Merryn Somerset Webb talks to Craig Yeaman, the manager of the Saracen Growth Fund, and finds out the secret to his remarkable success, plus a few tips on what he’s buying now.
• If you missed any of Merryn’s past interviews, you can see them all here.
Merryn: Hi, I’m Merryn Somerset Webb, and I am the editor-in-chief of MoneyWeek magazine. Welcome to another one of our video interviews. I am here today with Craig Yeaman, who is the manager of the Saracen Growth Fund, and we are going to talk a bit about the fund, about how he invest in a business and what he is interested in now. Which I am pleased to say are some of the same things that we are also interested in. So Craig, tell us a bit about the fund.
Craig: Morning Merryn. Yes the fund that I run is called the Saracen Growth Fund and is has been going now for 17 years. We have had a good performance since launch…
Merryn: Well I wouldn’t have bothered interviewing if you hadn’t.
Craig: Indeed. And we have outperformed 14 years out of 17. Since I took over stewardship of the fund in the beginning of January 09 we have outperformed, six years out of seven. So that is very good.
Merryn: So that makes the cumulative return or annualised return?
Craig: Annualised returns are about 12.5% since launch. So we have handsomely outperformed the market. Since launch we have returned 480% and the total return on the hold share is about 109% since launch. So we have done relatively well.
Merryn: And that’s genuine outperformance. We’re impressed.
Craig: That is, and the way we achieved that is we run a concentrated portfolio. So we will invest between 30 and 45 stocks at any one point in time. At the moment I am actually invested in 30 stocks. So I am very confident with the companies that I own.
Merryn: So when you say you invest in between 30 and 45 do you have any higher limits there or is that what you feel you can find that is good.
Craig: Yes. I don’t like to run long tails of stocks. Because quite frankly if I am sitting with half a percent on a stock and it doubles, it doesn’t do much for performance and if it halves it doesn’t really cost me much. So our view is if we invest for the long term, we do a lot of work at the beginning of the process. we put in sensible risk limits so for example we will invest up to 7.5% in any one stock. The reason we don’t go about that limit, which is a hard limit, is because, what if? You know, what if we are wrong and you have say eight or nine or 10% and it goes wrong? It really does cost you. So from a risk management point of view we will only go to seven and a half…
Craig: But we are finding a lot of value Merryn in the small to mid-cap, and I think maybe some potential shareholders are surprised in that.
Merryn: And so just back to that, have you always been biased to small-to-mid caps or are you saying that at the moment.
Merryn: This is where you are finding the value?
Craig: At the moment this is where we are seeing value. So when I took over stewardship of the fund at the beginning of 09 we had 60% in large-cap – we are an all-cap fund – but that’s where we saw more value. And actually, what you’ve seen since then, obviously the percentage of FTSE fell quite dramatically in the fund and the small-mid-cap actually increased. So at the moment we are sitting with roughly 18% in FTSE 100 with the remainder being the small and the mid-cap end of the market.
Merryn: Any particular sector bias?
We are not calling a bottom to the commodity cycle but we know prices of copper, iron etc will not always be at this level, hence the reason we have gone in
Craig: We have at the moment yes. For many years we had no banks, we had no miners, we had very little in oil and that is actually still the case. So at the moment we have one bank in the fund which is Lloyds Bank and we just actually initiated a holding about four months ago…
Merryn: And you haven’t had banks up until now, because why? Because they are complicated, ridiculously overpriced?
Craig: And they are very difficult to analyse and we just felt the risk to reward was not in our favour…
Merryn: And there is the political rick in there as well.
Craig: There is still a political risk. So, for example, I could have bought Lloyds at 20 pence, but to me there’s far too much risk associated with it. So we initiated a holding at 70 pence, which you know, OK, in hindsight it would have been great to buy earlier, but to me, as I said, there was just too much risk and I wanted to have more certainty. And obviously, now we know that the government is selling its stake, in terms of capital position of the bank they’re in a very strong position with their ratio and we think they are paying a dividend, but it’s a nominal dividend and that will change over the next couple of years. So Lloyds is perhaps not a stock you would associate with Sacaren Growth Fund, but it’s a stock we think we’ll make a lot of money on over the next five years.
Merryn: OK, and so back in to one bank and back in to miners…
Craig: One miner.
Merryn: One miner. Tiptoeing in here.
