Learning from life and death: Ten years of equity income investing

Key elements of success are admitting to errors, sharing information and asking the right questions. After 10 years at the helm of the UK Equity Income Fund, Chris Murphy shares his lessons learned.

3 minute read

black box

No-one ever learns from getting it right first time. In his book ‘Black Box Thinking’ Matthew Syed demonstrated there are recurrent themes and trends that explain why projects succeed or fail.

Key elements of success are admitting to errors, sharing information and being open. Asking the right questions is key: In the second world war, the airforce looked at where they were seeing damage in returning planes. They decided to reinforce those areas. However, it made no difference. They asked the wrong question. They missed a crucial bias. They should have asked about the planes that weren’t coming back, not just the ones that ‘survived’. When they looked more closely and factored this analysis in, more planes returned.

So what have I learned? Most fundamentally, I have learned that it is important to admit errors, to learn from them and to share that information.

Asking the right question is vitally important in fund management. And after ten years at the helm of our equity income fund, I thought it an opportune time to reflect. Matthew Syed’s framework provides a neat analytic lens from which to draw conclusions. For while fund management is not as directly link to mortality risk as, say, aviation, we are responsible for people’s livelihoods, by stewarding their retirement and saving assets.

History is littered with examples of this. The pools, for example, used to be the way that families bet on the football. The Littlewoods pools had the opportunity to bid for and run the National Lottery, but it felt its brand was so powerful, it didn’t need it. Almost no one has heard of it today. This is not uncommon and also happened to, for example, Xerox, Kodak and Nokia.

The pace of change and disruption is accelerating. M&S has failed to understand consumer trends for some time. It may be able to turn this around, but it is not going to be easy. Next has been a great business, but anyone with a retail footprint has struggled. What happens when there is a recession?

As fund managers, we always ask whether we are set up for things to go wrong. Is the fund inappropriately balanced for difficult periods? Or is it exposed to over-leveraged business?

It is important to change when the story changes. Restaurant Group, for example, had done well for many years. It had Frankie and Benny’s and Chiquitos, next to cinemas and away from the competition. There was a wobble, and the management team said it was ‘because of the referendum, but don’t worry’. For the next wobble, they blamed the films in the cinema. We spoke to the other pubs and cinema chains, and they hadn’t seen this sharp decline. Six months later, the CEO of Restaurant Group had gone. The group had been pricing significantly above the market. Landlords had started opening up more restaurant space because they couldn’t fill their buildings with retail tenants. Management believed it was fine, but that’s why you need a broad information set: companies can’t always recognise it themselves.

To survive, companies need to spot emerging threats. In Tesco, Terry Leahy built up a fantastic business. But it can be all too easy to believe your own press. Management needs some humility and to understand the reasons behind success. In meetings, Leahy talked endlessly about the business’s successes, but failed to recognise the growth of Aldi and Lidl. There was a lack of control and objectivity, and they treated their suppliers poorly. Justin King at Sainsbury’s recognised the threat, but he was leaving the business and therefore his interests weren’t necessarily aligned with shareholders.

We also believe it’s important to let fundamentals do the talking. Ashstead Group re-rated after Brexit because of its US business. We took profits to invest in beaten up in UK businesses. The business has rallied 140 per cent from 2016 to the middle of this year. All the reasons we originally wanted to own the stock – increasing penetration of rental equipment in a recovering economy, for example – are still in place post referendum.  The biggest driver for companies has been their own earnings potential, not the wider environment. That’s why we aim to buy fundamentally good businesses.

The hardest part of fund management is knowing when to go against the herd and when to fall into line; when to trust your instincts and when to challenge your own perceived wisdom. If I have l learned anything over the last ten years, it is that managing these tensions requires keeping an open mind and having endless curiosity. 

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The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested.

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