Schroder uk Enterprise fund manager tom carroll is happy holding ARM and value stocks, believing both have their place
Tom Carroll is the third manager of the £450m Schroder UK Enterprise fund in three years. He took over in April 2001, coming from a background in institutional fund management at Schroders and M&G. His predecessors on Schroder UK Enterprise, which has underperformed in recent times, are Philip Hardy and Jim Cox.
In the 12 months to 12 December, the fund is ranked 204 out of 285 funds in the UK All Companies sector, with an offer to bid loss of 21.1% compared to the sector average of 18.3%. Over the three years to the same date, it is ranked 136 out of 244 funds, with a negative return of 1.3% compared to a sector average of 5.2%.
Could you detail your investment career to date?
I qualified as a chartered accountant at Cooper's & Lybrand in London. During my last 18 months there, I was involved in corporate finance, which provoked my interest in investment. I joined M&G in 1992 and was there until April 2000 when I joined Schroders.
At M&G, I was running high performance UK institutional funds. I was recruited by Schroders to do similar work and moved into retail fund management when I took over Schroder UK Enterprise in April 2001.
How would you describe your investment style?
I have got a natural bias towards growth companies. My investment technique is to look at a company's growth rate and work out whether this carries reasonable assumptions for the business and the management.
Having worked at M&G, which is value-oriented, and seeing the advantages and drawbacks of that, I am flexible in the way I invest. I am happy holding Arm as well as value stocks.
What is your investment process?
The key is to utilise the research resources at Schroders. We have a strong team of investment analysts and a good process for picking stocks in the UK.
Rather than sitting as an individual running the fund, I am looking to take the best aspects of the Schroders' research capacity to make the fund reflect Schroders' best ideas from a stock point of view. Both fund managers and analysts are part of investment teams. The teams I sit on include the portfolio construction team for the institutional business, which gives me access to our analysts' best ideas.
However, I act as a screen and what goes into the fund is my responsibility. When I look at a stock, I am looking at the share price and growth prospects for the next five years.
How many stocks do you run and why?
Historically, it has been around 35 to 40 stocks but I have taken it up to around 55 stocks and that goes back to investment style. When you have a more concentrated portfolio, it is difficult to move it around. With more holdings, it is easier to shift the tilt of the portfolio. By having more stocks you can be more flexible.
If you have 30 stocks and you want to move from being more value to more growth-oriented, you would have to sell entire holdings. If you have 50 stocks, you can take a little bit out of some areas and add to others.
What risk controls do you have in place?
When I took over the fund, one of the first things was to look at the risk aspect. There had been too much of a concentration in a small number of stocks. The risk was coming from two or three very large positions.
We wanted to ensure all stocks were contributing a similar amount of risk. Our target is to outperform the FTSE All-Share by 2% after fees.
The tracking error of the fund tends to be around 5% to 7% and we are currently around 6%. Rather than saying that we do not want to be more than 3% overweight in a stock, we recognise there is a difference between being 3% overweight in Arm and being 3% overweight in BP.
We do not want any stock contributing more than 5% to the tracking error. That way, if we blow up on one or two holdings, it is not necessarily the end of our performance. David Gasparro is the chief investment officer here and it is his job to look at the risk profile of funds and whether the risks being taken are appropriate.
How far down the market cap scale can you go? Does the size of the fund place restrictions on this?
The fund is overweight in medium and smaller-sized companies. We do not want to have more than 5% of any one company and this could be an issue with companies with market caps of up to £150m.
What differences have you found between running retail and institutional portfolios?
The two are coming together although there is a greater appreciation of risk controls and efficient portfolio construction in institutional fund management, as has been the case for a number of years.
One of the other main differences is that institutional funds are looking at performance relative to a given objective. On retail, there is a greater appreciation that you have to deliver absolute returns. It is important to get both real and absolute return.
What have you changed about the way Schroder UK Enterprise is managed since taking over?
When I took the fund on, I wanted to make sure the portfolio reflected my views. I restructured the fund and sold around 25% of the holdings on day one.
There was also some rebuilding, particularly of the level of risk that was being taken, and I made sure Schroders' best ideas were in the portfolio. The fund is now a fairer reflection of these views.
How do you plan to address the recent underperformance?
It is early days but the key thing is to rebuild the long-term track record. The fund had a fantastic 10-year track record but other than that performance, does not look good.
We have got off to a reasonable start and the key thing is the cyclical bias of the fund, which has been delivering outperformance. I am a great believer that history repeats itself and if you look at the past four business cycles, there has been a consistent pattern of cyclicals and economically sensitive stocks outperforming at a certain period of time.
Cyclical stocks bottom out around six to nine months before the economy bottoms out. We had been expecting the economy to turn around, which has been delayed by 11 September, but we remain confident it will bottom out in the middle of 2002.
Interest rates have been at the lowest level in the modern era and we have also had beneficial fiscal policy and oil price falls. A $1 fall in the price of oil puts around $30bn in the hands of consumers.
We remain confident the recovery will come through and I have been running a pro-cyclical stance on the fund.
This was doing well up to 11 September but has since lost ground.
At present, people are more optimistic and I believe we are going to see a strong rally in cyclicals. It is happening now but is very volatile. We are seeing strong performance and then profit-taking.
What level of turnover do you anticipate and why?
We are not targeting any set level but at times when, for example, we switch the emphasis of the fund from cyclicals to defensives, you would expect to see an increase in turnover.
My investment horizon is 18 months and in the medium term it is not about trading stocks. I do not trade aggressively. Historically, Schroder UK Enterprise has seen annual turnover of around 50% and I would expect that to continue.
Are you playing any particular themes at the moment?
The cyclical element is the key theme. If economic recovery comes through, the fund is poised to take advantage. This will include cyclical service companies, media and industrial stocks. The other theme is that I think the FTSE 100 is very concentrated. Around 50% of it is made up of oils, banks, pharmaceuticals and telecoms. I do not believe it is a fair reflection of the broader economy so I am very happy to invest in the mid and small cap areas of the market. That is where the real value is at the moment. As a house which has a lot of ability to pick stocks from fundamentals, we can add value in these areas.
Will you ever buy a stock just because it is cheap?
Every stock has its price. There is no stock I would never look at. Having worked in a value environment in the past, I realise there is a great danger of getting sucked into value traps ' investing in companies that are cheap but which are failing to achieve their cost of capital and are on a downward spiral.
If I buy a company that is not growing, I would have to see a catalyst for change. For example, new management or an improving economic outlook. The key thing for the really cheap stocks is how the management of the company is addressing this; are they buying back shares, for example?
What factors will deter you from investing in a company?
I am a great believer, over the longer term, that a company must seek to earn more than its cost of capital. There are many good companies that have never achieved their cost of capital.
The other areas are industries where there is excess capacity, such as airlines. It will be interesting to see what happens in this industry post 11 September. We see there being a fall in global airline capacity for the first time in 20 years.
How important is getting economic forecasts right?
From a strategic point of view, it is important to have a view on where the economy and interest rates are going, which helps me decide whether to buy defensive or cyclical stocks. That said, it is more important I get the individual companies right.
What is your view on economic prospects for 2002?
I expect the economy to start to bottom out from the middle of 2002. I am suspicious of talk we will see a sharp rebound. V-shaped recoveries rarely happen.
Although I am confident the economy will start to turn around in 2002, I think the first half will be very volatile. During the reporting season in February and March, it will be interesting to see whether the markets can see through the bad news.
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