180. Our companies are not the most exciting – but they excite us

JOHCM UK Dynamic fund manager Alex Savvides says although the companies he invests in may not appear the most exciting – the potential for change and business transformation does offer exciting returns. He also explains why his fund is much more than just a value-orientated vehicle and what he looks for from management teams he hopes to invest with. Alex also talks us through the rampant M&A activity we’ve seen in the past year or so, and how he and his team had to fight for fair value when some of their holdings were bid for. He also tells us why 3i and Electrocomponents are some of the biggest turnaround stories in his career as well as giving us insight on a couple of holdings he is just as bullish on for the future.

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JOHCM UK Dynamic fund manager Alex Savvides is a contrarian who targets companies undergoing a period of change – taking advantage of this transition to deliver long-term growth returns. When building a portfolio of 35-50 holdings, Alex looks specifically for companies which are well established, in a structurally sound market and pay a dividend. Having built up an excellent long-term track record, Alex’s process of investing in UK companies which are undergoing substantive positive changes – which has not been recognised in the share price – has shown itself to be successful in numerous market conditions.

What’s covered in this episode:

  • Why the fund is much more than just a value-orientated vehicle
  • Valuation did not disappear, it will always matter
  • Our companies are not the most exciting – but they excite us
  • How the business turnaround in energy supplier Centrica is the perfect example of how you can make exciting returns
  • The importance of the “say do ratio” when assessing new management teams
  • Why 3i and Electrocomponents are the best turnaround stories of Alex’s career – and a few he is bullish on in the future
  • Why the strong levels of M&A activity seen in the past 18 months are unlikely to continue going forwards
  • Why he was not happy with certain bids for companies in his fund and having to fight for fair value for long-term shareholders

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. Today we’re discussing value investing, UK M&A activity and our guest explains the importance of what he calls the “say do ratio” when assessing a company’s management teams.


James Yardley (JY): I’m James Yardley and today I’m joined by Alex Savvides the Elite Rated manager of the JOHCM UK Dynamic fund, Alex. Thank you very much for joining us today.


Alex Savvides (AS): Hi James. Good morning. And thank you very much for having me.




JY: Alex. It seems like value is not dead after all. It’s had a great six months or so. Did you ever sort of lose faith in the value style of investing and can this strong run continue?


AS: Did we ever lose faith? It’s difficult not to when you have such major headwind to the style, but I think the first thing to say for us on UK Dynamic is that whilst value is a sort of a slight tailwind to this funds process. It doesn’t define the process. We’ve always said that sort of, we are more than just value. So while we pick from a, what you might describe a value cohort of stocks there always has to be a little bit more going on. We’re very focused on businesses. I think, you know, James, that are transforming their operations, so new management, strategic change. You know, at the point of time that we buy them, they might be perceived to be value in their sort of valuations price to book valuation, dividend yield calculation, PE rating.


To us, we are not just hopeful that there’ll be a change in external perception over value as a style. And maybe a company goes from a seven times PE to a 10 times PE, yield of six down to a yield of five, whatever. We want any change in the valuation movement to be based on what the company have done, you know, operationally, strategically, et cetera, to make the wider stock market and the investor think that it’s a more worthy business. Now that doesn’t, you know, that’s easier in an environment where people are willing to embrace a different subset of companies that are deemed to be more value oriented, maybe have been around for a lot longer. And so it does help that the style comes back.


Just, you know, philosophically well, you know, did value investing ever likely to disappear? I don’t think so. You know, I think the laws of sort of financial theory and sort of common sense will always prevail. A company that’s trading at a discount to its net assets where, you know, it has a viable and vibrant future where it can continue to earn a decent return on those assets will always be attractive to investors. And that will never change really. We might go through different preferential styles, ie prefer growth or momentum. But fundamentally the laws of common sense say that if something’s overvalued, you sell it. If something’s undervalued, you buy it. And it should all start there. And I think valuation will always matter. I hope it will.


JY: And the types of companies you buy, I mean, they aren’t really the exciting ones. I don’t know if that’s, if you’d agree with that, if that’s fair or not, but…


AS: They excite us James, they excite us, you know, maybe not the wider public. But yeah.

JY: But you’re not likely to invest in something like Tesla soon, I mean, I think instead, you’re more like to invest in something like Centrica, for example. So what is it which sort of catches your eye with these companies?

