Earlier last week, reputed investor Anthony Bolton was in the press discussing the relatively poor performance to date of Fidelity's China Special Situations, the publicly-listed fund he came out of retirement to launch. The fund's NAV is apparently down 21% since its April 2010 launch, slightly worse than the -18.5% for the MSCI China Index. Bolton has attributed the losses to market turbulence, the fund’s gearing and exposure to volatile small- and mid-cap stocks. That got us, Dave especially, to reading more about Bolton's approach (discussed below), and of course, mulling over the extent to which it might be replicated using a Anthony Bolton-esque quantitative screen via Stockopedia PRO (implementation details to be discussed in a subsequent piece).
For those that are interested, there are a number of useful primary sources of information on Bolton's investing. The first is the book, "Investing with Anthony Bolton", a very helpful summary of the performance and track record of the UK Special Situations fund co-written by Bolton and Jonathan Davis, the investment columnist of the Independent. Anthony Bolton has also written an excellent book, Investing against the Tide, in which he discusses his strategy, approach to stock-picking, the need to identify good managers, and how to run a portfolio. You can also read a series of articles by Bolton on the Fidelity website.
Anthony Bolton Investing In Brief
Anthony Bolton is widely regarded as one of the UK’s best fund managers, delivering an outstanding investment record over a 25-year period at the Fidelity Special Situations Fund until his retirement in 2007. He studied engineering at Cambridge University and joined Fidelity in 1979, aged 29, as one of its first London-based investment managers. During his time at the helm of Fidelity Special Situations, which he ran until the end of 2007, he delivered average annual returns of 20% (vs. 14% for the market). That would have turned £1000 into £147,000 over 28 years.
Bolton's approach is a contrarian one focused on buying recovery or turnaround stocks on attractive valuations. It is a fundamentals-based approach based on buying unfashionable and cheap companies with something to recapture investor attention. Interestingly, though, for a value investor, he blends in technical analysis as a warning signal against value traps. Bolton has traditionally invested in smaller and mid cap companies (broadly in the £50 - £500 million range). As the following summary suggests, inherent in his approach is an approach with limited regard for market weightings (on the basis that, to beat the market, a portfolio must be different from the market!) which tends to produce lumpier returns, perhaps some explanation of his recent experiences in China....
In broad terms, Anthony Bolton takes a value/contrarian approach to investing, which involves seeing the swings in the market as opportunities, and not being afraid to buy what's unpopular or businesses that have been doing poorly, perhaps for some time. He warns at all cost against buying shares on impulses or tips.
"A good investment manager is an independent thinker not over-influenced by, and often willing to challenge, conventional wisdom".
He cites his main influences as being Buffett, Lynch and Slater. From Buffett, a key lesson was to look for good business franchises with good free cash flow (he prefers good businesses run by an average management rather than the contrary), while he follows Peter Lynch in visiting companies and looking for managers who are consistent.
Making Contrarian Bets
At the heart of his approach is the idea of buying unfashionable and cheap companies with something to recapture investor attention. In his experience, many investors don't like to be associated with businesses that are not doing well and can therefore miss when a change for the better occurs. However, Bolton notes that you must not confuse a recovery situation in an underperforming but otherwise satisfactory business with a company with a poor business franchise, as the latter may never recover. He also notes that you need to buy a recovery stock before you have all the information - as a result, making the purchase isn't always comfortable. However, by the time the recovery is established, an investor will have missed some of the most rewarding times to own the shares. Having said that, it's also very easy to be too early in recovery stocks - the first profit warning is rarely the last, so a recovery buyer must be patient in timing the main entry point.
Understanding the Business & the Management
Bolton starts when looking at a share by assessing how good a business the business is and how sustainable is its franchise. Is it in control of its own destiny or is it heavily subject to currency fluctuations, interest rates, or tax changes?
"Often I ask myself: how likely is this business to be around in 10 years’ time and to be more valuable than today?” It’s surprising how many businesses fail this test".
Another important characteristic for him is whether the business generates cash over the medium term - this has generally given him a bias towards service businesses and against manufacturing.
He always insists on meeting management and seeks to assess their competence, how the management team works and most importantly how they are rewarded and what their incentives are. The managements that normally impress him are those that have a detailed knowledge of the business – strategically, operationally and financially. He looks for management who are candid and avoid hyperbole, who do not over-promise but consistently deliver a bit more than they indicated. He avoids ‘dodgy’ management at all cost.
