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Style over substance from BMO
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"If I make the same mistakes at the same time every day, people will start calling it style."
– John Prine
John Prine may be an American country songwriter – and the quote refers to his guitar playing – but there are surely echoes in the investment world.
At the risk of offending my fellow investors, I've noticed an increasing number of stock pickers explaining their disappointing performance through style or investment factors as though these are outside of their control. In particular, the recent claim is that "value" investment is out of fashion and therefore the performance of the value investor can be excused – it's not their fault that the investment background is out of kilter with their chosen style. I think this argument does not hold and can be exposed from a number of different angles.
What is value investing?
A firm definition is elusive, and its practice has definitely changed over time.
It's obviously important to distinguish between price and value; as Warren Buffett has said "Price is what you pay, value is what you get". We believe taking the time to properly analyse the value of any investment before purchase is the best course of action. The price paid for an investment is one of the very few component parts an investor can influence and it's clearly an important part of the equation that determines subsequent performance.
Value must be about a total assessment of a company's worth and into that calculation all aspects of the business should be considered. When we make our assessment of a company's valuation we try to cover as many facets as possible, but mostly our valuations are driven by forecasts of a company's cashflow; into that estimation, growth and stability of returns are vitally important factors. To characterise value investing as something as simple as buying stocks with a low multiple, whether that be book value, earnings, cash flow, sales or something else, is surely a gross over-simplification.
I think we all recognise these strong "value" criteria, but there are as many combinations of these as there are stocks so inevitably any definition of "value" investing becomes subjective.
Not only is it impossible to pin down a firm definition, the concept of value investing has morphed dramatically over time. Benjamin Graham, widely acknowledged as the 'father of value investing', and Warren Buffett's mentor, set out a short list of requirements for inclusion in his portfolio. Of those seven, only two (and incidentally the last two on the list) are directly related to price:
1 Price of stock no more than 1½ times net asset value
2 Price no more than 15 times average earnings of the past three years
The other five (all seven are listed at the end of this piece) would in no way be captured by the blunt description of value stocks most investors would cite.
It is also fair to say that market conditions are very different today to when Graham was most active. Markets are possibly more efficient now and arguably are higher priced, but the safe yields against which Graham was evaluating stock opportunities have changed out of all recognition, as the UK government long bond yield is currently around 1%, vastly lower than anything experienced in Graham's lifetime. Given the massive change in the investment landscape, it seems likely that some of the detail of Graham's value requirements might change, even if the broad concepts should be constant.
To be clear, I would say we are value investors, but in the Graham sense that we value companies as ongoing businesses, we put real value on growth and stability of strong returns and look for companies with strong finances. We would never find a company attractive just because it was trading at a low multiple of something or other.
It's stock pickers who blame style
The investors feeling they are out of sync with the market nearly always claim to be stock pickers. It certainly appears to be how their portfolios are constructed and their reports show the portfolio stock by stock but don't generally comment on factor and style exposures. Really, it is the performance of individual stocks that drives investment performance; performance is ultimately about stock picking.
A simple topical example should illustrate this – Thomas Cook would undoubtedly have been viewed as a "value" stock – the shares traded at a very low multiple of profits and it had substantial turnover relative to its market capitalisation. It certainly had some well-known value-biased investors as shareholders. Can the catastrophic performance of the company's shares be blamed on a bad patch for value investing? Absolutely not – it was a highly leveraged company, in a competitive sector, facing traditional rivals and internet competition, with a high degree of cyclicality and seasonality. Its failure will have had a negative impact on value indices, but no investors were forced to own it, so to hide behind an amorphous investment factor would just be wrong. In this case, the dent to performance comes not from style, but stock selection.
The recent crop of profit warnings shows us that the current environment is pretty unforgiving. But for all the negative media headlines, we should remember that in the UK, employment is at record highs and interest rates at extraordinarily low levels. If companies are struggling in this environment, and many of these might crudely fall into the 'value' category, I fear it says more about the strength of their businesses than anything else.
Use mistakes to learn, not to blame
Returning to the blame game, there's another adage that can help in the thought process: "Invert, always invert". This quote, originally from the German mathematician Carl Jacobi, has been more recently popularised by Warren Buffett's partner, Charlie Munger. It asks us to think about any statement the other way around to find solutions or to check for consistency. In this case, have these investors ever passed on credit for good performance to the value factor? I think not. "Please, it's not me, it's just my investment style that has come good." If an investor isn't ever going to admit that then they shouldn't look to blame poor performance on the same thing.
Over the 22 years I've been managing BMO Capital and Income Investment Trust, I'll openly admit mistakes, both in shares I've bought, and shares I should have bought, but I believe that I have learnt from these mistakes as stock picking errors, errors of strategic assessment and errors of portfolio construction. The evolution and improvement of our investment process, I believe, bears testimony to that.
None of us have perfect foresight, the world is a difficult and unpredictable place, but it seems the best way to make progress is to change what is going wrong and keep what is going well. We aim to learn not just from our own mistakes, but those of others as well.
