Of all the unit trust sectors, it has to be said that America remains the most disappointing. Whereas most of us can reel off our favourite fund managers in Europe, the UK and the Far East, it becomes so much harder in America where finding consistency of performance is near impossible. One fund which has hit my radar is the M&G American fund run by Aled Smith.
Some readers may remember that I reviewed his global leaders fund a few months ago and this obviously uses a similar investment process.
Smith has managed the American fund since December 2004 and is joint head of the global investment team at M&G. He joined M&G from JPMorgan where he was a sell-side analyst. He works very closely with Graham French and three other senior analysts. The team are focused on top-decile performance over a rolling three-year period.
The fund is orientated towards large caps so the investment universe is the S&P 500 plus any other liquid large-cap stocks. The focus is on total shareholder return.
The team are particularly interested in how firms allocate their capital and the return they achieve from this. As such, they use the Holt system extensively to see how successful firms have been in generating returns for shareholders. Smith believes there are four distinctive periods during a firm’s lifecycle from the perspective of return on capital employed:
- Companies that are growing their capital base unprofitably, which are clearly seem as no-go areas.
- Companies that have decided to restructure by selling off unproductive assets.
- Companies where there is a change of management which is focused on restructuring the business for future growth. To be considered for investment, there must be a catalyst that the team believe will lead to the business providing a higher return on the capital than it’s cost to the capital.
- As the company becomes unprofitable, Smith is willing to invest in a business that continues to shrink its asset base to increase the return on capital or to invest in research and development to produce future growth.
In Smith’s view, there are only a few key questions that need answering to understand whether positive internal change is taking place. For example, with companies that require a restructuring, including the disposal of underperforming assets, it is imperative that the analyst focuses on the management and their ability to dispose of these assets in an acceptable timeframe. As a company moves into profitability while still shrinking the assets, the key questions would revolve around how the management team expect to continue to reduce costs and improve margins. As the company becomes profitable and then begins to spend money to generate more returns from its core assets, the team may just focus on the strategy for growth and R&D requirements.
In addition to this focus on internal change, the American process will also leverage off the global team’s work, allowing it to benefit from a tailwind of global economic change that should be positive for business. For example, the team have been investing in soft commodities for quite some time, believing the supply and demand dynamics to be positive for this area. The team will also focus on special situations businesses that are generally mature, well run and shareholder-focused.
Smith uses Abercrombie & Fitch, the US clothing store, as an example. It suffered a substantial sell-off due to a massive build-up of inventory. However, M&G’s analysts suggested that the store opening programme would still add value, even with short-term problems. The price was undervaluing the business, suggesting that any recovery in the fundamentals would see a significant price appreciation. The key consideration is whether or not something detrimental has happened to the business that will make it continue to struggle or whether it is truly a short-term opportunity.
As I said in my global leaders piece, I was especially impressed with Smith and his extremely disciplined investment approach. Like many investment companies running American funds, he may appear to be under-resourced but I believe his strength lies in his understanding of issues which are very important to the company and the potential share price movement.
Despite the fund having a short-term track record, I would suggest you take a look at this fund now. I should also add that M&G’s analysis and commentaries on the fund are excellent and give you an invaluable insight into the process.