Talking to Barry Southcott and John Ainsworth about managing £31 bn in the wake of a merger
The merger of Lloyds Bank and TSB in 1995 created a new force in UK banking backed by one of the strongest high street presences around the country. It also brought together two relatively sizeable fund management operations under the banner of Hill Samuel Asset Management.
HSAM is now ranked in the UK's top 15 institutions by assets under management with some £31 bn in its charge. Barry Southcott, chief executive, claims that one of the groups strengths is the diversity of its asset base - roughly half comes from the retail market via the banks' distribution base; the rest is split between UK pension funds and other domestic and international institutional clients.
Some 48 percent of those funds are pumped into UK equity, making HSAM one of the largest holders of UK plc. It's particularly influential in UK small caps with around £1.5 bn currently pointed in their direction. But HSAM isn't just about the UK. Around 7 percent of total funds go into continental equity; 5 percent into North America; 5 percent into Japan; and 4 percent into Asia Pacific ex-Japan. The remainder is split between bonds, property and other investments, with as small a percentage as possible in cash.
John Ainsworth, head of global equities, explains that HSAM structures its decision-making process on a geographical basis, with desk heads with responsibility for the various regions - all of whom are based in London - getting together every week to discuss world markets and asset allocation options. 'On a global basis, we start at the top - equities, bonds or cash. The reality is, it tends to be an equity or bonds decision.'
Each desk head for, say North America or Japan is responsible for forecasting their own markets on a bottom up basis and then feeding this into the overall asset allocation picture. Ainsworth believes weekly meetings are crucial to developing decisions over a period of time: developing and talking through views about events which might only just be appearing on the horizon. 'If you meet every month or every quarter, it's a bit too long in between and you might have to make too hard a decision all at once. But with weekly meetings, you're thinking about what things might change in a couple of weeks time, starting to think you might have to become bearish or bullish - even if it's not fixed in your mind yet.' As he says, in many cases, you formulate decisions over a period of time and the frequent meetings give a chance to keep everyone informed and thrash out differences of opinion.
Hardened Views
These weekly get-togethers are formalized once a month with a smaller group meeting which makes the groups asset allocation decisions. It's a time to harden up the views which have been developing over the past four weeks rather than impose the will of the few on the committee across the group. But, as Ainsworth points out, somebody has to make a final decision on the relative merits of each market - otherwise everyone could be bullish on their own region. That final decision is down to the once-a-month asset allocation committee.
Peter Baxter, head of the life and pensions team, chairs the committee and has the final say if the team cannot agree. The team is made up of: Andrew November, a member of the Far East team and also responsible for asset allocation within the far east once an overall position for the region has been determined; David Kiddie, head of the continental European desk; Alan Boorer, responsible for emerging markets; Alan Brunsden, who runs UK life and pensions; Stewart Cowley, head of global fixed interest; and John Ainsworth, head of global equities.
The committee decides on the weightings for each region, the splits between asset classes and allocates accordingly. 'That decision is then taken forward into the various models,' says Ainsworth. 'We don't let people just go and do their own thing, we're quite controlled in that respect. For example, we have a global equity model and a balanced fund model and within that there is quite a range of different benchmarks.'
So if the committee decided the right risk profile for continental Europe was at say, 200 basis points overweight, that would then be applied to whatever benchmark the fund managers were trying to beat. There is no discretion within that decision. The lead fund managers would be asked to pull the whole list together and feed it back to David Kiddie in the continental European context or another desk head if it applies to other regions.
'We start at the top because we have to invest in world markets,' says Ainsworth, adding that you can't possibly decide on the merits of America or Japan unless you've got some views on those countries. Those views are driven by the geographic desk heads. 'Within markets and within regions, we combine bottom down and top up as well. You can't hang yourself on being too dogmatic about these things. Coming up with the right answer on things usually requires a combination of both.'
He points to the example of British Petroleum five years ago, arguing that many UK investors were assessing the company in terms of top down factors like world oil demand. 'That meant that most people completely missed the trick because what was really driving BP at the time were bottom up factors - management change and internal reorganization. You have to be very careful about being too much one way or the other. A lot of our internal efforts are based on what the important factors are and what is really going to drive the asset price.'
House Moves
The same level of flexibility and pragmatism is used to drive the stock-picking effort, according to Southcott and Ainsworth. There is no 'house way' of picking stocks across the globe since that would box them into one style - such as growth or value - and limit their options. It would also fail to take account of the different valuation ratios between, for instance, Japan and the UK.
'You have to be alert to the rules and sector of the market you're operating in,' argues Ainsworth. 'In the UK, for example, we don't try and reinvent the wheel. The UK's over-broked and there's more information than you could possibly read. Analysts are paid a lot of money to crunch the numbers and do all this work for you. There's really not a lot of value you can gain by doing you're own primary research. You can't get close enough to the companies anyway - particularly the big stocks. The value is added by interpreting the information you're being given and superimposing the economic view on top.'
