Download What makes a great value investor?

What makes a great value investor?
The influence of culture in sustaining success
within fund management organisations
By Jonas Cunningham and Halldór Sigurjónsson
5th September 2011
(excerpt)
Kennox
Background
Kennox was originally formed in 2007 as Contrarian Global Asset Management but
effectively re-formed in 2009 as Kennox Asset Management. The firm manages one
fund which is the Kennox Strategic Value Fund. The investment universe has few
constraints and the fund will invest in equities in any market with any capitalisation. The
investment style is value investing as reflected in the corporate slogan of “True Value
Investors”.
Investment approach
The Kennox investment approach is at its base microfundamentalist as the focus is on
stock picking. The Kennox approach could be considered to be macrofundamentalist in
as much as the fund is not restricted in the markets which it invests in although
geographic considerations would only be one of a number of secondary factors in the
investment process. The other macrofundamentalist aspect of the Kennox approach is
that the fund can allocate up to 20% of its capital to liquidity and that it can also own
gold within the investment portfolio. The two asset classes of liquidity and gold act to
provide true diversification and therefore reduce the fund’s exposure to equity markets
when Kennox believe these to be overvalued.
Results
The diagram on the next page shows the 4 year total shareholder returns of Kennox to
July 2011. The compounded annual returns over this period were 9.1% compared to
2.0% and 3.7% for the FTSE All Share Index and the MSCI World Index (Sterling)
respectively. £1,000 invested in Kennox over this period would have grown to £1,517 on
a total return basis compared to £1,084 for the FTSE All Share and £1,155 for the MSCI
World Index (Sterling).
50 %
Kennox
40 %
FTSE All Share
MSCI World
30 %
20 %
10 %
0%
- 10 %
- 20 %
- 30 %
07/2011
05/2011
03/2011
01/2011
11/2010
09/2010
07/2010
05/2010
03/2010
01/2010
11/2009
09/2009
07/2009
05/2009
03/2009
01/2009
11/2008
09/2008
07/2008
05/2008
03/2008
01/2008
11/2007
09/2007
07/2007
- 40 %
Figure 1 – Kennox’s 4 year returns (Sources: Bloomberg, Kennox)
Kennox’s own analysis has shown that the investment approach shows better returns in
comparison to the MSCI World Index at times when the overall markets are falling and
relatively poorer returns in comparison when the overall markets are rising. Therefore
the nature of the returns also reflects what we would expect from a value investor who
is focussed on reducing risk and preserving capital.
Cultural web - paradigm
Our research on Kennox is contained in Appendix G and summarised in the cultural web
set out on page Error! Bookmark not defined.. As with many small investment firms,
Kennox has an informal structure which allows the investment team to focus all of their
time on investing. The firm is owned by its employees who also have a significant
commitment to the fund in terms of their personal investment in it. The Kennox team’s
own commitment to value investing is supported by “cornerstone” investors such as
Angus Tulloch and the late Peter Cundill. The reason why the “cornerstone” investors
support Kennox is, in our opinion because they know the investment team, and Charles
Heenan in particular, very well and therefore are convinced that Heenan and his team
have a deep conviction in value investing.
In conclusion, we believe that Kennox has a simple approach and culture which are both
consistent with, and supportive of, value investing and this is the basis of the firm’s
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success in producing superior investment returns over longer time periods. The basis of
the culture is a deep personal conviction in value investing. The culture of the firm,
including the influence of the “cornerstone” investors, means that Kennox is likely to
remain focussed on the value investing approach which has provided it with a
sustainable competitive advantage as an investment manager.