AS: Yeah, look, that’s fair. You know, you say exciting and, you know, these companies can be exciting you know, but they can also be very dangerous as you’re seeing at the moment with some of the valuation movements. And again, I’m drawn to the word valuation. It’s very important that we don’t get over excited and over emotional about our asset allocation decisions that we take. You know, it might be very alluring to buy something that that’s growing at X or Y. But if the valuation is expecting a growth rate of Z for a longer period of time than is rational, then, you know, that’s a risky asset to invest in. So, you know, we are drawn to companies that have a history, have a track record have a long set of financial reports that we can draw on to sort of gather evidence about the qualities of the company it’s inherent qualities. It’s inherent market position, the inherent demand for the products over many cycles, many different external economic environments. I think that counts for a lot, I think it’s understated nowadays in the way that maybe some newer investors think about how to allocate capital. So, you know, maybe less exciting on the face of it, but in the potential for financial return, we’ve always thought that change stories, business transformation can generate very exciting returns.

And if I sort of stay with Centrica that you mentioned as an example, you know, here’s a company that two and a half years ago had an over levered balance sheet going nowhere, losing customers, you know, on a consistent and serial basis. Regulatory intervention put damage on returns. And here we are with a new management, new strategy two and a half years later, balance sheet is down to sort of net cash. If you ignore the pension deficit shrinking all the time because interest rates are going up you know, and the way that we think about how we discount future liabilities means that the sort of the liability here and now is shrinking. They have capital to invest. The regulatory structure that was in place has collapsed and has caused a complete hollowing out of the very competitive energy supply industry that was going on out there.

So Centrica went from having lost clients has taken on 770,000 new customers last year most through the supplier of last resort process that the regulator has in place, but, you know, we’ve gone from 70-75-ish suppliers down to 20-ish suppliers. And it’s going to be a less competitive market, you know in future, but more opportunity to grow their market share. They will, of course always be a regulated discipline to make sure that these companies don’t generate an access for return, but the problem was no one was making any return, let her own an excess return. And so, you know, and look at the earnings profile of that company, it did 20 peer earnings, four or five years ago through, you know, set of management poor actions and their external circumstances. They felt a sort of 3p of earnings really. And now, you know, we looked to next year, I was just looking at a Morgan Stanley note this morning, actually with a 13 pence per share earnings forecast for the next two years in 2023 and 2024. The share’s at 77p it just don’t bear any relation to the earnings progression. So, you know, buying it on a very low single digit PE, you know, here’s why I think you can make exciting financial returns from sort of business turnaround situations in less than exciting companies. And I can’t think of a better current example than Centrica, but there are many in the portfolio.


JY: Now I know a big part of your process is looking for positive change. And one of those positive changes is often a change in management. So how do you assess a new management team when they come in? What kind of characteristics are you looking for?


AS: That’s a really good question. We get asked that question all the time by our client base you know, let the characteristics of a turnaround do always start with the asset, you know, the quality of the asset that we are buying. So it would be remiss in answering this question, not to mention that a great deal of time and effort is spent on the quality of the asset longevity of cash flows, you know, is it instructional decline, if not, why not? You know and then sort of, are they hidden assets? Are they hidden growth characteristics? And, you know, the quality of the investments that have generated a strong return for this fund over time have managed to navigate from being sort of steamed to be going backwards, maybe in structural decline, can’t see a future for the company.


So put a low rating on the cash flows to, through a set of management, strategic changes, external changes, environment changes a little bit, but the combination of all those things to being a sort of top, right, actually growing in a structural way and generating good returns in excess of cost of capital -reinvesting in a business at high or good marginal rates of return that drives a sort of ongoing growth. And if that wasn’t there or valued to be there in the rating previously, that transition can be very powerful, but we are big believers in management with big believers in the ability of management to take good decisions. You know, it’s often management, bad management decisions that alert us to opportunities. So the opposite should also be true. And I think when we interview the management teams, talk to them, get to know them. We are looking for certain clues. We are looking for capital allocation discipline as an absolute first and foremost priority for us. So that maybe some historic skill sets around how they manage capital allocation, how they think about return on capital cashflow. We try to get into the mindset.


I’m drawn to a very good book that I’ve read historically called the Outsiders, which is all about some of the best capital allocators as CEOs in history and what a great effect they can have on the companies that they run. We like to see management teams that act like an owner of the business, not necessarily just through actively participating in the shares and the equity of the company, but the way that they think about the business, about running the business acting like an owner is a core part, not taking short term decisions, for example, taking decisions for the best of the business for its future health and sustainability.


