Stephen dolbear, manager of F&C's HIgh income Plan, succeeds by investing in derivatives as well as equities and bonds
Foreign & Colonial is not noted for being a high profile unit trust player but its Higher Income Plan is one of the best known funds in the market.
The portfolio, which aims to provide investors with an income 2% above UK base rates, has been run by Stephen Dolbear since 1995. Dolbear, who has a background in equity derivatives in the investment banking world, runs a portfolio comprising not only equities and bonds but derivatives too.
In addition to his role as a fund manager Dolbear is head of the growing derivatives capability at the group. His team has a key role to play in product development, including hedge funds, and distribution on the continent.
What is the percentage breakdown of Hip at the moment?
By percentage of NAV we have 30% in a FTSE 100 tracker with the rest in sterling denominated bonds and cash. This is because fund has three sets of rules it has to abide by: Ucits, Pep and Isa and its qualification as a bond fund.
But the risk of the fund is different. When the markets reached their recent lows the equity exposure reached 45% but as the market has rallied the equity rate has dropped to 30% with 70% exposure to cash-like instruments.
What is the difference between this percentage exposure and economic exposure?
This is the result of the derivative overlay we have on the fund.
Are you happy having 30% of the fund tracking the FTSE?
The index has not been doing well of late and there is a feeling that large companies are not necessarily good quality ones.
I am more convinced now than two or three years ago that it is a superior investment portfolio as it is less concentrated with single names. It is a far better portfolio now than it ever was when the index was at its peak.
In the past the fund has also had some reasonable weightings in foreign indices. So out of this 40% equity exposure maybe 30-32% is from the FTSE and the remainder is from foreign markets such as the S&P 500 and the Dax.
Could you talk about the breakdown of the bond element of the fund in more detail?
Today we have got about 10% of the fund in structured bonds and 60% in normal bonds and cash instruments. That means money on deposit, corporate bonds from well known British names and gilts.
Surely these corporate bonds are giving you exposure to the same stocks as you have via the FTSE tracker. Isn't that concentrating risk?
The bonds give us exposure to the credit risk of these companies. There is a positive correlation between credit spreads and the direction of the FTSE. If you and I agree that the yield curve is a bad place to have money then I couldn't move out as it would break the bond fund regulations.
These structured bonds look as if they are made just for you. Is that right?
Someone like the European Bank of Reconstruction and Development will structure one if you go and ask it.
It is probably not that common with unit trusts but it is for other types of portfolio. There will almost certainly be an investment bank intermediary. These issuers have an ongoing MTN issuance programme.
What is the minimum an issuer will make up a bond for you?
Probably around $10m. It is not just the European Bank that does this. We have Tesco doing this for us in the portfolio at the moment.
Hip has changed significantly over the years do you have any further plans to alter the underlying structure of it?
Seven or eight years ago I came on and knew what I wanted the portfolio to look like. That took a couple of years and then this process got derailed as the chancellor changed the rules on advanced corporation tax.
We had to have a unitholder meeting to put in place complex changes in the fund to maintain the tax efficiency of it. That was the last big evolution that will really happen. I don't anticipate any changes on that scale although obviously if the tax laws change, or something like that, it would be a different matter.
That said we are always looking to keep the fund outperforming so we are always looking at new ways of trading but it is not major evolution.
This fund used to make a great deal out of trading volatility. Do you still do this?
Yes and it is still an important part of excess returns but it is not as important as it was several years ago as we have successfully replaced some of the sources of excess return away from volatility towards other types of trades which are, by design, more independent of the level of the market.
During the Asia crisis the fund fell sharply because of its exposure to equity markets and equity market volatility. In the current downturn, because of the greater diversification it hasn't fallen as far this time.
How difficult is it to explain what you do to investors?
When it comes to equity volatility it was a bit of a 'trust me' product at first. But I have been running this fund since February 1995 and I have a track record which covers the full range of market conditions we have seen and each time it survives a little better due to the evolution of the fund.
How is the role of the derivatives desk at F&C changing?
It is the centre of derivative expertise for F&C as it was three years ago when Hypovereinsbank owned us. Under HVB we were getting a massive amount of new business in reasonably simple products from HVB.
Now our greatest source of new business is a different type of fund, the F&C Stiftungfonds or charities fund, which is sold through the HVB branches and from August is being sold direct and through other networks as well.
The two key differences are that it will have an F&C label on the fund and it is not just being distributed through HVB branches. HVB used to own-label our products but then it wanted to go multi-manager. So now we have a good relationship with them and are able to get the name F&C into the marketplace.