Cultural web for Kennox
Stories
Rituals & Routines
 Running valuation screens to identify stocks
which have fallen out of favour
 Reading financial and investment publications
to search for investment ideas
 Doing deep analysis and spending
substantial amounts on each stock before
purchase as only 3-5 new positions are taken
on in a year
 “Thinking aloud” - regular thought piece
publications
Control Systems
 Very detailed financial analysis and deep
understanding of key drivers
 Free cash flow of investee companies and
balance sheet strength
 Avoiding peek earnings of investee
companies
 Concentrated portfolio with 20-40 stocks
 Liquidity managed with up to 20% in cash
 Margin-of-safety, capital preservation and
diversification
 Global investment universe
 Heenan’s personality matching value
investing and not buying stocks personally
until after 10 year of professional investing
 Influences of Heenan’s mentors such as
Angus Tulloch and Peter Cundill
 The requirement to be contrarian
 Informal network of value investment
professionals such as Russell Napier and
James Montier
Symbols
 Kennox logo which includes “True value
investors” is part of the logo of the company
 The website for Kennox has a wealth of value
investing principles
Paradigm
 “True value investors”, fundamental belief on
the value investing approach
 Small, focussed team
 Deep focus on each stock and review
financials and key drivers of the business
 Employee ownership and full investment of
Heenan in the Kennox fund
 Concentration and contrarianism
Organizational
Structures
 Michael Adam (Non-exec Chairman) the
founder of AHL now operated by Man Group
 Small and informal
 Two person investment function and one
person to focus on attracting investors and
managing operational aspects
Figure 2 - Kennox's cultural web
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Power Structures
 Employee ownership seen as a critical factor
and investment of all personal equity of
Heenan into the fund
 Investment managers focus on investment
management rather than attracting new
investors
Case Study on Kennox Asset Management
Kennox Asset Management
Background
This case study focuses on the investment team at Kennox and the investment track
record that they have delivered across a four year period at CGAM and Kennox.
History
Kennox was founded in 2007 as Contrarian Global Asset Management (“CGAM”). The
funds to be managed were provided by an Australian company although the investment
team has always been based in Edinburgh. This initial structure was not destined to
endure and the different priorities of the two parties meant that the agreement was
ended in 2008. At this point, the investment management company underwent a rebranding and adopted the name Kennox Asset Management (“Kennox”) and relaunched the investment fund as the Kennox Strategic Value Fund in April 2009.
There was therefore a hiatus period between the original Contrarian Global Asset
Management structure and the re-launch as Kennox. Of the 22 stocks held when the
CGAM portfolio was closed in September 2008, 21 were bought to start the Kennox
Strategic Value Fund in April 2009. Assuming a static portfolio for the hiatus period
allows Kennox to show a continuous performance record dating back to July 2007. This
assumption appears fair as it matches the low portfolio turnover in the portfolio.
The Kennox Strategic Value Fund was launched in 2009 with just over £10million of
funds under management. The size of the fund has subsequently grown to just over
£30million at present. With a history of four years and this size of funds under
management, Kennox definitely falls into the category of being a relatively new
organisation. The existing level of funds under management provides an income stream
which means that Kennox is a sustainable business which has completed its start up
phase but it is still seeking to grow to a level where that sustainability is underpinned by
a higher level of funds under management and to a size where they no longer fall below
the minimum size for investment imposed by a number of asset allocating organisations
such as pension fund consultants. Including Kennox in our research therefore allows us
to examine a value investing firm which is at a relatively early stage of development and
therefore with a more recently formed culture which could be said to be still emerging.
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Investment approach
Kennox has adopted an approach to value investing which has few constraints. Potential
investments are not geographically constrained and the fund will invest in companies of
all sizes. The fund can hold up to 20% of assets in cash liquidity and also holds a position
(3.8% at the end of March 2011) in a gold exchange traded fund as part of its
investments.
There are three sources of investment ideas in the Kennox investment process. The first
is that regular valuation screens are run which identify stocks which are trading at low
valuations on either one or a number of valuation metrics. The screens can be based on
either valuation criteria or be tailored to review a certain region, sector or other theme.
The screening process includes the identification of stocks trading within 10% of 52
week lows in order to identify stocks where prices may have fallen further than value.
