SVG UK Focus has been a top-decile performer in the IMA UK All Companies sector since Seaton took over in April 2009, and the manager says that his edge comes from the proprietary research he and his team carry out.
The traditional methods that growth and value investors use to approach stocks are both flawed, he claims, and are best supplemented by the focus on cash-flow and debt that private equity firms use.
"We try to replicate the valuation techniques that private equity firms use when adding targets," Seaton said.
"This doesn’t mean we are investing in stocks that we think will get taken over, but most private equity funds tend to invest using techniques that are a better predictor of value on a three-year basis"
SVG Investment Managers is a boutique asset management firm that specialises in private equity. It launched the SVG UK Focus fund back in 2002 to make its techniques available to retail investors.
Since Jamie Seaton took over the fund in April 2009, it has made 158.06 per cent, according to data from FE Analytics, putting it 13th out of 255 funds in its sector. The average fund made 93.84 per cent.
Performance of fund vs sector and index since Apr 2009
Source: FE Analytics
The fund is top-quartile in terms of volatility over the past three years, and its Sharpe ratio of 0.96 is the 14th-best in the sector. The Sharpe ratio measures risk-adjusted returns, giving an idea of what the manager has achieved for the risk they have taken on.
Adam Steiner, chief executive of SVG, explains that the fund screens the market for stocks that are getting attention from private equity firms.
"We try to get to know companies extremely well," he said. "We have met most companies in the All Share at least once."
"We have weekly research meetings where we look for areas where private equity buyers are getting companies at multiples different from markets."
Steiner admits that private equity firms could be wrong about mis-valuations, as they were in 2008. The fund has ditched the "hard turnaround" situations that got a lot of investors into trouble at that time, ramping up the focus on quality.
Steiner explains that there are four main drivers of growth on which SVG assesses companies.
First, increases in their earnings power, which is the traditional focus of growth investors.
Secondly, the rating applied to that earnings power – the traditional value-investor strategy.
Thirdly, the team looks at the price the company is buying or selling assets for and if this is more or less than what people thought they were worth.
The fourth aspect is the most important: debt. Seaton explains that the public market does not recognise the boost in value to a company when it pays down debt, which represents a shift in value from debt- to equity-holders.
This provides some of the best opportunities for finding companies the public market is ignoring.
The manager says that the P/E ratio that is used by most investors and fund managers is an inferior measure.
Value investing, which often uses that metric, has been shown to outperform over the longer term, but Seaton says that it is still possible to get it very wrong if it is the only thing investors look at.
"Everyone seems to focus on earnings per share in the public market, but that is too easy to manipulate," he said.
"The problem with being only a value investor is that multiples are so random," he added.
He gives the example of mobile telecoms companies that have seen valuations swing between different apparent ranges, making it hard to predict what their correct rating should be.
The management team has built its own cash-flow model as an alternative to using P/E.
"It’s much easier to predict cash-flow movements rather than earnings per share," Seaton said.
"The sell-side focuses on EPS. Even for the biggest investment banks, you find their balance sheets and earnings they record don’t reconcile: they see the balance sheets as outputs of the profit and loss."
"It requires a lot of proprietary work. We have to build up our own cash-flow model. What the analysts use isn’t immediately usable."
The manager says that this strategy is designed to pay off over a longer timeframe.
"If your job is to beat an index on a quarterly basis, you are not going to be motivated to do that [research]. We think taking the medium-term view is a more sensible way to do it."
Seaton says that the team expects to make 2.6x their investment over three years using their model to select stocks.
The manager and his team have rigid price targets for the stocks they buy, stating when they expect to sell and at what price.
"We do a leveraged buyout model for each company. How much premium could a buyer afford to pay and still make a good return for themselves? If there isn’t at least a 15 per cent IRR, we would consider it to be uninvestable."
Steiner says that he does not expect these to be inaccurate.
"If our targets aren’t hit, that means we have got something wrong, which I don’t expect."
One of the key features of the fund is its determination to keep roughly a third of AUM in each of the large, mid and small cap sectors.
Seaton points out that a lot of funds have done very well by investing heavily in the FTSE 250 over the past year and a half, but this run will not continue for ever.
The £96.4m portfolio is highly concentrated, comprising just 26 stocks.
Media companies play a large role in the fund, which the managers explain have more reliable cash-flow than many sectors currently more in vogue.
The fund requires a minimum initial investment of £1,000 and has ongoing charges of 1.61 per cent.
