Style drift, in its various guises, has been the downfall of many a stockpicker, though abandoning a favoured philosophy in favour of chasing returns is very different from resolutely following, say, a momentum approach.
Similarly, flexibility in approach is not a sin, providing it is clearly laid out to an investor before they take the plunge. Indeed, British- based fund managers often wear their pragmatism as a badge of honour.
Take, for instance, Tim Russell and Sanditon Asset Management’s Business Cycle approach. Cyclicality, he says, affects the variability of profits and cashflow growth at different times, ie he is happy to move with the sway of the market.
Another example might be Stephen Message’s approach on the Old Mutual UK Equity Income Fund; he invests across the FTSE All Share, again all too aware that different types of company benefit at different points in the cycle.
Compare this to more dogmatic investors – those who have their niche and stick by it through thick and thin, and who know they will clearly underperform when their style or asset class goes out of favour.
“To me it is about managers who stick to their knitting throughout an economic cycle, or if they only look at stocks within particular industries or those of a certain size,” says Richard Philbin, chief investment officer at Harwood Multi-Manager.
“The vast majority of managers are pragmatic in approach, especially in the UK. The more dogmatic managers are often found in the US, such as Legg Mason Royce, where the managers have worked for years and only ever done small-cap value investing across their professional investment careers.
“In the UK, they would have been binned out because they had two or three years of underperformance.”
Roughing it out
Bill Hench is manager of the Legg Mason Royce US Small Cap Opportunity Fund, having been with the firm since 2002; before that he worked for a small-cap brokerage.
“We buy things that are statistically valid for a value fund, which is a nice way of saying we buy cheap stocks,” he says of his approach.
“This is not because people aren’t too smart to figure out how great it is, but rather because something is wrong. They could have had difficulties with earnings, a management shake-up, or perhaps their sector is out of favour.”
Hench concedes that the fund has been through some tough times as US small-cap value stocks have fallen out of favour, namely in 2002, 2008, 2011, 2014 and 2015, though he says he makes up for this with outperformance in other years.
“In the fallow times when things are completely out of favour, that’s when we try to earn our money,” he explains. “We position the portfolio in two ways. First, we make sure everything we own is really cheap and, second, that the names we own are the ones that will do best when our sector comes back into favour.
“We’ve just started looking at the energy sector, and have slowly started to build positions in names that don’t have any serious debt due within the next year, which will allow them to get through this ugly period.”
For Philbin, the archetypal dogmatic manager is likely to experience highs and lows and not change their position. Compared to a broad index, tracking errors are likely to always be high, while they will also have a lower turnover of holdings.
Portfolio turnover in the 250-stock Royce US Small Cap Opportunity Fund is around 35%, though just looking from a names basis the figure falls down to between 15-20%.
