Taking a top-down approach to US equities is the wrong way to approach value investing in the world's biggest economy says Ed Walczak, investment adviser to the Close Finsbury North American Equity fund.
Instead, investors need to start from the position of examining individual companies for particular strengths, then look at the share price in the market for any discounts to the estimated long-term value. Macroeconomics or currency forecasts add nothing to this process, Walczak says.
That approach has resulted in a fund with a 20% cash holding and a strongly overweight position in financial stocks compared to the S&P benchmark average.
Walczak says these positions may strike investors as odd, but to him and his team of analysts the “investible universe” of companies with enough qualities to recommend buying their shares is a mere 100 out of thousands listed, and throwing greater proportions of the funds’ money at existing holdings would undermine the risk position.
”We’re cowards,” he says.
”We don’t want the other 400 risky businesses,” a reference to the S&P 500.
”We would sit on 25% cash for two years if required, we won’t invest it in the wrong companies at any price,” he adds.
A quick flick through the list of the CFNAE fund’s portfolio shows all the companies held are highly cash generative, with high or dominant market share, and well entrenched with high barriers to new competition. They have proved their ability to withstand economic and stock market shocks over time.
Even at current pricing levels and with fears of what rising interest rates could do to demand for borrowing in the US, the fund has some 48% of its money in financials, of which 17% is in insurance and 17% in the biggest mortgage repackagers Fannie May and Freddie Mac.
Rising interest rates can hurt insurers and lenders, but they can also help to widen business margins by widening the spread between the wholesale cost of obtaining money to lend and the retail rates of interest that can be charged. Profits are therefore supported. Insurers gain from rising rates because they can invest premium income in higher-yielding debt.
Mortgages and the housing market are also relatively stable, despite fears expressed about the strength of Fannie Mae and Freddie Mac. House prices have gained every year since 1950, according to US Census Bureau figures, Walczak notes.
Peter Newell, managing director Vontobel Asset Management – adviser to the fund – says 1999 was a key year in developing the fund’s strategy of protecting investors’ capital in a market downturn and ensuring returns go up in a rising market.
That year the fund made a net loss for investors even as the S&P 500 index gained more than 20% on the rise of technology stocks.
In 2000 the tables turned as the technology bubble burst, however, the real test of the strategy was not apparent until 2002 and 2003 when the market continued to lose money, but CFNAE was able to make small gains or keep losses well down on the broader benchmark.
”Quality franchises are sustaining and will come back,” Newell says, indicating that taking a value approach focused on nitty-gritty stock picking will ensure returns against moderate risk positions.
David Morgan, sales director Close Finsbury, says the approach is similar to Warren Buffet, except, of course, that the fund does not have the resources to simply buy outright control of a blue-chip cash-cow as Buffet is able to do with his Berkshire Hathaway investment vehicle.
The CFNAE fund is run in a way that mirrors that of Vontobel’s US Value Equity fund, which among other companies has some 10% of its portfolio invested in shares of Berkshire Hathaway (BH).
As of 30 June, the top 10 holdings of CFNAE included the above mentioned BH, Fannie Mae, insurer American International Group, security firm Chubb, and bank Wells Fargo.IFAonline
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