True conviction bolsters class act

2 November 2009 | By James Smith, Fund Strategy contributor

Dalton Strategic Partnership was launched in 2002 and has £1.5billion in assets under management. The firm runs funds under its Melchior brand plus a global asset allocation service and private client business.


Dalton Strategic Partnership (DSP) started up in 2002 and has won admirers for its conviction-based investing. This style can sometimes lead to periods of volatility, however and the firm’s three-year numbers highlight a tough period for the range.

Andrew Dalton and Magnus Spence, founders of the group, had worked at various incarnations of what became Merrill Lynch Investment Managers (including SG Warburg and Mercury), with Dalton developing the international business. DSP’s proposition was formed on the back of changes at Merrills during the past decade, as the group moved away from its traditional expertise in British domestic pension funds.

Dalton says this area already peaked several years ago and Merrills moved from the wholesale market into retail and from purely domestic to international, with much higher margins available in non-UK regions. He therefore set up DSP as a global investment firm, both in terms of investment reach and ability to develop the business overseas.

Various colleagues from Merrills joined the fledgling firm and Dalton also established partnerships with other boutiques, including FuNNeX Asset Management in Japan. Ken Nishizawa founded the latter in 2000, before which he ran the Mercury Selected Trust Japan Opportunities fund for over a decade
DSP has offices in Hong Kong, London, Mumbai and New York, with affiliates based in Canada and Tokyo.

According to Dalton, the chief executive officer (CEO), global asset allocation lies at the heart of his firm. He says this is an extremely undervalued skill considering the cyclical nature of markets. “Asset allocation among equities, bonds and cash is the best way to achieve positive returns over an economic cycle. It also offers the best prospect for combining growth with capital preservation over the long term,” he says.

In determining asset allocation, the group considers five key factors: liquidity, interest rates, earnings momentum, valuation and volatility. It uses three basic levels of risk tolerance - a basic low, medium and high - with agreed investment limits.

With equity allocation for example, the higher-risk ­programme can go fully invested, whereas the limit is set at 75% on the medium portfolio and 55% on the lowest risk.

Dalton points to several pension funds that have failed to outperform the risk-free rate in recent years, negating the point of investing in the first place.
In comparison, the group’s medium-risk programme has produced yearly returns of 10.29% against the risk-free rate of 4.49%, despite the 75% equity ceiling.

While many institutional mandates make 1% or 2% allocation tweaks, Dalton says greater conviction is required to generate performance and he will zero weight any particular asset class if appropriate.

“Conviction should drive investment and while we are happy to display our performance relative to a suitable benchmark or equivalent universe of other funds, we do not believe in closeting indices or shadowing other managers,” adds Dalton.

“We also understand many clients have an asymmetric sense of risk - they like making money in rising markets but dislike losing it rather more in falling markets - and are happy to have no equity exposure when appropriate.”

Looking at the medium-risk programme again, equity exposure was at the maximum 75% when the market hit its peak on September 1, 2007, but had dropped to 33.9% by December, 22.8% by March 2008 and was effectively zero when Lehmans went bust.

As markets have recovered, Dalton has slowly rebuilt this position, getting up to 34.7% by March this year and returning to fully weighted last month. These strategies are a key part of the DSP proposition, with pooled products available for the active and balanced programmes and plans for a similar version of the low-risk portfolio. The group tweaked these pooled funds earlier in the year to remove previous benchmark constraints.

While Dalton is a long-term advocate of active asset allocation, he also says it is possible to pick stocks consistently well and has built up a team of specialist equity managers. He uses these funds in combination with vehicles such as exchange traded funds (ETFs) to enact asset allocation.
These funds are under the Melchior banner, with the name supposedly that of the richest wise man who brought gold, in the story of the Nativity.

Key managers include Glen Pratt on British equities, Peter Kaye on America and Henrietta Luk on Asia. Some funds are branded Advantage, which tend to be slightly lower risk, while those with the Opportunities tag are more focused. Offshore, DSP also boasts an Indian vehicle run by UR Bhat, while Kim Ward, of Canadian affiliate Interward Capita, heads up the Resources offering. It also has two hedge funds, a European portfolio headed up by former GLG-manager Leonard Charlton and Dalton’s own Global Macro.