Screening for stocks trading near historically low levels also identifies stocks which are
generally disliked by the market as a whole. This allows Kennox to identify opportunities
to make contrarian investments. The second source of investment ideas is the existing
portfolio of investments itself. Monitoring existing investments gives insights into
different sectors and countries which can lead to the identification of further potential
investment ideas. The third source of investment ideas is referred to as “the World” and
comprises the regular reading of financial and investment publications (such as the
Financial Times, Wall Street Journal and Barron’s) but also includes the ideas which arise
from interaction the wider world outside of the investment industry such as discussions
with friends in different industries and reading non-investment periodicals such as the
Economist.
The results of the screening / idea identification stage include a number of key summary
valuation metrics. Only those companies where these key valuation metrics meet
Kennox’s valuation criteria progress beyond the screening stage.
Following the
screening stage, there are two other steps in the process before an investment is
purchased for the portfolio. The second step is a financial analysis stage followed by the
third stage of detailed research. The financial analysis stage includes a review of 15-20
years of the company’s financial results. Typically, the first two steps of a review of a
valuation screen and the analysis of a company’s financial history takes a total of
approximately 20 minutes.
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The third step consists of detailed research. The type of research is unconstrained and
can include reading annual reports and talking to the company’s management team,
customers, competitors and suppliers. Based on the assumption that Kennox is likely to
hold a portfolio of 20-30 stocks with an annual turnover of around 15% this means that
Kennox is only likely to buy 3-5 stocks per year. While substantially more shares are
researched in detail than bought, this level of share transactions means that Kennox are
able to allocate substantial time to researching the shares which are eventually
purchased for the fund. In order to provide a concise summary of the reasons for
purchasing a share, Kennox have developed a two page summary template which is
completed for every share that is purchased. There is no limit to the amount of
additional research which can be appended to the two page summary but the summary
document is used as a ritual to ensure that the conclusions of the detailed research
focus on the most critical factors in the investment decision.
The result of the three step investment process is a list of shares which Kennox is
prepared to purchase. The final decision as to whether or not a share is purchased
depends on how it would fit into the portfolio and how it would affect the
diversification of the portfolio. Kennox’s literature identifies two quantitative measures
of diversification which it stresses are not rigid. These are that it is unlikely that any one
region will exceed 35% of the portfolio or that any one sector will exceed 20%. These
quantitative measures are useful indicators but Kennox think of diversification in a more
qualitative way. The first qualitative way of thinking about diversification is that Kennox
seeks to achieve diversification of the investee companies’ long-term earning streams
and therefore that these companies are exposed to different risks. The second
qualitative way of thinking about diversification is that Kennox seeks to hold a portfolio
of shares which are based on different categories of value stocks e.g. those that are
attractive value investments due to being either recovery situations, exposed to niche
markets or cyclical companies. While diversification is important to manage risk,
Heenan pointed out in our interview that controlled risk taking is an essential part of, if
not the definition of, investing: “The Manager is here to take risk but to do so
conservatively.” (Heenan, 2011)
In explaining their approach, Kennox provided us with a new concept which led us to reconsider how we thought of value investing. In our literature review we note that value
investing is often compared to growth investing but that Warren Buffett has
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commented that the distinction between “growth investing” and “value investing” is a
mistake as, in Buffett’s words, “[growth and value] are integrally linked since growth
must be treated as a component of value” (Cunningham, 1997). During the explanation
of the investment approach, Kennox compared their style to that of other investors who
also adopt a value orientated approach. This comparison was often made in the context
of how much growth in earnings the investor assumed that the investee company
would achieve as part of the estimation of intrinsic value and Kennox stated that as a
matter of principle their analysis assumed no growth in earnings.
In conclusion, we consider Kennox to be primarily a microfundamentalist value investor
though the ability to hold liquidity in the form of cash in the portfolio and willingness to
hold gold means that there is an aspect of macrofundamentalism to the Kennox
approach. Kennox can invest across geographical and sector boundaries and uses macro
economic analysis to provide what it refers to as “context” for stock picking. This
macroeconomic influence in the investment process provides further evidence that
Kennox has a significant macrofundamentalist aspect to its approach.
