It is the job of a contrarian investor to bet against the crowd but avoid those shares that have further to fall.
Laura Foll, who manages the Henderson UK Equity Income & Growth fund with James Henderson, an experienced and respected investor, explains the acid test she uses to determine which cheap shares offer value as opposed to those that are cheap for all the wrong reasons.
How do you pick shares?
I run the fund with James Henderson and we are both contrarian investors. But we do not buy cheap shares for the sake of them being cheap.
So when we see a share on say a single-digit p/e (price to earnings ratio) we take a view on whether it is a good business that will overcome the problems it has been facing or whether it is structurally challenged.
• How to find cheap shares: the main measures
We like to see businesses that possess strong barriers to competition, through having a strong brand or intellectual property, for example.
How is the fund positioned at the moment?
Two thirds of the portfolio is in shares outside the FTSE 100. This is not unusual; the fund is normally positioned in this way because we like to invest in dividend-paying businesses that are more geared to the British economy. This helped the FTSE 250 index of medium-sized firms make a positive return last year, while the more internationally focused FTSE 100 struggled.
We have, however, been trimming our holdings in some of the shares that have performed well in recent years and are now looking pricey. They include RPC Group, the packaging business.
Another holding that we have reduced is Bellway. I have turned negative on housebuilders, given that the shares are now trading significantly above their "book" value (the value of their assets). I fear that if a negative headwind were to hit the sector, such as house price growth cooling, there could be some profit taking.
• Six of the cheapest shares on the FTSE All-Share, which includes housebuilders
Which shares have you been buying?
Last year we participated in a couple of flotations, including that of DFS Furniture.
Laura Foll More recently we have been buying the big mining businesses, including Glencore. It may sound unusual that an income fund is purchasing shares in a firm that is no longer paying a dividend, but the entry price had become too cheap to ignore.
At some point demand for commodities will start to outweigh supply, which will spark a recovery in prices. I would like to think that in three years’ time the survivors, the big miners such as Glencore, which have cut costs, will be in a position to pay big dividends.
I have also been adding to Royal Dutch Shell. From my point of view I would not be concerned if the dividend is cut, as it could be the right thing to do. Even though I am an income investor I don’t like to see dividend payments prevent a business from growing.
GlaxoSmithKline, another holding I have been adding to, would also arguably benefit from reducing its dividend. It is questionable whether a payout ratio of more than 100pc is sustainable.
What types of shares are you avoiding?
We avoid businesses that we do not think are going to be able to regain the market share they once had. An example is Marks & Spencer.
What were your most successful and least successful investments last year?
The best performer was Redde (formerly Helphire Group). The firm provides specialist accident management services. Its share price has doubled (106pc) over the past year, boosted by some earnings upgrades.
Velocys, a gas-to-liquid fuel business, was the worst performer, falling by 75pc over the past year.
Do you invest your own money in the fund?
I actually invest in the other fund I co-manage with James – the Lowland investment trust. The portfolios are similar. The reason I picked one over the other is that I managed to buy Lowland at a discount (paying less than the trust's underlying assets are worth) when I bought a couple of years ago.
What would you have done if you hadn’t become a fund manager?
I did consider becoming a doctor but to be honest the thought of having to spend seven years at medical school put me off.
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Our verdict
Henderson's UK Equity Income & Growth fund is described as a “solid” choice by experts, thanks to its consistent record of outperforming rival funds and the wider stock market over both the short and long term.
But Jason Hollands of Tilney Bestinvest, the advisory firm, prefers the other fund that Ms Foll and Mr Henderson manage, the Lowland investment trust.
“Although the two portfolios are not identical, there is clearly a lot of crossover, with notable holdings in both being Hiscox, Senior, Phoenix Group and Provident Financial,” Mr Hollands said.
The investment trust structure, which does not force managers to buy more shares in response to money flowing in from investors, allows them to take more of a long-term view, he added.
Lowland is also cheaper, with an "ongoing charge figure" of 0.5pc a year, versus 0.84pc for the Henderson Equity UK Income & Growth fund.
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Standard Life's UK Equity Income Unconstrained fund was tipped by Mr Hollands as an alternative. He described the young fund manager, Thomas Moore, as a “rising star”.
Ben Willis of Whitechurch Securities, the wealth manager, tipped JOHCM UK Dynamic, but noted that it was a riskier option.
He also picked out Woodford Equity Income, managed by the celebrated stock-picker Neil Woodford.
“Not the most original choice for an alternative but one that offers, arguably, better returns in relation to risk," Mr Willis said. "Mr Woodford does have a propensity towards investing in blue-chip businesses, but his adeptness at looking at smaller high-growth businesses gives him a competitive edge.”
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How to buy the fund as cheaply as possible
The fund has a total cost (the “OCF” or “TER”) of 0.84pc a year. Be sure to buy the right “share class”, which is “I”.
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