The decision-making processes at CGU's £49bn asset management business
Good, solid growth companies.' Nick McLeod-Clarke knows what he likes. The head of UK equities at Morley Fund Management may sometimes be tempted into a flutter or two on a value story but he and his colleagues soon scuttle back into what they know best. 'The most interesting investment opportunities for us are companies that have good solid fundamental attributes, a growing top line and good cash flow generation. They are going to deliver the best performance over the long term for our life and pension fund clients.'
It's not just Morley's UK team which takes this approach. There is a strong orientation toward growth stories whichever market is under the microscope. And with some £49 bn of funds under management there's quite a bit to spread around. The bulk of funds may be directed at the UK market from this London-based fund manager but there's a good, growing chunk directed overseas, too, backed up by offices in North America and Asia. IROs would do well to keep Morley in their sights wherever they are located.
Our house
The trouble is, few IROs have heard of it. Not in its current form, anyway. Morley is the fund management arm of CGU – itself the result of last year's merger of UK life giants Commercial Union and General Accident. A few months after the merger announcement, most people had just got to grips with the relatively simple idea that CGU was the resultant amalgam of names when, out of the blue, up popped Morley with a big branding campaign in the Financial Times. Wasn't it all a bit fast moving for the conservative world of life assurance?
'What we're trying to do is develop a stand-alone investment management company,' explains Charles Brand, head of international equities. 'We want to have all the skills and disciplines of an external manager and we think the best way we can do that is to create our own identity.' The CGU life funds still account for over 85 percent of Morley's business so there's a way to go yet but, as Brand points out, the structure to attract clients is now in place to build upon the £7 bn or so of external money already under management. McLeod-Clarke adds that it also means a better level of service for the main 'client', CGU. The implication that the life company could farm out its fund management business via a competitive tender somewhat stretches the imagination.
Even if Morley has been relatively slow at building up its brand, it certainly seems to know what it is about. The hunt for growth stocks is built into a top-down investment philosophy tempered at every stage by a hefty dose of risk management. Indeed, it's difficult to recall an institution where risk control cropped up on such a regular basis in the interview. McLeod-Clarke notes that 'bottom quartile risk' has run alongside 'top quartile performance' over the past four years, although the historic figures are based on Commercial Union Investment Management (CUIM) rather than a joint figure from the two independent groups. To be fair, Morley's investment process is wholly based on the CUIM model but you cannot help thinking that combined figures might have come to the fore had CUIM's performance record not been so impressive.
From top to bottom
'It's important to stress that top-down investing does not mean that we don't look at stocks,' says Brand. 'Research and stock selection is very important for us but what we're trying to do is create an environment in which the stock selection takes place. There's always room in portfolios for specific ideas but the broad shape of portfolios is built with a very, very clear strategy in mind. It's a strategy we arrive at by considering all the macroeconomic variables that exist globally and then filtering them down regionally and into the various markets.'
The monthly strategy committee (see Naming names, page 43) sets the initial boundaries of this process. 'We believe that understanding what's happening to markets, where they are in their cycle, gives you the best way of understanding what kinds of assets are likely to outperform,' explains Brand.
The committee aims to establish what kind of regional equity or bond markets are likely to outperform and what kind of sectors or style of stock – growth or value – within each region are likely to outperform. 'It's a filtering process right from the top to bottom,' says Brand, 'based on the idea that markets are cyclical animals and they reflect the business cycles on which they function.' The committee's view is bound by the rule that it cannot deviate from the benchmark by more than 5 percent in any asset class.
Brand notes that it is extremely unlikely that the strategy committee's decision would be altered within the course of the month once it was established. 'We don't want to be a reactive house,' he says. To date the strategy has not been changed between meetings but there is flexibility within the system. Brand uses the example of the committee being too bearish on Japan over the past few months. 'We got that one wrong but instead of us standing up straight in the face of a force ten gale we acknowledge that fact.'
Keeping in touch
With asset allocation set by the strategy committee's view of macroeconomic themes, regional and sector strategy is then formulated by the regional teams backed up by bottom-up knowledge. The structure ensures that the 'on the coal-face' knowledge is fed back up to the strategy committee in a number of ways.
Regional teams hold weekly policy meetings, with the strategy committee's view as the first item on the agenda for discussion. McLeod-Clarke believes this allows for each team to take a wider global perspective which is then fed back up to the strategy committee. And to make even more sure that the strategy committee does not lose touch, several of its members are actively involved in managing money themselves. For example, chief investment officer Barry Sanjana looks after some UK money and Charles Brand is head of the US equity team as well as holding oversight responsibility for all overseas equities.
