Chris Complin's UK Strategic Value fund has achieved top-quartile performance over the 12 months to 24 August
Chris Complin has managed the JP Morgan Fleming UK Strategic Value fund, assisted by Andrew Spencer, since its launch in May last year.
Over the 12 months to 24 August, the £17.3m fund has returned 10.46%, compared to a sector average of -15.43%.
Complin puts the successful early performance of the fund down to buying stocks in companies he considers to have undervalued growth potential and that are able to pass an in-house screening process, which aims to separate stocks that are actually value stocks from those that are merely cheap.
Rather than rely on stock picking, asset allocation is derived from a formulaic process based on years of research and analysis that has culminated in an innovative form of style investing.
The in-house selection process prevents any risk of style drift and mitigates individual stock and sector risk by broad diversification and adherence to a stringent analytical team approach.
You are regarded as a firm proponent of value investing. Why is that?
The value phenomenon has been known about for quite a while. There was a very famous paper done by the economists Kenneth French and Eugene Fama in the early 1990s where they looked at the US and found that cheap versus expensive and large versus small could explain a lot of stock returns.
They did this work in Europe as well, looking at all the countries in Europe, and found that over the long term, on average, cheap stocks have outperformed expensive stocks. The explanation they gave for this was that cheap stocks are high risk and therefore you get a higher return.
If you empirically look at this it does not make any sense. If you've got a highly-rated technology stock and you've got a very cheap old economy stock, the tech stock is what you would think of as high risk.
What makes a cheap stock one that you want to own?
The explanation we use is coming back to this idea of whether or not you like the stocks. It is human psychology, behavioral finance.
These types of stocks, value investor stocks, have been out of fashion. There are actually a number of cognitive vices. People do not rationally invest, they are irrational investors but in systematic ways. They have a number of biases; for instance, if you decide you want to buy an Audi TT, you suddenly see Audi TTs everywhere.
If you are looking at price, say Marconi, it is half the price it was a month or so ago. People say it is half the price, so it is cheap. The company's earnings were downgraded by 60%, so the next day it was actually more expensive than it was the day before it crashed, even though it halved in price.
There are lots of cognitive vices people use when they are looking at these stocks, which means they do not behave in a rational manner.
That is what we are trying to capture. If you look at the out of fashion old economy at the beginning of last year, such as UK housebuilders, there were stocks on price earnings of three or four times and price to books of 0.5%. If you just bought the company and sold off the land you would have doubled your money.
There was nothing fundamentally wrong with the stocks. The Internet was not going to build houses for you or serve you beer. Those stocks were just out of fashion, there was nothing fundamentally wrong with them and that is what we try and capture.
Have you have done a lot of research into the methodology behind the running of the fund?
Yes, because it is quite hard to do value investing. You are buying stocks that people do not like. If a stock is expensive and there is bad news flow, it will drop like a stone.
If a stock is very cheap, people have not got the same inclination to sell it. If you have a housebuilder that is on a price to book of 0.5% and a price earnings ratio of five and it has disappointing earnings, people think, how much cheaper can it really get? If it gets much cheaper, someone is going to buy it out anyway so you get a lot of takeovers in that area.
Looking at the Morgan Stanley Value versus the Morgan Stanley Growth indices, in the past, the way academics defined value and growth was that value is cheap and growth is not cheap. That is not necessarily sensible and quite often you find good earnings growth does not necessarily mean it is expensive.
You can get stocks with price earnings ratios of 10 and earnings growth of 20%. What these indices are capturing, in our view, is not value versus growth but cheap versus expensive. We sort it on price to book.
In Europe, there has been the same trend over the past 25 years with cheap stocks outperforming expensive stocks but there is quite a lot of volatility along the way and periods where one strategy can outperform the other.
Have you conducted a lot of in-house research into the relative performance of value stocks?
Yes, in-house research has shown that if you take the cheapest stocks in the universe and in the UK, the size of the universe was 50% of stocks by forward price earnings ratio.
What you find is that if you look at the cheapest stocks that have got very bad earnings growth and very bad newsflow, they are the ones that will continue to underperform. If you avoid these, on average, all of the other shares will outperform the index.
You are looking for stocks with very bad earnings growth. Analysts following the stock are downgrading the numbers because the earnings growth is getting worse and the market sentiment is very poor. These are the factors that help you decide which stocks are cheap with good reason, because they are dogs.
How is the portfolio constructed?
We invest in the FTSE All-Share and have about 96% in the FTSE 350 and about 4% in small caps. When we are creating the universe of stocks, we first take the FTSE 350 and do the value screen to identify the cheapest 50% by price earnings, which gets you down to 175 names.
The second step is to exclude those stocks with very poor growth and newsflow. That gets you down to 140 names.
The final stage is a fundamental sanity check. Do we think, on a stockpicking view, the stock is going to go bust, and secondly, what is our view on the data. If the stock is very cheap on a price earnings basis, what does it look like on price to book, price to cashflow, price to sales and so on. Is it really cheap or is it just some kind of earnings anomaly.
If it has good earnings revisions, where have those estimates come from. Has it really been upgraded. Has it got good price momentum because it has been bought out recently.
We are not making stockpicking decisions in this fund. On top of this, we also have an equally-weighted, small cap portion, where we select stocks by exactly the same mechanisms. The way we have constructed it, about 50% of the fund is FTSE 100 and about 50% is FTSE 250 and small cap.
Within the FTSE 100, every stock that qualifies will get an equal active position of say 35 basis points and FTSE 250 stocks will also get an equal active position, which is say 70 basis points.
How many stocks are typically held within the fund?
The idea when you are constructing these funds is to minimise all those incidental risks. Equally weighted stock holdings is the first step.
What that means is that all the qualifying stocks get an equal active position versus the benchmark. We do not say, 'I like this stock more than that stock.' It does not work like that.
We have a very large number of stocks. In Europe it is 350 and in the UK it is 120 large-cap names plus 30 or so smaller companies.
Firstly, we are trying to reduce stock-specific risk. It is not a stockpicking fund. Secondly, it is all to do with sampling.
If, on average, cheap stocks outperform expensive stocks, what you want to make sure is that you capture that effect with a reasonable sample size.
Because we are not looking to get our returns from individual stocks, if you cannot buy a stock because it is not available in the market, you can substitute another stock with similar style characteristics, so it is a very efficient way of trading.
What are the constraints surrounding sector allocation?
Within the portfolio construction, what we are trying to do is maximise exposure to style and minimise any other risks. For example, in the European funds, you want to be country neutral. You do not want a style fund to outperform the index because it is overweight France and underweight Germany because that is not style return, it is asset allocation.
Sector bets are driven purely bottom up. They are not selected because of a fund managers view that oil companies are great, for example. If the stocks meet the criteria we want, we will buy them.
The sector constraints are purely to stop you getting too much sector risk. You want reasonable diversification.
The price earnings ratio of the fund is 12. For the UK market it is about 16 but the growth rates are not significantly different so for a similar growth to the market you are paying a lot less. That is basically the key to the fund. Style timing is not something we are trying to achieve.
FUND MANAGER: Chris Complin
• Chris Complin joined JP Morgan Fleming in 1998, working on quantitative analysis in the European equity group.
• Complin began managing JP Morgan European and UK Style Funds from launch in February 2000.
• The fund manager has a BSC in biology from King's College, University of London, an MSC in experimental psychology from the university of Sussex and a PhD in artificial intelligence from the University of Birmingham.
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