Craig: We’re very much so tiptoeing in here and the interesting thing is everyone to man is against miners that they are all negative because we have seen the iron lower price fall from one $165 a ton back in 2011, its currently at $40. Now the way the market works is the market thinks it will always be $40 and we don’t think that is the case. No. Demand supply and balances will come back into the market. And actually Rio (Tinto), the stock that we have bought is in a very strong position financially. Its gearings are at its lower range of 20%-30%. Even with commodity prices being where they are, they’re still making 40% operating margins and actually they have increased their dividend by 12%. Now that’s a great sign for investors, but of course investors in the market are focused on the next quarter, the next half year. Now, to be fair we don’t really concentrate on that, so we are not calling a bottom to the commodity cycle but we know prices of copper, iron etc will not always be at this level, hence the reason we have gone in.
Merryn: And we are not, say, if you look the supply side we are not seeing yet the major cuts to production in resources that you would like to see before you can begin to think of the proper bottom, the supply side is going to continue to seem pretty overdone with some time to come.
Craig: What you are seeing is interesting. The Rio chief executive said the other day some of his competitors are hanging on by their finger nails, so we expect supply to be coming into the market, demand will obviously increase at some point and at that point the lives of Rio improve and, to be fair, we’re in a very strong position. And what you’ll probably see is their will be a real snap in the prices of these commodities.
An interesting stat, actually Merryn, is the market cap of BAT is more than the entire mining sector in the UK. Now that is quite a frightening stat considering you have the likes of BHP, you have Rio, you have Glencore along with Anglo American and some of the others. So really these are unloved stocks and actually we’re being paid to wait at the moment, so Rio Tinto is yielding 8%. Now when you see a company yielding say 8%, you think the dividend is at risk. We actually think the dividend at Rio is not at risk. We have met the company management team twice now and they have basically said, all things being equal this dividend is sacrosanct and they find that they increased it by 12% gives us a lot of confidence. So these are traders that we are really underweight at the moment, as I say oils are underweight. We have been for a period of time as well…
Merryn: And you are going to stay underweight oil or does that fall under the same criteria as the miners for you?
Craig: No it doesn’t actually…
Merryn: Why is that?
Craig: We think the miners are more stable in terms of their balance sheets. If you look at the capex for example the miners can cut their capex much more quickly than the oil companies. So if you look at Shell, for example, I mean their capex is over £20bn. Rio Tinto is much less then that, with half of it being maintenance and half it being growth capex, so financially we think they’re in a stronger position. So the only oil stock we want to be in is BG and that is obviously trading at a discount to where it should be theoretically given the fact that it is been bought back by Shell.
Merryn: And do you have a view on oil price?
Craig: No, we don’t really have a view I mean obviously at the moment Brent is very low, very low it’s about $36 and over the long term we would expect that to increase, but I can’t sit here with a crystal ball and say this will happen over the next year or two years – but you know, over the long term we would expect it to increase.
Merryn: Ok, so should we go back briefly to BAT and it having a market cap larger than all the miners? I am assuming you are not investing in tobacco stocks.
Craig: No, we are not investing in tobacco stocks at all.
If you are paying an active management fee you want them to actually manage that fund actively. And by that I mean not buying and selling shares all the time, but taking proactive decisions and investing the money in the best thing they can
Merryn: Is that a moral decision or a price decision?
Craig: It’s not a moral decision no, it’s purely on a price decision. I mean these companies having been phenomenal in the past but actually if you look at the valuation they are trading on they are no bargain basement. So it’s not an area that we are invested in but it’s not because of morals.
Merryn: But you’ll find that the majority of the big funds in the UK will be heavily invested in tobacco.
Craig: They will be, they will be. And actually, Merryn, if you look at where we invested, going back to the beginning of the conversation, we are predominantly small-mid-cap. So the new buzz words around funds – your “active share” – the active share of Saracen Growth Fund is 94%.
Merryn: The active share, for readers who aren’t familiar with all these numbers, is the extent to which your holdings are separate to those of the index.
Craig: Correct, how far away from the benchmark you are, so we really are pure bottom of the stockpicking funds.
Merryn: From my point of view or from our readers’ point of view this is very important because if we are going to buy an active fund we want to know that it’s a genuinely active and that’s it very far away from the index.
Craig: Absolutely, because if you are paying an active management fee you want your fund manager to actually manage that fund actively. And by that I mean not buying, selling shares all the time but actually taking, decisions, proactive decisions and actually investing the money in the best thing he or she can invest in for you.
