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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 3 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 4 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. 5 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. 6 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 7 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 8 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”. 9 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. 10 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 11 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 12 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. 13 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 14 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) 15 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. 16 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- 17 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. 18