Results
The Kennox performance track record has now reached four years in duration. This
period started in July 2007 which is just before the onset of the “credit crunch” which
has seen dramatic falls and subsequent increases in global stock market levels. During
this period Kennox has produced superior investment returns with the value of the fund
increasing by 42% compared to an increase of 2% in the MSCI World index over the
same period. Expressing these returns as compound annual growth rates shows that
Kennox has compounded returns at a rate of 12.4% per annum compared to 0.7% per
annum for the MSCI World index. The 2% increase in the MSCI World Index over four
years leads to a fairly unrepresentative compound annual return. Over the last three
years, Kennox has returned a compound annual growth rate of 12.1% compared to 4.8%
for the MSCI World index.
An evaluation of the performance record of a value investor always needs to be carried
out over a longer period of time as it is an investment approach characterising by a long
time horizon. This is demonstrated when Kennox’s 1, 2 and 3 year records are set out as
follows with the performance of the MSCI World index in brackets: 1 year +11% (+5%);
2 years +41% (+48%); and 3 years +41% (+15%). This shows a typical performance
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profile for a successful value investor where superior performance is recorded over a
longer period but not over every shorter period.
One of the important tenets of value investing is the preservation of capital. Kennox has
performed an analysis of its own performance record which demonstrates this
preservation of capital. Kennox identified five notable peak to trough falls in the MSCI
World index which ranged from 7% to 31% and delivered a notional compounded fall of
60%. The Kennox portfolio fell over the same five periods with falls ranging from 1% to
7% and resulting in a notional compounded decline of 17%.
Kennox has also analysed its performance record by reviewing eight discrete six-month
performance periods during its four years of existence. Kennox’s investment returns
have been lower than the MSCI World index in three of these eight periods. During the
first period, Kennox returned -3% compared to -1% for the MSCI World index. The other
two periods of under-performance were recorded when the MSCI World index recorded
its two strongest six month returns. In those two periods Kennox returned +16% (MSCI
World +23%) and 15% (MSCI World +18%). It is also noteworthy that Kennox produced a
return of +15% in a six month period when the MSCI World index produced a -10%
return. This shows that the increase in price across a portfolio of shares selected on a
value basis can be uncorrelated to the overall market. While Kennox expects to
underperform the MSCI World Index when it shows large increases, it is important that
this underperformance is minimised in order that superior investment returns are
generated over the long term.
In conclusion, Kennox’s value investing approach has produced superior investment
results compared to the MSCI World Index and has also demonstrated the value
preservation characteristic of value investment by showing significant out performance
when the MSCI World index has produced negative returns.
Research results
In the course of our research we interviewed Charles Heenan (Investment Director) as
well as conducting a discourse analysis of literature produced by Kennox. This literature
includes a presentation produced by the firm setting out its structure and investment
approach. The literature also includes quarterly reports setting out the fund’s
performance with accompanying commentary and irregularly produced thought pieces,
appropriately titled “Thinking Aloud”.
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We have used discourse analysis to summarise and analyse the interviews and the
review of the literature produced by Kennox. Our findings from the research are set out
below under the headings of the sections of the cultural web.
Organisation structure
The Kennox team comprises three full time employees and a Non-Executive Chairman.
Peter Boyle is the Managing Director of Kennox with responsibility for running all of the
non-investment aspects of the firm including operations and raising further funds for
investment. Charles Heenan is the Investment Director responsible for the investment
process and therefore for managing the Kennox Strategic Value Fund. Charles is
supported by Geoff Legg who is an Investment Manager. The Non-Executive Chairman is
Michael Adam who is a co-founder and principal of Adam, Harding & Lueck Ltd and
subsequently of Aspect Capital. These firms are hedge funds which use systematic
trading strategies and Aspect Capital is recognised as one of the leading half dozen
hedge funds pursuing this strategy in London. While not having a value investing
background, Michael Adam is clearly experienced in the world of fund management and
his presence both as Chairman and an investor in the fund represents a substantial
endorsement in Kennox.