We look for, with a strong “say do ratio”. We love that term. We love the phrase. It comes from one of our CEOs at a business called Combetech. He said, look, I came into this business and the “say do ratio” was very poor. We said a lot. We did nothing. You know, and we like individuals that back up what they say, and they don’t say it, whether they’re going to be able to achieve it. So under promises as well, then we look for sort of simple things. Are you going to focus the business, simplify it? Are you going to manage the balance sheet more effectively? So it can be a source of optionality for growth. Are you going to think about being a more efficient version of yourself are, how do you think about your go to market strategy, how you price, how you treat your customer base, how you think about value that you provide to your customer base customer base. We investigate reinvestment strategy, you know, how will you reinvest any capital that you release from the company? We prefer organic versus big M&A, we don’t mind bolt on, it needs to be structured thought through planned methodically. We’ve had a very bad experience on big M&A qualitatively. We like persons, but, you know, true leaders that you want to get out of bed in the morning and work with and that can sort of, you know, encourage you to think like that we like ordered and structured minds and people that demystify the investment case and just think about clear narrative. You know, some of the things that you do to turn a business round are not, they’re not difficult, necessarily easy for us to say, sitting behind a spreadsheet and a screen, we don’t run the businesses, but, you know, simple decisions I think are always the most effective ones and quick clean decisions with enough thought going into why you should be doing it. But back to the “say do ratio,” don’t tie yourself up in not, you know, trying to cover off every angle, get on with it, there’s a job to be done. So that gives an insight into what we’re looking for. And you know, those that have managed the business in the portfolio that have done best over time exhibit all of those characteristics, James.


JY: And what has been the best turnaround story of your career?


AS: Well, the ones that have been best managed funny enough that have had very good asset bases to work with to begin with. So the one that springs to my mind first is 3i Group, which we put into the portfolio in 2009 post the financial crisis, post a rights issue, which itself was caused by the fact that they returned lots of capital to investors in 2007, late 2007 pre-financial crisis got over excited, management change, strategic change, rights issue and an asset base that was trading at material discount to NAV you know, it was 40%, I think at the time and an NAV base that was starting to stabilize and grow, you know, and then actually we supported a further management change in 2011, a cap called Simon Burrows took the helm as CEO and has been nothing short of outstanding for that company as a capital allocator, he definitely acted like an owner he bought in financially and continued to do so for many years, but he restructured the company, simplified it – 120 assets down to roughly 30 to 40 – putting growth capital behind the assets that he and the two team had a very strong and clear view would be winners. One of which was a business called action, which has become one of the preeminent value retailers in the whole of Europe.

It’s been a phenomenal success story. You know, you’ve got to deal with what’s in front of you. And he saw a deck of cards. He didn’t buy Action to begin with in 2011, when he joined, they only subsequently bought their first stake in the asset, but he knew as the team did that, it needed more capital. And it went from sort of 3% of assets to, you know, well, in excess of 15% to now I think it’s sort of 40-50% of the NAV. Oh and I might add that the cash return from that company have meant that when we bought it at roughly three pounds back in 2009, we’ve had all of that back through dividends. And we’ve had four times plus our money in sort of capital return and, you know, that’s a good risk to take and has been a good return.


Second Electrocomponents, very similar Lindsley Roof – who’s the CEO of that business in went in, I think, in 2015 executed a phenomenal turnaround everything that we said you know, efficiency, balance sheet management, reinvestment for growth, but in a structured way, thinking logically about how they go to market, who their customer is, what they need to do for their customer digital first strategy simple strategy you know, and the business had, you know, exhibited more control over pricing and has gone from sort of a business that was seeing declining gross margins, declining operating margins, year-in and year-out and sort of flat sales growth has gone the other way phenomenal sales growth globally as well. So it’s been more geographically diverse and at higher margins and more efficient, higher drop through gross margins have started to go back up.


So, you know, good management there again. I won’t label the sort of ideas for the future. Those are two from the past, but, you know, in the portfolio, and this is not an investment decision for your clients necessarily, but, you know, three ideas I might pick from the portfolio today that exhibit the same characteristics, Land Securities, in the UK property market, Pearson, in the global education market and Ricardo, which is a UK listed energy consultant, all three with new management teams, new strategies, and we’ve got reasonably high conviction that they will do good things with those companies.


JY: And we saw a lot of M&A last year, how did that impact the fund? And do you see M&A continuing this year as well?


