Investors, to steal from Rousseau, are born free, but everywhere are in chains; banged up for a long stretch in closet trackers, confined for life to risk rated funds, or making yesterday’s decisions tomorrow through passive investments. It’s hard to stay in touch, when you’re locked away.
Surely, it’s time to re-assert the rights of investing man and woman, to accept that risk and return are joined at the hip, and to remember that investors who wish to out-perform must be willing to do things differently, stand out from the crowd and be genuinely active. The question is, how to practice good active management?
We believe the answer is straight-forward. There is ample academic evidence that value investing works. This is most apparent in equities, where Warren Buffett is perhaps the greatest living exemplar. There is also evidence that value investing can bring success in other asset classes. After all, value investing is simply about buying assets when they’re cheap, and selling them when they’re expensive. Why should a value approach only be applied to equity, and not to the whole range of invested assets?
At Seneca, we apply this core principle of value investing to everything we do; we call it Multi-Asset Value Investing. Our approach is unique and this offers a significant advantage.
Bold assertions, but let’s look at the key components of our approach and organisation, and then at how we apply value thinking in our asset allocation work, and to each of the assets in which we invest.
We adhere to our value ethos come what may. We know that value investing is a patient game. It’s like breathing - you just do it. Value should never be out of fashion, but sometimes it is. For most of the last five years, other styles have ruled the roost but we are happy to be judged on our record over that period.
Secondly, we work as a team. The main focus of each of our fund managers is investment research. Each member of the team takes responsibility for one discipline, be that asset allocation, UK equities, overseas equites, fixed income or what we call specialist assets (infrastructure, leasing, property, private equity). These research responsibilities are central to our process. We only invest in things we believe we really understand. We like to dive deep, and if we come up mucky, better before we buy than after. Crucially, each specialist’s findings and recommendations must be value-based, and are subject to scrutiny from all members of the team prior to adoption. When ideas are adopted, they tend to be implemented across all of our portfolios.
Thirdly, process rules. Or should I say, process rules! Our process is simple and strict. Investors who use us know what they will get. We maintain target holding portfolios for each fund at the stock and asset allocation level. Each research specialist is responsible for target weightings in their area across every portfolio. Any change to the target for an individual holding or change to asset allocation has to be approved by the team, and logged on our research intranet, the grid. As with Spooks, if it’s not on the grid, it doesn’t exist. In our real portfolios, implementation is the responsibility of named pairs of individuals who have oversight in regard to each fund. The level of deviation between each actual portfolio and its target holding portfolio is monitored closely, with a maximum deviation of ten percent permitted. This is to accommodate income management, timing issues and similar, but not for other purposes.
Fourthly, we believe in simple, active management. The multi-asset world is a crowded space. Traditional balanced funds invested purely in equities and bonds, sit alongside smoke and mirrors funds, the true source of whose returns are obscured through the use of derivatives and other complex instruments. Seneca funds sit between these extremes. They are straightforward, long term, long only funds, investing mostly in a wide range of risk assets. We have been doing this, and only this, for a long time. What we do is transparent, to us and to our clients.
How active are we? Very. We ignore the composition of indices. We want our positions to count. Three brief examples. As at the end of February 2017, the annual tracking errors of our three public funds ranged from 4.5% to 5.3%. In other words plenty of scope for alpha. In regard to holding size, at end March 2017, these went up to 6.7% in the third-party fund area. In UK equities, for example in the Seneca Global Income & Growth Trust plc, we own twenty-two equally weighted stocks in position sizes of circa 1.5%, of which three are top 100 companies and 19 are mid-cap stocks. Our funds are diversified at asset class level and they are conviction driven within each asset class.
Fifthly, we adopt a multi-faceted approach to risk. Risk cannot be reduced to a single number, and it is absolutely not simply short term volatility. The most significant risk in our minds is the permanent loss of real capital. We strive to avoid this. Again, an example. We hold no developed market government debt. Why? Because it is screamingly expensive on any rational measure. Anyone buying the 50-year gilt in late March 2017 and holding to redemption is guaranteed to lose 59% of their real capital. This asset, whilst not volatile, will lose money in spades. So, a more rounded view of risk is required, incorporating factors such as risk of loss, volatility, liquidity and more, with value offering a margin for error in every decision.