Looking at performance over the past three years, three of the four onshore funds with a long enough track record - plus Indian Opportunities - are fourth quartile with North American Opportunities third.

Numbers are stronger over one year, with three of the five funds second quartile, Asian Opportunities first and Pratt’s UK Opportunities still languishing in the fourth.

In recent months, the manager has reduced his small-cap orientation in a bid to make performance more sustainable and repeatable and turn around this tough run.

Elsewhere, Kaye, manager of the North American Opportunities fund, has benefited from an accurate call on markets last year, highlighting several reasons for a strong rally in 2009.

Speaking last November, he said ex-bubble stocks tend to lead the market in initial recovery stages but then underperform, correctly predicting the financials bounce.

”We do not believe in closeting indices or shadowing other managers”

Among fund buyers Meera Patel, senior analyst at Hargreaves Lansdown, says DSP may not be that well known to many investors but the boutique boasts some fine manager talent.

“They are believers in delivering superior returns and the Melchior range tend to be high conviction unconstrained portfolios,” she adds.

Hargreaves has two Melchior products on its Wealth 150 list of recommended funds, Asian Opportunities and Japan Advantage.

Patel says the former is not for the faint hearted, with Luk often aggressive in terms of holdings and sector allocations and returns typically volatile over shorter periods.

“This means it may be at the top of manager tables one year and bottom the next but the up periods tend to offset the down, leaving investors with superb overall performance,” she adds.

Over three years, Luk’s fund is the worst in its sector, showing the ill effects of a volatile 2008 when it fell more than 65%. Its past 12 months are much improved, with near top-decile returns boosted by the manager’s positive views on the surging Chinese market.

With Japan Advantage, Patel says this is more of a core offering, with the managers going defensive during the downturns and looking to capture the upturn during a recovery.

Living up to its Advantage designation, the fund was defensively positioned for much of 2008 in companies with resilient earnings. Since the start of this year however, Akira Yoshimi, the manager, has been repositioning for a recovery, increasing exposure to export-orientated sectors. If a recovery does pan out, Patel and team say this fund is well placed to benefit.

“We have also looked at Pratt’s UK Opportunities fund but like the Asian offering, it is another volatile beast,” she adds.

Gary Potter, co-head of multi-manager at Thames River, is another DSP supporter, although he acknowledges a torrid time for the focused funds last year. In the past, Potter and Robert Burdett, the co-head, have owned the group’s North American and Asian Opportunities portfolios, although Japan Advantage is their sole Melchior holding.

“While all the managers have their own styles, most tend to focus on strong growth businesses, with risk levels reflecting that, and suffered when markets turned. As expected, Asian Opportunities has come back strongly this year and you know exactly what you should get from Luk’s approach,” Potter says.

On the American fund, he highlights Kaye’s methodical process and focus on earnings per share (EPS) revisions, which has worked in normal markets but slipped up in 2008.

North American Opportunities is on the pair’s reserve list. While Potter describes Luk as a striker type holding, he feels Melchior Japan Advantage is more defensive and offers steady returns to complement positions in JO Hambro Capital Management and Morant Wright funds.

They have never held Pratt, citing his volatile returns and the wealth of choice in the British equity space.

In general, the Thames River team are strong advocates of boutique houses and like the way Dalton has shaped his team and given the managers flexibility to run money.

“DSP has several strong managers and has potentially learnt a few lessons from a difficult 2008,” adds Potter.

Dalton stresses the managers all contribute to global market debate. Just as importantly, the firm has remained in independent hands.

“In our seven years, we have managed to build assets without surrendering the company to institutional control. That said, we do have a degree of institutional strength and resilience in terms of a proper risk management team and independent dealing unit. These are all the hallmarks of a class institution without the baggage of a bigger firm.”

Dalton has also avoided rushing into acquisitions, schooled in the Mercury idea that the way to build a firm is via organic growth. “Some firms may be able to integrate acquisitions successfully but my view is that organic growth is the best way to preserve an investment culture and mindset,” he says.