Nick Kirrage, manager of the UK-based Schroder Recovery Fund, shares his views on value investing.
How do you define value investing?
Value investing is the art of buying stuff for less than its intrinsic value. I suppose all fund managers say that they buy stocks that are worth more than they pay for them. That's the whole point of fund management. But with value investing, we have a more kind of disciplined way of identifying those companies, of finding businesses that trade explicitly low valuations, low P/Es, low cyclically adjusted P/Es, valuation metrics, and we fish in particular ponds of cheap stocks.
Businesses often are cheap for a reason, but is that a good reason? As value investors, we frequently find it's not. By investing in those businesses, when they're very out of favour, you can make significant returns for clients.
Does the macro view have a bearing with regards to value investing?
Value investing is a broad church and there are different ends. Warren Buffett started in the mold of his mentor, Benjamin Graham, who was around in the 1930s, 40s and 50s and is considered the father of value investing. His belief is that you focus explicitly on cheap valuations and you don't concern yourself overly with the macro economy.
The macro economy is very important. Macroeconomics and the business cycle have a big impact on companies. It's just very, very hard to know how the cycle will unfold and what the direct impact will actually be on the companies, and of course, on their share prices, because the stock market is a discounting mechanism.
We don't take an explicit macro view, but we always have in the back of our mind that economics is a very cyclical phenomenon. It's very mean reverting over time. So, where we are investing where the assumptions are the things are good and will remain good, that's potentially quite dangerous and where we are investing where things are bad and the assumption is it will never improve, that potentially approaches right side of the averages.
The nature of value investing is such that sometimes stocks will be cheap just because they are rubbish.
There is that. People often say things have changed, that's why the stock is cheap. And sometimes things have changed. But what we frequently find is that more often than not, things have not changed. The expression, it’s different this time, we believe are four of the most dangerous words in investment, because frequently it is not that different.
Companies are dynamic. They evolve. They change. If things have changed in their marketplace, they evolve to try and take advantage the way in which they've changed. So, what we find is businesses that are out of favour, frequently come back into favour.
When focusing on out-of-favour stocks, what is the dominant risk?
There are risks to the style of investment. The one we're more focused on is balance sheet risk, because we don't know the time period it will take for companies to improve, to see that recovery.
We can't control volatility. We can't control whether the stock market will like or dislike these businesses in the short term. But we can make sure that the businesses have better balance sheets, and where they don't have a stronger balance sheet, we're very compensated for that with large amount of upside. That's what our recovery fund does.
This interview has been taken from Morningstar UK and has been edited for an Indian audience.
