The manager of the AA-rated UK Blue Chip fund outlines the scoring system he uses to judge the 350 largest companies in the UK
Investec UK manager Jeremy Rigg is so confident with the rating system he has built for judging equities that he rarely makes company visits.
Rigg, who has run the Investec UK Blue Chip fund for just over three years, says he can hardly remember the last time he visited a company.
Last month, S&P gave the fund an AA rating and assets under management now stand at £51m, in part because the Hargreaves Lansdown UK performance fund was merged into it in May this year.
Over three years to 6 June, the fund is ranked 32 out of 245 companies in the UK All Companies sector, delivering returns of -19.3%, compared to the average of -29.3%. Over one year, it is ranked 19 out of 293 companies, with a return of -8.1%, compared to the average of -13.2%, bid to bid.
Portfolio construction is based on Systematic Idea Generation Matrix (Sigma), an in-house database that tracks factors identified by the team as the key drivers of share price performance. This produces a shortlist, which the UK equity team uses as a foundation for extra research and then portfolio construction.
How does the investment process work?
First of all it is worth noting the investment process adopted for the UK Blue Chip fund is the same as we use for our global equity funds.
Our UK Opportunities fund operates the same process and is a more concentrated and thus higher risk/reward offering. At its simplest, we look for one type of company to invest in and one type only. We have identified four factors that drive share prices over time and we believe that a consistent bias towards companies that exhibit a positive and attractive balance of these factors will provide excess returns for our clients.
They are: strategy, which covers the extent to which a company has been able to generate wealth for shareholders; valuation, which measures the gap between 'fair value' and the current share price; dynamics, which is a measure of the improvement of current operating performance; and technicals, which focuses on the share price itself to identify trends that can be exploited.
There are two stages in our process. The first is quantitative. We have designed a proprietary screening tool that we call Sigma. It allows us to systematically rank all of the companies in our investment universe according to these four factors. Crucially, it is completely objective in its analysis, providing us with a league table of investment ideas ranked in order of preference.
The second is the qualitative stage, where we do further due diligence on that quantitative screening output. This determines which companies go into the portfolios.
When we established the investment process, we were very clear that we wanted something systematic, very disciplined and repeatable.
How does this all fall into place?
Essentially we carry out this process once a week. It manifests itself in one single document, which ranks all stocks on these four key factors, which at a stroke does the heavy lifting for us.
Basically, all stocks go into the melting pot every week and all come up with a score every Monday.
The scoring system is very straightforward. Each of the four factors score one to four, so we have a minimum score of four and a maximum of 16.
We are looking to focus on companies that score highly, for example the 13s and 14s.
Of the 350 companies in our core universe, there are probably 150 to 200 companies that we are not interested in because they do not score well on our four factors.
So having got this screening output, which is produced every week on a Monday, we sit down on a Tuesday and construct an agenda of companies that we need to look at more closely as an investment team. Basically, we are already focused on the very best investment opportunities.
There are three types of company we are interested in looking at more closely. These are high scorers that we don't own (our cut-off for high scorers is 13), low scorers that we do own (cut-off is companies scoring less than 10), and fast movers, where the score is improving or deteriorating quickly. That might be interesting information and might throw up interesting opportunities. Generally we come up with four or five companies each week we might look at more closely.
Have you missed any good opportunities since introducing this system?
We have and we will miss many more good opportunities. There are plenty of companies that don't score well on our factors, that do go on to perform well. But that is totally irrelevant to us. All we are interested in is having confidence that this system and approach that we adopt will deliver our performance targets.
What kind of fund is UK Blue Chip?
The fund is designed as a core holding to provide exposure to the UK equity market with the intention of gradually building outperformance with only modest risk by comparison with the benchmark index.
The Investec UK Blue Chip fund typically invests in around 45 stocks selected from the UK's 350 largest companies. It focuses on the constituents of the FTSE 100, but also looks further afield for medium-sized companies that look set to be the success stories of tomorrow.
Do you have index risk constraints in place?
Yes, we do have risk constraints for the UK Blue Chip portfolio. We have controls at stock level where we will not deviate more than 3% overweight or underweight and at sector level where we have created five super sectors and have controls set at plus or minus 8%. Finally we have a target tracking error against the FTSE All-Share index of 5%.
These controls are designed to help us deliver on our aims of producing steady outperformance. This fund is designed to be a core holding for long-term growth.
Have you ended up with certain themes?
We do not have any macro economic or top-down overlay when we construct our portfolio. Therefore any sector or thematic biases that are evident in the portfolio are a by-product of the bottom-up stock selection.
A good example is that over the past two years we have been consistently overweight the UK house builders. This is a result of them all scoring well on earnings revisions and being attractively valued. They score well on strategy because they create a lot of value, and the share price trends have been very positive. That has driven us to be very overweight house builders. We have had big overweights in the likes of Barratt Development and Bellway.
Our overweight position is not due to some sort of view on the direction of interest rates, how many houses are being built and so on. It is purely being driven from the bottom up.
Where else do you have a strong bias?
A good example of an area we have moved into recently is telecoms. Back in September/ October last year we were somewhat underweight this sector. However, more recently, the likes of BT, Vodafone and mmO2, which we now hold in our portfolios, have started to score much better.
Has there been much change in emphasis?
Certainly, throughout the year we have reduced our defensive exposure and increased our cyclical exposure to the extent that we are much more balanced at the sector level. So we have cut areas like tobacco, food producers and beverages. We have increased areas like general retail, telecoms and media.
In what sector are you most negative?
Beverages is an area where we were quite overweight but are now quite underweight. Quite frankly, the individual attractions of stocks in this sector have waned.
One of the best examples of a company where we had a big overweight position, but currently hold zero, is Diageo. This did well throughout 2001 and 2002. As it performed very well the valuation case eroded. The technical trend, which had been strong, started to become mixed. Most importantly, the positive trend in earnings revisions relative to the market started to erode and turn negative. This drove down the overall score, so we sold it.
Is there any type of market condition where this fund will either thrive or suffer?
This process is designed to outperform in both bear and bull markets. We certainly have a lot of test data going back over 15 years that suggests such an approach would certainly have outperformed over that 15-year period, regardless of conditions.
One place where the fund will clearly struggle is at a market inflection point, as we have seen over the last four-to-six weeks. This is when the market starts buying all the shares that have been performing poorly and have had consistently negative earnings revisions.
Do you visit companies?
Rarely. We concentrate on our four investment criteria to the exclusion of all other criteria. Therefore, meeting company management is not something we do a lot of. In fact, I can't remember the last time I saw a company.
It is something I did in my past life at Schroders but I am pretty sceptical about the value of meeting company management. The only concession I would make to that is for small-cap managers, as management at smaller companies have more of a bearing on the direction of the company.
Joined the UK equity team at Investec Asset Management in January 2000 with the responsibility of building up the core UK equity business managing a number of pension fund clients and the UK Blue Chip fund.
This followed an 11-year period at Schroders, which he joined in 1989, initially working in corporate finance before moving to the UK Investment Management business in May 1994.
At Schroders he managed about £2bn on behalf of 20 institutional clients. He also managed the £400m Schroder UK Growth fund.
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