A Review

It is at this time of year that fund managers take stock and I thought I would share some of the thoughts from the managers we use both within the stable of St. James's Place fund managers as well as those from the Bespoke offering available through St. James's Place Stockbrokers, Rowan Dartington.

Terry Smith, manager of the Fundsmith Equity fund and Smithson Investment Trust is well known for his approach in seeking out companies with high returns on capital (ROCE) a way of assessing how well a company is generating profits from its capital employed.  Whilst returns on capital in 2020 were a little down on previous years this is hardly surprising in light of events. What is particularly striking and a positive argument for the case of active stock picking over the alternative of passive investment, is that whilst the indices will obviously include some very good companies, the benefit of stock selection means that the return on capital of the companies in his fund was +25% compared to +11% for the S&P 500 and +10% for the FTSE 100 indices. Further gross margins were +65% for the fund compared to +44% and 39% for the respective indices. In other words, the companies he owns within the fund are fundamentally a lot better than the average of those in either index and valued more highly too.

A similar tale was told by Hamish Douglass of Magellan Asset Management who runs the SJP International Fund from Australia. In his Wednesday morning webinar he explained why he has chosen not to invest into Amazon or Tesla. For him, the return on capital at this stage is just too small. This doesn’t mean he won’t buy Amazon at the appropriate price in the future, he agrees it is great company, but as his style of management limits the number of holdings in his portfolio to around 25 he prefers to look elsewhere at companies such as Alphabet whose ROCE is superior.  

It is the same for Tesla. Actually, he stated that he “couldn’t see any circumstance where he would buy Tesla.” Selling cars to individuals has never been very profitable, it is a massively capital intensive, low return on capital industry. In the end there will be so many competitors in the electric car market space and he believes that battery powered cars could well be the Beta Max of the car industry as Hydrogen cells may well trump them in the future.  He is however highly respectful of Elon Musk’s abilities as are the tribe of Musk followers who have chased up the share price, valuing the company to an eye watering £800 billion for a company that sells just 500,000 cars a year. Its followers say Tesla is much more than just a car company, but time will tell. Its inclusion into the S&P 500 index contributed to its meteoric share price rise helped by the increasing number of investors buying into passive investment strategies, but the downside of passive investment means that such investors cannot take gains. They are either all in or not, they must own the whole index warts and all.

Hamish’s mantra has always been “to achieve risk adjusted returns over the medium term while minimising the risk of permanent capital loss”.  He admits to being ultra-cautious last year, to being fearful when others were fearful and held around 20% of the fund in cash back in April. Even Warren Buffett did not buy into the bottom of the market. He has since reduced his cash weighting to around 6% this but whilst he missed out on the rally in equities in November when there was a rotation from defensive stock, of which he has around 50% of his portfolio, into cyclical / discretionary companies, he would prefer to be six months late to the party than six months too early. He remains wary. The vaccines arrived sooner than expected but the jury is still out on their effectiveness on new strains of the virus. Stock markets have priced in good news, but this is far from certain. So long as the virus does not worsen he is positive for world economies going forward and sees growth in the last quarter of this year and into next. He is also happy with the current valuations of his companies and sees gains being made on all of them over a three-to-five-year horizon.

Terry Smith’s prediction for 2021 is for a “K” shaped recovery, with some sectors doing very well, others less so. No one could have predicted the devastation to the airline or hospitality sectors and some areas of retail. Pandemics accelerate change, much of it for the better. Stock selection is now more important than ever.

The opinions expressed are those of Irongate and the fund managers above using their independent research and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast. You may get back less than the amount invested. The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise.