Emma Wall: Hello and welcome to the Morningstar series 'Why Should I Invest with You?' I'm Emma Wall, and here with me today is Jeremy Lang, Manager of the Ardevora U.K. Equity Income Fund.
Hello Jeremy.
Jeremy Lang: Hello.
Wall: So, I thought I'd start by highlighting the fact that your top 10 holdings look nothing like what people may expect from a top 10 holdings in an equity income fund which is probably quite a positive thing. The only sort of similar stock there is SSE (SSE). Why are your top 10 holdings so different?
Lang: I think it's probably because we start in quite a different place than most other income managers. Most other income managers I think start by looking at which stocks in the market are big and yield a lot whereas those two things we either completely ignore or we only pay attention to right at the end.
So, the kind of size of the company thing, we only pay attention to that in terms of – we don't like going into really small stuff because we want to be able to sell a stock if we're wrong and unfortunately, I've been doing it long enough to have experienced getting it wrong quite a few times. So, I've got to be able to get out of a position. So, nothing too small, but that still leaves me with around 300 either mid or large stocks I can look at. But after that we don't really care how big it is.
And then dividend yields, we only look at that kind of right at end because there are lots of other things we think are much more important to do with how the business is run, whether we think it's run sensibly or not, whether we think we can see evidence that either investors or the professional forecasters that look at businesses whether we think they are exhibiting some kind of bias because that's our kind of area of interest, if you like, is trying to understand the kinds of mistakes other people can make.
Wall: And this screening process is this because you want to ensure capital preservation and to smooth volatility? I mean, what's the sort of thought process behind the screening?
Lang: A lot of it goes back to some of the interesting stuff that's come out of cognitive psychology about the way people make decisions and in particular, the types of situations where you can be misled by things you shouldn't be misled by, you know, how you feel about things.
So, we know – one of the really interesting areas that's come out of general cognitive psychology is to do with the way people try and appraise risk and return. What you find in lots of studies outside of finance is that when people are asked questions about risk, they often reply with answers which are about how much money they can make and they think, well, if I can make a lot of money then it's low risk and if I think I can lose a lot of money then it's high risk.
So, with that, we deliberately structured the way we try and choose stocks by starting with risk first and that's our kind of capital preservation bit and for us, risk is all about how a business is set up and how it's run and the bit about how it's run is about how the people that run it, the senior management, how they are behaving and whether they are behaving in a very risky way than the way we look at it or a conservative way. So, that's where we start.
So we have some screens which are designed to kind of kick out businesses where there is a better than average chance they are being run badly and then that smaller cluster we then have a much more in-depth look at them, read what management is saying, look through the balance sheet and all that kind of boring stuff but in a very particular way to try and work out what we think is a relatively safe at the moment and that will give us a smaller group of stocks and then from there and only then what we think about, okay, can we make some money out of these?
Wall: And last year that really paid off. I think the fund was up 32% last year. Is that the sort of thing that people can consistently expect or do you think there was just a happy bias towards the things that you were investing in?
Lang: No, you can't expect that all the time. What tends to happen – again, which is why our fund is a little bit different is that we will end up with a bunch of stocks which look more like kind of value traditional income stocks some of them which we mentioned, but we also end up with stocks which we would more normally expect to find in – like a growth fund and so we have a bit of both in that because of that two different directions we go in and last year we did very well out of that growth bit if you like. It was kind of easier for businesses to grow, the environment was more benign and more importantly, it was easier for them to do surprisingly good things. And that was why we did very well.
This year it's quite different. It's kind of generally tougher and we have less exposure to some of those growth stocks partly because they did so well. We are more into the anxiety-inducing stocks and it's those that I would expect to be more rewarding this year. But as we've already experienced, it's been quite an ebb and flow of just general anxiety and so you tend to need sort of bit of a lift of general anxiety and then suddenly those ones that people are a bit nervous about, like say Sainsburys (SBRY) and SSE and then suddenly they can pop. But it's quite unpredictable.
Wall: Jeremy, thank you very much.
Lang: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
