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Reassess UK value funds to get the best returns

There has been a considerable divergence in the returns of UK value funds
March 21, 2022
  • A divergence in performance means it is necessary to reassess the differing approaches of UK value managers
  • Funds' allocations and their managers' mindsets are important factors to consider

In what has been a volatile period for equities, value-style investing funds have done better than most. Value investing generally involves picking stocks that appear to trade for less than their inherent worth. And over the past six months, quality growth stalwarts have fallen to the bottom of performance tables while more cyclically-minded funds have – at the very least – suffered less. 

But this is a generalisation and the situations regarding individual funds are less clear-cut. Some of the better-known value funds in the Investment Association and Association of Investment Companies UK equity sectors, for example, have seen a notable divergence in performance. Take the 13.1 per cent return generated by the sector leader, Invesco UK Opportunities (GB00BJ04KP99) over the six months to 17 March. That’s a decent way ahead of gains made by some better-known value funds, such as Schroder Recovery (GB00B3VVG600), and stands in contrast to losses by funds including Polar Capital UK Value Opportunities (IE00BD81XX91), which was down by 8 per cent over the same period.

The differences are due to a number reasons, from sector allocations to managers' stockpicking. So it's useful to assess how exactly the funds differ, and the extent to which they invest in 'deep' value plays, which require greater faith but can deliver bigger rewards.

 

Some differences

The chart below shows the recent sector allocations of Invesco UK Opportunities and some of the better-known UK value funds. The funds in the chart are ordered by performance over the six months to 17 March. Polar Capital UK Value Opportunities is not included in the chart because it breaks down its sector allocations differently to its peers.

Energy shares might have soared, but even UK value managers have been relatively restrained when it comes to direct exposure. Invesco UK Opportunities and Man GLG Undervalued Assets (GB00BFH3NC99) had allocations to this sector of 14.2 and 19.5 per cent, respectively, at the end of February, while Schroder Recovery had a 16 per cent allocation. While this can partly be attributed to the make-up of the UK equity market, it’s notable that all the funds have gone in more heavily on financials, the biggest or joint biggest sector allocation for every single name in the chart. JOHCM UK Dynamic (GB00BDZRJ101had the biggest allocation at 27.6 per cent.

Some other big sector bets are worth noting. Fidelity Special Values (FSV), managed by Alex Wright, has had decent net allocations to industrials and consumer discretionary stocks, as has Ninety One UK Special Situations (GB00B1XFJS91).

All these funds vary in terms of how contrarian they are and the extent to which they focus on classic value stocks. If you do have a contrarian bent, Schroder Recovery's and Schroder Global Recovery's (GB00BYRJXL91) managers, Nick Kirrage and Kevin Murphy, are considered to take more of a deep value approach. Tom Sparke, investment director at wealth firm GDIM, notes: “Schroders tends to be synonymous with value investing and it is no surprise that its Global Recovery fund has been a good performer this year.” 

Analysts at research firm FundCalibre, meanwhile, describe Schroder Recovery as a “quietly aggressive, value-driven fund”.

Kirrage and Murphy look for companies whose share prices or profitability have suffered a severe setback. They are willing to hold a stock for years while it improves. This approach results in volatility and bouts of underperformance for their funds. But Schroder Recovery and Schroder Global Recovery can provide a more forceful offset to some of the quality growth funds that have dominated many investor portfolios in recent years.

Taking a more systematic approach, PortfolioMetrix investment analyst Phil Wellington views the likes of Polar Capital's fund as a "light" value option, noting its bias towards mid and small cap domestic stocks, and the fact the managers "don’t tend to have overly concentrated portfolios (generally nothing higher than 3%) and [portfolios] based on conviction rather than with a market cap focus". Wellington would class Man GLG Undervalued Assets and River and Mercantile UK Recovery (GB00B614J053) as "medium" value options, and the Schroders funds and Redwheel UK Value (LU1017299071) as deeper value funds.

Tracker funds can also serve as a proxy for value. For example, the FTSE 100 index is a source of cyclical exposure due to its composition. Many UK equity income funds can also work as a play on value, from exchange traded funds (ETFs) such as iShares UK Dividend UCITS ETF (IUKD) to Temple Bar Investment Trust (TMPL). Note that funds chasing yield, especially index trackers, can experience big ups and downs.

 

Striking a balance

If they look appealing for now, more cyclical funds can be uncomfortable to hold because their holdings can perform poorly for a long time before coming good – if at all. Sparke, for one, notes: “We tend to use value funds sparingly as their volatility levels are often higher than [those of] their counterparts based on other styles, but we do have a few favourites.”

These include Man GLG Undervalued Assets, which Sparke likes because of its composition. He believes that this is “a more varied portfolio, which includes value stocks but not always the ones you might expect”.

One core belief held by this fund's investment team is that valuations are too heavily centred on earnings forecasts. So they focus on the current shape of a company’s balance sheet, looking for businesses whose profit streams or tangible assets are undervalued. The fund’s biggest overweight positions at the end of February included Grainger (GRI), Shell (SHEL) and Beazley (BEZ).

 

Fund performance – cumulative total returns (%)
Fund6m1yr3yr5yr10yr
Artemis UK Select -7.062.8737.3742.39146.62
Fidelity Special Values share price-2.1910.5320.2840.95233.9
Invesco UK Opportunities13.1422.8433.935.18152.25
ES River and Mercantile UK Recovery-4.181.5422.4228.63177.44
Polar Capital UK Value Opportunities-7.993.0116.2827.48 
Schroder Recovery7.4312.3815.7424.15144.11
Man GLG Undervalued Assets0.426.252.5821.77 
iShares Core FTSE 100 UCITS ETF6.1811.6312.3618.4476.08
JOHCM UK Dynamic -0.118.499.5616.77123.34
Jupiter UK Special Situations 3.198.221516.53118.59
Ninety One UK Special Situations -6.83-5.631.348.3969.84
iShares UK Dividend UCITS ETF 6.3413.8510.145.6267.13
M&G Recovery-4.14-3.6-7.72-6.6315.93
Source: FE, as of 17/03/22

More balanced funds that focus on value in a less aggressive manner include JOHCM UK Dynamic. Sparke also highlights Artemis UK Select (GB00B2PLJG05), managed by Ed Leggett, as a blended value option. If Leggett backs undervalued companies, Sparke notes that he diversifies beyond this in one respect.

“Typical sectors appear, such as oil and tobacco, but holdings such as Tesco (TSCO), 3i (III) and International Consolidated Airlines (IAG) are well-placed to outperform without being the names you find at the top of deep value [funds'] holdings lists,” he explains.

To give some sense of how such funds have fared in different environments, the table shows their short and medium-term performance. The list is ordered by five-year total returns. For some funds, such as iShares UK Dividend UCITS ETF, a meagre five-year return reflects the highs and lows, and sheer level of volatility, the portfolio has endured.