Despite being a lost decade for value investing, Temple Bar IT has delivered an annualised net asset value return of 10.6 per.
Value investing requires patience and nerves of steel – two attributes Alastair Mundy has in spades, having delivered an annualised net asset value return of 10.6 per cent over the past decade for shareholders of Temple Bar IT.
This puts the trust ahead of the majority of rival UK equity income trusts, and indeed the wider market, with the FTSE All-Share index delivering annualised returns of 6.6 per cent since 2008. This is a period that has been dubbed as a ‘lost decade’ for those who follow the value style of investing, due to the era of loose monetary policy which has made borrowing cheaper and helped boost share values across the board.
Overall, Mundy has managed successfully to navigate the quantitative easing (QE) fuelled rally that has been present since the financial crisis, but more recently performance has cooled. As the chart below shows, the trust’s five-year performance numbers fail to impress, showing a total return of 35.7 per cent versus 47.6 per cent for the average UK equity income trust. Over three years Temple Bar is ahead of the sector average, up 19.1 per cent versus 16.6 per cent for the sector, but it falls short on a one-year view to the start of March, returning 1.8 per cent against 6.6 per cent.
Market cycles matter
Apportioning blame to the behaviour of the wider market sounds like a ‘convenient excuse’, says Mundy – but it is true that value investing shines at certain points of the market cycle. Thus for a number of years now, the bond proxy stocks that fit the high-quality growth description have been taking centre stage alongside the technological disruptors, most notably the FANGs (Facebook, Amazon, Netflix and Google).
While growth stocks have seen their share prices and valuations rise, the cheap stocks that Mundy targets have attracted much less interest from investors. Benign market conditions of late haven’t helped, but Mundy is preparing for a spike in volatility, which should in theory provide a tailwind: the value style tends to shine during market pullbacks, as investors become more valuation conscious and go out hunting for bargains.
At some point Mundy expects the valuation gap between ‘value’ and ‘growth’ to close and is positioning his fund to take advantage of that, but he is also keeping a fair chunk of the portfolio on the sidelines, a position that will have contributed to short-term performance coming off the boil.
As at the end of January the trust had 13.1 per cent of its money in cash and short-dated gilts, as well as a 2.7 per cent weighting to physical gold and silver. Mundy says he is not trying to ‘time the market’, although he is cognisant that having money on the sidelines will help protect it against the prospect of QE being reversed, which would likely unsettle financial markets. But he says that while the discount aisle looks well-stocked, there’s a lack of good value opportunities.
‘History tells us that stocks with a high price to earnings ratio tend to disappoint, but when I look at the cheap stocks as a group today they are quite challenged, and there are not many stocks that interest me,’ he comments.
‘There are plenty of cheap stocks, but many have quite significant issues to deal with, which makes us wary about where they will be in five years’ time and whether dividends will prove to be sustainable. Some are carrying a lot of debt, which does not bode well when it looks as though we are entering a period of higher interest rates. Other cheap sectors, such as utilities, come with political risk.’
Mundy targets out-of-form shares that he believes will recover their poise. Specifically, he sizes up businesses that have fallen 50 per cent from their peak. In doing so, he is hoping to avoid ‘catching a falling knife’ or buying a cheap stock too early.
As an additional safety check in order to try and avoid shares that are cheap for all the wrong reasons, Mundy considers the enterprise value of a business, which accounts for debt and pension liabilities. He then takes a view on how profitable the business could be in the future if it resolves its problems.
But, sometimes, as Mundy knows all too well, timing can be unfortunate. He recently bought into Capita, one of the many cheap domestic stocks he holds in the portfolio – but a short time after he had hit the buy button, the firm issued a profit warning and its share price dived deep into the red. ‘We have suffered nothing comparable, in terms of the size and abruptness of a fall after buying a stock, in nearly two decades,’ he notes.
Not spooked by outsourcers
He describes Capita’s share price plunge as an ‘over-reaction to bad news’, with the recent collapse of fellow outsourcer Carillion spooking investors. He is therefore adding to his position. ‘While we always endeavour to learn something from our errors, it would be rash indeed if we were to similarly overreact and intemperately abandon a process that has served us pretty well over many years,’ he adds.
Other out-of-favour areas of the UK stock market that Mundy is backing to recover include banking stocks and retailers. In the case of banks, he believes the negative sentiment that remains a decade on from the financial crisis will start to shift, once the ‘regulatory blizzard’ eases.
He has a big weighting towards the sector, with HSBC, Barclays, Royal Bank of Scotland, Lloyds Banking Group and US lender Citigroup accounting for over one fifth of the portfolio. ‘Banks are still largely viewed in a negative light, but I think perceptions will change as the regulatory issues draw to close, which will put banks in a stronger position to return more cash to shareholders,’ he says.
He is in good company, as other fund managers have been returning to the banking sector – but an out-of-favour area where Mundy is something of a lone wolf is his positive stance towards UK high-street names, including M&S and Next. ‘It is tough out there for retailers, as there are clear structural changes in the way people shop,’ he says. ‘In the case of Next it has moved a lot of its business online, whereas M&S has been behind the curve but is now improving its online offering.’
Mundy also has positions in Tesco and Morrison’s, first identifying a value opportunity a couple of years ago when there were fears that discounters, the likes of Aldi and Lidl, would attract customers away from the big supermarket giants after aggressively cutting prices. Those fears have not gone away, but Mundy believes that both the businesses he holds are on the path to recovery, having moved to sort out their various issues, and that they are now competing more successfully against the discounters.
The missing sectors
Notable absentees from the portfolio, which rival fund managers with a value focus view as opportunities, are the housebuilding and mining sectors. He is avoiding the former amid concerns over sky-high UK house prices, while nervousness about China’s private sector debt has led him to shy away from the likes of Rio Tinto and Glencore.
He is steering clear of other businesses too; indeed, entering 2018 the trust had a mere 19 holdings. Together they represent what appears to be a big call on the UK consumer, and by extension on the fortunes of the UK economy. Mundy, however, says his current preference towards domestic stocks should not be mistaken for a bullish view on the economy post-Brexit. ‘We do not make big macro forecasts. Instead the portfolio is a reflection of working through stock by stock and then buying shares in out-of-favour businesses that we think will work through their specific problems and see their share price recover.’
Investors will be hoping for a recovery in Temple Bar’s fortunes as well, but in the meantime the board has moved to keep itself in their good books: it has recently upped the annual dividend by 5 per cent, which represents its biggest hike since the financial crisis and its 34th year of consecutive dividend increases.
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