The teams use a non-negotiable structured matrix to formulate the arena in which they can invest, this is then backed up by a team consent (or collegiate) approach for those wishing to stray to a significant position away from benchmark. Again, any position has to be within the boundaries set by the matrix which is formally reviewed on a fortnightly basis. The idea is that the strategy leads stock selection in the direction of outperformance and that team consent leads to a degree of consistency in that performance across portfolios.
Strict controls
McLeod-Clarke explains how this works in the UK setting. 'Take one of the broad sector groupings such as financials. We will never ever deviate by more than plus or minus 7 percent around the index for that sector. So the strategy will exist somewhere within that 7 percent. If we go down to the sub-sectors, such as banks, we'll never deviate by plus or minus 4 percent. As the potential for volatility gets greater then the risk control gets a little tighter. When we go down to stocks we have plus or minus 2 percent. Again stocks are more volatile than sectors so the controls get a little tighter once more.'
Key to the whole stock selection process is the need for fund managers to convince their team colleagues if they want to move away from benchmark within a particular stock. The fund managers-cum-analysts hold absolute responsibility for the portfolio within the frameworks described above; so it's in their interests to get it right. 'We're trying to strike a balance between having very motivated fund managers, who want to get out there and find ideas and want to add value, and having the right degree of control,' says McLeod-Clarke.
In the UK pension fund area, any manager going more than 25 basis points away from benchmark has to inform colleagues in the team that he or she has just taken, or is about to take, that view in a formal report at daily meetings. Once taking a significant view on a stock – more than 50 basis points away from the index – then he or she has to convince the team that this is the right thing to do before taking the action.
'There's a degree of tension there that somebody's got to do the work to convince colleagues, so it raises the quality of the thought process. And there may be somebody in the team who disagrees, in which case they've got to prepare the counter-argument, they've got to try and carry the day as well.' IROs would do well to bear in mind that the arguments they are putting forward might have to get through this third level selection process in order to attain a star weighting in the portfolio. Currently, most UK portfolios are running at about 80 stocks with a further exposure to around 120 smaller cap companies through a separate segregated portfolio or the unit trust.
Meeting agenda
There is plenty of opportunity for companies to meet with Morley, although it uses broker research as well. The key lies in the interpretation. Morley takes the view that there's no need for it to reinvent the wheel if perfectly good analysis is being done elsewhere, particularly on larger stocks. The difference is in the view taken on that research and how it adds to in-house knowledge. Smaller caps tend to be slightly more needy of in-house research because of the level and quality of coverage and risk.
Still, company meetings are a major part of the Morley game whatever the size of stock. McLeod-Clarke 'very conservatively' estimates that his UK team held some 400 company meetings last year. Brand reckons that the international equities teams held some 200 meetings with continental European companies, 200 US, 160 Japanese, 150 across the rest of the Asia-Pacific region and about 100 in emerging markets. And they are keen for more, too, even if companies are currently out of favor on Morley's sector analysis. 'The whole point about research is that it's there to help us implement the top-down strategy. If we want to buy companies that are going to respond to certain economic conditions, we have to know which companies in the market will do that,' explains McLeod-Clarke. Brand adds that no company should be shy of developing its own direct contact with Morley rather than relying on the helping hand of its brokers or financial PR advisors.
Indeed, to that end, Morley's fund managers are regularly using the internet to source information from current and potential holdings. 'It's an easy place where companies can put basic information and is a very useful starting point for analysis,' says McLeod-Clarke.
Such research is also part and parcel of the build up to a one-on-one meeting.'What we're trying to do in meetings is understand the company, understand what its financial characteristics are, what drives its P&L and what are the sensitivities within its P&L,' says Brand. He commends many of the investor relations officers at the US companies he sees, who he says generally do a good job. 'I think they understand that a high level of access to senior people within the company generates loyalty from shareholders. Loyalty also comes from predictability and that predictability doesn't have to come from a steady earnings stream – although that's nice, but not all industries can provide that – but on understanding or predicting when things are likely to go wrong because we understand what moves its P&L.' Tellingly, he adds: 'It's important that companies don't see that point of contact as a time of continually promoting the company to us. You don't want to be promoted to, you want to sit down and have a discussion.'
McLeod-Clarke has also seen a steady improvement in IR in the UK. 'Where I'm encouraged is that people are now very happy to sit down and have a discussion with us about what's going on – they're happy to put the presentation to one side and go off-script. But it's also up to institutions to think carefully about what they want from companies. You get a very different type of meeting if you're prepared to put some time in first, develop an agenda and cover the real issues.'