He adds that for UK small caps it's clearly a different scenario. The research is poorer which means fund managers have to do a bit more work of their own. But it's generally easier to get closer to smaller companies - if you have the resources to devote to the task - than it is with the blue chips. 'It's the same sort of argument when you go to continental Europe,' says Ainsworth. 'It isn't a developed equity market yet - the quality and quantity of research isn't as high. Our European team do more of their own primary research and profit forecasts. For the US we treat it as a bit in-between (in terms of the split between in and out of house research). Japan is different again because you can't interrogate the companies in the same way - sometimess they want the questions in advance and often you have to do it through an interpreter so the questions have to be unambiguous.'
There may not be a strict house view for picking stocks across the globe, but there certainly is a level of consistency for the type of thing HSAM's fund managers-cum-analysts are looking out for. Ainsworth recites an arbitrary list to give an idea of some of the key parameters, including: the quality of the balance sheet, earnings predictability, quality of the management, the industry sector, the economic cycle. He qualifies this by pointing out it is always important to check whether an industry cycle is in tune with an economic cycle otherwise they could rule each other out in terms of likely performance.
Company meetings are very important to HSAM - whether those are one-on-ones in its offices in London or visits to company headquarters across the globe. Meetings with management are particularly important for UK small caps and in the US, continental Europe and Japan where HSAM's knowledge level about the companies may be lower. Ainsworth points out that there is often little value to be derived from too many meetings with UK large caps as long as things are going to plan, management remains stable and there is no change in strategy. He prefers to stick to one meeting a year in such instances, although he notes that the total number of meetings with UK blue chips has substantially increased from three years ago. 'The need for meetings becomes less frequent the larger a company becomes. You get to the point where with the very largest companies if things are going the right way there is a limit to the amount you can extract. It's about the degree of extra information to be obtained from a meeting.'
Armed with the information from primary research and interpretations from the secondary research, HSAM's fund managers are then charged with making the final decision as to whether a company is going to outperform the market. That is all HSAM is interested in, stresses Ainsworth. The fund managers don't compile a matrix and tick a number of performance indicators which might suggest that Company X is a good investment.
The whole rationale is based upon individual assessment of individual companies. 'All companies behave in different ways. What we say to our UK analysts for example, is, You cover the stocks, your view on this stock has got to be - Is it going to outperform the All Share? That is all we are interested in. If it's a good company - fine. But we do not want a good company that is going to underperform the market.'
In the UK, HSAM has developed a system whereby analysts express their view on a stock numerically - according to their judgement on whether it is likely to underperform or outperform the market. Thus, those viewed as outperformers may be awarded positive one, those likely to underperform, negative one. The database locks the view, logging the date of the recommendation and starts multiplying the view by the performance of the stock. Views can be geared according to how positive or negative the analyst/fund manager feels regarding its likely performance.
'The two key things we're focusing on with this system are direction and strength of feeling about those views,' says Ainsworth. 'We believe it's pointless saying a stock is going to outperform by eight or ten points over the next three months. How can you know? All our views are expressed relative to the market and they tell us what we need to know for our portfolios.'
Southcott believes that the point scoring system means that the fund managers are very careful about what they say on a stock. Everyone can see the judgement logged on the database and changing a view has to be carefully justified. 'The concept of buying and selling and taking profits and losses is not what drives the performance of portfolios, it's the relative performance against chosen benchmarks,' says Southcott. 'This process means that we only take a view when we've got a fairly strong view on a stock and that means we come out as fairly long holders.'
Inside Danger
Being relatively long-term and large holders in the UK small cap market means that HSAM regularly has to face the question of how to deal with the danger of inadvertently being given inside information. Ainsworth says that small cap executives often have less experience in this area, which can lead to awkward situations.
'If you're on your own with a chief executive then you only have one word against the other and in an environment where you tend to be guilty until you prove yourself innocent that can be a problem. For that reason, we don't let fund managers meet by themselves on our small cap team and, if possible, we try to have a broker present.'
Ainsworth is extremely reluctant to become an insider on large stocks but is prepared to waive this rule for some smaller caps when they are coming up to a significant deal. 'In a small company, it's different to large caps because quite often big deals are the only point when there's liquidity.' Becoming an insider prior to an announcement and putting a stop on the stock can give the chance to have a better understanding of a deal before it hits the market.
These different approaches to large and small caps also apply in some instances to its corporate governance attitudes. Southcott says that HSAM is generally a supporter of Cadbury, Greenbury and the like, but is not keen to see a tick box mentality foisted on companies. 'I think it really comes back to the culture and the ways in which companies approach corporate governance,' say Southcott, 'rather than look as if they've met all the requirements so everyone's going to be happy. You've got to judge every company on its merits; what's right for one company may not be right for another one.'
HSAM currently votes on all its UK holdings - usually in line with management unless there is a particularly contentious issue. 'We start from the view that it's the job of management to run the company, it's our job to interpret their actions on the share price. Clearly we have some large investor obligations on that sort of thing,' says Ainsworth. He adds that corporate governance can be viewed in two ways. First is ensuring that a company is well run in the interest of shareholders; second is becoming an activist shareholder along the lines of Calpers in the US. HSAM is happy to fulfil its obligations in the first element but believes that proactively seeking change is not part of its job.
'We take the view that if you want to get involved in that type of activity, you shouldn't be holding the company in the first place.'