Two value buys – and why banks are still a bargain

Temple Bar co-manager Ian Lance sits down with ii's Sam Benstead to discuss how he manages his value-focused UK portfolio.

Lance gives an overview of the strategy, and reveals a number of key buys and sells, including companies in the materials and financials sector. He also explains why, despite a strong run for cheap shares, the portfolio hasn't become too expensive.

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Ian Lance, co-manager of Temple Bar Ord (LSE:TMPL) investment trust. Ian, thank you very much for coming into the studio.

Ian Lance, co-manager of Temple Bar: Pleasure.

Sam Benstead: Can you give me a quick overview of how you manage money in this investment trust?

Ian Lance: Yes, Temple Bar is a classic value investment trust. That means that we try to buy what we consider to be deeply discounted equities for the trust. It's relatively long term, so we tend to think about a five-year time frame. It is quite concentrated, so about 35 stocks and pretty low turnover.

Sam Benstead: It's a UK investment trust?

Ian Lance: Correct, so 70% of the trust is invested in UK equities.

Sam Benstead: So, a value investment approach. What does that mean for you as a fund manager?

Ian Lance: OK, so philosophically, we believe that the average investor has a tendency to overreact to things that don't really influence long-term value. So, typically, if the earnings of a business go down, the share price will follow it down, and often, actually, that decline in earnings doesn't really impact the long-run value of the business.

So, what we're trying to do as value investors is effectively look longer term than the average investor. So, we look five years out. We ask ourselves, where do we think the earnings of that business can get back to on a five-year view? Then we'll value the business off that. We come up with what we think is the intrinsic value of the business. If we can buy an equity where we see at least 50% upside to that intrinsic value, then that's normally an interesting stock for the trust.

Sam Benstead: In the UK then, what types of sectors and companies does this approach lead you to today?

Ian Lance: The most attractive, one of the most significant parts of the trust at the moment, is financials. We think that, amazingly, even though the great financial crisis was a long time ago, a lot of people were almost scarred by that and virtually swore never to invest in banks again and therefore they've missed a massive change in the industry.

The industry is so much different from back in 2008. So, we got the opportunity to buy what we think are good businesses at very, very low valuations, and that still makes up a substantial proportion of the trust today.

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Sam Benstead: Can you give some examples of some recent buys and sells in the portfolio?

Ian Lance: Well, let's start with the sells because some of those banks that I was just talking about have done so well that they became a very large part of the trust and we've taken some money out of them.

So, if I told you that NatWest Group (LSE:NWG) doubled last year and has gone up another 30% this year, you can see how that would become a big part of trust, and so we've taken money out. We haven't sold them completely. We've taken some money off them.

On the other side, what have we been buying? The platinum company Johnson Matthey (LSE:JMAT). We bought that a few months ago, timed that very well. They sold a business recently called Catalyst Technologies. Although it was only 20% of profits, they got about 80% of the market cap of the company for it. So, that's done very well.

We bought Smith & Nephew (LSE:SN.), which is a medical devices company.

Then the last one, which I think possibly might interest you a lot, is last year we were buying Aberdeen Group (LSE:ABDN). One of the reasons for buying Aberdeen is that we felt that lots of people weren't looking at the interactive investor part of the business, and were probably undervaluing it.

A lot of people might not even know that within Aberdeen, you've got interactive investor, you've a business called Adviser, [and] at the time that we were buying it, we thought those two bits of the business made up the market cap of the company, and the fund management business was being valued at zero.

The fund management business has undoubtedly got problems, but it's definitely not worth zero. Then there are other bits of Aberdeen, [for example]pension fund surplus, a stake in Phoenix.

You add all that lot together and we thought you were getting sort of nearly double the market cap at the time we were buying it. So, that was another big purchase last year.

Sam Benstead: That's good to hear. So, you're quite an active investor then. In a given year, what's the kind of normal level of turnover?

Ian Lance: We have been active recently because the opportunity set has been good. But in the long run, our turnover is around 15%. Our average holding period is about five years.

What typically happens is you will get big events in which the opportunity set goes up. A classic example will be the pandemic. Obviously, lots of share prices fell very heavily during the pandemic, and it offered you a fabulous opportunity to buy some very, very cheap shares, so turnover went up then.

Then it will go back down again, as you come out of those periods in which you, basically, just sit and harness the undervaluation of those stocks you've bought.

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Sam Benstead: Value investors tend to be bottom-up stock pickers, but do you also look at the macro picture as well when you make investments?