Multi-asset value investing
How do we apply value criteria to the different elements of our funds? Tactical asset allocation means we focus on market yields. Adjustments to tactical asset allocation are made primarily in light of the yields available in different asset markets, relative to one another; to their own histories; and to where we sit in the business cycle. Yields which are higher than they ought to be are generally indicative of attractive future returns. Indeed, the focus on income and dividends is persistent throughout our thinking.
Value is predominantly apparent in UK equity mid-caps. We emphasise the combination of value and quality, expressed through companies’ ability to deploy capital effectively, and from this to generate profit and dividend paying capacity. In aggregate, our mid-cap holdings offer higher dividend yields, the same dividend cover, lower price to book ratios and significantly stronger returns on equity than their mid-cap peers. We believe our portfolio has secure dividends, significant re-rating potential and premium quality, without having to pay a premium price. What we do works, having comfortably out-performed both the mid-cap and all-cap UK markets over the five years to end 2016.
We access overseas equities indirectly, through funds, looking for like-minded fund managers who share our value ethos and invest in their own funds, as we do. Insisting on high active share, our open-door policy for experienced value managers starting out with new funds allows us to pick winners early. This is when returns can be at their best. Prusik Asian Equity Income is a fund whose manager focuses on value, quality and high, sustainable dividend yields. As at end February 2017, the fund has significantly out-performed its benchmark since launch in 2011, when we first invested.
In fixed income, we invest both directly and indirectly, though the former approach is reserved for developed government and investment grade debt, of which we hold nothing at the moment. Asset allocation decisions are a big determinant of fixed income positions, current thinking favouring the short end of the curve due to interest rate risk, and sub-investment grade for real yield pick up over the gilt. The Royal London Short Duration Global High Yield fund is another example of a fund we have backed since launch in 2013. It has produced strong risk adjusted returns, has a history of low defaults, low sensitivity to interest rates and a distribution yield of 6.1% as at end March 2017. As with equities, yields which are higher than they should be point to strong future returns.
Finally, we see in specialist assets a range of opportunities which can deliver relatively secure income streams that are more stable than those of equities and more capable of growth than those of fixed income. Our analysis in this area focuses on the reliability of future cash flows, and the quality and future values of the assets from which the income is generated. Again, we are happy to invest away from the crowd. We hold no mainstream property, rather, owning specialist vehicles such as Custodian, Civitas and AEW. These funds offer or aspire to higher yields than mainstream REITs such as British Land, and operate in niches which we believe offer better returns than the relatively late cycle main-stream commercial property market.
The value ethos set out above, together with the principles and selection criteria we use, add up to an assurance as to how we will behave as investors. We can’t guarantee the results we will achieve, but we can be clear as to how we manage money. We believe that this approach, built on our value commitment, gives us the edge. We are happy to be different. We are aiming to win.
Past performance should not be seen as an indication of future performance. The value of investments and any income may fluctuate and investors may not get back the full amount invested.
The views expressed are current at the time of writing and are subject to change without notice. They are not intended as investment advice or a recommendation to invest in any of the investments mentioned. Whilst Seneca has used all reasonable efforts to ensure the accuracy of the information contained in this communication, we cannot guarantee the reliability, completeness or accuracy of the content.
This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
The CF Seneca Investment Funds may experience high volatility due to the composition of the portfolio or the portfolio management techniques used. Before investing you must read the key investor information document (KIID) as it contains important information regarding the funds, including charges, tax and fund specific risk warnings and will form the basis of any investment. The prospectus, KIID and application forms are available from Capita Financial Managers, the Authorised Corporate Director of the Funds (0345 608 1497).FP17/94
Before investing in the Seneca Global Income & Growth Trust you should refer to the latest Annual Report for details of the principle risks and information on the trust’s fees and expenses. Net Asset Value (NAV) performance may not be linked to share price performance, and shareholders could realise returns that are lower or higher in performance. The annual investment management charge and other charges are deducted from income and capital.
Seneca Investment Managers Limited is the Investment Manager of the Funds (0151 906 2450) and is authorised and regulated by the Financial Conduct Authority and is registered in England No. 4325961 with its registered office at Tenth Floor, Horton House, Exchange Flags, Liverpool, L2 3YL. FP17/93
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