From Benjamin Graham's The Intelligent Investor Ch13 Seven Statistical Requirements for inclusion in a defensive investor's portfolio:
1 Adequate size
2 A sufficiently strong financial condition
3 Continued dividends for at least the past 20 years
4 No earnings deficit in the past 10 years
5 Ten-year growth of at least one-third in per-share earnings
6 Price of stock no more than 1 ½ rimes net asset value
7 Price no more than 15 times average earnings of the past three year
The value of your investment is dependent on the supply and demand for the shares of the Investment Trust rather than its underlying assets. The value of your investment will not be the same as the value of the Investment Trust's underlying assets.
Capital is at risk.
Views and opinions have been arrived at by BMO Global Asset Management and should not be considered a recommendation or solicitation to buy or sell any companies that may be mentioned.
The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.
Q&A with Julian Cane
Q&A with Julian Cane, investment manager BMO Capital and Income Investment Trust
Q What are the advantages of BMO Capital and Income Investment
Trust versus other savings funds?
JC BMO Capital and Income Investment Trust (the Company) has a long track record of delivering good performance. We have outperformed our benchmark, the FTSE All-Share Index, over the last 1, 3, 5, 10 and 20 years, and increased our dividend each and every year since launch in 1992. Dividend growth has been more than twice the rate of inflation on average over this period.
One of our key advantages is that the Company is an investment trust, not a unit trust or OEIC. Investors are shareholders in the investment trust, are encouraged to attend our Annual General Meeting (AGM) and have the extra protection of a Board of Directors that supervises the investment manager. We have the ability to borrow modestly if we think investment opportunities look attractive and we are not required to pay all of our net income to shareholders, meaning we can produce a more steady progression of dividends. By withholding some income in exceptionally strong years, we are better able to weather more difficult periods. We pay dividends at the end of each calendar quarter.
We invest primarily in well-established UK companies and have a well-diversified portfolio of over 60 names. Our charges and costs are low, with an Ongoing Charges Figure (OCF) of 0.58%.
The Company has a market value in excess of £350m and well over 20,000 individual shareholding accounts, the majority of them held via the BMO savings plans.
Q Talk us through the performance over the longer track record
JC I have been the investment manager of the Company since 1997 – more than 22 years. Over that period, we have experienced some pretty varied and challenging conditions, including the booms of the late 1990s and mid-2000s to the crashes of 2000 and 2007/08. Although we can't claim to
have beaten the performance of the FTSE All-Share Index each and every year (I'm not aware of any fund that has), our cumulative performance is such that we are well ahead over all standard time periods.
It is a key aim of the Company to grow our dividend above of the rate of inflation. Despite periods when dividends from the UK stock market have fallen (particularly due to market crashes), we have still increased our dividend each and every year, earning our designation from the Association of Investment Companies as a 'Dividend Hero'. Our long-term record shows we have increased the dividend on average at more than twice the rate of inflation. By building up a dividend reserve well in excess of the annual cost of the dividend, we have put the Company ina very strong position to able to develop this record further.
For definitions of the terms used within this document, please refer to the glossary on our website.
Q Explain how you manage the supply of shares and how this creates liquidity
JC As a company in our own right, investors wanting to invest in BMO Capital and Income Investment Trust buy shares in the company, which are quoted on the London Stock Exchange, rather than units in a fund. At any one time, the number of shares in issue is fixed so investors buy and sell shares in the secondary market. If there is strong enough demand and the shares trade at a small premium to the underlying Net Asset Value, then the company will issue new shares. Conversely, if the shares trade at a material discount the company will buy-back its own shares. We have been issuing shares since 2003 and have grown the number of shares in issue by more than 50%.
Our last share buy-back was over 10 years ago, as since then the shares have been trading close to or at a premium to the Net Asset Value. Using a combination of these two operations, the company is effectively operating as a market maker in its own shares and, importantly, is able to provide greater liquidity to investors than may be available from traditional market makers. It is not in shareholders' interests that the shares should become too detached from the underlying Net Asset Value.
Further information such as Annual Reports, Factsheets and information about the Board can be found at bmocapitalandincome.com.
Cumulative performance (%) as at 30-Nov-19
1 month Year to date 1 year 3 years 5 years
NAV 2.59% 21.76% 17.49% 34.47% 56.39%
Share price 2.94% 17.50% 15.02% 33.00% 52.38%
Benchmark 2.24% 15.33% 11.01% 24.00% 36.99%
Discrete performance (%) as at 30-Nov-19
NAV 17.49% -3.79% 18.96% 9.02% 6.68%
Share price 15.02% -4.40% 20.95% 8.62% 5.47%
Benchmark 11.01% -1.46% 13.35% 9.77% 0.64%
Stock market movements may cause the value of investments and the income from them to fall as well as rise and investors may not get back the amount originally invested. Changes in rates of exchange may have an adverse effect on the value, price or income of investments. If markets fall, gearing can magnify the negative impact on performance.
Past performance is not a guide to future performance.
Source: Thomson Reuters Eikon, Lipper and BMO. Basis: Percentage growth, total return, bid to bid price with net income reinvested in sterling. The discrete performance table refers to 12 month periods, ending at the date shown.
Find out how to deal online from £1.50 in a SIPP, ISA or Dealing account.
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