Fund manager rating company Vadevalor is a treasure trove of hidden gems in the asset management market, containing a host of names that might not be well known to the market but the individuals’ performance (judged over their career) has earned them a mention.
However, the site also contains some names that investors should know well, such as Alexander Darwall (read here) and River & Mercantile’s Hugh Sergeant (pictured).
Having honed his value investing skills at UBS Phillips & Drew (P&D) under the stewardship of Tony Dye (‘affectionately’ named Dr Doom for his less than optimistic views of the stock market over a decade ago), Mr Sergeant now runs four funds at River & Mercantile where he is also head of equities. These are the UK and Global High Alpha funds as well as a UK and global recovery fund.
“We're very confident that buying things cheaply the value approach will return to form in terms of being able to generate superior returns,” says Mr Sergeant, who went on to chart whether we are in a value market or not.
“The strongest return to form for value was q4, last year, and that was in the context of the vaccines that were discovered,” he added.
The vaccines gave investors a lot more confidence and encouraged interest rates and bond yields to move upwards which created a much more supportive environment for value according to Mr Sergeant.
Given that P&D was pilloried for not following the herd into any company with ‘.com’ in its name many years ago only to have the last laugh when that bubble burst, it’s perhaps apt that one of the value enthusiasts from that firm is once again the beneficiary of a market rotation.
What to look for
The process used by Mr Sergeant and his team is called PVT, short for potential, valuation and timing. The potential describes companies that grow their shareholder value at an above average pace over the medium term, therefore they are on the lookout for firms that can grow profits and cashflow.
Valuation is essentially the value part of the style although the timing element is curious. Mr Sergeant says that the team use tools in order to time the allocation of capital correctly to their investment ideas.
“We use earnings revisions bottoming out and then trending positively and share price technicals for the share price starting to outperform. We also look at fundamental catalysts like a management change or existing management becoming more focused on shareholder value,” says Mr Sergeant.
Given the wide universe of stocks available to Mr Sergeant, he uses a combination of quants with fundamentals due in part to the small size of the team. Once stocks have been identified comes the real part of a fund manager’s job: “The traditional kicking the tyres to understand the business franchise, understanding the risks to a thesis, meeting the management where it's relevant.”
Avoiding the pitfalls
As one value manager recently described the problems with this particular style of management, it is the problem of catching falling knives or buying value traps. Mr Sergeant says that some managers have been accused of taking positions in companies too early and this is where the timing part of PVT proves useful.
“We just to try and reduce our exposure to falling knives or things that are going wrong, you need to wait for the fundamentals to be bottoming out, then starting to improve. Your timing tools just give you that insight,” explains Mr Sergeant, adding that it’s worth paying more for a stock once the improving fundamentals have started to show.
With the recovery funds, the potential for calamity is even more apparent which is perhaps the reason that there aren’t many players in this subsector. He explains the reason for the relatively large number of stocks in these funds: “There is quite an idiosyncratic risk associated with recovery stocks so we would rather diversify and have a reasonably large number of stocks in the portfolio so that if even one individual one blows up for whatever reason, it won't have a very significant negative impact on the portfolio.”
The potential upside for recovery stocks is the main draw for investors although depending on what type of industry a company is part of can also be crucial. Mr Sergeant says: “The best recovery stocks are the ones that are exposed to structural growth markets so you get the double benefits of recovered profits but also compounding of the revenue growth. Typically those stocks can go up three or four times, versus a conventional recovery of just margins.”
Describing his process as being around 20 percent macro with the majority bottom-up stock picking, in relation to the former, he and his team track where the market is in terms of various cycles, from profit and interest rate cycles to where house prices are at the time. For a deep value play this corresponds to the overweight positions in banks and energy companies with the latter shunned by the majority of the market.
Looking at the performance of the four funds, they’ve all beaten their benchmarks over a range of time periods, with each easily outdoing the index on a one, three and five-year annualised returns basis.
From his days working with the (in)famous Dr Doom, to creating alpha generating funds from a collection of unloved stocks, especially in his recovery funds, Hugh Sergeant seems to have truly earned his triple A fund manager rating from Vadevalor, the highest honour the company hands out.
