John Thomson talks about the Scottish fund manager's approach to investing 49 bn of client funds
And he's off... John Thomson wants to talk about the future. Without giving your reporter a moment to pour the tea, crunch into the biscuits or even switch on the tape recorder, Standard Life's chief investment manager is busy pointing out the strengths and weaknesses of the 49 bn fund management operation over which he presides. 'We recognize that standing still in our existing markets is not good enough,' he says. 'We've got to continue to extend the product offering and the level of service to our external customers.'
Of course, Thomson's dissection of the failings of fund management at the Edinburgh-based assurance company is not as exciting as it initially promised. It rarely is in these situations - corporate speak soon takes over.
In a nutshell his message runs like this: we're good at life assurance and pensions products; we're pretty awful at other investment products such as personal equity plans and unit trust business. But we're going to get better and we've got a plan.
Thomson's plan involves training and recruiting those with expertise in the areas where Standard Life remains weak. There are no acquisitions involved: 'We have the resources and patience to build organically on a very strong investment operation,' he says. One option being looked at is hiving off the fund management operation into a separate business, creating its own investment brand. 'That's one possible route but we will consider many other routes.'
During this conversation we are sitting in Thomson's pristine new office in the Standard Life building on Edinburgh's Lothian Road. Very grand it is too. The fund management operation has only been in the new building for a few weeks but somehow images of the usual chaos of office moves seem out of place. Thomson does say that there were a 'few concerns' about keeping everything running smoothly, but it is hard to imagine that he was even forced to raise an eyebrow. His only comment is that perhaps he needs some more pictures.
Apart from these minor decorative complaints, Thomson has settled in quickly behind his new desk. Indeed, it was only a few months before the 'big move' that he was settling into the position of chief investment manager, taking over from Dick Barfield. Again, you cannot help thinking that he strode smoothly into the job without having to adjust his step. Mind you, some 15 or so years experience at Standard Life probably helped ease the transition.
Thomson now sits at the head of one of the UK's largest fund managers. The 49 bn is split into roughly 25 bn in equities and 20 bn in bonds, with most of the remaining 4 bn in property. The firm's UK equity holdings currently stand at around 2 per cent of the market, so when Standard Life speaks, UK companies listen. They have even been known to jump to attention when Standard Life bangs its corporate governance drum, but, in general, this fund management group answers the description of active investor better than that of activist investor.
Investment decisions begin with the house view, or current overall strategy, of the fund management operation. The view is formulated by regular meetings between Thomson, Ken Forman, the strategist, and the heads of the different asset class teams (see box). This group gets together on a formal basis once a month to review long and short-term trends and factors such as investment liquidity.
But those formal meetings do not set the house view in stone by any means. The same group also meets every morning to review the markets and see if strategy needs tweaking. 'We can change the view at any time during the month,' stresses Thomson. 'It's an evolving process.'
So does the 'house view' approach mean that Standard Life should be classified as top down? 'We're probably more top down than bottom up,' says Thomson, who then proceeds to wrestle with his own answer. 'But then the way it works is that the asset class teams develop their view on their markets and then feed them up to the strategist. That is probably more of a bottom up approach. The strategist puts the view together and then it gets fed back down. It cascades up and then cascades down again so it's a combination of the two.'
With the house view safely in mind, the group can concentrate its efforts on asset allocation. 'We look at all sorts of value measures which will vary according to different markets,' says Thomson. 'In some, that might be PE ratios and yields; in others, it will be more asset focused. Then we look for a dynamic overlay where we see what is happening to cashflow, the money supply, whether there's enough money in the system or whether, due to economic growth, there is a shortage of financial assets. All such things will be taken into account when we determine strategy at a high level.'
All of the asset class managers are feeding into this discussion process, which could lead to a few problems if everyone was feeling bullish on their own markets. That is where the strategist plays a key role again by weighing up the relevant attractions of different markets. The strategy group looks at equities, bonds, cash and currencies in all the major markets - UK, US, Germany and Japan - to reach 'light or heavy' decisions which are then fed down to the fund managers and entered into their cashflow.
'The fund managers have their benchmarks and can vary their funds according to those benchmarks,' says Thomson. 'Every fund has a specification which determines the risk associated with that fund. When we go light or heavy it's always relative to the benchmark,' he explains.
Fund managers in each team are then armed with the resources to start stock selection. Models used vary for each team. In the UK, for example, the equity team will typically look for inexpensive companies which they deem likely to be re-rated by the market. Methods of evaluating companies' value relative to the market differ across sectors but can include a look at PE ratios, net asset values, yields and the like.
That by itself is not enough to trigger a buy or hold decision, though. As Thomson points out, there is no point in just buying cheap stocks if there is never any reason for the market to re-rate them. 'There needs to be some sort of newsflow which will improve their rating by the market,' he says. 'That might be our anticipation of what will happen to profits, sector sentiment or some other factor. We're not just value investors. There's got to be some sort of growth expectation, something to take the thing forward, otherwise the stock will always stay cheap.'
Determining whether a stock is likely to move 'forward' is done through a wide variety of research methods. In-house analysts, broke reports, electronic sources and company meetings all have their part to play. Standard Life remains shy of the Web as a research tool - although Thomson notes that there was a request for a connection the morning he spoke to Investor Relations magazine - but he expects that position to change in the next year or so.
