Fund manager Nick Sheridan will continue to manage the fund using an investment model that he has been developing over the last 10 years.
Sheridan believes that a focused and process driven approach works best within Europe. He constructs a concentrated portfolio of 30-40 stocks which each have a clearly defined target value.
Sheridan believes 30-40 stocks is the right size for a portfolio as including more could dilute returns, while fewer stocks could reduce diversification and increase the risk to an unacceptable level.
The portfolio will comprise stocks that are trading at the biggest discount to the target value New Star’s model gives them.
The target values derive from New Star’s belief that although there is a lot of company research and company information in Europe, there is a great inefficiency in how this information is used and reacted to by different investors. This leads to anomalies in stock pricing which we seek to exploit.
Stocks are often mispriced because many investors are concerned with short-term performance, so they will often head for the door or pile into stocks on the basis of short-term rather than long-term performance. Sheridan’s model aims to identify the points at which short-term investors pile in and out, as he believes this will make analyzing performance easier. Other factors such as balance sheet strength and earnings will also be considered.
Once the theoretical value for each individual stock has been determined they are ranked in order of the current discount of the share price to the target value. The rankings are divided into 20 equal groups and the fund typically restricts its investment universe to the top two groups to improve the chances of outperformance.
It is likely that the fund will have a bias towards bigger companies as these are more liquid and have more analysts covering them, so there is more information which can lead to the short-term mispricing that Sheridan is looking for.
One of the advantages of Sheridan’s model is that it can be back-tested. Although Sheridan’s model has stacked up on the whole when back-tested, it has shown that investors should be prepared short-term periods of underperformance when markets are not in tune with the long-term fundamentals.