AS: I might deal with the last, the second question first. I’m not sure it will continue to the same degree. There was a very clear arbitrage available in global markets in, and certainly in UK markets that you know, with interest rates and sort of monetary policy where it was through 2020-2021, as a result of the pandemic, you know, and the distresses and, you know, stresses and strains we’ve had from that. You know, there were a lot of very cheap companies trading on very high earnings yields, re cash yields, but the ability to borrow at very low rates, for long terms. And in the UK that arbitrage was very clear, clearer than anywhere else in global markets, really. So it was only natural that you might find coming out of the pandemic when, you know, when we realized it was less of a demand problem and more of a supply problem, that money might find its way into, into a certain cohort of stocks that have been harshly treated by the pandemic.


How did it affect? And I don’t think the same, you know, it’s the same arbitrage is not there to the same degree today, James, you know, because interest rates are moving long term rates are moving. You know, obviously, you know, we sit here today, it’s early March. I think the 1st of March, you know, there’s lots going on in the world on a macro basis that can change things very quickly. Valuations are moving you know, interest rate expectations are moving, but I don’t think the same arbitrage exist today as it all related to the fund in 2021, it was, and coming out of 2020, it was pretty remarkable really.


I mean, this is a fund for over a 12-month period. Historically a rolling 12 months had never had more than two bids. We had 10, of which nine consummated, in a rolling 12 month period. It was quite extraordinary. It shows you how much value was in the portfolio at that particular point in time. It was surprising to us to some degree, but then when we looked at the valuations, we looked at the characteristics of the companies that got bid for, not so surprising at all. And it was those characteristics that were so interesting to, and linked to the buyers of those assets. You know, these were businesses that had infrastructure like characteristics, you know, they had big property bases or big asset bases, manufacturing bases, they had long term cash flows. They, you know, you could look at them and say, yeah, you know, in 10, 15, 20 years’ time, that set of assets is still probably going to be generating a reasonably strong cash flow.


As long as management do the right things, to keep those asset bases fresh and invest in them, you know, and those, to some degree there was inflation protection amongst those asset bases as well. They were all cheap relative to their book value. They were trading at price to book discounts and the buyers on the flip side were all long term capital. They were very high quality private equity. I would say that weren’t thinking about the very short term or like in the case, suburban and civic they were the welcome trust, very long term investors. They were infrastructure like investors, thought processes. And I think that was really, really interesting and where they were private equity investors. Some of these private equity houses had sold non-real asset companies, two stock markets in IPOs, you know, tech companies or biotech companies, or, you know, Gogo structural growth companies for, you know, in the energy transition say high valuations and were recycling their capital in existing listed companies at really low valuations and sort of more traditional companies that you might think are the less exciting. And we thought that was really interesting. So good characteristics for the fund. I think a good endorsement of what the fund does, how it tries to generate value from its investment decisions.


JY: Were you happy with the bids you got though? I mean, or…


AS: Not in all cases, no, it’s a really good point.


JY: You had to let go of some things, which you perhaps wouldn’t have otherwise.


AS: That’s a really good question. You know, no, I don’t think so. And, you know, I think a lot of those bids were at discounts to what we thought were fair value. And I think it’s you know, it’s a sad state of affairs that some of the boards were willing to back those bids and were so readily willing in our view to back those bids and not play a harder more Machiavellian game with the potential acquirers to try and get better value. We had to stand. So, you know, absent the board’s doing it, who is it incumbent on to do that, to protect shareholders, it’s incumbent on us the more institutional minded shareholders that take a longer term view. And we did that. We stepped up to the plate and, and we would do it again.


And, you know, in the case of three companies we were very vocal in the case of St. Modwen, in the case of DMGT you know, in, in particular and in both cases, we, you know, we, along with others in the case of DMGT, I don’t think any others in the case of St. Modwen managed to squeeze a bit of extra that you from the acquirers, but it was tough. It’s tough to negotiate when you are, you sort of, you feel alone, but we do it again. And it is our job as stewards of capital to do that. And we take that job very, very seriously.


JY: Well, that’s been really interesting as always Alex. Thank you very much for that.


AS: That’s okay. You’re very welcome. Thank you.


SW: As we’ve highlighted in this interview, the JOHCM UK Dynamic fund targets companies undergoing a period of change – taking advantage of this transition to deliver long-term growth returns. Having built up an excellent long-term track record, Alex’s process has shown itself to be successful in numerous market conditions. To learn more about the JOHCM UK Dynamic fund visit fundcalibre.com – and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts.


Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.


This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions.Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice.Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.