is built, using 10 years of historic data, to forecast forward earnings. They also use seven ‘red’ questions to help avoid value traps, including whether profits are turned into cash and if the business would withstand a financial stress test.
On organisational issues, the team liaises with its in-house ESG (Environmental, Social and Governance) specialists. How a business manages these factors affects the sustainability of profit margins. If the managers believe a company is not acting in the long-term interests of shareholders they actively engage to protect their investment.
When deciding whether to invest they try to avoid any behavioural bias. Companies are given a 0-10 risk score and an expected upside return. The team then weigh up the risk versus reward and debate wider influences such as structural disruption, using their judgment to assess whether such risks are factored in to the share price. Every company is ascribed what is considered a true current valuation, what it should be worth and the price they are prepared to pay.
A margin of safety is always built into the price paid for shares. The size of a holding depends on the risk score to limit the possibility of losing capital. It is very difficult to call the bottom for share prices so purchases may be spread out when building a position. Conversely, profits are usually taken well before the peak.
Employing this strict approach has helped avoid impending disasters such as Thomas Cook and Carillion. In fact, 98% of companies analysed are rejected all research is saved in the archive and team take learning days to review any mistakes, such as Debenhams.
Performance & costs
Since launch on October 30th 2015, the fund has delivered a total return, in sterling terms, of 55% compared with 69% for the MSCI World index and 58% for the IA Global sector (source: FE analytics).
The under-performance relative to the benchmark reflects disappointing returns from the value style in recent years. On the few occasions it has experienced an upturn, the fund has performed strongly relative to its peer group which bodes well should the style return to favour.
The fund is significantly overweight in financials, energy and materials reflecting the concentration of value stocks in these sectors. Four banks feature in the top 10 holdings. Unsurprisingly, the fund is underweight in information technology, healthcare and consumer staples. There is a bias to large companies because they tend to have the long track records required.
Geographically, the fund is currently notably underweight in the US, at around 21% compared to 54% for the benchmark. The fund has high exposure by revenue to Europe and emerging markets where valuations have become increasingly attractive.
Currently the biggest holdings are Sanofi, Standard Chartered, Royal Bank of Scotland and Anglo American. Sanofi, a French pharmaceutical business is attractively valued relative to its peers while Standard Chartered has exposure to strong growth in Asia at a modest rating. Anglo American offers cyclical recovery exposure to the mining sector and is the world’s leading platinum producer.
A recent purchase is NHK, a Japanese manufacturer of springs for the automotive sector. Even allowing for a slowdown in auto sales, the managers considered it to be cheap on all financial ratios and that the company has demonstrated impressive cash conversion characteristics. There are no structural concerns as cars will always need wheels and seats.
Centrica has been the main source of disappointment this year as all divisions experienced a downturn. However, Schroders have been influential in bringing about management change and unprofitable businesses are now up for sale. Further analysis concluded that sufficient upside exists so they topped up the holding.
US retailer Buckle is one stock they sold after revisiting the investment case. Although they investigated 31 US retailers and turned down 29, this purchase was not a success and has taught the managers to look at wider industry margins rather than just company ones.
The team believe there is a unique opportunity today to invest in unloved businesses. Value indices trade at a record gap to their growth counterparts, offering significant potential for a re-rating on a five year view. The most compelling valuations are in autos, banks and oil & gas companies.
Whilst a pick-up in growth, and even interest rates, would be supportive for the portfolio, the managers are confident that it is robust enough to cope with a moderate slowdown. They note the value style has done well in Japan against a low growth background.
Companies fall out of favour for many reasons, including profit setbacks and macroeconomic concerns, and the managers exploit the poor sentiment among short-term investors. Patience is paramount and the team remain highly committed to their process.
There has been a flight to growth-orientated strategies in recent years which has left many portfolios lacking style diversification. According to Schroder’s research, over 90% of funds focus on growth shares so an allocation to this fund could provide useful diversification if a change in market focus occurs.
The focused strategy (around 45 stocks are held) means the fund may be volatile. It has a ‘go-anywhere’ mandate and will be skewed towards specific industries or regions at any time depending on which are in a recovery phase.
There are few deep-value managers and we like the disciplined process of the Schroder team. Nevertheless, we accept that re-ratings take time (typical holding period is 5 years) and investors should be prepared to weather periods of underperformance. It retains a Morningstar Analyst Rating of Bronze.
Important information: Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Nothing in this article is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment.
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