Value investors aim to buy shares in companies at a significant discount to their true worth - typically stocks that are overlooked and out of favour - in the hope that over the longer term this will be realised.
Henry Dixon, manager of the GLG Undervalued Assets Fund, adopts just such an approach. By focusing more on the current shape of the balance sheet he targets companies whose share prices do not fully reflect their intrinsic value. Aided by co-manager, Jack Barrat, Mr Dixon searches for two types of companies; those trading below the analysis of their ‘replacement cost’, and those whose profit streams he believes are undervalued by the market.
There is an important distinction to be made between this kind of approach and one of a ‘recovery’ fund that targets cheap areas where fundamentals have deteriorated but a turnaround is possible. Mr Dixon is keen to guard against financial risk and has a strong preference for companies with little or no debt with emphasis on quality and strength.
The fund endured a relatively poor period in 2016 but came back strongly in 2017 gaining 30.3 per cent against 13.1 per cent for the FTSE All Share. Source: FE Analytics 01/01/2017 to 01/01/2018, total return basis with net income reinvested; past performance is not an indication of future returns. Buying shares in areas depressed amidst the Brexit vote including domestic businesses such as housebuilders, laid the foundations for the rebound.
Source: FE Analytics, per cent total return basis with net income reinvested. Past performance is not an indication of future returns.
So far the fund has enjoyed a market-beating start to 2018 too. According to Mr Dixon, global economic growth is leading to, broadly speaking, increases in company earnings across the globe and strength in commodity prices. In this environment bond yields are rising in anticipation of higher inflation and interest rates. Market volatility in the first quarter of 2018 was, he asserts, at odds with the progression of company earnings and, coupled with relatively low expectations from the investor community, has resulted in the recent surge to new highs.
Company earnings across different sectors are increasing at different speeds, however. Mr Dixon believes this is positive for the fund because the process the managers take seeks to uncover areas where earnings potential is underappreciated. He believes some of the best areas of opportunities currently lie in mining and energy, and the fund presently has BHP Billiton, Rio Tinto and Royal Dutch Shell among its top ten holdings. These have already been positive for the fund, as was a position in Tullow Oil bonds where Mr Dixon felt there was an opportunity to generate a strong, equity-like return in the corporate bond of the company without excessive risk.
In addition, Mr Dixon remains positive on the life insurance sector, an important area for some time, with the top holding in the area being Legal & General. Interestingly, more recent purchases have been among tobacco firms that have fallen out of favour with investors over the past year.
Another factor at work in the UK stock market has been merger and acquisition activity. The weak pound and relative underperformance of the UK market has attracted the interest of overseas firms looking to expand taking over other companies or private equity firms looking for a bargain. The fund was a beneficiary of a bid for technology components supplier Laird Group last year, and Mr Dixon anticipates there could be further activity that serves to boost the share prices of takeover targets.
A flip side to this is that acquiring firms are taking on large amounts of debt, something the manager is increasingly wary of. Coupled with a trend of companies issuing debt to fund share buy backs, he believes there has been a potentially dangerous build-up of debt with some sectors of the market leaning heavily on their balance sheets. These areas, he contends, could be at risk from rising bond yields that makes debt more expensive to service and reduces the price investors are prepared for a certain quantity of earnings.
Mr Dixon’s longer term performance has been strong, and we admire his disciplined, patient investment process and focused approach. We recognise the fund could struggle in periods where market volatility is elevated or the very largest, most defensive UK companies and sectors outperform smaller firms. However, it remains one of our highest conviction ideas for exposure to UK equities and part of our Foundation Fundlist of preferred investments.
This research article is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investors should be aware that past performance is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested. Investment decisions in collectives should only be made after reading the Key Investor Information Document, Supplemental Information Document and/or Prospectus. If you are unsure of the suitability of your investment please seek professional advice.