It's uncomfortable being a value investor, but the rewards are worth it, Jamie Carter of Oldfield Partners tells Merryn Somerset Webb.
For years now, equity investment has been all about buying shares that have international presence, solid brands and rising earnings. It hasn't much mattered to the world's big investors how expensive these stocks have become: they've provided yield in a time of almost no yield and have kept looking like good value relative to bond yields (which have just kept falling).
One thing all investors constantly say, says Albert Edwards of Societe Generale, is that despite equities being "very expensive" in absolute terms, they remain the "cheapest" asset there is in relative terms. Thanks to super-loose monetary policy, bonds (corporate and government) and property are seen as being "more ludicrously expensive" than equities. Look at it like that and "there is no alternative" (TINA) to buying and holding equities.
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Anyone who doubts this need only look to the fabulous performance of equities since the last recession and US equities in particular. Price, it seems, just doesn't matter: if you have to be in equities, it might as well be in good ones. Edwards is far from convinced.
History, he says, attempts to teach us over and over again that buying expensive things just because it looks like TINA often turns out to be a very bad idea. With that in mind, we wonder if it isn't time for investors who feel they must be in equities at least to turn away from looking to invest in growth equities and turn back to looking for real value stocks stocks that are not just cheap on a relative-to-bonds basis, but on an absolute basis.
There are few fund managers in the UK doing this (the style has been out of favour for a good decade and in investing, as in everything else, fashion matters). There is Jeroen Bos who runs a Deep Value Investments Fund at Church House. There is our own Tim Price, who has a newish fund of value funds called the VT Price Value Portfolio (which interestingly has very little of its assets invested in the UK or the US, but a lot invested in Japan).
But one of the biggest names in UK value investing is Oldfield Partners, launched back in 2005 and fully focused on value. Its six different fund strategies, says its website, come with a distinctive approach: a limited number of holdings, long-only, no leverage, value-focused, diversified, index-ignorant and suspicious of short-termism. So I went to see them.
Oldfield's CEO Jamie Carter starts by telling me just how difficult and "uncomfortable" being a real value investor in the Benjamin Graham style is (see below). The key to getting it right is to buy and hold stocks over a long period of time that most investors find in some way repellent. That just isn't human nature.
But what makes it even harder is that when you are running money according to value principles, it isn't just you that has to be OK with being different and uncomfortable, it is your clients too. If there aren't stocks in the portfolio that don't make new clients actually "feel sick", you probably aren't doing your job.
So a good value investor needs to be different able to focus on cheap rather than exciting, for example and also very patient. One of the main reasons you see so few value investors about is that success can be a long time coming: something can be cheap for years before it moves, so you have to be prepared to wait. In an intensely short-term world, most people aren't. Look at most investment houses and you will see that the pressure on anyone with, say, six to seven months of underperformance to shift style is enormous. This is just too hard for most firms.
OK, I say: it sounds awful. Why do you bother with it? There is a simple answer to that one. "Because it is the right way to invest there is 100 years of data that shows you that value outperforms over the long term." Everyone knows it works it is just that very few people are ever given the time to have a go at proving it.
We move on to talk about value. Many fund managers tell me they have a value focus Graham's name comes up a lot. But what does it actually mean for Oldfield? It's about stocks looking cheap on a valuation basis (price-to-earnings, price-to-cash flow, price-to-book (p/b)) relative to its past history, its peers and in absolute terms. This isn't about building models jammed with forecasts for 20 years: "no one can do that". It's about looking out two to three years and being able to make "an absolute minimum" of a 25% gain in two to three years.
There also has to be a "plausible argument" as to what might make the stock price move a reason as to why the rest of the market will "wake up and see the value". An example? Five years back one of the firm's funds bought Renault. Renault had a stake in Nissan. But Renault itself was so unloved that its shares were trading below the value of the Nissan stake. However "rubbish" French cars might be, that was pushing it on the valuation front. Eventually other people noticed.
What about examples of uncomfortable stocks the various funds hold now? There is Russia's Lukoil. It is valued at around $2.50 per barrel of oil reserves against more like $12 for the big oil majors. It makes sense that Lukoil should trade at a discount (all that political risk), but not one quite that big. After all, a large part of everyone's oil assets are in dodgy places: "there's no oil in Switzerland".
Or there is Japan's Nishimatsu Construction, which has a perfectly good business with particular expertise in tunnels, dams and expressways, but also cash and equity holdings equivalent to two-thirds of its market cap. It trades on an oddly low price-to-earnings ratio of under ten times and a price-to-book (p/b) of 0.9 times.
Also in Japan there is Dai Nippon Printing, a firm that like many in Japan is seeing a transformation in the way it looks at balance sheet efficiency and shareholder returns and which has equity holdings equivalent to 60% of its market cap but a p/b ratio of only 0.6 times. It also relatively unusually for Japan pays a yield of more than 3%.
In the US there is coal miner Hallador. Some 40% of the US coal industry is currently in bankruptcy after a "perfect storm" of a rising dollar killing the export market and a flood of natural gas production from shale. Yet Hallador "continues to generate profits, pay dividends and reduce its debt" thanks to it very low cost of production.
Historically, say the analysts at Oldfield, "the company has made profits of $5-$10 per tonne so, at full capacity, the company could earn $60m-$120m a year. The current market capitalisation is less than $200m". That's a value stock. And in Canada there is one of our old favourites, Barrick Gold. Gold shares, say the analysts, are still "remarkably depressed compared with bullion" and Barrick has been making great strides in the improvement of its business, lowering the cost of production and debt levels.
So you buy a stock. It does well. Perhaps the business improves. When do you sell it? The answer to that is much the same for Oldfield as "when do you buy": too early. When they buy they set a price at which they will sell. And, tempting as it is to hang on to stuff going up especially if more people are coming to a newly exciting story they try to stick to it.
Oldfield's funds are set up in the kind of way we approve of no more than 25 holdings and active share ratios into the 90s (this means there is little crossover between the fund portfolios and the ones that make up the index). There is relatively low turnover too (not much buying and selling), so ongoing charges for each one come in at a relatively reasonable 1.05% (the management fees are mostly 0.9%).
That's all fine as long as Carter is right and value really does do best over the long term: the emerging-market fund has outperformed since inception, the rest have not. To conclude, I ask my (new) standard final question: what will Brexit do to your business? And I get my standard final answer: beyond some committees delaying investment decisions for a bit, "nothing much".
The father of value investing
Benjamin Graham published The Intelligent Investorin 1949 it has been the bible of value investingever since.
In it he explained why investors hadto ignore all the hype and noise of "Mr Market"(Oldfield has a go at this by having its office outsidethe gossip machines of the City and Mayfair) andbuy sustainable businesses when the market givesyou a margin of safety by offering them to youcheaply.What's cheap? At its best, Graham definedit as lower than the firm's liquidation value.