The Kennox team is small and therefore there is little in the way of formal
organisational structures. It is likely that the small size of the team allows for quicker
decision making and a high degree of conviction but we do not consider that we have
identified any major conclusions from this section of the cultural web.
Power structure
The power structure at Kennox appears to be very simple and can be summarised by
two quotes from Charles Hennan. The first is that “Having control is absolutely
essentially important.” The second is that “It is important to do exactly what you believe
in.” (Heenan, 2011) These quotes demonstrate that the value investing philosophy is
central to the culture at Kennox and that the power structure is secondary to this.
Heenan made these statements during a point in the interview when raising investment
funds was being discussed. Many investment firms raise investment funds as part of an
agreement that gives the provider of those investment funds an ownership stake, and
possibly non-executive board representation, in the investment management company.
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This type of structure would clearly place a lot of power with the provider of the
investment funds.
During our interview with Heenan we also discussed large investment organisations by
way of contrast to Kennox. The economic rewards to an investment manager are driven
by the investment returns on any funds invested by the manager in the investment fund
and by fees earned for managing those funds. Economic returns are therefore driven
both by investment performance and by increasing the value of assets under
management by attracting new investors. Heenan considered that in certain
circumstances the imperative to increase assets under management through attracting
new investor had the potential to negatively affect the investment management process
as stable short term performance could be seen to be more important in attracting
investors rather than the long term performance which characterises value investing.
The power structure at Kennox supports long term performance as this is consistent
with value investing. It is also consistent with attracting new investors who understand
value investing and are interested in long term performance as increasing investment
funds from this source is important to the long term growth of Kennox.
In conclusion, we consider the power structure at Kennox to be simple and supportive
of a value investing approach.
Control systems
Kennox produces a quarterly investment report for the Strategic Value Fund which
reports performance over 1,3 and 6 month periods as well as over a year and since
inception. In common with many funds’ regular investment reports it includes
disclosure of the largest individual stock positions in the portfolio. In Kennox’s case it
reports the top eight positions.
In our literature review note that Greenwald et al. (2001) identify investors who
practice stock picking relative to an index as not being value investors. Many value
investors, including Kennox, recognise this by specifically refusing to identify a
benchmark against which to measure their performance. Some of Kennox’s marketing
literature specifically mentions that there is no identified benchmark but at the same
time other Kennox marketing literature compares performance against the MSCI World
Index, making this a de facto comparator if not an actual benchmark. The fact that
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Kennox’s investment approach is geographically unconstrained makes the MSCI World
Index an appropriate comparator in our opinion.
In the research and appraisal of individual stocks as investment opportunities Kennox
uses a range of valuation metrics and Heenan mentioned a number in particular during
our interview. The first set of metrics that were mentioned were price to sales, book
value and tangible book value. Kennox also use the price / earnings ratio but prefer to
look at the ratio of price to the average of the previous five years’ earnings in order to
avoid falsely identifying value stocks which have low price /earnings ratios due to peak
earnings. The Kennox evaluation process is also focussed on cash, both in terms of the
free cash flow yield of a company and the net cash or net position on the company’s
balance sheet. The free cash flow metric was mentioned at another point in the
interview where Heenan said: “We expect to buy assets at a price where we will get
double digit returns after tax. We look for a free cash flow of 10% or more. Any growth
we get is a bonus.” (Heenan, 2011) After identifying the metrics that Kennox focus on,
Heenan also noted that they prefer to review metrics over a longer period such and
mentioned 15 years as the preferred time frame.
