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The value stocks displaying classic growth characteristics 2018
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Judith MacKenzie
Partner and Head of Downing Fund Managers
Downing launches new actively managed liquid alternatives fund aiming to deliver 7% to 10%+ per annum and positive returns in most markets. The new MGTS Downing Active Defined Return Assets Fund (‘Active Defined Returns’, the ‘Fund’), is the first fund from its new Liquid Alternatives team.
The Fund is aimed at institutional investors, Discretionary Fund Managers, IFAs and advised sophisticated individual investors, and will primarily consist of UK Government bonds and large-cap equity index options, which provide significant scalability and strong liquidity. It aims to deliver 7% to 10%+ per annum and positive returns in all markets except for a sustained equity market fall (generally more than 35%), over a period of at least six years.
The Fund is the first to be launched by the new Liquid Alternatives Team established by Downing. Collectively, the team has over 125 years of experience and sector knowledge, and includes Tony Stenning, who held senior roles at BlackRock and most recently was CEO of Atlantic House Group; Russell Catley, founder and also a former CEO of Atlantic House Group; Huw Price, a former Executive Director at Santander Asset Management, and Paul Adams, former Head of Cash Equities and Derivatives Sales, Royal Bank of Canada.
The Fund offers investors a compelling building block for multi-asset portfolios, aiming to add consistent and predictable returns, typically secured with a portfolio of UK Government bonds. The unique proposition includes a hybrid approach of using systematic derivative strategies and active management, combining liquid investments with predictable returns, and an equity like risk profile.
Investment strategy: Maximising the probability of delivering predictable defined returns across the economic cycle.
Systematic Liquid Derivatives: Systematic, derivative strategies optimise the equity risk-return profile. The Fund uses rules-based derivative strategies linked to the most liquid, large-cap global equity indices (i.e. FTSE100, S&P500) with the aim of harvesting well-proven consistent returns across a wide corridor of market conditions.
Strong security: The Fund will hold a high-quality portfolio of assets as secure collateral – typically UK Government bonds.
Active benefits: At times, rules-based, passive derivative strategies can underperform when markets move strongly – this is when specialist active management can add incremental gains by monitoring and monetising positions and applying active risk management.
Key benefits
Increased consistency and predictability of returns: Positive returns in all markets except for a sustained equity market fall of more than 35% over at least six years.
Diversification of risk: The Fund’s risk components are diversified across large, liquid equity indices, observation levels and counterparties. Secured with high-quality assets – typically UK Government bonds.
Active management: Our experienced team will actively manage the Fund and its investments to optimise risk and reward for investors.
Russell Catley, Head of Retail, Liquid Alternatives at Downing, said: “Put simply, we focus your investment risk on the probability of receiving the returns you need, not those you don’t. We target the highest probability of delivering 7% to 10%+ per annum with active management adding material incremental gains. We believe that we are building the next evolution of the proven success of Defined Returns funds
The Downing team isseeing strong demand from clients looking for alternatives to large-cap equity funds which are becoming concentrated in technology stocks, or alternatives to UK equity income funds and illiquid alternatives.”
Tony Stenning, Head of Liquid Alternatives at Downing, said: “The launch of our Active Defined Return Assets Fund is a significant milestone in the ambitious build-out of our new Liquid Alternatives strategies. It is a solution-focused fund that should deliver stable high single or low double-digit returns across a wide spectrum of equity market conditions, except for a persistent multi-year bear market. The Fund is designed to enhance balanced portfolios by providing consistent, predictable returns and is suitable for accumulation or drawdown.
“We aim to deliver a unique combination of proven systematic derivative strategies and specialist active management, and we are doing so at a very compelling fee level, below our closest competitors and in line with active ETFs.”
How the Fund is expected to perform in different markets
In bullish markets: UK Government bonds secure the capital, and the equity index options deliver a predictable 7-10%+ return per annum – giving up some less likely upside.
In neutral markets and normal market corrections: UK Government bonds secure the capital, and the index options deliver a predictable 7-10%+ return per annum.
In a sustained sell-off: if markets fall more than the cover to capital loss and do not recover for six years. Then capital is eroded 1:1 in line with the worst performing index.
The average Cover to Capital Loss is targeted at 35%: the average cover to capital loss represents the average level the Global indices within the Fund could fall before capital is at risk.
Fund key risks
Performance: Capital is at risk. Investors may not get back the full amount invested.
Liquidity: Access to capital is always subject to liquidity.
Counterparty risk: Other parties could default on the contractual obligations.
Fund Structure
UK regulated OEIC fund structure, fully UCITS compliant
Daily dealing, at published NAV
Minimum investment: £100,000
SRRI: 6 out of 7
Depositary: Bank of New York
Authorised corporate Director (‘ACD’): Margetts Fund Management Ltd.
I share-class: SEDOL: BM8J604 / ISIN: GB00BM8J6044
F share-class: SEDOL: BM8J615 / ISIN: GB00BM8J6150
Risk warning: Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained therein. Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in this fund should be held for the long term.
