interactive investor’s collectives editor Kyle Caldwell speaks to the UK’s very own Warren Buffett, Keith Ashworth-Lord, manager of the CFP SDL UK Buffettology and CFP SDL Free Spirit funds. In the interview, Ashworth-Lord addresses short-term performance coming off the boil, explains how he applies Warren Buffett's principles, and names the most recent share purchases.
Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Keith Ashworth-Lord, fund manager of the CFP SDL UK Buffettology fund. Keith, thanks for coming in today.
Keith Ashworth-Lord, fund manager of the CFP SDL UK Buffettology fund: Thanks for inviting me, Kyle.
Kyle Caldwell: So, Keith, could you start off by explaining how your investment approach aims to mimic Warren Buffett's principles in order to try and find high-quality growth companies?
Keith Ashworth-Lord: Yes, it's a very disciplined process. We start off looking for businesses with an economic moat, which effectively means they've got barriers to entry and they've got pricing power. And the way we go about it is we analyse the growth potential of the companies in their markets, the growth potential of the markets themselves.
We keep a very wary eye on margin development because if you're growing you should be improving your margins. And just to give you the measure, I mean the average gross margin in Buffettology is 58%, and the average operating margin is 22%, so well above what the market averages are.
But more important than the return on sales is the return on equity. We look very closely at that. We want to see a high return on equity, both average equity and also marginal equity, the latest incrementals. The average for the fund is currently 28.1% return on equity, so we really are high. And then the other thing that we're very keen on is cash conversion. We like companies that convert at least 80% of their accounting earnings into free cash measured over a five-year moving average. And again, we have that within the fund.
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Because of that, our companies tend to have very strong balance sheets, this focus on cash flow. And, to give you the median interest cover for companies in the fund is currently about 28 times. We've got 14 of the 27 companies with net cash and another 11 with modest gearing. So those are the sort of financial metrics we're looking at, but the key thing is management, management that acts with the owner's eye and behaves like an owner of the business, not a sort of hired hand.
Kyle Caldwell: And it's a long-term focus. And you don't often make changes to the fund?
Keith Ashworth-Lord: Very rarely. I mean, our portfolio turnover currently, if you exclude where we've had to sell things, say, for meeting redemptions or whatever, it's currently 7.5%, and that's high by historic standards. So no, we don't chop and change the fund. Like Buffett, our ideal holding period is forever.
Kyle Caldwell: 2022 is a year that most investors will want to forget. Your fund, it was a tough year. It was down 23% in 2022. Was this primarily down to the macro rather than the micro?
Keith Ashworth-Lord: Very much so. What you were seeing there was a contraction of price-to-earnings (P/E) multiples on the investee companies that we own. And just to prove that point, 23 of our 27 companies in 2022 reported earnings or trading statements that were in line with expectations or even better than expectations. But of those 27 companies, 22 of them finished the year with their share prices down and in some cases down quite a lot. So, I can't stress really too much that the operating performance of the companies is absolutely up to scratch. And it's been purely a market phenomenon. This rotation, so-called rotation into value, which has affected the multiples that the market accords our companies.
Kyle Caldwell: And that rotation into value, which has benefited certain value sectors, such as oil and the miners in particular. If that were to persist for a long time, would you change your approach at all?
Keith Ashworth-Lord: No, we wouldn't. First, I don't think it'll persist for a long time. I mean, I've been through these rotations before and they tend to be relatively short-lived. But no, we wouldn't. We don't like miners. We don't like oil and gas, we don't like energy. It's just not a sector that we think has got the long-term sustainable returns that we seek. So, you know, given the way we set our stall out and the businesses we're looking for, these businesses will never fit into our investment philosophy. So, the answer to the question is a very firm no. We will stick with what we do.
Kyle Caldwell: Looking ahead to 2023, how do the valuations stack up in terms of your portfolio holdings? And do those lower valuations give you greater confidence that over the long term you can produce a strong level of outperformance?
Keith Ashworth-Lord: The free cash flow yield of the fund has gone up from around 3% at the turn of 2022 to 4.8% as we came into the new year. And the way we look at it is that, that's not a bad entry point when you've got businesses where the underlying portfolio is growing its free cash flow at about 10-12% per annum. ,So it's almost like a bond with an expanding coupon. So, definitely, we think valuations are now at a level where they are attractive, parent company Sanford DeLand has committed to putting £4 million into both the Buffettology fund and the Free Spirit fund, its smaller sister fund, over the next eight months on a pound-cost averaging exercise, because we feel that valuations have now got so low. We view it as almost like a spring that's being coiled. You know, being turned and turned. Share prices are under pressure, but the operating performances are [getting] better. At some point that's going to blow, and when it blows, it will blow suddenly and in a big way. And if you're not actually in by then, you're going to miss it because nobody ever times the bottom of the market. So that's kind of what we feel about where we are on valuations. We think there’s some really attractive opportunities.
Kyle Caldwell: And given there was a lot of volatility across stock markets last year, particularly within the UK, mid and small-cap names, did this open up plenty of buying opportunities, or does the fact that you only have 27 holdings show that there weren't actually that many bargains out there?
Keith Ashworth-Lord: There are a jolly sight more than there were at the beginning of 2022. One of the things we've had to do, let's be straight about it, it's been a bad year for inflows across the UK AllCompanies sector. We've seen equity outflows and we're not immune to that. So, we've had to manage outflows as well, which has really taken a little bit of the shine off it because I would have been preferring to put some of that money back into bombed-out situations. But I mean, we have found new investments. In the main, they've gone into the sister fund Free Spirit. We bought Calnex Solutions (LSE:CLX), we bought SDI Group (LSE:SDI), we bought Keystone Law (LSE:KEYS).
And the one that we've got a good opportunity with, at long last, was Fevertree Drinks (LSE:FEVR). And that, you would have thought, should have gone into Buffettology, given the size of it. The reason we put it into Free Spirit and not Buffettology, was that Buffettology already owns Diageo (LSE:DGE), which is its sort of premium-brand business, and it also owns Barr (A G) (LSE:BAG), in a more sort-of general area so, we thought, well, Fever-Tree will go more naturally into Free Spirit. It doesn't have that exposure. So that's why it went in there. But in terms of Buffettology, as I say, the only thing that we've really done is and it's been very limited, is just top up one or two. We haven't put any new names, as they call it, into the portfolio.
Kyle Caldwell: Could you give a couple of examples of companies that you already hold that you've been topping up?
Keith Ashworth-Lord: Yes. I mean, we thought Liontrust (LSE:LIO) was really rather bombed out, but it's a high beta stock. So, it's always going to get beaten up in a bad market. So, that was definitely one business that we felt had probably gone a little bit too far the wrong way. And the other one where there was a great opportunity was Jet2 (LSE:JET2), which again managed to get itself beaten up terribly and has since recovered.
Kyle Caldwell: Keith, thanks for your time today.
Keith Ashworth-Lord: Thank you.
Kyle Caldwell: That's all we have time for. You can check out the rest of our Insider Interviews on our YouTube channel where you can like and subscribe. Hopefully, see you next time.
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