Nick Kirrage Interview - Inside The Mind Of A Deep Value Fund Manager

6th Sep '16 by Ben Hobson

13 comments 38857 reads

Buying bargain basement stocks that nobody else wants is a strategy that’s forged the reputations of some of the world’s greatest investors. Yet, while value investing has a rich heritage and stellar performance history, it comes with drawbacks. Performance can be volatile and deep value stocks can be unpredictable. Ultimately, it’s an approach that suffers periods of underperformance.

With this in mind, it’s hardly surprising that disciplined, long-term value investing isn’t exactly prevalent in professional fund management. In an industry notorious for short-term performance targets, value-focused fund managers arguably suffer from career risk more than most.

But one exception is the Value Investment Team at the asset management giant, Schroders. Headed by Nick Kirrage and Kevin Murphy, the team manages around $18 billion across a suite of value funds, including the Schroder Recovery fund, which they took over in 2006, and the Schroder Income fund.

Having just celebrated the tenth year running the £750m deep-value Recovery fund, I met with Nick Kirrage to find out what it really takes to beat the market in stocks that nobody else will touch.

You’ve now been running the Recovery fund for 10 years, and it’s up 127.1% against a sector average of 72.5%. What are your reflections on what you’ve achieved and how it has performed?

Kevin and I have been investing for over 15 years, and 10 of those have been spent running the Recovery fund. When we took it on there was quite a lot of responsibility, even though very few in the UK market knew about it. It was an unconstrained fund that was benchmark-unaware and half the book was institutional and internal money. We were invited to showcase what we could do, as long as it was in a value style. Of course, the first thing we did was underperform for two years!

But that’s the nature of the market. Value outperforms over time, and when it doesn’t I think a lot of the skill in the job is psychological. It’s about learning not to drive yourself crazy or fall apart on bad performance. Over time you have a strategy that outperforms, but you also know that you’ll struggle with it.

So it was a huge source of celebration after 10 years because we’d set ourselves the target of being in the top decile over that time period, and we were. The fund’s performance is around 18th out of…

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timk

7th Sep '16

Interesting, will need to re read for personal investor lessons

PJ0077

Agreed!

smallcapman

8th Sep '16

Did I read that correctly? Up 127% in 10 years.

Wow, that's stunning. Must be all of, what... 2.5% a year CAGR.

I guess one could live happily on bread and water knowing that they outperformed other funds.

Buffy

"You’ve now been running the Recovery fund for 10 years, and it’s up 127.1% against a sector average of 72.5%."

This would imply the Recovery Fund has returned 8.5% p.a. over ten years vs 5.6% p.a. sector average.

This is a credible performance, possibly incredible if they've managed the assets in a low risk manner.

jlm980

127% in 10 years = 8.5%pa. And that's starting counting from the previous market peak. This is the new normal Buffy! Do you think the market will do better than that over the next 10 years? I'm not sure.

pka

Hi Smallcapman, 2.5% a year CAGR over 10 years would produce a cumulative return of +28%, not +127%. The latter is equivalent to 8.5% a year CAGR over 10 years, as others have pointed out.

Rusty2

Think you did misread it, it's up 127% not 27%.

Disco Ball

Why anyone would buy RBS is completely beyond me. I'd rather stick the money in an Israeli binary options account!

ap8889again

That's kind of the point. Value is contrarian. When the majority believe a bombed out disaster like RBS to be gash, thats a good time to buy, subject to some due diligence checks.

shipoffrogs

How can you do due diligence on RBS when it's beyond the management's abilities? Some things are just too hard.

staverly

9th Sep '16

According my maths 127% in 10 years equates to CAGR just over 8% per annum. Take off any up front fees (say 0.5%) and adjust for active management fees, let's be kind and say 2% per annum, then a more realistic figure is around 80% over the decade. Admittedly it is article of faith that the majority of active FMs will not beat the market, so this chap has performed relatively well, but to laud him as some sort of master of the universe when the overall market has risen 72% is ridiculous.

Index classification aside, stressing your MO as a "Value" investor is nonsense, let alone a "deep" one. By definition every participant is a VI. Stock valuation is purely subjective, by way of example how can Jim Chanos act as counterparty to a Warren Buffett trade or vice-versa, as we know is the case from time to time.

Hot Socks

12th Sep '16

Don't they deduct the management fees and costs each year so if it is up 127% in ten years that is net of fees?

LongbeardRanger

21st Jun '17

Just read this article after Ben linked to it. I think the following comment is worth some analysis:

But let’s take a blank piece of paper and go through Porter’s five forces. What’s the competition for lending in the UK? Pretty benign, frankly.

I don't think that is right. The mortgage market seems far from benign to me - it seems highly competitive. Not only are all the large banks competing strongly with each other (pushed in that direction by low returns on assets generally). There is also increasing competition from challenger banks - admittedly a small section of the market at the moment - and peer to peer lending platforms. Yields on unsecured consumer lending are very low at the moment. (If you want proof of this - read the transcript of Metro Bank's most recent analyst call, available on the investor relations section of their website. Metro's CEO basically says they aren't doing any consumer lending at all as the yield simply doesn't compensate for risk.)

The only area where I see the incumbents having a big lending advantage is in their risk weightings. Basically, they can use what is called "AIRB" - the advanced calculation of risk weightings - to hold less capital against their assets than the challenger banks. The challengers don't have the lending history to use AIRB. They are forced to use the standard method which means their risk weighted assets (and hence capital required) are much higher. However, that will not be a permanent advantage. It is temporary only.

I agree, however, that the large banks have a strong market position in deposit taking. They have very high customer retention and it appears that banks generally can only lose customers - not take them, That's an important distinction as it means that competitive intensity on the deposit taking side of the business is very low. RBS, Barclays and (particularly) Lloyds have very, very strong deposit franchises. Unfortunately, they all still have big legacy issues, IT problems, and overstretched balance sheets. I would like to invest in Lloyds, for example, but its loan to deposit ratio is still too high (over 100% last time I checked) so as a matter of prudence I'm not prepared to invest.

I am long Metro Bank (LON:MTRO), however - which I see as a good opportunity to invest in what is, potentially, the strongest deposit franchise in the UK. It also has a very clean balance sheet and I think in the years to come it will become apparent that Metro Bank (LON:MTRO) has the most profitable and predictable model of all the UK banks.

Nick Kirrage Interview - Inside the mind of a deep value fund manager

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Ben Hobson

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