The art of cutting your losses

Conviction on stock selection and the humility and discipline to learn from poor investment decisions is essential for long term returns. Chris Murphy and James Balfour explain how this works in practice.

Hedge cutting

With a focus on long-term growth and cash-generative companies, Chris Murphy does not believe in trading stocks on a short-term basis as a result of market noise or following the herd. Within the Aviva Investors UK Listed Equity Income Fund this long-term conviction means stock turnover in the portfolio is low; on average a company is held for five years – more than triple the fund market norm of around 18 months. Indeed, one of the best performing stocks in the portfolio is alternative asset management company Intermediate Capital Group, which Murphy bought in 2009 (see below).

“Many people try to second guess the market or company results and end up trading in and out of stocks as a result. I do not think I can do that because few, if any, managers are ever able to accurately predict how well a stock is likely to perform over the short term,” he explains.

When we see a new opportunity, we will typically start with a fairly small position

“What I can do however is judge good business models and use that analysis to decide whether to buy or sell a company. That is why when we see a new opportunity, we will typically start with a fairly small position, around one per cent; and only add exposure if the investment case materially improves.”

However, Murphy adds that as fund managers it is important to learn from negative stock decisions and experiences too. For example, when the team can see a company story is beginning to deteriorate, they move quickly to limit performance cost and dampen (in some cases negate) negative portfolio returns. This was the case with advertising holding company WPP (see below).

“We take pride in our ability to quickly recognise if an investment thesis isn’t playing out as initially expected and make a change. Embedding the possibility of investment error into portfolio construction will continue to be integral to our success.”

Intermediate Capital Group
Bought: April 2009

Intermediate Capital Group (ICG) has a strong track record, with the firm not having recorded an annual net outflow since it was formed. The global company invests in private debt, credit and equity, bridge financing, acquisitions and other financial instruments. Its operations have flourished since 2008 as smaller businesses, shut off from global banks, sought alternative sources of cash.

“The operations of the business were perhaps unnoticed by the market – the company has progressed from the FTSE 250 to the FTSE 100,” explains James Balfour, co-manager of the Aviva Investors UK Listed Equity Income Fund. 

By scaling up, demand for its strategies has remained high

“Over the past decade, the business has not only diversified its offering by fundraising for a number of new vintage funds, it has continued to expand its team and build up its sales and marketing efforts. By scaling up, demand for its strategies has remained high. It is one of the only fund management businesses that we know of that is actually maintaining fees or even putting them up.”

“This is a stock that deals in what we call ‘sticky capital,’ because it’s typically locked into those long-term vintage funds.”

The stock accounts for 4.9 per cent of the Fund’s holdings (as at 31 December 2019) and makes up a weighty part of the portfolio’s allocation to financials. Although it is top relative contributor to performance, Balfour notes ICG’s status as a ‘compounding business’ in terms of future growth could make it a viable long-term contributor to the portfolio.

ICG has also shifted its focus to the growth of the asset management business. This is reflected in the company’s AUM which, driven by high revenue margins, have delivered profits that are double the sector average. 

WPP
Bought: April 2017
Sold: February 2018

As the world’s biggest advertising holding company, fears surrounding the future direction of WPP have been well documented. The main concern has focused on how the creative and communication giant stays relevant in the new world of digital advertising and media. 

Murphy explains he saw WPP as a business that “understood the digital world changes, but there was a question over how it migrated through those challenges”. 

The team bought into the stock in the spring of 2017, confident it would be able to make the structural changes needed to adapt to the new world of advertising. Further driving the purchase was the fact the company had begun to yield a dividend above four per cent for the first time in several years.

“We were acutely aware of the downside risks and therefore restricted our entry position to one per cent with a view to only increasing it if the structural story materially improved,” Murphy says. “[But] within six months or so, it became apparent the company wasn’t making enough progress and we exited the position in February 2018.”

Sir Martin Sorrell, WPP’s chief executive at the time, left in April 2018, causing further share price falls.

It is imperative as a fund manager to understand when you have made a mistake

Murphy believes that while it can be argued it may have been a mistake to buy the stock, it is important to note that not all companies are equal. In addition, it is imperative as a fund manager to understand when you have made a mistake.

“There are many risky companies available, and because we could see there was a risk in buying this stock, we started with a small position that was appropriate for the fund,” he says. “Although we always take a long-term view, by having the discipline to admit it was not the right call for us at the time and getting out early, we were able to limit the performance cost of our position significantly.”

Key risks

The value of investments and the income from them will change over time. The Fund price may fall as well as rise and as a result you may not get back the original amount you invested.

Equities Risk: Equities can lose value rapidly, can remain at low prices indefinitely, and generally involve higher risks — especially market risk — than bonds or money market instruments. Bankruptcy or other financial restructuring can cause the issuer's equities to lose most or all of their value. 

Target outcome risk: Any outcomes stated as targets are not guaranteed and may not be achieved.

For further information on the risks and risk profiles of our funds, please refer to the relevant KIID and Prospectus.

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Important information

This document is for investment professionals only. It is not to be distributed to or relied on by retail clients. Except where stated as otherwise, the source of all information is Aviva Investors as at June 12, 2020. Unless stated otherwise any opinions expressed are those of Aviva Investors.

They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature.

The UK Listed Equity Income Fund is a sub-fund of the Aviva Investors Portfolio Funds ICVC. For further information please read the latest Key Investor Information Document and Supplementary Information Document. The Prospectus and the annual and interim reports are also available on request. Copies in English can be obtained free of charge from Aviva Investors UK Fund Services Limited, St Helen’s, 1 Undershaft, London EC3P 3DQ. You can also download copies from our website www.avivainvestors.com

Issued by Aviva Investors UK Fund Services Limited. Registered in England No. 1973412. Authorised and regulated in the UK by the Financial Conduct Authority. Firm Reference No. 119310. Registered address: St Helen’s, 1 Undershaft, London EC3P 3DQ. An Aviva company.