In this paper we talk to Thomas Moore of Standard Life Investments. He manages their UK Equity Income Unconstrained Fund and Income Trust.
Many books have been written by ‘financial gurus’ which encourage the reader to believe that anyone can invest money (and make money). As an aftermath of the 2008 global crisis it was (possibly) easier than ever for investors to make money.
There is a strong argument that 2008 was a unique point in investment history where everything was so beaten up that to make money was very easy. Now as we return to a ‘new norm’ making money is much harder.
If we step away from the crowd, money can be made but like everything it is about identifying the right stock. Investing in Woolworths because it was cheap doesn’t necessarily bring success. As we have seen with the likes of Tesco’s there is much more to a stock than meets the eye and the reality is that for most people it is much easier to allow an expert to choose the investments.
This in itself brings challenges. How does an investor choose the right fund? Investment houses tend to promote their star funds, or last year’s success and for investors it is very easy to invest based on last year’s performance.
The danger of a star manager is all too apparent when that manager leaves because the fund is their fund and without them what happens?
At shiniglights.co.uk we catch up with some of the leading managers in the industry to understand how they approach investing.
In this paper we talk to Thomas Moore of Standard Life Investments. He manages their UK Equity Income Unconstrained Fund and Income Trust.
Shininglights.co.uk: “Going back to a young Thomas in your teenage years, did you always want to be a fund manager? If you did what route did you take and when did you first assume your first management role? If you didn’t why did you end up in fund management and again what route did you take and when did you first assume your first management role?”
From an early age I have been fascinated in analysing trends – as a small boy on train journeys I would keep a notebook recording how many passengers alighted at each station and on long car journeys I would record the popularity of different car manufacturers. Building up a notebook of statistics allowed me to spot any trends or anomalies that would develop over time. This curiosity for numbers lent itself into an interest in economics and markets and I made my first investment in 1989 at the age of 13 in the privatisation of Thames Water. This gradually developed into a full portfolio of individual stocks, with varying degrees of success and a lot of learning by doing. Food producer Albert Fisher (now extinct) was probably my worst investment, teaching me that even the most defensive of businesses isn’t truly defensive if the balance sheet is over-stretched (a lesson that helped me avoid Tesco more recently!).
Whilst studying Economics and Politics at Exeter University, it dawned on me that fund management would suit my skills well and I decided to apply for various graduate trainee positions. I joined Schroders as a graduate in 1998 before moving to Standard Life Investments in 2002.
Shininglights.co.uk: “With over 15 years’ experience in the industry, what motivates you daily, yearly and for the long term?”
What motivates me most is that as part of a successful team, I am a steward of our clients’ hard-earned capital. By delivering an attractive stream of growing income and capital, I can make a real difference to people’s standard of living in their retirement.
Any data analytics tool will highlight the enormous gulf in total return (i.e. income and capital) between different UK Equity Income funds over 3 year and 5 year periods. We are right up towards the top end of our peer group over these time periods and this means we have achieved what we originally told clients we believed we could achieve. I can go back to those clients who had confidence in our process, look them in the eye and tell them how we have done it and why we believe it is repeatable in the future. They tell me that it is making a difference to their clients and that gives me a real buzz because it brings home the human impact of what I am doing day to day.
Shiningligts.co.uk: “You entered the industry just after 1998 surviving the technology bubble, 9.11, the global financial meltdown and near collapse of Europe (although this is not necessarily over). Going back over your career can you think of any major mistakes you made, what you have learnt and how has this been used to mould what you do today (and going forward)?”
You are right that it has been a rough ride for equity markets since I joined the industry in 1998. At Schroders I sat alongside some really big names. I watched some careers being wrecked by the Tech Bubble – ironically it was often the people who (correctly) resisted buying over-valued tech stocks whose careers came to abrupt end. This reflects a tendency in the industry to focus too heavily on short-term performance relative to the benchmark, which can often drive bad decisions (both at the investment level and the commercial level).
A lot comes down to the culture of the management team at a firm – we are fortunate at Standard Life Investments as investment people remain right at the heart of the culture and there has been a conscious effort to get the right balance between investment people and commercial people. When investment markets become stressed and time horizons shorten, the benefit of having investment people at the heart of the culture becomes more evident as it prevents bad decisions being made based on short term performance grounds.
Avoiding short term thinking doesn’t mean that fund managers should be allowed to ignore risk. Portfolio construction is an important skill that sits alongside stock selection. Backing one’s conviction at the stock level does not need to be at the expense of risk management and it is by leveraging some of the in-house risk tools at my disposal that I have sharpened my portfolio construction skills in recent years. The satisfaction that comes from continually learning and improving comes in a year like 2014 (when the FTSE 100 was down) when the fund outperformed the peer group against the popular perception that an unconstrained approach implies higher risk.
Shininglights.co.uk: “How would you describe your style of management? The industry talks about value managers, growth mangers, contrarians etc. For the average investor what does this mean? And how does your style make you stand out as different in the market?”
Our approach is called “Focus on Change” – it is based on our belief that share prices respond to changes in fundamental drivers where these changes have not yet been priced in by the wider market. What unites all the stocks that we invest in is that they are change situations where we have an “angle” or “difference from consensus”. By focusing on changes in fundamentals, we avoid over-concentration in stocks of any particular style such as growth or value, each of which comes in and out of style from year to year.
Shininlights.co.uk: “Many commentators say that the global financial crisis was a unique event, and a game changer going forward. Particularly as we don’t know the consequences of QE, how long we will remain in a low interest environment etc. If this is the case then everything we have learnt about investing goes out of the window because we just don’t know what will happen? There is also an argument that any manager could make money in the last five years, however going forward only the good managers will shine. What is your view, and do you feel you need to adapt your style to reflect this new environment?