Merryn: What’s the average holding period for one of your stocks? I know you have long term investors. What is a long term hold for a stock?
Craig: Well, long term for us means about five years so. If you look back historically at this fund the average portfolio turnover has been between 20-25% per annum, hence at a four to five year investment horizon. But with some we are more than that, for example this company is not flavour of the month at the moment but the Weir Group, we have held since 1999. So we have held it since the launch of the fund and obviously the past we have had a much higher position then we do at the moment but that gives you an idea of what we are trying to do. Because for us we are not clever enough to tell you what the market is going to do over say the next three months or day the next six months we’re about investing for about 3-5-7 years” time.
Merryn: Ok, we talked about the sectors you are underweight in, sectors you are just beginning to get interested in what are you overweight in?
Craig: Well we are over with a few sectors, but I have to stress this to your readers this is not the way we look at stocks…
Merryn: You look at it in the companies but in the end they will be sectors.
Craig: We do end up in these sectors, absolutely. And an area that we are overweight is industrials, and once again this may come as a surprise to some of your readers because we know that are a lot of problems out there, but we are overweight with industrials, so we have companies as diverse as Avon Rubber, Hill and Smith, The Weir Group, which we touched upon earlier.
GKN is one or the largest holdings in the fund now. GKN is a stock that I bought after taking over running of the fund back in 09 and we initiated a position at the end of 09, so we have now held that for a number of years and to us the represents extraordinary value. We are buying GKN today and we still are buying it on a price to earnings (PE) ratio of less than ten for next year. Now that to me feels like the wrong level because this company is doing very well in its own markets of automotive and air space, it’s recently bought another company in the air space sector called Faulkner, margins are increasing and of course we know what is happening with the civil air space outside with the likes of Airbus and Boeing have long order books. So GKN are really benefitting.
To us, a PE ratio of ten or less is buy territory, between ten and 15 we will call a hold and 15 and above looks very expensive
Merryn: So we talked about, well you just talked about value and you refer to it in terms of P/E, what other metrics do you use, I mean you look at something and what do you say this is cheap.
Craig: It’s not just PE I mean we look at DCF, which is discounted cash flow. We look at NAVs, the asset values if we are looking a property companies, but if we do come back to PE what we are trying to identify Merryn is stock that will be trading on a PE of ten or less in five years’ time. So this doesn’t mean we won’t buy stock as they look expensive today if we can see the growth coming through with a five-year view and that is what we are looking to identify. Because we believe that if you can identify stocks on a PE bases of ten or less in five years’ time you will do very well from the stock. So to us ten or less is buy territory, between 10-15 we will call a hold and 15 and above looks very expensive.
Merryn: OK so the average PE fund is well below 15.
Craig: The average PE of the fund today is actually less than 15. On a five-year view is way less than 15.
Merryn: Interesting. What about yield? I know you are not an income fund you are a growth fund but are readers are often looking for yield.
Merryn: What do they get from your fund?
Craig: Well at the moment the yield isn’t that attractive, if you look at yield you can get in the market. So we’re yielding just less than 2%. But like anyone else I like companies that pay dividends. I like companies that pay growing dividends, because I think it is very important for management teams, for directors, to actually have this as goal, you know. What they don’t what to do is to cut dividends. And it’s also a sign of the health of the business. A lot of my companies are pre dividend or just starting to pay dividends but when we meet with the company we have to look at their five-year projections, not just for dividends obviously but how the business is going to grow over time and if a company is generating excess profits then of course they do pay dividends that is why it happens. But a number of our companies also pay special dividends. Now that is something you cannot rely on, but if you look at companies such as Victrex, Victrex has paid a number of special dividends over the years. Dunelm which is a recent holding in the fund has paid a number of special dividends over the years and Elementis pay a rolling special dividend.
Merryn: So is it a special dividend?
Craig: It’s unusual, they have to special dividend policy so they have they ordinary dividend which they want to increase but in addition to that, they will pay up half the net cash pay on the balance sheet every year as s special dividend…
Craig: And because it’s a very cash accretive business there is often a lot of it, so unless they can find out there uses and we love them to find other uses, if the acquire companies or invest in them they will hand that back to us.
Merryn: Lovely. So when you go and see a company – because clearly you are going to visit all the companies that you are invested in – what are you looking for? You’re looking for a 5 year plan that involves a dividend and at some point looking for evidence that growth is building ect. What are you asking in the management?
