Purchase of Portfolio has left Edinburgh's Harry Morgan with task of trying to unite best of both groups' approachesEdinburgh multi-manager review
Intermediaries with clients invested in fund of funds platforms such as Edinburgh Fund Managers' Managed Growth portfolios have seen unprecedented management changes in the past six months.
What was for years a quiet area has been a merry-go-round with managers changing groups and new products brought to market.
Despite the apparent riches on offer to managers, Edinburgh's Harry Morgan has obdurately refused to be tempted back to London.
Even so, Morgan's role is set to change in the coming months, following the purchase by Edinburgh of Portfolio, the specialist fund of funds manager.
Mergers of the Edinburgh and Portfolio funds are likely to follow, Morgan admits, with the new combined service rebranded Edinburgh Portfolio. However, Morgan stresses continuity and evolution rather than revolution.
He tells investors in his £138m Edinburgh Managed Growth Portfolio and £3m Edinburgh Global Growth Portfolio, that the future combined investment process will be stronger than the current offering.
What is the current attraction of fund of funds?
When I started my career in 1983/84 fund of funds were completely out of fashion.
They were at the bottom of the league tables and they were expensive. Suddenly in 2001 everybody is talking about fund of funds again and that is because the good ones have performed well. They give you diversity and are quite tax efficient with the new complicated CGT regime that has just come in. You can rotate managers and style very easily within funds.
Press coverage means intermediaries are talking about fund of funds, markets are increasingly complex and there is massive regulatory change. Fund of funds therefore look very much more relevant than they have in the past.
Have you been tempted to leave Edinburgh for another company?
Clearly I do receive phone calls and have had a number this year but I am not interested in doing so because I genuinely believe that Edinburgh has got potentially a market leading service both in private clients and fund of funds. I'm content with my remuneration, I like my colleagues and I like the clients. I've been asked to come down to London by a number of people both in fund of funds and private clients, but I'm just not interested.
What is different about Edinburgh's service from the service offered by Rothschild Asset Management, or Hendersons, or Lazards, or Jupiter, or the new service from Credit Suisse?
I think there is scope in the market place for a number of products. I call all the recent movement the M25 effect. You build a road and massive extra traffic appears from nowhere. You have got big profile moves to Credit Suisse and Jupiter in particular but I don't think they will take business from us or other people. I think they are going to create genuinely new business. It's positive for all of us.
The only way to differentiate yourself is to have acceptable to strong performance. If you shoot the lights out, people will mistrust you. People have become wary of groups with spectacular numbers.
It tends to mean that they have a particular style which is in favour at that time. We are looking to be there or thereabouts the sector average. Consistent second quartile feeds through into long-term first quartile.
The strength, depth and credibility of the investment process is also key. A key part of that is the people that you have working with you.
Who is a member of the current Edinburgh private clients team?
Looking at the Edinburgh side, the team is myself, Ken Wilson, who is responsible for the day-to-day management of the Edinburgh Global Growth Portfolio, the smaller of the two fund of funds. There is also a full-time funds analyst called Craig Heron, who does most of our manager meetings. He's done about 70 in the past three months. He's outstandingly good.
We are a small team. The purchase of Portfolio will bring an additional depth of resources.
How do you cut down the universe of funds in which you invest to a manageable size?
We have two formal meetings every month. In the first we analyse and screen all the Micropal sectors; all the funds in the entire market place. Clearly, that is too many funds to manage. You have to distil that down into a core universe. Our core universe is very simply those funds which are above average over what we regard as the three key time periods, six months, one year and three years. It is incredible the extent to which that simple screen knocks out huge numbers of funds.
Apart from reducing the number of funds in the universe, how else do you use that screen?
There will be funds that were in the core universe last month but have had a difficult month and their six month numbers will not look as good. The screen identifies that.
Then we have to decide whether that is a serious problem. A classic example again is the Barings UK Growth. When it began to fall away we asked every month why it was happening. Do we understand why? Do we give it longer to turn the corner? But of course, the underperformance intensified as the growth theme intensified.
This successfully identifies from a quantitative standpoint the funds which are beginning to struggle. A good example of this is the Schroder UK Enterprise fund. In the months prior to us selling it, the screen continued to indicate the good long-term numbers but the short-term numbers were difficult. Aberdeen UK Blue Chip was another one. It is a very, very helpful screen.
What about positive uses?
We are always trying to identify funds which don't have three or one year numbers but have first quartile on a three or six month view.
That is where you can incorporate new issues, or funds that have shocking long-term numbers but a change of style or manager that makes them attractive. A good example here was the Credit Suisse Income fund, which as at March 2000 looked horrendous.
Then the style came back into favour and the manager made a few changes to the portfolio. When Bill Mott came back he gave it more of an Anthony Bolton deep value feel and a fund with a poor three-year number, month by month was getting better, which was a warning light that this was happening.
More important than the quant side of it is the qualitative side; the meeting the managers, listening to what they are saying, making sure that their rhetoric matches with reality, trying to get behind the performance numbers.
How do you deal with fund manager changes on the funds you hold? Can you give any recent examples?
Our usual strategy is not to have a knee-jerk reaction. So when Ashton Bradbury left HSBC for Hill Samuel we didn't sell the HSBC fund because there was a good number two coming in.
But with Richard Buxton's Barings UK Growth fund the issue is very much up for debate and it is very likely we will be coming out of that holding. It's let us down and we are not convinced that the number two, good guy that he is, is going to be able to turn that fund around. There are plenty of other available choices. We are looking at the Merrill Lynch UK Dynamic fund, which has a very strong team.
How do you decide on the asset allocation for the Edinburgh fund of funds?
The second monthly meeting is the investment strategy meeting where we sit down and look at the Edinburgh Fund Managers' in-house fund views. We also look outside Edinburgh at the best external views available, to come up with an agreed asset allocation.
We draw together a lot of information so we have a view on macroeconomics, on global growth, on interest rates and inflation and general markets direction. Which markets do we favour? Which style do we favour? We then apply that to the portfolios. It is a pragmatic approach.
The bulk of the assets you invest go into the UK markets. Do they take up the bulk of your time?
The Managed Growth Portfolio, which is around £135m in size. The UK element of that is around £75m to £80m. If we get the call on the UK market right we can add huge value.
On a quarterly basis, although this is to go monthly, we get up-to-date portfolio valuations from all the funds we hold, construct an enormous spreadsheet and the Edinburgh institutional quants team analyses it for risk, telling us the predicted tracking error for the UK component of the portfolio and what style and size bias it has.
We did very well from March 1999 to March 2000 when the TMT boom was at its height because we had holdings in funds like ABN Amro UK Growth, Edinburgh UK Small Companies and Dresdner UK Growth. These all had a strong growth bias and the tracking error on our UK component rose from an average 1.7 to 3.5. That told us the fund had potential to do very well or very badly.
What we did in September and October was to reduce the tracking error and rein in some of the bets to protect performance.
Which funds did you bring in to achieve that?
We switched Schroder UK Enterprise fund, which was running big weightings in second-line media stocks, which was not sensible, into Schroder UK Equity fund, which had an improving record and value bias. It added a lot of value.
In the US we bought Putnam US Income and Growth (US Value), which was a switch from the Framlington US Growth fund, which was struggling. A high growth style was just not going to work.
Finally we sold Fidelity Income Plus, which was actually performing quite well, and bought Credit Suisse Income, a move that has added enormous value. It alone has been accountable for a lot of our outperformance of the fund against the market in 2001.
Do you take that quants analysis down to individual stock holdings?
It allows us to go down to a very fine level. In the UK we are 68% in FTSE stocks, 21% in mid caps and just over 8% in small caps, with the balance being in cash. I know that if suddenly a massive momentum run happens in telecommunications, banks and pharmaceuticals and the FTSE is up then we are likely to underperform.
I don't expect that to happen but it is important to know where you stand. I suspect that some of our competitors have just got 10 cracking funds in their portfolios and aren't concerned with the underlying stocks.
This level of analysis meant that I knew at the end of April our Vodafone weighting was 5.6%.
I don't like Vodafone and was very worried about it. We have to hold it for benchmark reasons in the UK component but the analysis meant we knew we weren't overly exposed to it.
If we thought it was going to run and run and the Americans were going to pile in we could buy more of Deutsche UK Blue Chip.
Should intermediaries who bought into Harry Morgan be worried that the Edinburgh proposition will change beyond recognition now that the Edinburgh fund of funds business is going to merge with Portfolio?
Over a number of months we are going to synchronise the two processes into one which is absolutely top notch. The way that Portfolio have done things is different to the way that we do things.
However, there are a number of key commonalties. We have two meetings.
The first is a number crunching meeting and the second is a markets meeting. Portfolio have just the one at which they do both. I think between the two of these we can easily bring them together into a nice combination.
How aggressive do you go on price when dealing with the fund managers?
There's no getting away from double charging. We have to make a charge to cover our costs. Clearly the underlying groups have to do the same. My job is to reduce the double charging as much as we can. We are as aggressive as we can be with groups. Where the management fee is 1.5% we would expect at least 0.5% and ideally 0.75%. If an institutional share class is available we will go for that.
FUND MANAGER: Harry Morgan
Morgan is head of private client company at Edinburgh Fund Managers and runs the Edinburgh Managed Growth portfolios, which have around £140m of assets under management.
Under Morgan's tenure, the private client assets of Edinburgh more than doubled from around £160m, the size of the private client business acquired with the purchase of Dunedin in late 1996, to £330m in addition to the fund of funds assets.
He joined Edinburgh in February 1997 from the Royal Bank of Scotland Group where he was a discretionary private client manager.
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