New Star UK Special Situations manager James Ridgewell favours stocks that are simply out of favour with the market or have suffered profit warnings but have turnaround potential.
Good news: You are a fresh-faced young fund manager and you land a job at New Start just after launch. Bad news: Your fund will consist almost entirely of John Duffield’s personal cash. And the great man is sitting just down the corridor. Gulp.But it did not faze James Ridgewell. He has run one of New Star’s more successful “incubator” funds, so much so that Ridgewell features as one of the three “new stars” on the eponymous billboard advertising campaign. If you are wondering which one he is, there is the slightly bug-eyed one on the right, the suave one in the middle and the somewhat geeky one on the left. Yep, Ridgewell is the one on the left. He probably will not resent the “geeky” tag; he will be more concerned by words like “junior” or “fresh-faced”. Ridgewell actually has a nine-year record as an investment manager, starting first at Abbey Life then World Invest, the asset management arm of Bank of America. World Invest was acquired by New Star, which gave Ridgewell his big break. Performance figures on UK Special Situations are pretty special. Over one year it is up 44.8% and over three years – when Ridgewell took over full control from Guy de Blonay – it is up 147%. Over five years it is the third-best-performing fund out of 220 in the UK All Companies sector, and New Star is hopeful that money exiting Fidelity Special Situations will come Ridgewell’s way. It is still a small fund – just under 45m under management – but that is a long way up from when Ridgewell took over. “It was a 1m fund, it had not been marketed, and was 80% John Duffield’s money,” he says. “It was utterly tiny, and in a way I could have been a bit spivvy, chucking loads of the fund into IPOs [initial public offerings] and so on. But I have always run the fund the same way, with around 100 stocks and low turnover.” Ridgewell says he has two categories of stocks, each of which make up 50% of the fund. One half is the unloved and the unfashionable; the other is what he calls “the deep and dirty”. The unloved are stocks that have not done anything too terrible, they are just out of favour. Here he names sectors such as retail, banks and media. They are a good risk-control on the fund, as although they are unloved, they are unlikely to go bust. The deep and dirty are the stocks that may have suffered a string of profit warnings and where Ridgewell goes fishing for turnaround stories. They tend to be held for around 18 months. Inevitably, the fund’s investment approach takes him down the market cap scale, with about half held in small and Aim-listed stocks. What it does not hold is much, if anything, in the way of resources. Ridgewell acknowledges he got that call wrong – but it has not hurt his fund one bit. Other special situations funds may have a lot of explorers and far-flung mining stocks, but they still have not eclipsed Ridgewell’s numbers. And he thinks that resource stocks are now “just too risky”. Recently, he has been finding all his best ideas in retail and media. Last week he started buying HMV. It is on a price/earnings ratio of 10, with the market consensus that high street music retailers face doom from the internet downloaders. Ridgewell simply does not agree, believing that HMV’s two-prong clicks-and-mortar strategy should work -and he is comforted by the fact that it has had two takeover approaches. He has also just bought Morrison supermarkets. The Safeway acquisition sent the group into tailspin, but Ridgewell reckons the painful absorption is now complete and the group is strongly into recovery. Among his media favourites is Reuters. It recently reported its first like-for-like revenue growth in five years. But management has decided it is the time to reinvest in the business, and has told the market that its capex spend will mean a couple of years of lower profits. The market hates it, which Ridgewell finds “perverse”. The company is in good shape, yet it is being marked down. Overall, he is pretty sanguine about the outlook for corporate earnings. “Fundamentally, the market is still quite cheap,” he says. “Look at just how few companies have disappointed on earnings. I am particularly impressed by the nature of M&A activity. A few years ago it was venture capital companies leading the buyouts. Now it is quoted competitors, which is a really good check on value in the market.” But I want Ridgewell to start talking deep and dirty. What really turns him on? He picks music company Sanctuary, which has had a torrid time since an ill-inspired takeover. What impresses him is that none of its major artists quit despite the avalanche of bad publicity. Elton John and Iron Maiden may have reduced their contracts to six months, but crucially they did not lose them. A recent trading statement from Sanctuary contained a lot of bad news, which sent the stock down another 12%. But Ridgewell reckons the bad news was all history. The market has overlooked the good news – that current trading is pretty good. And with a PE of eight when the rest of the music sector is on 16, he reckons it is a safe buy. What about the dirty stocks that stayed dirty, or got even worse? Ridgewell knows his fund will always contain the odd turkey, and he confesses to mistakes buying bus maker Henley and construction company Jarvis. “The lesson I have learned from both is that where the management has a very limited stake in the business, it is not worth getting involved,” he says. “I now focus very closely on what directors are doing and what they are buying.” His best-performing stock has been M&S. “The reason I bought it when I did was that all the time I have been in this industry, I have never known a departing board member on leaving to buy more stock,” he says. “He was Stuart Rose’s right hand man, and was simply moving to another position. That was a great buy signal for me.” I have not run through the fund’s top 10 holdings, largely because the vast majority of the 100 holdings are equally weighted just below 1% of the portfolio. But Ridgewell’s single biggest holding is curious. It is New Star Asset Management itself. I am sure his marketing department would like to know if New Star fits into the “deep and dirty” category or merely the unfashionable. “We have got better operating margins and are growing faster than our peers, yet when we listed we were only on a PE around 12 when others were on 16 or 17. That was good enough reason for me,” he says.