Liquidity remains plentiful across the global financial system, most recently driven by the announcement of further unconventional monetary policy measures by the European Central Bank and Bank of Japan. Quantitative easing is designed to inject liquidity into the real economy as central banks acquire bonds from investors at low yields and encouraging them to reinvest the proceeds into higher yielding investments. The result has been a downward shift in yields across different asset classes, including riskier assets such as Real Estate, Credit and Equities. As the US and UK economies get closer to reaching self-sustaining recovery momentum, the time will come for monetary policy to tighten, but the pace of interest rate hikes in these 2 economies will be constrained by the actions of central banks that are still easing. No economy is an island, as any central bank that tries to go it alone by hiking interest rates will be immediately whacked by a flood of capital inflows and a strengthening currency.
These macro themes have also permeated equity market behaviour at the sector level. As an example, consumer staple stocks have performed well in recent years, driven by the global rotation towards bond-like defensive growth stocks. Funds that have been heavy in these sectors have performed well, but there will come a time with this style goes out of favour, probably linked to a reversal in macro trends (e.g. bond yields heading north). At this point, it will become clear which funds have been over-reliant on macro-driven style drivers.
Shininglights.co.uk: “For personal investors we have seen the collapse in share price of banks and now supermarkets, does this highlight that without the research it is much harder for them to invest directly in shares?”
Information is more freely available than it ever has been and individual investors may have views on individual stocks, but without systematic coverage of all stocks and sectors it is difficult for individual investors to take a holistic view on which parts of the market offer the greatest opportunities for total return.
Buy and Hold is often deemed to be a low maintenance form of investing, but this pre-supposes that the same stocks will offer consistent returns year in, year out. I suspect that 9 out of 10 individuals would have perceived Centrica and Tesco as safe investments a few years ago, yet these same companies have recently cut their dividends. Many individual investors were shocked by the performance of Lloyds or RBS during the Great Financial Crisis, partly because events unfolded so quickly.
Shininglights.co.uk: “There remains an argument that active fund managers particularly in the US rarely over the long term outperform the index. For personal investors looking at funds what do you feel they need to look at both from choosing active over passive, and more importantly looking at the investment style of an active manager?”
Investing in passive funds means being exposed to all sectors at all times. This may be fine at times when there is little sector dispersion, but there are pitfalls to this approach. Consider owning a passive in March 2000 when the Tech sector was riding high or 2007 when the Banks sector was riding high or 2010 when the Mining sector was riding high or 2014 when the Oils sector was riding high. Passive funds force the end client to be fully exposed to the riskiest sectors of the market at the worst point in the cycle when their sector weightings are at the highest.
While many active managers do not justify their active fees, a good fund selection process will quickly weed out the weaker managers, based on qualitative factors such as research resource and process and quantitative factors such as the consistency of risk adjusted returns. Strong managers will have the courage of their conviction, being confident enough to take stock and sector positions that deviate significantly from the index, while cognisant of the risk implications of their actions. Having witnessed active management adding value at Standard Life Investments, I am confident it can and does work given the right resource and process.
Shininglights.co.uk: “Connected with the question above. Some funds have become victims of their own success where the size of assets impact future returns. Do you believe size can be a problem or that a good manager can deliver consistent outperformance over the longer term irrespective of the size of their fund?”
Fund size will dictate what range of stocks a fund can invest in by market capitalisation. There are many interesting stock opportunities among under-researched small and mid cap names, so this is a fertile hunting ground for fund managers with sufficient research resource and process. Fund managers whose mandates allow investment in small and mid cap names will tend to want to retain the ability to invest at this end of the market, which argues against their funds becoming too big.
This said, the UK market is very broad, so the range of investible stocks is rarely an impediment to finding good stock ideas. It is also important that fund managers use their time efficiently, so there is little point in a fund manager doing the work on a micro-cap stock of £50m market capitalisation if liquidity is insufficient to allow them to build a meaningful-sized position.
Shininglights.co.uk: “Short-termism remains a problem, investors want returns quickly and in reality they sell when the market is falling and buy when the market is rising. How long should investors look to hold investments and what would be your best tip to investing.”
While animal instincts urge human beings to jump onto bandwagons when times are good and jump off bandwagons when times are bad, it is worth remembering that the stock market is highly efficient at discounting news flow (both good and bad news flow), so the key is to remain focused on the change in fundamentals rather than the actual fundamentals. Euphoria results in investors tending to buy good news situations when valuations are already high, inhibiting future returns. Pessimism when times are tough tends to discourage investors from building holdings when valuations are low. Looking back, the doom and gloom in March 2009 made investors over-cautious about investing in the stock market, yet this was the point at which the news flow could not get much worse and the change in fundamentals was beginning to turn less negative. There is a stock market axiom that markets don’t top out on bad news and they don’t bottom out on good news. By the time the newspapers are reporting on boom times again, the market will almost certainly have peaked out.
Shininglights.co.uk: “Finally, with a crystal ball to the future (which of course we don’t have), what do you feel are the challenges facing investors, and in reality do you think these have changed or will change?”
I see the biggest challenge facing investors as the widespread herd-like mentality that drives fund managers into the same stocks and sectors across different portfolios, which is linked to the reluctance of fund managers to move away from the index. The heavy concentration of the UK market to a handful of stocks could lead to a situation where multiple income funds will suffer dividend cuts from some of their core holdings at the same time. Dividend cover is falling in sectors such as Oil & Gas and Pharmaceuticals due to deteriorating fundamentals in terms of earnings and cash flows. Some of the drivers for these sectors are inherently difficult to predict (e.g. the oil price) which argues for avoiding these sectors and focusing on stocks and sectors where greater conviction can be held and therefore the risk of a dividend cut can be minimised.