There are a number of formal limits to the composition of the portfolio. The portfolio
should consist of 20-40 individual stocks and can invest up to 20% in cash. Heenan
stated that he would have preferred a mandate that allowed him to be 100% invested in
cash if he believed that were the right portfolio but that the practical realities of
attracting investors to the fund meant that the maximum liquidity level was restricted
to 20%. Kennox’s marketing literature also states that it is unlikely that any one region
will exceed 35% of the portfolio or that any one sector will exceed 20%.
There are three other items which we consider to be important key control systems for
Kennox but which are measured qualitatively rather than quantitatively. These are the
margin of safety, capital preservation and diversification.
During our interview Heenan mentioned the margin of safety on several occasions. This
is of course a central tenet in value investing being the title of chapter 20 in Graham’s
The Intelligent Investor and the title of Klarman’s important book. With regard to stock
selection, Heenan states that "For individual stocks we are always looking for that
margin of safety." (Heenan, 2011) Kennox’s two page summary of individual stocks does
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not include a formal valuation or formal target price. The evaluation of the margin of
safety is therefore qualitative and informal.
When it comes to capital preservation Heenan noted that: "Risk is losing money,
nothing else." (Heenan, 2011) Kennox does not have formal limits on the size of a loss
on an individual position or the portfolio as a whole before a specific action are taken
such as reducing or selling an individual position or exposure to equities. While there is
no formal risk limit, Kennox does comment on performance compared to movements in
the MSCI World Index and seeks to explain the reasons for differences in performance,
both positive and adverse.
During our interview Heenan identified two methods by which risk (defined as losing
capital) is managed. The first is the margin of safety which we have discussed above and
the second is true diversification. While there are formal limits on the proportion of the
portfolio which can be invested in any one region or sector, one of Kennox’s Thinking
Aloud pieces gave the following insight on Kennox’s view of diversification: "We at
[Kennox] look for diversification of the long-term (meaning five to ten years) earnings
and cash flow streams of the companies that make up our portfolio. In the long term,
these are the factors that will provide true diversification." (Kennox Asset Management Thinking out loud, 2011) From this definition we can see that it is very difficult to
quantify diversification across the earnings and cash flow streams of 20-40 companies
across the world. This means that true diversification is another concept which is
measured qualitatively rather than quantitatively.
In conclusion, Kennox have regular performance measurement and portfolio analyses
which compare to those of most investment organisations. There are a number of
quantitative measures in Kennox’s investment process which are consistent with value
investing but the most important insight which we have gained from Kennox’s control
systems is that some of the most important aspects of the investment process such as
managing risk through margin of safety and true diversification are very difficult to
measure quantitatively. This does not mean that Kennox does not measure these
aspects of the portfolio but rather that this measurement is qualitative and internalised
and difficult for third parties to copy.
The control system which most marks out Kennox as a value investor is the performance
record over longer time periods and in times when the MSCI World Index has declined.
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This result is consistent with what would be expected of a value investing organisation
and we are surprised that Kennox does not publicise this more prominently in its
marketing literature.
Symbols
We met with Charles Heenan just after Kennox had moved to new offices on
Edinburgh’s Melville Street. This street is home to several investment management
organisations. Kennox occupy office space in a serviced office and we met in a bookable
meeting room available to all tenants of the serviced office. The office was modern and
comfortable but did not appear to have any great significance of meaning for Kennox.
The Kennox logo is simply the word Kennox spelled in capital letters with an upward
arrow placed above the gap between the two “n” letters in Kennox. The words “True
value investors” appears below the word Kennox in capital letters but in a smaller font
such that these three words are the same length as the word Kennox. In discussing the
marketing material with Charles Heenan he noted that the firm had rebranded itself and
in doing so had chosen to place more emphasis on their identity as a value investor. This
has led to the “True Value Investor” tag line in the logo.
Rituals
Regular occurrences include running valuation screens to identify ideas for further
review and potential research and writing regular quarterly investment reports and
irregular “Thinking Aloud” thought pieces. The team spends most of its’ time
researching investments and keeping up to date with current affairs to understand the
impact that these may have on individual stock positions or the portfolio as a whole.
