Investors shouldn’t worry about underperforming in the next few months as we are likely to be entering a ‘dash for trash Mark 2’, where some of the lowest-quality businesses deliver the highest returns.
This is according to Rosemary Banyard, manager of the VT Downing Unique Opportunities fund. Banyard has a long track record of outperformance, much of which was built up during her time on the Schroder UK Mid Cap trust and Schroder UK Smaller Companies fund.
Performance of manager vs peer group
Source: FE Analytics
Yet no manager can hope to outperform in all market conditions and Banyard said her worst period in relative terms came during 2009, during what became known as the ‘dash for trash’.
Performance of trust vs sector and index in 2009
Source: FE Analytics
“It was this huge relief rally after the global financial crisis where everyone thought a lot of these companies weren’t going bust, they were going to survive, and all sorts of things went rocketing up,” she noted.
“I have thought for some time that this could happen again and I think it might be happening now.
“With the potential of various vaccines, a lot of companies that looked like they might not survive Covid now look like they will get through it.”
Yet Banyard said it is important to bear in mind the temporary nature of such relief rallies.
While the stocks that rode the wave of the original ‘dash for trash’ delivered spectacular returns in a matter of months, in most cases these were not companies that could be relied on to deliver consistent outperformance over the long term.
And it appears a similar situation is developing now. A recent study showed many of the funds that have done the best since the positive vaccine news broke have been among the worst performers in 2020 and over the longer term.
“Fundamentally, in my heart, I’m focused on giving people a real return on their investment,” Banyard continued.
“I would hope I don’t underperform in that sense, because if you’ve got companies with resilient balance sheets and they’re predictable enough to be able to forecast, over time they keep on delivering.
“But it’s interesting, even in the last week or so when we’ve had this surge in businesses that looked as though they were at risk, I’m still seeing some of the holdings in the fund announcing positive updates.”
VT Downing Unique Opportunities is a concentrated fund that is typically made up of 25 to 40 companies of between £150m and £10bn in size.
The name refers to its focus on companies with a distinctive strategy, that are either one of a kind in the UK or one of a handful. Banyard likes companies with an “economic moat”, such as a patent: for example, kettle-control manufacturer Strix, which rigorously defends its intellectual property and forced competitors to remove 17 products last year for infringements.
Most important for Banyard, however, is that the companies she owns deliver a strong return on equity.
“That means in the teens at least,” she continued. “I screen for that. The average return on equity in the fund is 28 per cent, double what I’m looking for.
“My theory is that if you’ve got good return on equity, then you’ve usually got something about the business that is keeping out competition and it is just a question of identifying what the barriers are and whether I think they can be sustained.
“Then having done that, I do a model of the company’s 10-year history, then a three-year forecast and discount the cash flow back to a valuation. It’s cash-flow based rather than P/E-based [price-to-earnings] or anything like that.”
With 2020 being such an usual year, Banyard has focused her analysis more on how businesses performed before Covid-19 struck. The world should begin to return to normal next year with the rollout of vaccines from Moderna and Pfizer, but while the end is in sight for the coronavirus crisis, the UK still has the uncertainty around the Brexit transition to contend with.
However, Banyard is confident her portfolio holdings are in a good position to cope with the challenges ahead.
“Companies have had quite a long time to prepare and well-managed businesses have been preparing,” the manager said.
“For example, a company I own called Tristel, which makes disinfectant for use in hospital settings, has a lot of business in France and Germany and it said in its most recent statement that it has quite a lot of buffer stock of chlorine dioxide held in Europe.
“There may well be disruption at ports, but good companies are well aware of that risk and are already prepared for that, so I’m hopeful.”
And the manager said that any potential disruption is more than priced into the FTSE – and it is not just UK-focused managers who are aware of this.
“In the last couple of weeks, there have been a couple of bid approaches for UK mid caps from the US,” she added.
“One of them is in this fund, which is Elementis. I stress that’s an approach at the moment rather than an actual bid. But I think there’s evidence around that overseas buyers are starting to get interested in the UK market again.”
Data from FE Analytics shows VT Downing Unique Opportunities has made 38.99 per cent since launch in March, compared with gains of 36.64 per cent from the IA UK All Companies sector and 25.82 per cent from the FTSE All Share.
Performance of fund vs sector and index since launch
Source: FE Analytics
The £16.5m fund has ongoing charges of 1 per cent.