Polar Opposites? A Fund Management Firm and an ETF

I read too much – an occupational hazard of a soon to be ex-academic. Although famed investors like Warren Buffett and Charlie Munger regard deep and wide reading as fundamental to sound investment decisions, too many ideas can spur too much trading.

I may have committed this error in recent days as frustrated by my current account turning from 1-2-3 to 1-2-1.5 I’ve committed a very small amount of incremental capital in search of yield.

To my surprise, my disparate reading prompted me to make my first ever investment in an ETF (to be discussed in a future post). It also alerted me to an intriguing test case of the value opportunity versus value trap question that haunts many investment decisions.

Another recent investment I’ve made is in the shares of Polar Capital  (LSE ticker POLR) a small(some might say ‘boutique’) fund management company. I can’t deny that the current yield of over 8% was a major attraction.
However the shares may be a longer-term recovery prospect with a clear potential catalyst for re-rating emerging in early 2017.

One of several frustrations of 2016 was the sudden departure of George Godber and Georgina Hamilton from Miton, and thus from managing their successful Miton UK Value Opportunities Fund, in which I’d invested with some success.

It quickly became apparent that they were headed for Polar Capital, although both had to serve long notice periods of 12 and 6 months respectively.

The recent interim results from their new employer confirmed that Georgina Hamilton will be running the new Polar Capital UK Value Fund due to launch in January with Godber joining in April.

It might seem rather speculative to base an investment case on two relatively young fund managers operating in a new institutional context. Yet not only is the macro-investment climate arguably more favourable to their style of value investing today than when they launched their Miton fund, there is more to Polar Capital than this new fund.

The steady decline in the Polar Capital share price from a peak of over £5.50 in early 2014 to just under £3.00 today mirrors a decline in assets under management, some of which stems from the relatively poor performance of a Japan fund, and related outflows, as well as “difficult industry conditions” in the first half of 2016 as the active fund management industry as a whole suffered outflows.

Yet according to the December 2016 results a number of the company’s funds, Biotechnology, Healthcare and the long/short UK Absolute strategy experienced inflows in more recent months.

Most of the Polar Capital funds are in the first or second quartile of their respective sectors since inception, and their Technology investment trust recently reported strong benchmark-topping results.

Admittedly the stated intention to hold the full year dividend for the current year at 25p (implying a 19.5p final dividend) may outstrip cashflow and the 2018 dividend could well come under pressure.

The interim results presentation describes the 2018 dividend as “expected to be defended, even uncovered" subject to: Evidence of return to growth and imminent EPS coverage anticipated; a strong balance sheet (although ‘strong’ is not defined) and there being no compelling alternative use of cash.
Reading between the lines potential investors should steel themselves for a dividend cut. But even if the 2018 full year dividend became 15p, this would be a yield on current share price of 5%.

Both profits and earnings per share in the half-year to September 2016 were down by around 20%, but the chief executive ended the interim results on an optimistic note: “Overall we have become somewhat more positive on the outlook for our business over the second half of the financial year.” In addition, although not at the forefront of my thinking, it’s easy to think of a number of larger fund management firms who are weak in the specialist niches (biotech, health, technology) where Polar Capital seem strong, making Polar Capital a possible takeover target.

So there is more to this investment than depending on the success of two ‘value’ fund managers to increase the underlying value of the company.

As ever, the following disclaimer applies: the above is an attempt to explain my investment strategy, not to be taken as advice suitable for anyone reading this site.