selling stocks at the right time is one of the most important skills of fund management, according to JO Hambro's Mark Costar
Mark Costar, manager of the recently-launched JO Hambro UK Growth fund, does not believe in having a large backroom team, graduate trainees preparing 'doorstep size pieces of research' or buying in expensive research which is often not of much use.
Meeting with companies and using the knowledge of other fund managers at JO Hambro is a more productive way of gathering information about stocks and the wider economy, he said.
Costar believes selling stocks is one of the most important and underestimated skills of fund management. He employs a ruthless sell discipline, describing his process as a 'survival of the fittest' approach.
He seeks to understand the management of the company and avoids firms which are too interested in preserving their own lifestyles, while not concentrating on the needs of investors.
Can you describe the philosophy behind the fund?
It's a balanced fund with concentrated stock positions and the diversity to insulate it from macroeconomic risk. The aim of the fund is to deliver consistent capital growth ahead of the FTSE All-Share Index, with low volatility. It does this by having a rigorous stock selection methodology, balanced portfolio construction and a ruthless sell discipline.
How important is sell discipline?
It is the underestimated skill of fund management. The sell decision is far more emotional than the buy decision. If you're selling, it's either a stock that's made you a lot of money, which is like parting with an old friend, or you're crystalising a loss. This is in effect putting your hands up and saying you're wrong. Neither of the two decisions is easy.
We use the clean piece of paper approach to selling. Looking at each stock in the portfolio and saying: if I didn't own it, would I buy it today at today's prices? If not, you have to ask why you're holding it. The fund becomes a survival of the fittest portfolio. I'm culling the stocks which aren't going to perform at a very early stage.
How many stocks do you like to hold?
Some 50 to 60, which gives a good balance between the concentration necessary to generate good performance and the adequate risk control and diversity you'd expect from this type of portfolio.
What bias will there be in the size of company the fund invests in?
I invest across the whole marketplace. We take smaller positions where the situation is less mature, or where the company is smaller, to reflect the higher level of liquidity and risk constraints. Typically, the fund will be overweight the small and mid-cap areas primarily because of the investment opportunities there. I don't set out specifically to structure the fund with a size bias; its where the opportunities take me.
What is your attitude to risk and how will you control it?
One control is diversification through the number of stocks in the portfolio. Individual stock positions are controlled in that they won't be more than plus or minus 3.5% of the All-Share Index. There will be thorough research into the companies in which we invest and extensive balance sheet tyre kicking. We run the portfolio through quantitiative screens to assess the systematic risk it is taking.
Do you have a preference between value and growth stocks?
I have a natural growth bias because I have a predilection to invest in secular growth companies ' that is, those that operate in marketplaces that can grow faster than GDP. Businesses in secular growth markets should be able to demonstrate good organic growth potential and the strong cash-flow and consistency of return we look for.
How will you decide your sector weightings?
I don't analyse by sector. My sector weightings are driven by individual stock positions. Of course I monitor and control the level of sector risk I am taking but it is not the primary driver of portfolio construction.
Tell me about your overweight and underweight sector positions.
I have a meaningful overweight position in the support services sector where I see plenty of secular growth opportunities. For example, there's PHS in the washroom services area and utility services company South Staffordshire Water.
In financial services, I have got Man Group, a niche fund management operation with a strong product offering. I also have the IG Group, the leader in the spread-betting market which is growing at 30% per year.
I am underweight in the telecommunications sector because there is fundamental over-capacity in the marketplace which means there persistent pricing pressure. To derive attractive returns on capital you will need to see significant consolidation in the market place.
What do you look for in a company when deciding whether to invest?
I look for companies that operate in attractive markets, with consistent incentivised management and business models we can understand. I am not looking to invest in businesses that are run as directors' lifestyle support vehicles but ones where they are committed to improving the fundamental returns for all investors.
I also look for companies that have strong enough franchises in their business areas to have genuine pricing power; companies that are able to push through price increases, a very rare phenomenon these days.
BSkyB is a good example of this. It is raising the price of its basic package because of its strong market position. If you look at Marks & Spencer's figures, you can see evidence of price increases coming through and the beneficial effect it is having on the gross margin for the group.
Tell me about your sources of information.
We have an extremely proactive approach to stock selection. We are not spoon-fed ideas by the large brokers like some of the big institutions. We don't have a huge academically-driven army of research analysts. Our ideas come from being out in the field, from contacts and the knowledge of the investment professionals we have here.
I put a lot of store in meeting company management. I need to understand what the likely future drivers of share prices are. I see a lot of companies both in and outside the investible universe. They can help validate business models in companies we do invest in and help us understand structural changes in the economy.
Because we are a small boutique operation, we are seeing companies outside their results cycle, which means we see them when other investors are not so we are often able to get news ahead of the market.
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