Legal & General took a high conviction approach to boosting its British and European equity funds – and it has paid off, says Mark Burgess, head of active equity. Simon Hildrey reports.
One of the biggest challenges facing Legal & General Investment Management (LGIM) is to promote its actively managed equity funds. This part of the business has been overshadowed by the asset manager’s index tracker funds that, along with its life funds, make it the largest investor in the British stockmarket, according to LGIM. But LGIM has sought to raise the profile of its actively managed equity funds, with a focus on improving the performance of its British and European funds.
Indeed, Darius McDermott, managing director of Chelsea Financial Services, says that if he asked about LGIM two or three years ago, the conversation would have started and ended with its index tracker funds. LGIM says the actively managed portfolios are attracting wider interest and recognition as the performance of some of the UK equity funds improves. The Growth Trust, UK Alpha R Trust and UK Active Opportunities funds are first or second quartile over one and three years to February 11 2008, according to Morningstar.
This has followed the arrival five years ago of Mark Burgess as head of active equity at LGIM. He moved from Deutsche Asset Management, where he was head of UK equity and balanced products, in January 2003. “When I joined five years ago, the UK actively managed equity funds had been underperforming with low risk and low target portfolios,” says Burgess. Four years ago he recruited Robert Churchlow as head of UK equities. Churchlow was previously head of UK institutional equities at Invesco.
“Robert and I worked together to introduce a new investment process,” says Burgess. “This is a focused and high conviction process. Whereas before LGIM UK active funds were aiming for a return of 1% above the market, the high conviction approach is aiming for plus 3% or plus 4%.”
The Growth Trust implemented the new approach at the end of 2004 with the portfolio holding 25 equally weighted stocks. “This is a process that is easy to manage and understand,” says Burgess. “If you believe two stocks are 20% undervalued why have a 2% allocation to one and 4% allocation to the other stock? Why consider the weighting in the index and why invest in BP, for example, just because it comprises a large portion of the index?”
LGIM launched the UK Alpha R Trust in May 2005. This fund, which is managed by Richard Penny who was formerly at M&G, also has 25 equally weighted stocks. Burgess says the UK Alpha R Trust has a tracking error of 8% while the Growth Trust has a tracking error of 4.5%. The UK Alpha R Trust is an all-cap fund, having the ability to invest in Alternative Investment Market (Aim) and small cap stocks. In contrast, the Growth Trust invests in the FTSE 350.
McDermott highlights the Growth Trust and the UK Alpha R Trust as examples of improved performance by LGIM. But McDermot adds: “The UK Alpha R Trust focuses on recovery and microcap stocks so it might be a fund you want to hold when it is small. I am not sure how scaleable the process is for this fund.”
Burgess, however, argues that the UK Alpha R Trust has plenty of capacity at the moment as it only has £20m in assets. He admits there is a capacity limit on this fund and the Growth Trust has greater potential capacity because of its investment focus.
The UK fund managers all contribute stock ideas. The approved stocks comprise a 40-stock model portfolio from which the funds are constructed. The other UK funds have 35-45 stocks. This is a point highlighted by Bambos Hambi, head of multi-management at Gartmore, who says the British funds have come on to his radar. “The key has been the recruitment of Mark Burgess and Robert Churchlow.
“We like their team-based approach. We have been impressed with the UK Growth and the UK Alpha R Trust funds although we have yet to invest in them.”
The European equity funds have adopted a similar investment approach. The previous European actively managed team left in 2006. In its place, the funds were managed on a passive basis. But in early 2007, Ian King was recruited from American Express Asset Management and he has subsequently hired an active fund management team. They have adopted the 25 equally weighted stock approach for the European actively managed funds since last summer.
In managing the UK and European funds, says Burgess, the managers have a two-stage investment process. About 60-70% is invested in companies that Burgess describes as long-term winners and are able to generate sustainable returns and growth. He points to Man Group as an example, saying it reinvests earnings to generate growth and outperformance.
The rest of the portfolio is invested in turnaround stocks, such as those undergoing a change in management. Robert Burdett, joint head of multi-manager at Thames River Capital, says the European teams are behind Britain in terms of improved performance. But he says this is because King only joined LGIM at the start of 2007.
Burgess says the equity team is also trying to leverage off the fact that LGIM is the largest investor in Britain, particularly through its tracker and life funds. He says LGIM owns about 5% of the British stockmarket. LGIM also owns 0.75% of continental European stockmarkets with £19 billion-£20 billion invested.
“This means we gain great access to management of companies, including one-to-one meetings,” says Burgess. “We can gain access at the time we want because of the investments we hold. We believe it is important to meet management and understand what their business model is and their plans for developing the business.
“For example, we believed Compass was a good business. They brought in Richard Cousin as chief executive. We knew him from his previous roles so we were confident about his management.
“Even though the active funds were not invested in Compass we were able to get quick access because of our stake in the business through the rest of our business.”
Burdett says he is convinced this leverage can benefit fund performance. “LGIM is keen to leverage off its position as the largest investor in the UK.”
“Trading costs are also relatively low because LGIM can pool the capital from index trackers and the actively managed funds.”
Hambi and Burdett both say they held the Japanese fund in their portfolios until Andrew Nagele decided to focus on his hedge fund. But Burgess says most investors have remained in the fund since Nagele stepped down. “Andrew is still part of the Japan team and therefore contributes to the Japanese fund. Alan Booker runs the fund and has worked here with Andrew since 1994.”
Over one year to February 11 2008, LGIM had three funds in the first quartile and 19 funds in the second quartile. LGIM had 14 funds in the third and fourth quartiles. Over three years, LGIM had five funds in the first quartile, 10 funds in the second quartile and 19 funds in the third and fourth quartiles.
With Burgess saying he is happier with the performance of the LGIM actively managed funds than five years ago, he says he is considering more launches. These will possibly include equity income and UK special situations funds. The equity income funds may not be confined to Britain. Burgess highlights L&G’s experience of managing income in Asia, for example, with such a fund probably comprising 50-60 stocks.
LEGAL & GENERAL GROUP is a FTSE 100 company with more than five million customers, 8,800 employees and £268 billion in assets under management (as at September 30, 2007). LGIM, its investment management business, has £10 billion in its actively managed equity funds, £6.4 billion of which is held in British stocks. LGIM offers 13 actively managed unit trusts to British retail investors as well as a range of passively managed tracker funds.