Investment lessons from the experts

Back in 1979, investment boutiques such as Neptune and Jupiter were not even glints in their founders' eyes, and US fund management giant Fidelity was just opening its first office in London. The choice for private investors was between insurance companies, investment trusts and a few specialist fund managers such as M&G, Hill Samuel or Perpetual.
Some of our most successful investment and wealth managers today were mere novices in 1979, managers such as Anthony Bolton, Colin McLean, Angus Tulloch, Mark Mobius, Robin Geffen, Richard Hughes, Bill Mott, Alan Brown, Nigel Thomas, Jim Stride, Nigel Cuming and Paul Killik.
Today they are veterans who have worked through Thatcherism, and witnessed the death of protectionism and exchange controls. They've seen it all: from the bust of the 1987 market crash and the subsequent boom that ended with the bursting of the dotcom bubble, to the Asian crisis and the recent financial meltdown.
And if there is one thing our veteran investment managers agree about it is that the biggest influence on how they work and where they invest has been new technology.

Alan Brown, chief investment officer at Schroder Investment Management, says his colleagues were surprised when he turned up on his first day at Morgan Grenfell (now part of Deutsche Bank) in 1974 with his own calculator and slide rule.
Nigel Cuming, chief investment officer at Collins Stewart Wealth Management, recalls that his 1970s employer, the gilt broker Laurie Millbank, was one of the first in that industry to install a computer.

He says: "All it did was calculate the gross redemption yield [a key measure of gilt pricing]. It was so big that it filled an average-sized room and had less functionality than the average mobile phone has now."

Information revolution

Today, most fund managers will have at least one computer terminal on their desks. But back in the 1970s, getting information as basic as a company's share price was far from straightforward.

Richard Hughes, manager of M&G's Dividend Fund, recalls that prices were updated only once an hour and that the Datastream machine gave only the top 20 risers and fallers across the market. "For anything else, you had to phone a stockbroker, who would have to check around the market for quotes," he says.

Robin Geffen, founder of the Neptune fund management boutique, says that even during the 1987 crash it was unusual to have a computer screen on your desk. Instead, Topic screens provided rudimentary pricing and news.
Getting information about companies was also far less straightforward. Now, companies issue results at least twice - and, increasingly, four times - a year as well as trading updates and interim management statements, spiced with investor days and site visits, many of which will be accompanied by press conferences or one-to-one meetings. In the past, the brokers' lunch was one of the main ways of getting information.
"There were no presentations, powerpoints or investor relations professionals," says Hughes. Now, says Jim Stride, manager of AXA Framlington's Distribution range of funds, most big companies have a well-developed investor relations function and information is widely, and more or less instantly, disseminated through newswires, emails and even videocasts.

Accounting and financial reporting, too, have improved dramatically. "There is more spin, and it is harder to take company statements at face value, says Colin McLean, founder of Edinburgh-based SVM Asset Management.

"But accounting was poor when I started out. There was rampant inflation, but no attempt to recognise that in the accounts. Now, there is much more concern to make sure the accounts reflect things fairly."

The huge increase in information has come about partly because of increased regulation. In the 1970s and early 1980s, even the predecessors to the Financial Services Authority, such as the Securities and Investments Board, had not been established, while the advent of the Financial Reporting Council, which oversees accounting probity, was a long way off. Insider dealing was not seen as a crime.

Indeed tip-offs and rumours about bids and other corporate actions were part of day-to-day trading.

Brown recalls that directors at Morgan Grenfell were actively discouraged from managing their own portfolios and funds were directed instead to their own trading accounts.

Firms such as Morgan Grenfell were regularly offered stock at below market price, and the first place it went into was these accounts. Brown says: "[With hindsight], it was scandalous. But then it was not regarded as wrong."

Perhaps because of the relative lack of information and computer power, investment theory was underdeveloped. The likes of alpha, beta, capital asset pricing models, and even price/earnings to growth ratios, were not calculated, let alone discussed by analysts and investors. "There was more of a long-term focus, divorced from the day-to-day noise of the markets," says McLean.

"And there was less acceptance of equity market efficiency theory [which holds that the market always operates in an efficient manner], which gained credence in the 1980s, although it has fallen out of favour again recently."

The focus now, says Geffen, is on absorbing and analysing information rather than finding it. But the fact that we have just seen the worst financial crisis in a century suggests that the extra information and increased technical resources have not improved the operation of financial markets.

Built on hubris

Indeed, Brown thinks the explosion in risk management techniques and computer modelling could actually have been harmful. The problem, he says, is that the use of computers to do things such as value-at-risk (VAR) calculations persuaded investors that they could understand and control risk.
"Hubris comes into play, says Brown. "If you are wearing seat belts in a car, you feel safer, so you drive faster. It is the same in investment. If you think you understand VAR, you are encouraged to go closer to the edge."

While, in the 1970s, high tax rates - the top rate was 98% - had dampened enthusiasm for equity investing in the 1970s, "[Margaret] Thatcher turned everything on its head", says Paul Killik, founder of stockbroker Killik & Co.

As well as slashing taxes, ending the limits on what banks could lend and getting rid of exchange controls, she also started the privatisation programme, which sucked in millions of private investors.
Killik was at the heart of that, as his then employer, Quilter Goodison, made a bid to run the retail offer for the sale of BT - the first big retail offer. The firm was awarded a contract to handle London and the home counties, and it hit on the idea of running a share shop in Debenhams on London's Oxford Street.

