There are 150 funds in the cautious managed sector, but how exactly does one define "cautious"? One of the funds that can claim to be taking the label seriously is the Investec Cautious Managed Fund, run by Alastair Mundy. Yes, it's chalked up some of the best long-term positive returns in the sector. But more importantly, it has minimised losses. During 2008, an annus horribilis for most managers, it lost less than 11 per cent in contrast to a plunge of nearly 33 per cent for the FTSE All Share, and more than 16 per cent for the average Cautious Managed Fund.
So how does Mr Mundy restrict losses? He describes his method of risk management as the "dinner party approach".
"Invite a good mix," he says. "Hold assets in your portfolio which will do something at one point or another during a cycle. Don't wish for all your investments to rise simultaneously: if they do, they will probably fall simultaneously."
He suggests holding complementary assets, with aim of having something that will go up even when other things are going down. "But don't expect too much of them," he cautions. "They may not have been historically correlated but this might not be the case in future."
A classic example is his practice of holding high quality bonds alongside equities, with the former accounting for at least 35 per cent of the portfolio, while equities are limited to a maximum of 60 per cent. Normally, they move in opposite directions, but sometimes rise and fall at the same time, as was the case in the latter part of 2010.
When to sell
Extending the dinner party metaphor, Mr Mundy is never afraid to depart early, leaving other guests to over-indulge. It reminds me of John Pierpont Morgan's famous quip that he "got rich by selling too soon."
"Every single equity we buy is unloved but one day will be regarded as neutral or average, so we look to sell it when it is considered average," says Mr Mundy. "Selling a stock when it is too late is not a substitute for getting out at the right time, especially as there will be a huge number of other investors trying to sell it at that point."
Investec's UK contrarian equity team, which Mr Mundy heads, has a sell discipline to ensure that good buys are not diluted by badly timed sales. They set a review price for every stock, and when it reaches its review price it might be sold. "There are no automatic sell criteria such as a profit warning, dividend cut or chart breakout," says Mr Mundy. "We believe these mechanistic approaches, while making a decision easy, can hide the opportunities that such events can often create. In fact, many of the buy decisions are actually triggered by the automatic sell rules used by other investors."
A stock will be sold if the fundamentals have changed significantly for the worse, and this is not reflected in the value of the company. This could be if the balance sheet has deteriorated, if the strategic position of the company has worsened or if the earnings capability of the company has been reduced.
"While not a rigid discipline, the continual search for new buy ideas will result in cash needing to be raised from the existing portfolio," adds Mr Mundy. "This should ensure the portfolio is constantly refreshed with new ideas."
That said, rather than looking at short-term performance concerns the fund concentrates on the long-term potential of under valued stocks. This allows for Mr Mundy and his investment team to focus on the potential upside as they believe many of the negatives are already discounted in the share price. Likewise, when identifying which undervalued stocks, they do not follow short-term trends, but rather look for good underlying fundamentals such as assets, cash flows and profits.
| Alastair Mundy CV |
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Alastair Mundy is head of the contrarian equity team at Investec Asset Management and manages funds including Investec Cautious Managed. He has worked there since August 2000, before which he worked at Morley Fund Management. Mr Mundy has a degree in actuarial science from City University. |
Tough time
Even with a sell discipline, timing is notoriously difficult, adds Mr Mundy. He recalls selling Anglo Irish Bank too early and Jessops too late. "Every single fund manager has disasters, but we hopefully learn from them and I would argue that if you haven't lost money you haven't lived. After a long career I am getting better".
Another important tenet of cautious management is getting a good return every year, rather than the odd great year. He is not looking to be the best, but rather get 7 to 8 per cent a year in a low-risk way. Continuing his dining metaphor, he says: "Focus on creating a series of good dinner parties, and not about creating the one best dinner party ever."
It is also important to understand that "risk is the potential for permanent capital loss".
"Make sure you understand the worst case scenario for each investment," he says. "If you can't think of one, then you don't understand what you are buying. You cannot sensibly control risk, markets do - there are no promises anyone can make. So don't pretend to yourself you know all the answers; neuroses and schizophrenia are the best bedfellows. Always doubt yourself, always ask yourself how you might be wrong."
He believes there is a difference between permanent capital loss and volatility - the latter gives opportunities to buy something cheaper. One of the reasons why Mr Mundy favours cheap stocks is risk control. "Pay a great deal of attention to valuations - buying something that is cheap is a great way to reduce risk."