Ian Lance: That's the way to think about it, is that we tend to use, I suppose, other people's overreaction to macro factors to look for opportunities. This year would be a great example, wouldn't it, if you cast your mind back to 'Liberation Day' and the tariffs. The market went down quite substantially, but quite quickly.

Then, within weeks, people had changed their mind and decided that it wasn't going to be as bad as they thought, and things were rallying again. So, had you positioned your fund around the sort of very bearish macro view, you would have been proven wrong pretty quickly. So, what we did during that period was basically used that to just top up some of our core holdings.

Sam Benstead: Do you hold cash as well, typically, to take advantage?

Ian Lance: Not a lot. We kind of work in capital-type levels of cash, so sort of 3% to 4%, which allows you to take a bit of advantage. There's a little bit of gearing in the trust, about 5%.

Typically, what we'll do is just rotate around the portfolio, so we might take money out of the things that have held up well and just rotate that into where we see the value in the market.

Sam Benstead: How do you know when to buy more of a company if it's not doing well or cut your losses and sell?

Ian Lance: This is one of the hardest things for value investors to know; when [is] the share price going down just offering you a better opportunity to buy things? And when do you have to put your hands up and say, 'I was wrong here and the market was right'? So, let me give you a couple of examples.

During the pandemic, we had started buying shares in Marks & Spencer Group (LSE:MKS) because we really believe that the new management team had a terrific strategy for turning that business round. That share price sold off very heavily during the pandemic. Our feeling then was that, actually, the pandemic didn't really change the long-term strategy, and in actual fact, with the benefit of time, it allowed them to speed up some of those key decisions that they were making.

So, that was a clear opportunity where you could buy more of it at a very low price, and actually that paid off.

An area which I think the jury is still out on at the moment is autos. Auto stocks have looked very cheap for the last couple of years. We own the car company Stellantis NV (EURONEXT:STLAP) within the portfolio. The share price has performed quite poorly. We think there's potential that there is a structural issue going on here and that this is all to do with converting from petrol and diesel to electric vehicles in the end, and the amount of investment that has to go in and so on and so forth. So, actually we haven't sold that, but we haven't bought any more of it.

Sam Benstead: And what is the long-term case for value investing? We've generally seen investors move to higher growth assets or simply tracking the US market. Why does value deserve a place in portfolios?

Ian Lance: Funnily enough, I think the case is virtually what you've just said, which is that in the long run, there's a lot of evidence to show that value is one of the factors that beats the market in the long run.

The period 2010 to 2020 was quite an anomalous period. That was a period in which growth did better than value.

Contrary to perhaps a lot of people's wisdom, value has started to outperform again from about 2021, so pretty much from the bottom of the pandemic through today, in pretty much every area with one exception, which is large-cap US.

Of course, a lot people focus their attention on large-cap US, and they miss the fact that in the UK, Europe, Japan and emerging markets, value has been beating growth since about 2021. So, we've returned to that historical pattern and, touch wood, it looks like even in the US this year, after we saw the sell-off of the technology stocks, value is doing OK in the US this year as well.

I think the case for value now, really, is the start point, which is that we think growth stocks are still very, very expensive on a historic basis, value looks very cheap on a historic basis, and that normally is a precursor of good returns.

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Sam Benstead: So, even after a good run for value, there's still plenty of cheap shares out there?

Ian Lance: There are. This almost sounds sort of counterintuitive. Temple Bar has had a very, very good few years since we took over the management of it. It's up over 180% and yet the average price/earnings ratio across the portfolio is about nine times, dividend yield, 4%. Those are quite attractive valuation metrics, and people might wonder how that could possibly be the case.

Of course, part of the reason is because we recycle money. So, we've sold some of the more expensive things and recycled the cheaper things.

The other part of it though is that, actually, the earnings of some of the companies that we own are going up very, very dramatically. In a lot of cases because they used the fact that their shares were very, very cheap to buy back lots of very cheap stock and that's enhanced their earnings. So, the share price is only going up at the same rate as the earnings and therefore you're not really seeing a re-rating.

So, yes, despite the good performance, we think valuation is still very attractive.

Sam Benstead: Ian, thanks very much for coming into the studio.

Ian Lance: Pleasure.

Sam Benstead: And that's all we've got time for today. You can watch more of our Insider Interviews on our YouTube channel where you can like, comment, and subscribe. See you next time.