"It was an extraordinary success, he says. "It started day trading, which did not really exist then."

These days, internet stockbrokers have made not just day trading but also spreadbetting and trading in instruments such as contracts for difference much more accessible.

Killik does not think private investors are necessarily more short-term in their approach today - he points out that, in the 1970s and early 1980s, the three-week account period under which the stock market operated made it possible to deal "in account" without having to actually settle all of the trades. Others, however, think horizons have narrowed considerably.

McLean says that investing should still be about careful analysis of companies and consideration of long-term trends, but he adds that the huge increase in volatility and market noise mean it is difficult to ignore short-term trends.

"In the long-term, I am sure that some banks will fall further in value. But if their shares rally by four to five times in value, it is difficult to ignore."

Anthony Bolton, who managed the Fidelity Special Situations Fund from its launch in 1979 until the end of 2007 - producing an average return of around 20% a year in the process - thinks the trend towards short-termism can actually bring advantages. "I've always thought that the best environment for a fund manager to perform well in is one in which they don't know how they are doing," he says.

"Unfortunately, in the real world, the opposite is the case, and every manager is only too well aware of how they are doing. So much money is now managed on a very short-term basis that this has, in my view, increased the opportunities for those prepared to take a view longer than a few months."

Virtually all our fund management veterans agree that standing against the market has become harder. Bill Mott, one of the founding partners of Psigma Investment Management, who had previously spent most of his career at Credit Suisse Asset Management, says one of the key lessons he has learned in 32 years in the market is that they are not always efficient.

"If you believe that is the case, you have got to stand against the crowd and back your own judgement, not just accept the mood of the market."

He did that during the dotcom boom, selling most of his technology, media and telecoms stocks heavily near the peak of the market in March 2000 and buying instead the old-economy shares that had fallen out of favour. "That led to three years of excellent performance, though at the time it was a brave decision to make. I am proud I could do it," he says.

Low point

The dotcom boom is a low point for many fund managers. Bolton cites the three consecutive years in the 1990s when his Fidelity Special Situations fund underperformed the index as one of his career low points. And AXA's Stride says the technology bubble was the stand out low point of his career.

"I was under a lot of pressure from inside and outside the company to change strategy and commit to interesting, but unproven, technology stocks."

Almost all other asset types have undergone booms and busts over the past 30 years - including supposedly low-risk assets such as gold and property. The government bond market is no exception.

While gilt prices may now be extremely low, they have fluctuated dramatically over the past three decades. Cuming recalls that, during the era of rampant inflation, yields got close to 20%, and in the case of War Loan perpetual stock, the price actually fell below its yield.
He has also watched pension investment theory come full circle. When he started his career in the 1970s, most were weighted heavily towards gilts, but they were then infected with enthusiasm for equities, switching the majority of their assets into the stock market during the 1980s.

Increasing longevity, the volatility in share prices and the tumble in gilt yields - which are used to value pension liabilities - has sent that sharply into reverse over the past few years, and many pension funds are back to being heavily invested in gilts.

But Cuming cautions that low or zero inflation, which has been a holy grail for governments around the world over the past decade or so, may not be as desirable as it seems. "There is no inflation to reduce the debts of governments and companies," he says.

What next?

The next 30 years is too long a period for even our talented veterans to make predictions about, but they are willing to hazard a guess as to the likely trends over the next decade or so.
SVM's McLean expects absolute return and other hedging and risk management techniques to be absorbed into the day-to-day operation of fund managers. The next 10 years will also see "more commoditisation" of the industry as trading and distribution become easier and cheaper. But managers who can achieve the elusive alpha - returns above what would be expected from market variation - will be even more in demand.

Nigel Thomas, manager of AXA Framlington's UK Select Opportunities fund, warns that we are in for a period of stagflation - characterised by stagnant growth and rising inflation. "We could go back to the days of the 'nifty 50', where a few real growth companies command a premium, but others struggle."

Bolton also thinks higher inflation is likely, along with greater regulation, and at some point a recovery among banks.
Geffen says: "The relative importance of capital markets will have shifted irrevocably. As a matter of course, investors will own a China fund and be flabbergasted that there was a time when people did not." He also thinks we will have to do our own retirement planning in future, along the lines of the US 401,000 individual retirement accounts.

While many of our veterans are likely to be contemplating their retirements, most say that they would still recommend fund management as a career to anyone starting out, even though it may not quite bring the rewards of the past 30 years.

Thomas says he has found it "an absolutely fascinating business to be in. He adds: "You can meet a chief executive one week and visit a widget maker the next. And there is the chance to travel."

Brown warns that new entrants could have to wait rather longer to get to senior positions. In the 1970s, the head of fixed income at Morgan Grenfell had just seven years of experience in the area. "That wouldn't happen now, he says. "The head of fixed income would need at least 15 or 20 years of experience before getting into that position."

They would also probably need a lot more exams under their belt. Hughes says: "Many successful managers came in with no training and learnt from their mentors. Now, there is much more rigorous exam-based training."

Mott warns that the best days of being a fund manager could be over. "We are at a transition point in the economy, he says. "The drivers of prosperity have to come from other areas."

This article was originally published in Money Observer - Moneywise's sister publication - in October 2009