Meet The Manager

Against The Tide

Mark Breedon, manager of Investec Global Free Enterprise, looks to make gains by exploiting the tendency of other investors to remain "anchored" in the past. He tells Scott Longley how, as a result, he has taken advantage of the current poor sentiment towards privatisation

Investec Global Free Enterprise could be said to be operating under something of a misnomer – and not just because its name makes it sound like the fund is really a cross-channel ferry.

Such a descriptive moniker gives the fund an ideological feel but, as it happens, this couldn't be further from the truth. Rather, it is the closely-held views of other participants in the market – and more pertinently the mistakes that derive from them – that in effect provides the fertile ground from which the fund and its manager Mark Breedon make money.

Although Global Free Enterprise started out as a portfolio that looked to profit from privatisations – remember them? – it now runs under a far broader mandate. However, as Breedon explains, it still has a strong connection to its roots.

"Privatisation funds had done remarkably well when privatisations were regarded as being good and people had made money out of them," he says. "But then, suddenly, no one was interested in them anymore because privatisation was beginning to get a bad name. Railtrack was happening at the time and that was upsetting people. On top of that, the market view held at the time was why buy into a privatisation fund when privatisations were going to run out?"

Such an argument makes obvious sense but it led some people to start questioning why privatisation funds had done so well in the first place. The answer, apparently, was to be found in the minds and motivations of investors. Prepare, if you will, to enter the world of behavioural finance – and another dip into nautical metaphor.

"If you look at privatisations, one of the behavioural errors that was happening was a thing called 'anchoring'," Breedon explains. "People tend to 'anchor' to the past and so they find it difficult to adjust their expectations to something new.

"Take, for example, BT – what the company was like when it was nationalised and what it became afterwards were very different. But it took a long time for the market to come round to this idea. What that meant was it took investors a long time to adjust their earnings expectations up to the new sustainable level that was the new, slimmed down, profit-focused BT."

Privatisations were just one theme where such discrepancies of perception can occur. Wherever there is significant change in an industry, the possibility remains for behavioural finance-type errors – hence the mandate of the fund has evolved to include such investment themes as company spin-offs, demutualisations, deregulation, areas undergoing a liberalisation of trade and so on and so on.

"All of these areas are where you can see a significant change where people might potentially be anchoring about what the business was like before," says Breedon. "We sit down every week with our analysts, asking them to talk about the companies in their sectors that are likely to be undergoing any of these themes and we build up the portfolio's universe from there. We keep it at 500 and, if anyone wants to put something new in, then something has to come out. Hopefully we are always there at the leading edge."

Once the analysts have "aggressively targeted" such companies, Breedon builds a portfolio of about 100 stocks using what he calls a "four-factor process" – that's stockpicking to you and me.

"We identify four things we think are pretty important for share prices," he says. "If you go back over time, you can see how certain aspects of a company can lead to it potentially outperforming. So we look for companies that have a higher than average quality – companies that add a decent rate of return to their cost of capital. In other words, they are adding value for their shareholders. The companies that do that tend to be outperformers over time.

"Second, we are looking for companies that are cheap, so valuation is important. Cheap companies tend to outperform – as long as they don't fall apart, of course. So we look for cheapness on a global basis.

"The third component is earnings revisions. Companies that are getting earnings revisions tend to do well. The more upward earnings revisions a company has had, the more probable the next earnings revision is going to be upward as well. It comes back to anchoring – it takes time for people to adjust.

"Finally, we look for stocks that have attracted some investor attention – the technicals. For example, is the company trading above its 50-day moving average? Is it trading above its 200-day moving average? Is the volatility increasing? And so on and so on."

Beyond this process, there are very few other constraints on the fund. "We have a maximum tracking error of 10% against the MSCI World index, which constrains you on the minimum side," says Breedon. "But the only other geographic constraint is that we are not allowed to have more than 20% in emerging markets."

As Breedon goes on to add, a 10% tracking error can be "quite a whack". "Clearly, we have to have some risk constraint," he says. "Your investors have to know how far you might go in terms of focus. We want to be in a position where we can be fairly aggressive. But our volatility in the last three years has been lower than the index and our tracking error is currently at the lower end of the range."

Breedon argues this is markedly different to other funds within the grouping of portfolios that invest on a global basis. "Part of the problem with global funds is that people have constructed them as a diversification tool and not as a tool for generating return," he says.

"People will say, for example, that they will have a maximum 10% overweight or underweight with regard to the US and the result of that in terms of returns from global funds is that they have been terrible over the last 10 years. Considerably less than 25% of global growth funds have outperformed their benchmark over the last 10 years. What we want to target is return."

As the fund's performance numbers testify, its investment process has – in comparison with many others – withstood the recent torrid times with some style. "What it has done is outperform in growth markets, value markets, bull markets and bear markets," says Breedon. "It has shown it is flexible enough to target the more interesting areas at any one time and that has been its great strength. Much as everyone would like to put in a box, they can't. We are very flexible and adaptable to market conditions.

"We can always see the other side of these things. The process holds your nerve for you so there is no way I am going to sit there and call the top – that would be an emotional angle. We don't want to be making the same behavioural mistakes as everyone else."

What it often comes down to, says Breedon, is "the old Keynes quote" – that many people are more comfortable with being wrong within a crowd than with being right on their own. "It is a human instinct – and herding gravitates towards received wisdom," he adds. "Tough calls are – by definition – hard to make. Are you going to stand out on your own when everyone else is saying you are an idiot?"

As rallying cries go, "We're not afraid to be called an idiot" sounds vaguely Pythonesque. Still, it does have a certain ring to it. Anchors aweigh.

Breedon on...