Cool head keeps growth fund steady

The £1.3 billion Threadneedle UK fund is in good shape because of decisions taken well before the unforeseen credit crunch, thanks to defensive positioning by its manager, Leigh Harrison.

Leigh Harrison of Threadneedle regards himself as an income manager, but he’s doing a pretty good job as a growth manager. Apart from being Threadneedle’s overall head of UK equities, he also runs Threadneedle UK, a £1.3 billion fund that has easily outperformed its sector average over one and three years.

Given how fragile equity markets are, he has done well to keep the fund in positive territory over the past 12 months. It is up 1.7% over the past year, compared with a fall of 7.7% for the average fund in the IMA All Companies sector, according to Trustnet.

Harrison says the fund is in good shape because of decisions taken back in the last quarter of 2006 and early 2007. It was pre-credit crunch, and markets were being driven by leveraged buyouts and credit spreads were narrowing. “It was clear to us that credit was being mispriced. We decided to adopt a more risk-averse stance. We thought that the impact of rate rises would be to slow growth to a greater degree than the market was expecting. Some people at the time were talking about going into big caps for safety, but you’ll find they talked the talk but we walked the walk.”

Harrison does not pretend to have predicted the credit crunch. It’s just that he was better positioned than others when it happened. “We did pretty well in the second half of 2007 as we had gone very low in financials and property. We minimised our exposure to discretionary consumer spending, and anything we were not sure about we sold out. We also reduced our exposure to small and mid cap stocks.”

He shifted into some fairly basic defensive stocks – “We bought National Grid, BAT, Imperial and Tesco, plus commodity companies”- and for now is happy to remain defensive. The bet on commodities, though it was the right thing to do, is curious. If one’s position is that rates are rising and growth is slowing, then one might expect the commodity boom to burst. Maybe it’s just a late-cycle thing.

“We felt that Chinese demand for resources was going to remain strong and were impressed by the cash flows we were seeing from the companies,” says Harrison. “Valuations for a lot of resource stocks are based on mean reversion to historic commodity prices, which we thought was nonsense.”

In other words, the market is valuing resource stocks in the belief that the price of copper and similar commodities will eventually revert to their averages, whereas Threadneedle reckons China’s entry into the world economy means that commodity prices may be permanently higher.

Back in Britain, he sees it as optimistic to think the problems are over. “The impact of the credit crunch has turned out to be far worse than most people expected. We don’t yet see the conditions in which to start buying aggressively. This could last another year yet.”

I have to confess I had never heard of a monoline insurer until we started writing headlines about them, and Harrison, who strikes you as a naturally honest person, admits he would not have heard about them much before the news broke. He says it is typical of the contagion caused by the drying up of liquidity, and that it could get worse yet.

But amid the panic, there are companies that have become caught up in the backwash for no good reason. He likes Intermediate Capital Group, a company that provides mezzanine and sub-investment-grade finance. That means they deal in collateralised debt obligations, leveraged loans and structured debt. It sounds like the sort of business you really don’t want to be in at the moment, and it’s not surprising that its share price plummeted from about £20 at the start of the credit crunch in June to about £14 three months later.

Today the shares trade at about £15, which Harrison says shows a misunderstanding of what the company is about. “They are not only a good business but they are in a prime position to exploit what is happening in credit markets.”

If Harrison sounds broadly pessimistic about equity markets, that misrepresents him. He says there will be a “terrific opportunity” to get back into equities over the next 12-18 months – “but you just can’t be sure whether or not at that stage the market will be a lot lower than where we are today. If the Fed bails out the monolines and the US housing market figures bottom out, then equities could re-rate upwards.”

He is relatively relaxed about the downturn in markets globally. “You can get bad years, you can get a bad two or three years. My job is to minimise the losses in the bad years and to max up the good years. It’s all about owning the right stocks. I firmly believe in the long-term attraction of investing in equities, and I really think retail investors need to put their money in and not look at it for another five years.”

Harrison does not see asset allocation as a big part of his role but, when pressed, says: “We still want to be in large-cap equity, we prefer emerging markets to the developed world and Europe to the US.”

Is the bond team at Threadneedle, like so many other bond teams I speak to these days, deeply alarmed about what is going on in credit markets?

“Our bond team are very cautious. But I think bond management is in new territory. As an equity manager, you get used to the lack of liquidity in some stocks. That just doesn’t happen in bonds, and the fact that it’s happening now means they are in a whole new world.”

But he sees the bursting of the credit bubble as an Anglo-centric problem which, though it’s hurting us, will not cause deep distress elsewhere. “Consumer credit hardly exists in Germany and Asia; this is a very US- and UK-centric problem. I think it tells you that the growth outlook for the US is worse than the market is expecting.”

Harrison strikes you as a cool-head-in-a-crisis person. It’s unlikely that this fund will perform spectacularly when growth returns, but it will protect you when things are going wrong. And most clients prefer the latter to the former.