Important notice: This document is intended for professional investors and has been approved as a financial promotion in line with Section 21 of the FSMA by Downing LLP (“Downing”). This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is a trading name of Downing LLP. Downing LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England and Wales (No. OC341575). Registered Office: 10 Lower Thames Street, London EC3R 6AF.
Virtues of value investing
While the AIM market is a great hunting ground for growth companies, many of these ‘AIM darlings’ have become very expensive. Judith MacKenzie, Head of Downing Public Equity, discusses the virtues of value investing and her focus on unearthing value companies with distinct growth characteristics.
Current market valuations look vulnerable to us in the face of higher interest rates and other economic pressures, reigniting the traditional ‘growth versus value’ debate. Rather than discuss the attributes of one style over another, it may be more helpful and enlightening to our investors to determine what constitutes a ‘good’ company in 2018. We have a strong value bias, seeking to buy intrinsically good quality businesses at bargain prices. However, we do love growth – we just don’t want to overpay for it.
In the AIM market, the divergence in valuations between companies considered growth and those considered value can be significant – stocks with a market cap of more than £1 billion are trading on an average P/E multiple of 27.9x, while the smaller sub £150 million market cap companies at the value end are trading on a multiple of just 8.3x. This is due in some part to tax reasons – IHT qualifying stocks are popular with investors seeking to reduce their IHT liabilities – but we think it is predominantly due to investors piling into companies on a sharp growth trajectory. Obvious recent examples are Fever Tree, the upmarket soft drinks manufacturer, and Purple Bricks, the online estate agent. Both have been heavily bought by momentum investors and growth stocks like these are becoming very expensive. Our focus is on unearthing the ‘hidden gems’, those good value stocks that sit beneath most investors’ radar, despite exhibiting classic growth characteristics.
Another consideration is that advances in technology have had a massive impact on the fortunes of companies in recent years[1], so working out which companies will thrive on digital disruption and those which will falter could be a more meaningful indicator of future success than merely putting stocks into either a growth or a value bucket.
A case in point is one of our holdings, AdEPT Technology Group, which was once just a fixed line telecoms company. However, CEO Ian Fishwick has driven an ambitious acquisition strategy and AdEPT has developed into a much broader managed services provider, adopting new IP including Voice Over Internet Protocol (VOIP), and embracing cyber solutions. It was also recently named as one of the top 25 quoted technology companies in the UK[2]. AdEPT has a tremendous quality of earnings and earnings growth, and recent results demonstrate a track record of delivering nine consecutive years of EPS growth, a feat only matched or bettered by three in over 700 companies listed on AIM. Adept has all the attributes of a growth company, but it is considered a value stock by the market because it is sitting at a discount to its peer group.[3]
Synectics is another of our portfolio companies that demonstrates the irrelevance of the value or growth label and instead the importance of backing successful digital strategies. Synectics is a designer of end-to-end integrated security and surveillance solutions specifically for gaming, oil and gas, marine, transport, infrastructure and public space applications. In its latest interim results for the six months to 31 May 2018, it reported revenue was up 3%, order book growth up 18%, and underlying profits up 12%. Synectics is building on its 30 years’ experience of customer-driven innovation and continuing to adjust its product and business development activities towards the emerging needs and opportunities in both established and developing market segments.[4] We think that this is a great company delivering double digit growth and quality of earnings, and another we consider a value company despite showing distinct growth characteristics.
A respected fellow investor, James Sullivan of MitonOptimal UK, recently highlighted the ‘Death by Amazon Index’, which was created in 2014 by a US-based advisory group, Bespoke Investment Group. It is home to about 50 stocks that haven’t embraced technology and were therefore obvious victims of the Amazon and wider technological revolution. Unsurprisingly, the index in question has performed poorly versus the broader market.
I agree with James that this doesn’t simply mean all tech companies are good and traditional ones bad, but it does possibly provide a more relevant framework for assessing how and why companies will succeed. Some companies are embracing technology and can disrupt markets, while those that do not may be disrupted.
Possibly, more important than casting aside an arguably outdated debate is our primary focus of providing a solution for what our investors want rather than back ourselves into a rigid style straightjacket. First and foremost, we are active managers employing a private equity investment process that aims to manage risk and drive strong returns for our investors over the long term.
Any personal opinions expressed are the views of the Fund Manager at the time of publication and are subject to change and should not be interpreted as advice or a recommendation.
Important notice: this is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. An investment should only be made based on the relevant product literature. Capital is at risk. The value of investments and any income derived from may go down as well as up and investors may not get back the full amount invested. Where any estimates, forecasts or projections have been made, these are what the Fund Manager believes to be reasonable as of the date of this document. Any statements may involve known or unknown risks, uncertainties and other important factors, which could cause actual performance to differ from those expected, as such they are not reliable indicators of future performance and should not be relied upon. Past performance is not a reliable indicator of future results. We recommend investors seek professional advice before deciding to invest.
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