The Sceptre UK Fund was up by 0.4% in September which compares to a rise of 1.7% for the FT All Share index. Over the 3rd Quarter the fund has returned +0.2% net compared to -2.6% decline in the FT All Share index.

These numbers fail to fully illustrate the high volatility that has been seen in the equity indices over the Quarter and the recent spike in historic volatility has been much less in the fund than in the FT All Share index. At the end of September, we make the trailing 90 day annualised volatility for the index 23.4% and only 13.5% for the fund. Whilst some of this difference was due to the fund having a cash weighting of between 15% and 20%, most was due to the individual stocks and overall portfolio being less volatile. We select our investments based on our long term expectations of future “real” cash flows, a tax efficient level of debt, real (tangible) net asset backing, shareholder friendly management team and a “margin of safety” that we believe allows us to buy at a large discount (30% - 50%) to our own calculation of “fair” value. We do not consider that volatility is a proxy for risk and historical volatilities of stock prices have no impact on the decisions we take to invest in a business but this does demonstrate that our concentrated portfolio has been much less volatile than the very broad index*.

Higher levels of uncertainty in the market, which manifests as higher volatility can give us opportunities to buy stocks more cheaply and during the month we have continued adding to some positions as stock price swings have allowed us a cheaper entry price. As a result of some large share price declines during the last few months we have identified a number of new opportunities in very good sectors, some well managed businesses whose prices are currently close to offering us sufficient margins of safety. We may never buy shares in these businesses if our price targets are not hit but we are patient and hopeful that we may be able to add to the portfolio at some stage. We have ended the month with over 15% cash which is available should the increased market volatility reduce the price of these businesses further.

Following the disruptions in the credit market, declines in US house prices and their knock-on effects, the chances of an economic slowdown are now much higher but further reductions in interest rates may cloud the issues for the equity markets and we will continue to veer away from any predictions on the likely direction of equity prices in the short/medium term. However, we are happy that, over the medium/long term good businesses can continue to make excellent returns on capital employed and, if we can buy these businesses cheaply, we can carry on making superior returns.

[* The calculations of historical volatility assume, as is the orthodox, that prices are log normally distributed – that the bell curve can be used to model price movements. We do not believe this is the case and acknowledge that large moves in equity prices happen a lot more often than this model would predict – precisely why we base our investment decisions on fundamental analysis of cash generation and balance sheets rather than volatilities. Failure to acknowledge this trait in markets has been responsible for the significant losses in a number of high profile Quant Funds during the Quarter.]

As always, if you have any questions about our investment approach or the fund, please let us know.

Chris Broadhurst
CEO