Craig: We are asking the management a number of questions, obviously what we want to know about the business, the business model as you would do, what is there five-year business model, because of management don’t have a model for five year then we are not interested. How can we possible model that company? We want to know what they are thinking about, their end markets, how they are finding their customer at the moment. And obviously with meeting management they are a bit more candid in the meeting than they would be to the City now that not to say they have given us any extra information..
Merryn: Of course not..
Craig: But you it is something we can discuss and of course because we are a long term shareholders and companies we get to know the management well, so you do build up a rapport with them.
Merryn: Now just before we finish, have you got a favourite stock that you bought recently or the one stock you think is the most interesting in your portfolio at the moment.
Craig: We have a number of interesting stocks, Merryn.
Merryn: I’m sure you do…
Craig: Well, the company that I would highlight and it’s not a new stock but it’s a stock we have held now for about three years and it’s a company that many of your readers may well not know about and it’s called MG Gleeson…
Merryn: Tell us about it.
Craig: I will tell you about it, Gleeson has two divisions. It has an affordable housing division in the north of England. They basically build houses between, say Newcastle and Stoke, Hull and Liverpool, that is their natural territory and they also have a strategic land buying division in the second half of the country where they will buy land, will gain planning permission and they will sell on to the likes of Persimmon, Bellway, Bovis, Barrett… But the main division is the house building and the advantage they have is that land is cheaper in the north of England than in the south. So their average plot costs are about £10,000 a unit so that equates to a 9% of the selling cost. So when I talk about affordable housing I’m not talking about social housing: each house that they sell is to a private buyer so they are selling for an average of about £120,000-£125.000.
What we like about the company is firstly they have a large management stake – the chief executive owns about 4% of the business and other directors own a lot. We like how they have a seven-year land bank so they’ve futureproofed themselves. They are getting some price inflation, although they don’t need prices to increase for them. They are seeing some inflation, and it’s nice to have and they have cash in the balance sheet. So they are in very very strong position and coming back to the dividend discussion we had earlier on, they have recently initiated a dividend and we expect that dividend to increase materially over the next five years. So what we like is at present they are building about 800 houses a year. It is a very small housebuilder but they have plans to get to 1,500.
Merryn: this is interesting because there aren’t that many small housebuilders left in the UK are there?
Craig: There aren’t.
Merryn: It’s become a very concentrated sector.
Craig: It is. If you look at the larger companies with in the sector, Barrets, Persimmons, Berkeley Group, which we also own, are large builders. If you look at MG Gleeson and MG Gleeson is our larger position in the funds. Now we bought it at about £1.50 a share, we are trading for about £4.70…
Merryn: Would you buy it again today at that price?
Craig: I would buy it again today at that price. Unfortunately because we do have rules that say I won’t go above7.5%, I can’t do it. But you know if it was a lesser position I would. They actually had a positive profit warning just last week and it’s not often you get companies saying actually things are better than what we said they were going to be, so their brokers increased by 9% recently. So it’s a very strong company it’s in a niche area of the market and they are doing very well. So that is one I would certainly highlight to your readers.
Other companies that we are very keen on. STV – Scottish Television. We bought Scottish television in 2010 and in all honesty bought it a few years too early. But this shows you that we don’t panic because things aren’t progressing as well as we hoped in the surplus terms and in 2013 the share price went up 200%. Last year it went up 100% and this year it’s up 20% and actually still a very cheap share.
Merryn: Would you buy that one again?
Craig: We would buy that one again absolutely and we have actually been adding to the holding. Just think of a mini ITV. It’s doing very well and it’s on a single digit rating, the debit is coming down nicely, they’re on top of the pension deficit and it looks like a very solid company now so I would highlight STV.
But a new company that I have bought recent is Pets At Home. Now Pets At Home is a real category killer in what it does. You know, it’s much larger than its nearest competitors put together, it’s got a flourishing veterinary arm that will do very well over the coming years. It’s got involved with grooming pets. You don’t just go in a buy the pets of buy the pet food but you actually go in and get your pets groomed as well. Although it is only a small part of the business, the management think that there is a lot of growth to come from it. So that is a company that on today you would say looks fairly valued, over a five year view looks very good value to us and we have been talking a position recently.
Merryn: Ok. Thank you, three really interesting stocks to think about. Thank you, Craig.
Craig: Thank you Merryn.