Richard Pease of the New Star European Growth Fund uses four separate areas of analysis when deciding which stocks to invest in
The New Star European Growth Fund managed by ex-Jupiter man Richard Pease has recently been awarded three AAA ratings by Standard & Poor's, Citywire and Forsyth-OBSR. The portfolio has a mid-cap focus and since its inception in August 2002 has returned 47.1% compared with a rise of 23.1% in the FTSE World Europe ex-UK Index.
Pease runs the fund using a bottom-up active management approach. The portfolio is not benchmarked to any index and he is not forced to hold stocks just because they are heavily represented in an index. There are generally around 75 stocks in the portfolio.
According to Pease, he focuses on four areas when choosing stocks. These are business, management, financials and valuations. When initially looking at the business side of the stockpicking process, Pease decides whether returns on capital for the company are high and sustainable.
He says: "We try to work out where the margin pressures are, where the company is in terms of the market and the pricing power of the business. We also try to focus on companies that have a service element as we believes companies that provide a good service have high retention rates for business."
Pease looks for businesses that are not likely to lose customers. For example, he has been underweight in the tech high growth market. Although the market has been upbeat on growth, Pease does not believe these expectations are all likely to be fufilled and thinks there are many risks to this situation.
On the management side Pease looks at what has been done for shareholders. He prefers companies with managers that have proven track records in delivering added value and where shareholder and management are closely aligned. Pease cross references what he hears from one particular management team with its competitors, suppliers and customers to see if its claims are supported. He looks to see whether the company has consistency in profits in various stages of the economic cycle.
He says: "We put the onus on management having invested a good stake in the business themselves. This is a good self-controlling factor. If the management are willing to risk there own money tied up in the business then it is usually a good sign the management believes the business will do well."
For this reason the fund is mainly biased towards mid-cap stocks. Pease has found in these types of stocks the management generally own large shares of the company.
When he looks at the financial side of the business he examines a company's balance sheet and whether or not the returns generate free cash flow. He sees this as a very important factor as it indicates how sustainable a business is. According to Pease, valuations are a function of the free cash flow yield.
He thinks it is important that management can demonstrate that they can grow the business, and also considers whether or not further leverage can be used or if the firm is likely to undergo a management buyout. Naturally enough, he favours companies that have pricing power.
When Pease meets with a company he wants to know everything about its financial situation. Some companies ask to meet Pease because they want him to invest in the business. He thinks it is important to question management rigorously about why they want a fund manager to invest in them.
It is possible some people could exaggerate profits and long-term projections for the company. So, he asks them questions like how much money they have invested in the business and what their salary is. He examines what the business model is, what they are trying to achieve through it and what the risks are for the business.
The fund does not have a high portfolio turnover and some stocks have been held since its inception. For example, Pease has held Anglo Irish since the portfolio launched because it has had 40% earnings growth over the past 10 years and its valuations do not reflect this.
Pease sells stocks when he has been disappointed by management, for example, if he feels it has not been truthful or has been too optimistic about its growth prospects. He also sells once he feels a stock has been revalued sufficiently by the market.
Fund: New Star European Growth Fund
Minimum investment: $5,000, e5,000, £3,500
Management fee: 1.75% per annum
How investors can access: International and UK investors can have access to the fund through worldwide intermediaries and professional investers. The fund is, however, registered in Hong Kong and Malta and is currently being registered in a number of European countries.
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