Hold your nerve when performance dries up

Adrian Paterson, manager of the Artemis UK Growth fund, answers questions from Adam Lewis.

Adrian Paterson manages the Artemis UK Growth fund. He joined Artemis in September 2002 as a senior fund manager from Jupiter Asset Management. At Jupiter Paterson was part of the UK specialist equity team, running institutional and retail funds totalling approximately 1bn, including the Primadona investment trust. Before joining Jupiter in 1993 he spent a year as a stockbroker in Paris with Finacor, part of the Credit Lyonnais Group. Paterson graduated in 1990 from the University of Durham with a degree in economics and politics.

Q: The UK Growth fund has suffered in performance terms over the last three months and one year. What has caused this?

A: There have been a couple of factors that have hurt the fund in the last two months. One of the main reasons for the underperformance was the savage fall in the share price of Regal Petroleum following a disappointing drilling report in Greece. This stock has been a major holding in the portfolio for the last three years: we started buying at 80p and it peaked at 500p in March this year. However, it was announced in May that the company had hit a dry well and its share price subsequently fell back some 80%.

This fall was not solely because of the news itself; it was also because Regal’s management had made out to investors and the media that there was a lot of oil in this well, which made those people lose confidence in them. Indeed, subsequent to the announcement there have been a number of changes to the board, with its executive chairman resigning. The fall in Regal’s share price also had a knock-on effect on a number of other companies in the portfolio because of forced selling from hedge funds and others seeking to recoup their losses.

Another reason for the recent underperformance is the portfolio’s overweight position in small-cap companies. The fund has one-third of its assets in smaller companies, which have performed poorly since March this year.

Q: Have you altered the fund as a result?

A: No. I have actually been adding to my holding in Regal Petroleum. The stock bottomed at 55p and I started buying it again when the share price hit 59p and 95p. As at the close of play on July 4, 2005 the share price was standing at 140p. Having seen the managements of the other affected companies in the portfolio, I am satisfied that all are trading well and therefore that the share prices will start to recover. I am also sticking to my weighting in small-caps, and we have started to see their prices bounce back in the last two to three weeks.

Q: How long will it take to repair the damage?

A: That’s the big question. In May the fund witnessed an 8% drop in performance and I think we can get this back within the next 12 months. I am happy with the shares that are in the portfolio and I won’t be making any wholesale changes to try to make any quick gains. This is because a lot of the stocks I hold have gone down for non-fundamental reasons and if I am right they should all bounce back soon.

Q: Are we in a growth environment or are value companies still most in favour?

A: We are probably in a growth environment at present, but that is not an issue for this fund. I invest in all the companies in the British stockmarket on a total return basis, be they growth companies or value companies. However, following the end of the bull run of small and mid-cap companies in February this year, there are more opportunities to make money in that sector of the market.

Q: How would you describe your investment process?

A: We invest across a combination of different company sizes, looking for those stocks that will make an absolute return over the next three years. However, while we try to buy companies that will make a lot of money, we know there will be short-term dips. This is because share prices will often fall for technical reasons outside of a company’s control, such as a drop in sentiment, and this causes forced selling. In this fund we have seen a number of share prices fall for no real fundamental reason.

We look to take a three to five-year view on stocks. We want to see where the company will go, we want to see good cashflows as well as profits growth, and we want to make sure the management are committed to growing shareholder value.

Q: In what sectors are you overweight and underweight?

A: Our most favoured sector is oil. The reason for this is that oil prices are very high and in our opinion will stay high because of demand factors from Asia. While there will be a short-term dip in demand from Asia, in the long term demand will continue to rise. From a supply point of view, there are a number of supply problems because of the political problems in a number of the oil-rich countries. The combination of these two factors should lead to oil prices remaining high.

Meanwhile, the portfolio is very underweight in banks. This is mainly because of the consumer issues of bad debt and a weak housing market.

Q: What are your current top three holdings?

A: Regus, Vodafone and Anglo Irish Bank.

Q: How many stocks do you have in the portfolio at present, and has this changed recently?

A: There are 73 stocks in the portfolio and this is pretty much the average level. For me this is the ideal number of holdings to run with in a fund of this nature.

Q: How do you manage risk?

A: We have a diversified portfolio and I always look to keep an eye on the over and underweights in the main sectors. However, in my view the perception of risk is more to do with how well I understand each of the companies in the fund, rather than how we are positioned versus the benchmark index [FTSE All-Share], where five or six shares make up nearly half of the whole market.

Q: What is your overall outlook for the British economy?

A: The problems with the housing market and the British consumer are leading to the possibility of an interest rate cut, which would good for the stockmarket. So we have a situation where two opposing forces are at work – that is, a struggling economy could actually prove beneficial to the stockmarket.

Q: Are you invested in the fund?

A: Yes. It is Artemis policy for its managers to be invested both in the group and in the funds they manage. This is important as it shows we believe in what we do.

Q: What is one of the most important lessons you have learned in fund management?

A: In light of what has happened with Regal Petroleum, I think it shows you always have to retain a certain degree of cynicism when investing, but without being too prejudicial. This means you have to be flexible while being cynical, because if you adopt an overly cynical approach you can often miss investing opportunities.