EquitiesApr 16 2014

Fund themes: To buy and to hold

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Even the most experienced investment professionals benefit from a periodic revisiting of the principles that underpin sound portfolio management, doing so keeps us all on the straight and narrow.

Below are several nuggets of wisdom, borrowed from legendary investors that add up to an outline for a buy and hold investment strategy.

1. “If you want different investment performance you must invest differently,” according to US-born philanthropist and stock investor the late Sir John Templeton.

This is an unpalatable, but incontrovertible truth. If you want different performance – for which I suppose read “better performance” – then you have to do something that others do not. But investors must never lose sight of the risks that need to be taken in order to achieve that “different” return. For us perhaps the most obvious differentiator between investment managers is time horizon, as measured by levels of portfolio turnover.

A typical UK equity Oeic will experience annual turnover of close to 100 per cent. It is helpful – though not strictly scientific – to say if a given portfolio turnover is 100 per cent in a year that implies the investment manager is taking on average a one-year time horizon for each holding. By contrast, turnover of less than 6 per cent a year – as it has been for our longest UK track record for example - indicates each position will be held for 17 years or longer. The one certain benefit of a buy and hold approach such as this with its relative inactivity – although there are disadvantages too - is that total running costs will tend to be lower, potentially much lower, than for other funds with a higher frequency of costly transactions.

2. “Stocks are simple. All you do is buy shares in a great business for less than the business is intrinsically worth, with managers of the highest integrity and ability. Then you own those shares forever,” according to US investor Warren Buffett.

An explanation for a low-turnover approach (and the type of company in which to invest) is found in this advice from Mr Buffett. One could be forgiven for asking, how can such a simple suggestion – even from the world’s greatest investor – be the basis of a credible investment philosophy? But it is what it is and by and large it has worked – for Mr Buffett obviously and for others too. In passing, let me assure you that it is not so easy to identify, then stick with investments in even great companies. The pressure to “do something”, particularly when a great company is going through an inevitable dull patch, is intense. Unilever’s current dull share performance is one example. During such periods it helps to remember the comment below of another outstanding investor – Peter Lynch – who, just like Mr Buffett, is famous for running his winners.

3. “Other investors invent arbitrary rules for when to sell,” according to US investor Peter Lynch.

Mr Lynch argued that if a share has done well over time – like Unilever – then there is every reason to expect it to continue to do well (although always remembering that nothing goes up in a straight line). He disputes the conventional wisdom that says: “It’s never wrong to take a profit”. It can be very wrong; if by doing so you permanently reduce your interest in a great long term investment. Share prices of the best companies double, then double again and again over time. Locking into that observed propensity for wonderful businesses to compound wealth for their owners is at the heart of our approach. For instance, Diageo shares have more than doubled since our business was founded, in late 2000, but we have no doubt that Diageo shares will double again – as its cashflows grow and the pricing power of its brands protects owners against inflation.

4. “If a company’s products taste good buy the shares,” is a recommendation by Vivian Bazalegette, my former and much-admired boss at M&G, whose comments about stock selection continue to inspire.

He was drawn to companies whose products were regarded as irreplaceable by their customers. So, for instance, scientists and lawyers around the world have little option but to subscribe to Reed Elsevier’s services – they can’t do their work without them. But, as Mr Bazalegette recognised, consumer loyalty to a tasty product is just as reliable and highly profitable. Investors in Unilever, Diageo, AG Barr and similar companies can take comfort knowing that their investment is being supported by people’s insatiable love of, for instance – Guinness, Johnnie Walker, IRN-BRU, Rubicon, Fuller’s London Pride, Old Speckled Hen, Dr Pepper, Cadbury Dairy Milk, Oreo cookies, Toblerone bars, Magnum ice cream, Hellmann’s products, Knorr goods and my own choice brand, which I cannot do without: Marmite.

These products will be enjoyed 30 years from now and, in an uncertain world, that is enough to mean the companies that own these brands are likely to be terrific investments over time.

Another distinguishing factor of investment styles is portfolio concentration – does the manager have courage in his or her convictions? Richard Thornton, a pioneer of international fund management and the T behind GT Management, who hired me back in 1981was a great proponent of conviction portfolios. Sadly he died in 2013, mourned by colleagues as a formidable stock market operator. I have never forgotten his account – to a group of then feckless graduate trainees – of his secret to investment success:

5. “First, identify your great idea. Next, invest into it as much as you can possibly afford. Third, double the size of your holding, so you can no longer sleep at night. Finally – tell everyone else about it.”

Mr Thornton knew that great investment opportunities are rare and must be backed with conviction, when you happen across one. He also knew how easy it was to suffer “diworseification”, from a lazy proliferation of “it seemed like a good idea at the time” holdings cluttered across a portfolio.

Turning to the outlook for equity markets – we remain bullish for both global and UK equities. It seems to us that the background conditions are as encouraging for equity investing as at any time since, say, 1801, when the London Stock Exchange was founded.

We know it would be comforting for cautious readers to be offered more certainty as to the likely shape and timing of those promised equity returns. The fact is Anglo-Saxon equities have delivered 6 per cent to 7 per cent a year total returns over and above inflation over decades, if not centuries. But they have never done so at a metronomic, regular pace. No, the truth of the likely shape of equity returns is best expressed in this wonderful observation from light versifier, the late US poet Ogden Nash:

6. “Shake and shake the ketchup bottle. First none will come and then a lot’ll.”

It is indeed hard, we might say impossible, to time the equity markets. And yet it is imperative investors maintain adequate exposure to equity.

Nick Train is investment manager of the Finsbury Growth & Income Trust

Key Points

If you want different performance then you have to do something that others do not

Warren Buffett is one of the most famous buy and hold investors

The background conditions are as encouraging for equity investing as at any time since 1801 when the London Stock Exchange was founded