Cazenove cycles past the pitfalls

Cazenove Capital Management aims to benefit from reaching a turning point in the global economy as markets undergo a correction sparked by the credit crisis. Adam Lewis reports.

Robin Minter-Kemp, managing director of specialist investment at Cazenove Capital Management, expects 2008 to be one of the group’s strongest years for relative performance. This is because he says the group’s investment style and process is well suited to what is now taking place in global markets: “a universal re-rating of risk”.

“We believe Cazenove has reached a turning point,” says Minter-Kemp. “As a group we have been waiting for this correction for some time. A protracted liquidity cycle held up the correction but it is here now and it will be compounded as more fourth-quarter results come through.”

Since the beginning of the bull market in 2003, Minter-Kemp says, investors have been rewarded for taking risk away from the market. This, he notes, is not the way Cazenove runs money. Instead its philosophy is to manage portfolios over full economic cycles.

He says: “A full economic cycle follows four phases: expansion, contraction, recession and recovery. We have just been through the expansion and are now going through the contraction, which could tip into a recession and then there will be the recovery.

“Last year was a classic year of two halves. The first two quarters followed the pattern of the previous years in terms of being liquidity driven, the China story and the demand for high beta stocks. Then the catalyst for change arrived with the start of the credit crunch. This caused a degree of fear and trepidation in investors in terms of where it would end.”

With this in mind, Minter-Kemp says, last year the group positioned its core equity portfolios to be in the unloved areas, such as pharmaceuticals, and underweight in the classic industrials and consumer cyclical companies.

The first core fund to make this call was Chris Rice’s £361m European fund and the impact on performance was positive. According to Morningstar, over one and three years to January 14, 2008, the fund is ranked first quartile in the IMA Europe Ex UK sector. “Last year was about avoiding the pitfalls which occurred in the last two quarters,” says Minter-Kemp.

However, the group’s core British equity offering, Tim Russell’s £679m UK Growth & Income fund, has not done as well, being ranked third quartile over both periods. Minter-Kemp says this is because Russell was last year underweight in mining and commodities, the two sectors in which fund managers generated the most alpha.

“Chris’s European fund was quicker and more successful in underweighting the mid cap and industrial cyclicals,” explains Minter-Kemp. However, he adds: “We expect these core managers to do well going forward, given their business cycle view of the world as we reach an inflection point in the market. At this point in the cycle it is not about looking for great stocks, it is all about looking at macro calls. Beta is now a higher consideration for managers than alpha.”

Richard Philbin, head of funds of funds at F&C, has held Russell’s fund since its launch at the end of 2002. He says that, given the fund’s investment style, approach, philosophy and stability of holdings, it is a core holding across F&C’s range of funds of funds. “We expect it will outperform the FTSE All-Share over the long term without causing any undue shocks,” he says.

However, to get the full benefit of the fund, Philbin says investors have to hold it for the long term. “The fund launched with a good starting yield and this has since grown 12-14% compound, which is a nice income stream,” he says.

While not an owner of Rice’s fund, Philbin appreciates the qualities of its manager. “Chris is more pragmatic and flexible than Tim,” he says. “Tim is more of a dogmatic investor. While they both invest across business cycles, Chris plays momentum a bit better and makes more top-down calls and he has been rewarded accordingly. However, the opportunity to make money relative is easier in Europe than the UK, as for one thing there are more stocks to look at.”

Of Cazenove’s 13 managed onshore funds carrying a one-year track record, seven are ranked first or second quartile in their peer groups. Over three years, five out of 11 funds are in the top half of their sectors.

Ben Yearsley, senior investment manager at Hargreaves Lansdown, says it has three of Cazenove’s funds on its Wealth 150 list of recommended funds. In addition to holding Russell’s Income & Growth fund and Rice’s European fund, he says Harvgreaves Lansdown also recommends Neil Pegrum’s UK Dynamic fund, even though the fund is fourth quartile in the IMA UK All Companies sector over one year after posting a negative return of 7.47%. Over three years the fund is down 3.37%, ranking it third quartile”You have to bear in mind that Neil invests in mid, small and micro cap companies and these are the ones that have been hit the hardest over the past six to 12 months,” says Yearsley. “Such has been the fall that the fund’s three-year numbers have also been affected. However, he has proven over time to be a quality stockpicker and over the long term we think he should do fine.”

