PRESENTER: To discuss value as a strategy and its relevance in today’s economic climate, I’m joined by Steve McGill, who’s the Head of European Equity Value for UBS. Steve, it’s good to have you with us today.
STEVE MCGILL: Thank you Jenny.
PRESENTER: So let’s start by your offering and approach, talk me through this.
STEVE MCGILL: At UBS, we have a long heritage of investing in the UK market that actually dates back to our predecessor firm Phillips and Drew, which I joined in 1986. So our approach is very value focused and very differentiated from the other investors in the income segment. I would highlight three particular areas: our disciplined value approach and our willingness to take on contrarian opportunities as they arise; our long-term horizon which means that our average holding period is in excess of five years; and also our focus on corporate governance. On behalf of our clients we think like owners of companies, rather than traders or shares, so therefore we get to know the management teams very well of the companies we invest in. Often we’re holding the shares for longer than the management team are in place, so therefore it’s important for us to have contact with other board members, and to think about the company from a holistic viewpoint, rather than just focusing on the chief exec and the last set of results.
PRESENTER: Your UK team has a long history in the institutional space, but how are you going about approaching the retail market?
STEVE MCGILL: Yes, we do have a long track record in the institutional market. Our performance record dates back 34 years, and over that period we’ve generated strong performance on short, medium and long-term timeframes. And in fact our average client has been with us for over 25 years. So we’re very experienced in the UK market. We’ve started managing the retail fund more recently, so my colleague, Guy Walker, and I took on management of the fund in May 2013. We’re using the same approach that we use in the institutional market. So that’s the same value philosophy and process. Really, I would describe the income fund as a best ideas fund. We ran it to a higher performance objective and we saw that in the results in 2016 where the fund was the best performing fund in the UK equity income segment.
PRESENTER: Now value approach has been known to be quite volatile, so how do you manage this?
STEVE MCGILL: Well, all investment styles are cyclical. The value style is no exception. But remember cyclicality is the mother of opportunity, in that the volatility that we see in value shares enables us to buy undervalued shares at times when there are troubles or short-term issues, and it allows us to take profits when other investors recognise the value in these stocks. So, all investment styles are volatile. What we’ve been successful at doing in the past is minimising the downside, the down periods through careful risk management, whilst retaining the upside through careful stock selection.
PRESENTER: Well, valuations are quite high at the moment, so is now really the time for this approach?
STEVE MCGILL: I agree. Stock markets are generally high relative to where they have been over the last five years. The UK market has actually lagged markets, globally, but within the UK market we’re seeing a high degree of polarisation between sectors. And really that divides into safe or bond like sectors like consumer staples, and at the other end of the spectrum sectors like banks, mining and energy which are riskier but very lowly valued, so we see clear distinction between different segments of value in the market, and that enables us to run a portfolio that’s got a good upside opportunity in it.
PRESENTER: So the UK income fund, now this has been the best performing fund in its sector over the past year, what would you attribute to its success?
STEVE MCGILL: Last year was a strikingly good year, but for us really it was business as usual. We didn’t behave in a different way to what we’ve always done. So our level of trading wasn’t elevated, the risk wasn’t elevated. Last year really it was down to a combination of stocks that we’ve held for the last five years that performed well, and they were broadly based, but also a particularly good investment in the mining sector, which was a classic cyclical opportunity for us.
So in the mining sector, the UK mining sector, for the last five years stocks have performed very poorly as commodity prices have fallen. We’ve been carefully watching this situation, and we do detailed research on all stocks we invest in. We saw that valuations were very low, and although from a stock market perspective these shares were seen as very risky, to us we felt comforted by the very attractive valuations and our due diligence in terms of both management teams and the financial positions of these companies. So we took a large position in this sector. It was seen as very contrarian at the time, and since then those shares have performed very strongly.
PRESENTER: So how do you manage income for the fund?
STEVE MCGILL: Well the value style typically generates above average income, and that’s what we’ve seen historically over long periods of time, so we would continue to expect a premium in dividend yield terms, so for the FTSE All Share Index over time.
PRESENTER: Where do you see the opportunities over the next three years?
STEVE MCGILL: As we’ve already discussed there appears to be a significant polarisation in the UK market between what I would call safe but expensive stocks, like Reckitt Benckiser, and more depressed yet attractive from a valuation perspective cyclical stocks, like miners, banks and energy stocks. If we just wind back to the start of the financial crisis, the financial crisis was an earthquake not just for consumers and companies, but also for investors, and since then investors have been pretty cautious and have been more focused on wealth preservation and therefore have tended to invest in stocks that would be described as growth or quality. We would accept that these stocks are generally high quality, have good franchises, but for us the price that you pay for a share determines the return that you achieve. So therefore we’re more interested in companies that have depressed valuations and where we see upside going forwards. And in particular those sectors, energy, mining and banks, represent a big opportunity.
We’ve talked about the attractive sectors within the stock market. Now I’d like to talk about some attractive stocks, because after all what we’re spending our time doing is meeting management of individual companies, we’re looking at share prices, we’re taking opportunities when there are profit warnings, our analysts are doing detailed worked across the market. So let’s touch on two stocks that we hold in the portfolio. We have significant holdings and they have been good contributors to performance. They are 3I Group, the private equity investor, where we see them benefiting from their large investment in Action, which is a European discount retailer which is growing very well in Continental Europe, and also Balfour Beattie, the UK and international construction services group, which is benefiting from increasing infrastructure spend over time.
PRESENTER: So here in the UK Brexit is of course the big issue, so what do you foresee the impact being on markets and indeed your portfolio?
STEVE MCGILL: Well Brexit is a great opportunity for us to talk about the crystal ball. The crystal ball is metaphorically speaking what a lot of investors use to predict the future, and as we’ve seen over the last few years the crystal ball is no longer working, whether it’s the EU referendum, the US presidential election. So instead of using a crystal ball, we focus on valuation. So we behave in a very disciplined way; we’re always focusing on what the long term value of a company is and the current share price. So coming back to Brexit and the EU referendum, from that date, 23rd of June last year, we saw a great deal of volatility, particularly in domestic stocks. And remember on the morning of the referendum announcement we were in the market and we were buying shares at very depressed levels. I would highlight Barclays as a bank where the share selloff was completely out of proportion with the long-term implications of Brexit in our view. So we’ve been able to take advantage of that volatility and it’s added to the performance of the fund to date. On a forward looking basis there will be more volatility, and for us volatility is the mother of opportunity. So we’ll take it as it comes but I would expect that we can take advantage of it.
PRESENTER: Well finally then who do you see as your main competitors?
STEVE MCGILL: We don’t spend a lot of time looking at our competitors; we’re very much focused on the day job. But what we would say is when we look at the universe of UK equity income funds we notice that there’s what I would call a degree of clustering with fund managers focused on those quality stocks that allow you to sleep at night but we would say the valuations are quite demanding. So we see ourselves as outliers, outliers because of our very value focused approach, which means we’re often very contrarian. And you see that, the evidence of that is in the performance that we’ve generated. So last year we weren’t just the number one fund in the sector, we were number one by a significant margin. So I mention that because that highlights how different we are. And therefore I believe that we can be not just interesting as a fund on a standalone basis, but we could be a good complement to investors’ other fund holdings.
PRESENTER: Steve, thank you.
STEVE MCGILL: Thank you.