Fund of the Fortnight: Ardevora UK Income
UK equity income remains incredibly popular with investors and has been one of the best-selling sectors in recent months. Notably, the launch of the CF Woodford Equity Income fund, a new venture by high profile manager Neil Woodford, creamed in an eye-popping £1.6 billion in June.
In stark contrast to the torrent of publicity over the launch of Mr. Woodford’s business, another star manager with a long and excellent track record, Jeremy Lang, quietly set up his own boutique with colleague William Pattisson three years ago. That business, called Ardevora, is certainly not a household name and its UK Income fund is a modest £225m in size, but the record so far has been seriously impressive. This hidden gem deserves greater attention.
The approach used on Ardevora UK Income is very distinct and differs considerably from its peers. While most fund managers argue how important it is that they meet the senior management at companies, Lang and colleagues pointedly will not meet companies.
The refusal to see the UK PLC’s top brass is one manifestation of Ardevora’s approach, which is grounded in the field of cognitive psychology. They see investing as about recognising things the market has got “wrong” and this comes down to the impact of bias. In the field of equity investing, bias comes from the behaviour of three groups: company management, analysts and investors.
The Ardevora approach to building the portfolio of the UK Income fund is to a large degree about rejecting stock as much as selecting stocks. Lang and team believe managers of businesses are prone to excessive risk taking, as chief executives often have big egos and share-based remuneration schemes encourage risky – even reckless – behaviour. With this in mind, rather than press the flesh of company management, Ardevora like to delve into the numbers – the balance sheet and cash flow statements – for signs of excessive risk taking. Where they find this, those companies are screened out.
Likewise, whiz kid investment banking analysts are often over-confident in their forecasting abilities and reluctant to admit they are wrong, so bias creeps in as models get only incrementally tweaked rather than ditched and started again. Analysts often act like a herd, scared to stray too far from consensus. Ardevora looks for companies that have a pattern of surprising analysts.
The team also argues that investors are prone to bias in the form of overreaction, perhaps panicking on the back of short-term news or extrapolating the latest quarterly earnings numbers. The Ardevora team actively targets companies that have a high degree of anxiety surrounding them, as these can represent value opportunities. Examples in the portfolio include domestic energy companies Centrica and SEE, which had been out of favour when politicians were banging the drum over utility bills and calling for greater competition.
A final way in which the team seeks to avoid bias in the structure of the fund is by equally weighting all stocks in the portfolio. This is very different from a bog standard UK equity income fund, where the top 10 holdings will typically be skewed towards big positions in FTSE 100 companies simply because they are large components of the index. It means every stock in the fund can contribute meaningfully to returns, and that the fund is about as far removed from an index tracker as you can get – but then that is surely what an investors should want from an “actively” managed fund?
Jason Hollands is Managing Director of Tilney Bestinvest.
For more Fund of the Fortnight reviews click HERE.