He adds: “In a way Cazenove is not a newsworthy company. This isn’t a bad thing, it just means it is not a follower of fads or fashions. It is happy to have three or four good managers and it is not interested in going after the mass market.”

Minter-Kemp agrees. “We tend to launch funds for the duration,” he says. “We have spent a lot of time building our business with clients, all of whom understand our process. As such we do not feel intimidated to have to broaden the range because of thematics. We did at one stage consider going into Asia but we felt it was better to properly compete in just a few areas rather than try and be good at everything.

“We have a long-only business that focuses on offering core active management throughout the economic cycle and we only specialise in four areas. These are pan-European equities, fixed income, a distinctive multi-manager offering and an absolute return business, which is run by the same managers as our long-only funds.”

Indeed, it is within the absolute return space that investors can expect Cazenove to launch products in 2008. Minter-Kemp says this is because the market re-rating is a perfect time to expand its credentials in this area.

“We currently manage six hedge funds but we have not yet transitioned these skills into the Ucits III market space,” he says. “We are looking to expand in this area so as to fulfil the requirement of wealth preservation in the IFA market.”

This expansion will not be via the launch of any 130/30type products. Instead, he says one option is to launch a Dublin Oeic as this would allow any manager the potential to short companies using a prime broker instead of having to use derivative-type instruments as is necessary for British Oeics. A Dublin fund also allows performance fees.

“The only restriction would be at a gearing level,” notes Minter-Kemp. “However, whatever we do, the first product we are looking to roll out will likely be next month.”

Despite not launching any funds, Cazenove was in the news at the end of last year. This followed a large merry-go-round in September in which Mark Harries, manager of the group’s range of funds of funds, and four of his colleagues left Cazenove to join Scottish Widows Investment Partnership. However, Cazenove was quick to act on these departures, bringing in Marcus Brookes, deputy head of multi-manager at Gartmore, and his colleague Robin McDonald.

“We didn’t start the merry-go-round,” says Minter-Kemp. “However, it does show the increasing competitiveness in the multi-manager market, with many life companies now positioning themselves in this space. We aren’t surprised this resource is high on their agenda. For us the key to building a multi-manager business is that it is hugely important to offer best in class.”

Minter-Kemp says the groups that perform best within multi-manager are those with good in-house funds and those that have a private client business alongside the investment management business. This means groups can diversify their distribution away from just selling the funds to IFAs.

He says: “When we lost the team to Swip our immediate priority was to find someone who is high profile in the IFA adviser space and to have someone known well in the trade press. The third priority was to have someone who was fully conversant in dealing with private clients. Marcus’s experience at Rothschild really stood out and to date, despite only joining in January, we have been thrilled with his overall contribution.”

Minter-Kemp says the multi-manager team has conducted a thorough due-diligence process on what went on in the funds before their arrival. “This process has now concluded and has resulted in a number of third party funds being redeemed [from the portfolios],” he says.

The group’s priority is to implement a strategy with the multi-manager team and educate private clients about this approach. “Only after we have done all this will we consider further mandates. Our existing funds are selling well, taking £8m of fund flows in December alone,” says Minter-Kemp.

The final strain of Cazenove’s business, fixed income, is performing well. Its Corporate Bond fund, managed by Chris Greaves, is first quartile over one year and second quartile over three, while the Strategic Bond Income fund, launched last April, is ranked seventh out of 49 funds in the IMA UK Other Bond sector. The fund, run by Peter Harvey, head of credit, takes advantage of Ucits III powers so as to import protection into the portfolio. The aim is to provide an annual return of 2.75 percentage points over the London inter-bank offered rate (Libor).

Philbin concludes: “In all honesty, for a fund group with such a small number of funds, [Cazenove] are punching above their weight in terms of the funds they do offer.”

CAZENOVE CAPITAL MANAGEMENT provides investment management services to a range of clients and had a total of £11.2 billion in assets under management at December 31, 2007. The company is split into three main areas: specialist investment management, private clients and charities. Within specialist investment management it runs a range of pooled funds – both UK and Dublin domiciled – as well as several segregated portfolios and hedge funds.