This includes reading of financial and investment publications such as FT, WSJ and
Baron’s but also more general publications such as the Economist.
The rituals surrounding the investment process are quite detailed and include significant
effort as due to the concentration of the portfolio and low turnover there are not many
purchases done each year.
Stories
Charles Heenan is an engaging individual who clearly enjoys talking about his
experiences as an investor, what he does and the people that he has worked with. Our
interview with Charles therefore yielded a number of stories which added to the many
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stories contained in Kennox’s “Thinking Aloud” thought pieces. We have therefore
grouped these stories into three categories.
Stories about value investing
The stories about value investing showed that this is a discipline which Charles Heenan
has a strong personal affinity with. This was particularly demonstrated by a quote where
Heenan identified the concept of margin of safety as something which has importance
to him in a wider context than investing: "I am an incredibly conservative person. I
always want a margin of safety in everything I do." Heenan also noted that he was
taken by value investing as soon as he came into contact with it: "Value investing rang
with me like nothing else.” Contrarianism is an important part of value investing and
Heenan has clearly thought deeply about this, understanding both the importance of
contrarianism and his natural inclination to be a contrarian: "[Value investing] is a very
strange combination of stubbornness and that contrarianism, being really willing to go
against the crowd. Because that comes naturally to me I really struggle to understand
why there are so few value fund managers. I struggle to find many people who I think
are very good at this style." (Heenan, 2011)
In our literature review we note that the implication of a value investment strategy can
vary significantly between different practitioners. In one of its thought pieces, Kennox
identified the concept of peak earnings as having particular significance for its approach:
"There are several concepts associated with value investing: margin of safety, hunting
for low Price-to-Earnings (PER) and Price-to-Book ratios, being contrarian. Another
point, one that we feel is underappreciated, is avoiding peak earnings." Another
thought piece also re-confirmed the importance of the concept of margin of safety: "We
at Kennox think that, of all the aspects of value investing, margin of safety is the most
important. This means buying an asset that is significantly cheaper than a conservative
estimate of its intrinsic value." (Heenan, 2011)
There are many stories which underline the importance of capital preservation to
Kennox and this is of course another central tenet of value investing. This is a simple
concept and we thought it appropriate to demonstrate Kennox’s commitment to it with
a simple quote: "Capital preservation is at the heart of our investment philosophy."
(Kennox Asset Management - Thinking out loud, 2011)
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Stories about people
The people who are important to Kennox tend to be either those who have had an
influence on Charles Heenan’s development as an investor or significant investors in the
Kennox Strategic Value Fund. One person who falls into both categories is Angus Tulloch
who runs the First State Asian investment team in Edinburgh. Heenan worked for
Tulloch from 1997 to 2007 and describes Tulloch as an eclectic investor who takes a
value approach to a number of his investments but also includes many investments
based on a growth approach. Heenan left First State as he wished to manage money in a
different style but clearly speaks fondly of his time working for Tulloch at First State and
Tulloch has shown his continuing support for Heenan by investing in the Kennox
Strategic Value Fund.
We met with Charles Heenan a few weeks after our initial interview and on that day he
had received a copy of a biography for a value investor called Peter Cundill who had
invested his personal capital in the Kennox Strategic Value Fund. While Cundill passed
away in January 2011 he has an important influence on Kennox’s culture both through
being an investor in the fund and also through his influence as a fellow value investor
who the people at Kennox admire.
A number of other individuals who can only be described as being members of the
wider value investing community were also identified by Heenan as being part of his
informal network or people whose work he reads and admires. Russell Napier is an
analyst with CLSA who in addition to writing regular research is also the author of a
book about significant stock market declines called Anatomy of the Bear (Napier, 2005).