Company meetings do form a major part of the stock selection process, with two or three companies visiting the Standard Life offices every day to meet with the investment managers. Although he is not directly involved in such meetings any longer, Thomson puts great emphasis on the need for executive level communication between companies and their shareholders. His fund managers were recently voted as holding the best prepared one-on-one meetings in an independent survey of UK executives. And that comes as little surprise if the passion for communication which he evokes is emulated by his colleagues.
For the most part, Thomson thinks that corporate UK is good at communicating with its owners. 'Companies are generally pretty professional, they behave in a sensible and mature fashion. The situation over the last ten years has improved tremendously,' he says. 'There's no point in just going to see shareholders when you're in a bad situation. If we see managements on a regular basis it makes it far easier for them to come and tell us bad news about results or to talk us out of accepting a bid.'
Communication from companies does not necessarily have to come from the very top. Indeed, Thomson says that he and his colleagues are happy with the increase in the number of investor relations professionals. That eases the communications burden on chief executives, but CEOs should not interpret this as a justification for opting out of the process altogether.
'The chief executive has a duty to communicate with shareholders,' says Thomson. 'That's the CEOs responsibility. If he employs an investor relations manager or he delegates the job to his finance director then that's fine, let them do it on a day-to-day basis. But the chief executive has to be involved as well in meeting with shareholders.'
Thomson may be enthusiastic about good communication lines between companies and shareholders, but he warns that fund managers risk being caught between a rock and a hard place by the insider trading legislation. He understands that the government wants shareholders to take longer-term views on their investments by gaining a deeper understanding of, say, research and development expenditure, but warns that this can cause conflicts.
'If a company comes to us and says that in the next couple of years it is going to spend a lot of money on research and development which it hasn't done previously; or that it's going to spend money on acquisitions, that may make us insiders,' notes Thomson. 'The insider information legislation is very woolly. I'd like to see some sort of guidance issued by the stock exchange or some other authority which says, for example, that when a company is doing a regular investor relations roadshow everyone should assume that any information being disclosed is not insider information. At the moment we issue all companies which come and see us with a warning: we don't wish to be made insiders.'
Of course, the problem does not occur if information is widely disclosed to the market. And Thomson thinks that if UK companies were generally more open in their reporting policies then many of his concerns would be answered. He suggests that quarterly or short-term trading statements to make announcements about strategy might go some way to easing the problem.
'I think it's very useful to hear what a company's strategy is, what its longer-term plans are, what its vision is, what its key milestones will be over the next two or three years. That can all be very important to us and some companies just don't do enough of that visionary stuff.'
Corporate governance is not a box ticking exercise. That is the clear message from Standard Life, which takes governance more seriously than many of its peers in the UK fund management industry. The firm votes 'as a matter of course' at all shareholder meetings in the UK in which it holds a stake. It has made its own corporate governance guidelines available for public scrutiny. And it has even gone so far as to appoint a full time corporate governance manager.
'Corporate governance is something that we've been doing for many years,' says the corporate governance manager, Guy Jubb. 'But it's only since Cadbury came along that we had a label to attach to it.'
For Jubb, good governance is part and parcel of good investment management. (He draws a subtle distinction between 'investment' and 'fund' management.) And that existed at Standard Life long before there was any fancy term applied to it. Constructive dialogue with companies has long been the modus operandi.
However, after the publication of the Cadbury Report, Jubb says that corporate governance concerns were taking up more of the fund managers' time; and it was not always possible to be sure that everyone was singing from the same hymn sheet on certain issues. Something had to be done to answer the governance queries of both clients and companies in which Standard Life is invested.
The result was the creation of the corporate governance position in early 1993 which Jubb has held ever since. He is responsible for analyzing contentious issues and making decisions on voting policy in line with the corporate governance guidelines which were approved by the Standard Life board just over a year ago.
'When we started this we had the benefit of Cadbury,' he says. 'So we were not coming from a standing start. We were certainly well down the first furlong and possibly second time round the course.'
Jubb and colleagues may be well ahead in the corporate governance race but they are prepared to take their time over the hurdles as they appear on the horizon. This is where the aversion to a 'template' or 'box-ticking' approach comes into play.
'The guidelines are not a code. We take a firm but flexible line in terms of our relationships with companies,' comments Jubb. 'It is not prescriptive but it is not totally flexible. It is flexibility with a spine of firmness to it.'
The 'firm but flexible' approach covers five main areas: splitting the role of chairman and chief executive; remuneration disclosure; three independent non-executive directors; performance conditions; and one year service contracts for directors.
The penalties used against companies which do not meet the basic criteria range from having a word behind closed doors to voting against the company and public opposition. The latter approach is not used very often, though. Both John Thomson and Jubb think that - in most cases - a great deal more can be achieved behind the scenes than by fighting it out in public. The number of times that the press has been used to help wage a campaign against a company are few and far between. This is not a Calpers type of operation.
'When you take up a confrontation with a company it becomes a sort of macho thing as to who is going to win,' says Thomson. 'A lot of companies don't like to be seen losing out to faceless institutions, so it's not in their interests to have a stand-up fight. Far better to resolve things quietly.'