MAY 2012 Conviction breeds success
How does an asset manager create the right environment for funds to outperform? Liontrust says it comes through having the right culture and distinct and robust investment processes
ANTHONY CROSS
Fund manager, Liontrust
When a football club pays tens of mil- lions of pounds for a centre forward with a track record of scoring goals, they would naturally expect him to con- tinue to produce this form at his new home. There have been notable exam- ples, however, where forwards have failed to live up their previous reputa- tions. There can be multiple reasons for this, including a new living and work- ing environment, a new set of team mates playing to a different system and a lack of decent service or support on and off the pitch from the other players. The same can happen with fund managers. How a fund manager per- forms is not just down to the talent of the individual or team but also the cul- ture and environment in which they work. Creating the right culture for fund managers to perform has been a central tenet of Liontrust since the com- pany was established in 1995. At the heart of this culture, Lion- trust says, are the proprietary invest- ment processes that each team applies to the management of their funds along with creating an environment in which fund managers can focus on running money and not get distracted by other day-to-day aspects of running a fund management business, particularly administration. For example, Anthony Cross, who co-manages Liontrust UK equity funds with Julian Fosh, works from home. “I am away from the noise of the City and the office. I can concen- trate on fund management in a quiet environment. It makes an enormous difference to my productivity.” Another aspect of the Liontrust cul- ture is that the managers invest in funds they run, which the company argues shows a belief in and a commit- ment to their investment processes and fellow investors. In return for providing a culture that gives fund managers the freedom to manage their portfolios according to their own investment processes and market views, Liontrust requires fund managers to document their investment process.
Cross, who applies the Economic Advantage process to the management
of the Liontrust UK Growth, Special Sit- uations and UK Smaller Companies funds with Fosh, argues that there are a number of advantages for Liontrust, fund managers and, most importantly, clients in documenting investment processes. “Liontrust believes invest- ment processes are key to long-term performance and effective risk control. These processes must be robust, scaleable and repeatable.
“As processes are documented, clients know exactly how we manage money and therefore the fund or port- folio in which they are investing. Thus, fund managers are justifying what they do and why to our investors. The way we manage money at Liontrust is pre- dictable. This aids clients’ own processes of blending our funds with others in their portfolios.”
As well as Economic Advantage, Liontrust applies the Cashflow Solution process (James Inglis-Jones and Gary West), the Asia Process (Mark Williams and Carolyn Chan), and the Macro-The- matic process (Stephen Bailey and Jan Luthman), to the management of its fund range.
Cross says that documenting an investment process and then having it reviewed by other managers at Lion- trust is a good discipline to go through. Articulating a process in detail makes fund managers review all aspects of how they manage money.
He adds that investment processes also act as a form of risk control on fund managers. “Staying true to a docu- mented process helps to create an in- built risk control, especially in environments that are more challeng- ing for our processes, by preventing us buying stocks for the wrong reasons. “There is an acceptance that no process will work 100% of the time. But there is also an understanding that robust and good processes have the potential to deliver excellent long-term returns punctuated by short-term peri- ods of underperformance.”
Take Economic Advantage as an example. The managers start with an investment philosophy. Cross and Fosh believe the key to successful investing is to identify those few companies that have a durable economic advantage. “This allows companies to sustain a higher than average level of profitabil- ity for longer than expected. This sur- prises the market and leads to strong share price appreciation.”
Cross defines economic advantage as the collection of distinctive characteris- tics of a company that competitors strug- gle to reproduce. Cross says the hardest to replicate characteristics are intellec- tual property, strong distribution chan- nels and significant recurring business. A company must have at least one of these characteristics to be included in funds managed by Cross and Fosh. Occa- sionally companies have all three. “Intellectual property can be found in pharmaceutical and software busi- nesses and a lot of world beating manu- facturing companies that are listed in the UK,” says Cross. “Intellectual prop- erty may be built up over many years through a commitment to research and development, is often legally protected and can enable companies to protect their pricing power.
“Strong distribution networks are powerful in terms of the local knowl- edge and service they give to their client base. Such physical distribution net- works are difficult for competitors to replicate in the short term. The other type is an electronic distribution net- work that features in some media com- panies, software businesses and financial companies.”
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Cross says businesses with high recurring income, which is defined as at least 70% of annual turnover, are attractive because not only does the stock market value their earnings stream more highly but they allow man- agement to think more long term and strategically. Many companies with high recurring income are in the finan- cial and software sectors.
The way we manage money at Liontrust is predictable. This aids clients’ own processes of blending our funds with others in their portfolios
The other intangible strengths Cross and Fosh look for in companies are franchises and licences, customer data- bases and relationships, procedures and formats, culture and brand. Cross and Fosh construct their port- folios from the stocks with the most com- pelling economic advantage taking into account the current economic conditions. Each company is then graded for finan- cial and industry risk and valuations. If a company within their portfolios retains its strong barriers to entry, Cross and Fosh will hold it for the long term. Cross says: “You need to get to know a business and you can’t do that if you are constantly changing.” Liontrust has built a distinct culture based on having the courage of its con- victions through its investment processes. Lion-hearted indeed.
FUND PROFILE
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