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23 May 2017

Finding a balance between caution and growth

By Keely Double, investment editor

Alastair Mundy, the man behind both the Elite Rated Investec Cautious Managed and Investec UK Special Situations funds, is one of the UK's best-known value investors - which means he likes to buy 'cheap' assets and wait for them to make money. But how practical is this style when many markets are at record highs? We asked Alastair for an update.

Putting an "insurance policy" in place

Looking first to the macroeconomic environment, Alastair says he is concerned about debt and inflation. While he stresses that many of the "worst case scenarios" he and his team plan for may never happen, he does highlight that an unexpectedly rapid rise in inflation is not out of the question.

Among other ramifications, this would likely have a negative impact on bond values, which have been pushed up since the global financial crisis by central bank buying.

In this context, Alastair believes his Investec Cautious Managed fund needs an "insurance policy" in place. He is currently holding the minimum permitted allocation of bonds and he has no exposure to medium and long-dated bonds (i.e. those most likely to be affected by rising inflation).

Following the same theme, he has conversely upped exposure to precious metals and precious metal shares to just under 14% of the portfolio. He likes precious metals because they "can't be printed by central banks" and therefore should hold their value better in an inflationary environment. Another interesting holding within the Cautious Managed fund currently is a 7% weighting to the Norwegian krone, for exposure to a currency that is generally uncorrelated to most others1.

US and UK equities expensive

By investing part of the fund very cautiously, Alastair says he can take more risk to target growth in other parts of the portfolio. But finding the exciting value opportunities requires a lot of digging and in-depth analysis in the current environment.

Relative to earnings, US equities have only been this expensive once since 1930 - and that was just before the dot com bubble burst in 20002. Median UK stock valuations are also as expensive as they've been in the last 45 years3.

While Alastair acknowledges these markets may well go higher still, he emphasises that this is not the point of 'value investing'.

"It's quite straightforward. If you pay a high price for equities, your next 10 years of returns are likely to be pretty moderate. If you pay a low price, you've got a better chance of getting stronger returns.

"We always look for the 'forgotten firms' and the companies that nobody can say a nice thing about. We're not interested in whether they're 'good' companies now; we're interested in whether they can be good companies in a few years' time."

So where are the opportunities?

One bright spot is banks, which are finally offering a favourable risk/return trade-off, Alastair says. Across the board, their valuations remain far more modest than many other sectors.

Indeed, there are several banks in the Investec Cautious Managed fund's top ten and it is the largest sector weighting in the portfolio. Alastair says he holds a few UK and US banks, as well as one Japanese firm. He continues to avoid European banks, however, where he assesses that the downside risk is still too great, despite promising signs of growth on the continent.

More broadly, Alastair likes several companies in Japan at the moment. He says Japan's shares are cheap relative to other markets and its own history, and he believes there will be a lot of support for equity prices over the coming years. The Bank of Japan and Japanese pension funds are big buyers of equities, while corporate share buybacks have also been on the increase. All three of these demand factors could help push up prices, especially in a market where there aren't a lot of sellers.

In the UK specifically, Alastair is also finding value in house builders and home maintenance stocks. He calls these kinds of companies "growth cyclicals" and says the time to buy them is when people think the cycle is against them - giving his funds plenty of opportunities to buy in the past year. The Brexit vote dinted confidence in companies whose growth relies heavily on a strong domestic economy and the Investec UK Special Situations has built up significant exposure to the this theme, Alastair says. It also holds several retail stocks, which have been hit by similar sentiment.

Where to next?

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Alastair's views are his own and do not constitute financial advice.

1Source: Investec Asset Management, 30/04/2017 2Source:, 15/05/2017, quoted in Investec Asset Management Value in Value, Spring roadshow presentation 3Source: Morgan Stanley research, 31/03/2017, quoted in Investec Asset Management Value in Value, Spring roadshow presentation

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