This book is widely read by value investors and reinforces the concept that markets as a
whole can reach very low levels of valuation which provide an abundance of
opportunities for value investors. James Montier was formerly a publishing analyst at
Societie Generale who has also written books on the subjects of value investing and
behavioural finance. Montier has now moved to GMO which is a well known value
investing firm and Montier can be considered to be an important contemporary writer
on the theory of value investing. His former team at Societie Generale continues to
write research on market valuation which is considered important by many value
investors and this team is headed by Dylan Grice who Heenan also identified as
someone that he produces valuable material.
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Stories about stocks
Kennox’s quarterly investment reports always contain a discussion of a stock of interest
and the firm’s marketing materials also contains a number of case studies of individual
investments. One notable success story was Oriental Weavers. This was an Egyptian
share with a market capitalisation of ca. $100m (circa £62m). This relatively small size
and the strong negative sentiment prevailing toward the Egyptian equity market meant
that any investment in this share would be strongly contrarian. The price / earnings
multiple for the stock was three but earnings were below their peak which provided the
potential for an increase in the market price based on both a higher price / earnings
multiple and a higher level of earnings.
The story of a company called debts.co.uk (“Debts”) was used by Kennox to illustrate
the importance of diversification. This share was bought on the basis of an attractive
valuation but also because it’s business, arranging Individual Voluntary Arrangements
for private individuals to reduce unsustainable levels of personal debt, should have
been well placed to benefit from a recession. This sector came under increasing
regulatory pressure and Debts operations were poorly run and eventually led to the
insolvency of the firm. While Kennox sold the position before the company became
insolvent this was an investment where the Kennox team did a lot of research and
continued to hold the investment for a significant period of time.
During our interview, Heenan also identified a number of stocks which had been
successful investments for Kennox but recorded further significant increases after
Kennox has sold the positions as they no longer matched Kennox’s value criteria. The
most notable stock in this category was the Brazilian oil company Petrobras where
Kennox achieved a 100% return but the share has increased by a total of ca. 1,000%
since Kennox’s original purchase.
We gained the impression that Kennox did not attach particular importance to
individual stories of success or failure but treat each investment as a unique business in
a unique set of circumstances.
In conclusion, the stories told by Kennox during our interview and in their literature
demonstrate a strong culture of value investing. Many of these stories repeat or re-
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examine the key tenets of value investing and how these are incorporated into Kennox’s
processes and culture.
Paradigm
The paradigm at Kennox is well summarised the corporate motto: “True value
investors”. The team is small with one person dedicated to managing the operational
aspects of the firm and engaging with investors in the Kennox Strategic Value Fund. This
leaves two people dedicated to focus on managing the investment portfolio and
researching new potential investments.
Charles Heenan is the investment director and during our interview with him he told
stories of his formative career working for Angus Tulloch at First State Investments.
Heenan described Tulloch’s investment approach as eclectic but also commented that
Tulloch’s investment porfoltios always include a number of positions which can be
described as value investments. Tulloch has invested in the Kennox Strategic Value Fund
in a personal capacity and this investment is considered as almost an endorsement of
Kennox by Tulloch. Other prominent investors in Kennox include the investment held by
the noted value investor Peter Cundill before his death in early 2011.
In addition to the support provided by these “cornerstone” investors, the employees of
Kennox are investors in the Kennox Strategic Value Fund (Heenan’s entire investment
portfolio consists of an investment in the Fund) and also own the Kennox Asset
Management company. We believe that the ownership and investment act as further
confirmation of the employees to Kennox and the value investing approach. The
strength of commitment of the Kennox team and the support received from the
“cornerstone” investors supports a culture which allows Kennox to act in a contrarian
manner and maintain the focussed portfolio of around 20 shares.
The result of Kennox’s investment approach and the culture which supports that
approach is that Kennox has provided superior investment returns from the inception of
the fund. In our opinion the characteristic of those returns which provides the most
convincing validation of Kennox’s adherence to value investing is the outperformance in
falling markets. This is consistent with the objective of preserving capital which is one of
the important tenets of value investing.
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