David Shapiro, manager of the Collins Stewart UK Focus fund, answers questions from Will Jackson.
Q: You launched the Collins Stewart UK Focus fund in January. What is the fund aiming to do?
A: The main aim of the fund is to outperform the FTSE All-Share. It is also a store of long-term value, and I am trying to buy the best companies in the UK. A lot of people are using it for long-term wealth planning, so I also keep an eye on absolute returns. Basically you get equity exposure to some stunning companies on good valuations.
Q: The fund holds about 30 stocks. With the markets so volatile, why have you decided to run the fund in such a concentrated way?
A: The fund has a reasonable amount of diversification and the companies themselves are diverse, so I do not need to hold 90-100 stocks.
I run a concentrated portfolio because I want to maximise the upside – I do not want my 90th best idea in the portfolio. It is a point of differentiation and I have had meetings with several funds of funds.
Professional investors object to paying fees for quasi-passive management and although my track record is institutional, many funds of funds want to see me again next quarter.
Q: Is UK Focus fully invested?
A: We are nearly there – about 90%. All of the liquid stuff is done, so we have bought all of the large caps and pretty much all of the mid caps. I am tiptoeing around the smaller names and the money is dribbling in every day. There was no seed money – it is mostly money from friends and family.
Q: How has the volatility affected the launch of the fund?
A: On the investment side it has been fantastic and the number of opportunities I am finding has increased significantly. But when asking people for contributions it has been very hard. I have put my money in, but I can not grumble when people are cautious under current conditions.
Q: How do you assess which stocks are undervalued?
A: The decision to invest is on the basis of intrinsic value. I look at cashflows – what I call “owner earnings” – and compare them against enterprise value, which considers obligations such as debt. I look at companies as though I were buying them. It is a private market valuation mentality, and I have to be able to understand the businesses I invest in.
I look for companies that are 40-50% undervalued, which is a big hurdle. There are 25 stocks in the fund at the moment which we expect to reach fair value over the next three to five years.
Q: How does the number of investment opportunities you are finding compare with a year ago?
A: If I did the same screens now, they would offer twice as many companies as 12 to 18 months ago. It is allowing me to build a better-quality portfolio.
Q: How does the fund break down in terms of market capitalisation?
A: The portfolio is 40% FTSE 100, 40% FTSE Mid 250 and 20% small caps. At the moment that is as much as I dare put into mid and small caps, with the economy deteriorating before our eyes. It is easier to be confident of the future outcomes for large caps.
The main areas that I am not invested in are banks, pharma, mining companies and the oil majors. Banks may look cheap based on the earnings of the past few years, but you simply do not know what is under the lid. It is likely another high street bank will get into trouble and I am not sure I can avoid the mines in the minefield.
Q: Which sectors are providing the most opportunities?
A: The areas that interest me are food retailers, drinks manufacturers, pubs, asset management, recurring revenue plays, telecoms and distribution businesses.
Within food retailers, one of my largest holdings is Tesco. It has about £11 billion of property assets which are not on its balance sheet, and growing international opportunities. Tesco also gets paid in cash but pays its suppliers on credit. It is looking very cheap. I also hold Unilever, Greggs and Thorntons.
In pubs, JD Wetherspoon looks unbelievably cheap and is offering a decent yield. Sentiment has been hit by the smoking ban, but people will still be drinking in Wetherspoon pubs in 10 years’ time.
There is another big block of the fund in real estate, including British Land and CLS Holdings. Property valuations are off the top but I do not think the falls are going to be cataclysmic.
Q: You recently called the use of price/ earnings (P/E) ratios a flawed way of measuring value. Why?
A: Using P/Es is a fantastic short cut. But when you take P against E the numbers can be misleading. The price is the market price of a company and does not include its obligations. Earnings can be manipulated, so both sides have flaws that can be exploited. The P/E ratio is also a terrible predictor of future performance.
Q: You said that you need to understand the businesses you invest in. What are the key characteristics of such companies?
A: Looking at the companies in the fund, they are mostly household names – my mother should know what they do. If I can understand a business I am able to project its cashflows into the future.
Investors are usually prepared to pay more for predictable businesses, but you are paying less than 13 times earnings for companies like BT and Vodafone. I generally think this is a good entry point.
Q: Is there any top-down input into the fund?
A: The only top-down is a common sense check, so if there are too many cyclicals I would need to manage that exposure.
Q: The fund holds companies for three to five years. Will you sell stocks earlier if they hit a certain price target?
A: Circumstances tend to intervene, but I like to think that I will hold all the stocks I buy for three to five years. I have known a lot of these companies for a long time.
For example, I owned Sage when it was still a small cap, 12 years ago. I do not set targets but I have a valuation and it is great if a company realises that valuation.
David Shapiro joined Collins Stewart Fund Management in August 2007 from Morley Fund Management, where he was head of UK value. Before that, he managed funds at UBS Asset Management, Montanaro, the Universities Superannuation Scheme and Manulife. During his time with UBS he was also responsible for the firm’s pan-European sector funds.