Catalysts & Special Situations
He looks for whether there are any possible factors to excite interest. Some of the things he looks for are:
- Companies with recovery potential (an example might be the retailer Next (LON:NXT) which was restructured and revitalised in the 1990s) or strong growth potential;
- Companies with unrecognised asset value or a special product that has a particular market niche and therefore good earnings potential;
- Companies with takeover potential, such as the independent television companies in the 1990s
- Companies subject to restructuring and/or changes in management or which are under-researched by brokers- He gives the examples like the cable TV companies, Marconi and Eurotunnel which "tend to be completely off most equity institutional investor's radar screens".
The Importance of Ownership
He stresses the importance of checking director deals, significant shareholdings, and whether insiders have control. Bolton looks for companies where managers have a decent shareholding in the company and where the objectives of management and shareholders are aligned.
Sometimes, when I meet a large company where senior managers own only a few shares, I have the impression that their main incentive is the prestige of running a large company and shareholder returns are lower on the list.
Share‐dealing by insiders can be a very useful lead indicator to a business improving or deteriorating. He considers the size of the deal; whether it is a one‐off or there have been several deals including other insiders. Does the individual have a track record of buying shares opportunistically? Is it the chief executive or finance director?
He also looks for whether institutions over- or under-own, and the degree of analyst coverage.
"A great sign often comes when analysts give up on a company and there are few people making forecasts on the business.
How Anthony Bolton Values Stocks
Bolton apparently examines the company’s valuation history in depth (over as long as possible but at least one business cycle), noting that, during the bull phase, valuation methods move from the conservative to the speculative. For most companies, and particularly non-financial ones, he looks at five main types of ratios (he has less time for the PEG ratio or for DCF models, arguing that the latter is too dependent on assumptions many years into the future):
- Price/earnings ratio in the current year and up to two following years (on both an absolute and relative basis)
- Enterprise value to prospective gross cash flow, or EV to EBITDA
- Forecast free cash flow per share divided by the share price
- Price to sales (or, even better, EV to sales)
- Cash flow return on investment (CFROI)
In essence, he seems to be looking for stocks that, within the next 2 years, will be on single digit PEs or with a Free Cash Flow Yield above prevailing interest rates.
Z-Scores: How to cut through the Balance Sheet
Bolton emphasises the importance of understudying a company's debt position, including include all forms of debt including pension fund deficits and convertible preference shares that will not be converted. He notes that balance sheets are the most common cause of grief for investors. "When I've analysed the biggest mistakes I've made over the years they have nearly always been in companies with poor balance sheets". This is not to say an investor should never buy companies with weak balance sheets but that an investor should do so with their eyes open to the risks involved and pay special attention to their progress. If something starts to go wrong, he suggests that these are the holdings that should be sold early even at a loss. Highly geared companies are particularly exposed if business conditions change for the worse. As a shorthand to assess a company’s financial strength, he advises use of the “Z” score (he uses a proprietary system called the H-Score which is a variant of the Altman Z-score). He keeps a special eye on the companies in the weakest quartile of scores in their particular industry are the ones on which to keep a special eye, especially if the score is in the lowest decile.
Why Bolton Rates Technical Analysis
Unlike many value investors, Bolton regards technical analysis as a useful tool in the investor's armoury (particularly for larger stocks). He looks at the company's chart over three, five and ten years to see how it's been performing. He uses technical analysis (espectially momentum/relative strength) as a framework into which he puts his fundamental bets on individual stocks. If the technical analysis confirms his fundamental views, he may take a bigger position than when they conflict. Charting also guides his view on whether a growth story has run too far. He particularly dislikes “pass the parcel” stocks — those where the valuation is very high and investors hope there is a bit more to go and they can sell them to someone else before the music stops.
“I like to put today’s price in the context of the stock’s recent price history. I will look at a stock completely differently if I know it’s already performed well for several years as compared to one that hasn’t”.
We'll be discussing a possible quantitative implementation of this approach in a subsequent piece.
- Wikipedia on Anthony Bolton
- Investing with Anthony Bolton
- Investing against the Tide
- Learn to expect the unexpected
- Anthony Bolton's Secret Weapon
- My favourite type of share
- Book Review: Investing Against the Tide
Disclosure of Interest: The Author has an indirect holding in Fidelity's China Special Situations