This fund is not for investors easily shaken by volatility. The portfolio is highly concentrated. It invests in about 25 stocks that are roughly equal weighted. There are no limits on manager Robert Churchlow's ability to over- or underweight any stocks or sectors relative to an index. The fund can also invest in Aim securities exposing it to the higher volatility and business risk inherent in such issues (the fund currently has about 8% in AIM-listed shares). Moreover, the fund can run a significant mid-cap exposure, and Churchlow is a bit more willing than his typical peer to pay up for growth (as evident from its above-average val
uations and growth scores), both of which can impart added volatility.
Such strategies can backfire sharply in the wrong hands, but we believe investors can take comfort in the experience and process in place here. Although Churchlow has only been named manager on the fund since mid 2006, he has 20 years' experience focusing on UK equities. He is also LGIM's head of UK equities, and was previously the head of institutional equities at Invesco. Moreover, the switch to the focused approach used now was largely completed in August 2005 under his predecessor Mervyn Douglas, and Churchlow draws heavily on the work of his three other colleagues on the UK equities team.
The strategy used to dig out holdings here is consistent and sound. It is largely bottom- up, but the team does not ignore macro factors. From a fundamental perspective, the team looks for evidence of sustainable competitive advantage and shareholder value creation, as measured by improving cash flows. As do many managers, they also like companies experiencing positive change such as a top-management reshuffle.
The portfolio resulting from this strategy typically spans the market-cap spectrum, but with a mid- and large-cap bias and a distinct growth tilt. However, despite those growth leanings, the team pays some attention to valuation. They assign each stock a price target, which strongly influences their buy and sell decisions. For example, concern about valuations kept Churchlow out of mining, which hurt 2007 returns. It also led him to avoid banks (he believed their apparently low valuations relied too much on low-quality earnings that could not be maintained in the future)-- much to his credit. Performance relative to the Morningstar UK Equity Large Blend category has been exceptional, with financials and consumer services underweight as well as a large-cap overweight helping the fund's dominant selection returns in recent times.
We like this fund's disciplined process and strong returns. The manager pay is closely linked to returns over one, two and three years, aligning the investor's and team's interests. The firm has also recently decided to hire one more analyst, which should help rationalise the workload of the current team. The fund's compact portfolio and unconstrained style means that it's inappropriate for investors who shy from risk or who have short time horizons, but we think it's a strong choice for those seeking aggressive, go-anywhere, exposure to UK equities.
