UK growth – long term focus with short-term nuance
How is investing for the long term within investment trusts compatible with adapting to structural change in markets and industries?
04 Sep 2015
For many investors, investment growth is synonymous with revenue growth, but for Philip Matthews, manager of the Schroder UK Growth Fund plc, growth requires a broader and more nuanced definition. This means not simply buying and holding companies that appear to have the ability to grow revenues over the long term, but looking for growth that the market is missing.
A clear advantage for investment trusts is that a captive pool of assets allows fund managers to take a uniquely long-term perspective. They do not have to manage inflows and outflows and can therefore invest for sound investment reasons rather than to manage liquidity. Investment trust managers can be more agnostic on the liquidity of individual companies than managers of open-ended investment companies. With the necessity of managing inflows or outflows removed, an investment trust manager can hold a company over time and watch it grow, rather than having to trade in and out.
But this is not to suggest that investment trust managers can be equally agnostic on price or the shifting prospects of individual industries. The global economy is increasingly fast-moving as new, disruptive technologies emerge, and old - apparently untouchable - businesses fall away.
This is seen clearly in industries such as high street retailing, where the internet has created a permanent and profound shift in buying habits in relation to food, clothes, travel, banking and more. High street stalwarts have seen their businesses challenged by companies that may not have existed 12 months previously. In the case of food retailing, people have changed the way they shop for their groceries; shopping more frequently and buying smaller baskets. Online competition is greater, as is competition from the discounters. Investors have to ask themselves whether these issues are permanent and whether there is anything the companies in these sectors can do to reposition themselves and regain the margins that they have historically enjoyed.
In this environment it is tempting to simply leap on the next ‘big thing’, but this is unlikely to fulfil a true ‘growth’ mandate. In general, this type of growth is relatively easy to spot: After all, most investors can read the statistics on the growth of ecommerce or the rise of online advertising. It does not mean it is a quick and easy way to make money because, in general, the opportunity will already be in the price.
The key to achieving real long-term growth is to find something undiscovered or under-appreciated by markets. As the technology bubble so aptly showed, markets tend to get over-excited about change, but may underestimate the ability of incumbents to adapt. The Schroder UK Growth Fund plc aims to find a way to ensure that structural change in markets is recognised and accommodated, while not over-estimating the profundity of that change before it happens.
In adapting to market conditions, manager Philip Matthews focuses on the valuation of assets to ensure that changes are made without paying an excessive price. He looks at company performance over the long-term, assessing what type of earnings might be expected. This does not assume that all companies revert to the mean, but allows for structural change in individual industries.
Philip sees valuation as a key determinant of future returns: there are plenty of reasons why an investor might be seduced into over-paying for assets: a company may appear to deliver reliable earnings at a time when growth is scarce, they may have a lengthy dividend track record, management may be particularly adept, with a strong track record elsewhere. However, none of these factors are likely to have the same long-term impact as simply buying the company at the right price.
Buying the obvious ‘growth’ companies tends to lead investors to overweight certain parts of the market. In contrast, the systematic screening of the market Philip uses for the trust forces a constant re-evaluation of where this best combination of value and quality lies in the market. The nature of the screens penalises businesses whose profit streams are cyclically extended, are capital intensive, and where those profits do not convert into cash over time.
The market may be focusing on those areas exhibiting the strongest revenue growth, but the real excitement may be found in those companies that are quietly re-grouping, rebuilding their growth strategy, but whose past performance has set investors against them. Investors can be savage in their assessment of companies that have disappointed in the past, but this is where some of best opportunities may lie. Over time, the market will reassess its previous poor opinion.
Stockmarket history is littered with these ‘revival’ stories. The house builders, sold off violently in the aftermath of the global financial crisis, were reappraised significantly to the benefit of shareholders as economic recovery unfurled. More recently, the banks have undergone their own reappraisal as greater regulatory controls have been introduced. Companies written off by investors have managed to turn their businesses around.
Matthews examines cyclical risks, structural growth trends and ultimately cash generation (via a ‘Return on Operating Capital’ metric). Analysis of a company’s franchise and balance sheet strength as well as relative and absolute valuation helps to build a margin of safety into the investment. In assessing a company’s valuation, Matthews looks at enterprise value, which helps assess a company in the same way as a trade buyer.
As such, companies in the Schroder UK Growth Fund plc portfolio will have strong business models and franchises, and healthy balance sheets, but this is not sufficient to build a position. Companies must also have unrecognised potential on a two to three year view. This may be because there has been a short-term set-back, or because the market is under-appreciating the growth potential of a certain part of the business.
An understanding of the company's franchise is very important: its position in its marketplace, competitive advantage, ability to take market share and the strength of its brand as well as the structural trends that are driving its growth. Although Matthews is a stock-driven rather than macroeconomic investor, he recognises that the fortunes of individual companies cannot be entirely disaggregated from broader themes – economic or regulatory, for example. Such themes are discussed with Schroders’ economists and their views complement his bottom-up stock level research.
In this way, he aims to distinguish between a company’s earnings or revenue growth and the opportunity for investors to achieve capital growth over the medium term. In uncovering real, long-term growth in companies, investors need to be more nuanced than simply looking for the next big trend. Often the best opportunities are to be found when the rest of the market is looking in the opposite direction.
The Schroder UK Growth Fund Plc is managed by Philip Matthews. The Company's principal investment objective is to achieve capital growth predominantly from investment in UK equities, with the aim of providing a total return in excess of the FTSE All-Share Index. It aims to invest in those equities that we believe offer the best combination of value and quality in the market. It identifies appropriate equity investments through fundamental research and has no pre-determined style bias.
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