We have sold maybe E150m of the Stiftungfonds in nine months. It has a similar risk profile and investment aims to Hip but set up for the German tax regime.
How has your revenue base changed as a team?
The percentage of assets managed by the desk was 70% Europe and 30% from the UK under HVB with revenues more along the lines of a 50-50 split. Now we are drifting towards more of a parity in terms of assets under management split while the revenue divide remains the same. We have less volume of German business but we have replaced it with Stiftungfonds which has a higher margin.
Have you got plans to launch more derivative-based funds to the UK market? You already have Hip, With Prospects and Blue.
As a desk we are always considering what product could be best offered to investors. We spend a quarter to a half of our time supporting existing funds and looking to develop new products.
Does the desk have any institutional business.
We have no such mandates and no plans to develop such products.
At present Hip is offering income 2% above base rates. Is that sustainable?
We are happy that is achievable.
Is that the case, even if there is huge and growing demand for bonds, pushing yields down further and further?
There is speculation in the marketplace that Boots is looking to sell out of bonds and move back into equities. I think most valuation experts would say equities are looking cheaper compared to bonds. If you ask me whether I am worried that people will sell equities and just buy bonds then the answer is 'no'.
There is a continued appetite among investors for structured products. As an expert in derivatives, what is your view of them?
The basic rule is the more complex a product is, be in attached to an index, a group of indices or a group of stocks, the higher the transaction charges are. At the end of the day an investment bank has got to hedge those risks out. So complexity does not necessarily go hand in hand with value for money.
A second point is that the more complex it is then the less likely the man in the street will understand what he has bought.
What other factors are there that should be taken into account?
Unlike a collective investment such as Hip, it is not clear what fees the investors are actually paying to hold the product. It is not just about the cost of intermediary commission there are also profit margins for the insurance company and then for the investment bank.
In a lot of these products investors are totally unable to take a view on whether they are receiving a good price for the risk they are taking. The product might offer them 8% a year but how are they to know whether for the risk they are taking they should be demanding 15%?
All the back-testing that is done contains a sample bias because if you pick 30 stocks for back-testing they will all have been survivors up until now. It never picks up the Marconis or the WorldComs.
Some of these products are actually increasing risk to investors. If you pick big companies across a broad range of industries then if one industry goes wrong then it is quite likely that individual stock could be in trouble.
What is your view of products based on the performance of a group of named companies rather than an index?
To make the headline rates to investors as attractive as possible it is sometimes profitable to choose a group of names rather than the index itself. So if the index can give you 8% pa this group of 30 stocks might be able to give you 11%. So it helps them to sell more.
We have had a really difficult three years in the market. What are your views on how cheap equities are at the moment?
Based on the previous relationship established over the last 20 years it is quite clear equities are cheap relative to bonds. Equity markets are priced to give a future risk premium of somewhere around 3%-4% pa over cash going into the future. In the long term, equities are reasonable to cheap.
How difficult is the market to call at present?
Right now the market is really very technical and it is very high risk. In 20 years' time it will be fine but you are not going to get your timing right buying into it, volatility will see to that.
There are key issues that need to be resolved: accounting, the need for institutions to sell equities, any effects on consumer confidence. When these start to become clearer then it will be safer to be in equities. You might be paying more for equities then but it will be a lot safer.
Are hedge funds causing all the current market volatility?
For the market to be healthy it needs a range of market participants providing risk capital to provide liquidity to the market. In the old days it used to be that a significant part of the risk capital came from the market makers. Over the years they have tightened up their limits and now provide less and less risk capital, which is effectively the oil needed to keep the market functioning.
The new participants providing that oil are the hedge funds. The hedge funds are helping to push the market where it should be, either up or down.
If there is not risk capital then the markets will become more volatile not less. Liquidity is essential for smooth operating and functioning of a market.
The covered warrants market is taking off in the UK. How do you view it?
It is just another instrument we would consider using if there was the opportunity to get excess returns for using it. But we would want to see liquidity in them before we use them.
Is your derivatives group going to launch hedge funds?
Our chief executive officer Bob Jenkins said six to nine months ago that we would be entering the hedge fund market and we are now working towards that. We are still deciding the structure of the hedge funds business within the Eureko group.
FUND MANAGER: Stephen Dolbear
June 2002: Assets under management for F&C derivatives desk reach £2.2bn
28 February 1995: Joined F&C as head of derivatives desk and named manager on Higher Income Plan. £600m under management on derivatives desk.
1991-95: Swiss Bank Corporation ' equity derivatives operation.
PhD in computational fluid dynamics
Member of the executive committee of the Financial Option and Research Centre, Warwick University. This researches the risk and pricing of financial derivative contracts.
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