Fund Manager Focus - April 2009

Alistair Graham, Longview Partners - London

London-based Longview Partners is a Global Equities money manager founded in 2001. Assets under management are approximately $2.7 billion, including $1.25 billion invested in US equities. Clients include very high net worth individuals ($25m - $100m+) and institutions, including US pension accounts. Longview runs concentrated portfolios – usually holding 30 - 35 stocks.

Alistair Graham started his investment management career in 1994 at Standard Life in Edinburgh. He then moved to Scottish Widows in 1998 and to Schroder Investment Management in London in 2002 before joining Longview in 2003.

How are you organized at Longview?

“At Longview the investment process is the fund manager, we have seven analysts. We are all global and there is no official sector specialisation.”

What is your investment focus?

“As a team we are entirely global. Personally, I spend a little more of my time on the US. Partly because of the type of stocks I look at. Our focus is on cash generating stocks with high levels of recurring revenues and I look at a lot of business services and technology stocks in the US which fit these criteria.”

How do you regard US equities in a global context?

“We are quite positive. Not because we are particularly positive on the US market but because we like companies with service driven recurring revenues and there are more companies of that type in the United States.”

How has the credit crunch affected your investment style?

“Our stock selection criteria of quality, improving business fundamentals and cash based valuations are a balanced approach to investing. Our investment process is exactly the same but we have to take more consideration of how macro events may affect the businesses we own.”

How does working for a relative newcomer such as Longview differ from working for more established names such as Standard Life and Schroders?

“Day to day the job is exactly the same. However, in a smaller organisation it’s actually easier to focus on the job of investing money and less time is spent on bureaucracy.”

Do you get sufficient corporate access?

“It’s not hard to get corporate access if you focus your efforts. We hold very few positions so our average position size is quite large. At around $100 million apiece our individual stock exposure is often larger than institutions with much more under management. Also our process which very much concentrates on understanding a business, its cashflows and the competitive environment means that management often enjoy talking about their companies with us. On the other hand, brokers who are driven by commission volume might focus on the houses that turn over their portfolios more than us. Some stockbrokers organise meetings for a company in London and we might not even get a call. So unless the company knows we’re interested or a holder and tells them to call us, they might not bother as they know we won’t pay them. Clearly there is a conflict of interest here as we believe that companies want to meet investors not commission payers.”

How many brokers do you have relationships with?

“For the US market? Less than we used to as they keep disappearing! Eight. It’s changed a lot recently with the disappearance of Bank of America and Bear Stearns. Also, the very large number of personnel changes at the brokers means we’ve changed our broker list.”

How do you screen stocks?

“Our main screening process is to meet companies and to spend time trying to understand how their business works. However, we do run some very high level quantitative screens which suggest stocks that are likely to pass our process. In these screens we focus on looking for companies with high returns and cashflows, but it’s just a starting point for ideas, a way of focussing our research effort.”

How would you describe your investment style?

“As I mentioned we have no style bias and are focussed on a balanced approach. We seek to invest in good quality businesses, with good returns, recurring revenues and good cash flows at an attractive valuation.”

You have a long investment horizon?

“Yes. If a company continues to be undervalued and keeps doing what we expect of it, we’ll keep owning it. There are stocks we’ve owned for five or six years now. Equally if conditions change or a stock just gets too expensive we’ll sell it. Our average holding period is 18-20 months.”

What is your Active Share ratio? (i.e. how much you diverge from the index)

“I don’t know exactly but between 80 and 90%. However, our tracking error is very low as we are very diversified in what we own. We don’t think about sector diversification, we think about end market diversification. You could be an elevator company and a cement company both selling to construction, they are both in different sectors but they have a lot of the same end market risk. So we are very careful to limit our end market and thematic exposure. We don’t think sectors are very representative.”

Do you have any market cap constraints?

“Because we have concentrated positions, we tend to invest in companies over $2.5 - $3 billion in size. Normally, the average company we are invested in is significantly larger than that.”

Are there any sectors you won’t invest in?

“We don’t own stocks driven by commodity prices so energy stocks and material stocks where the price of the product they sell is very volatile. So no gold stocks, for example. We’re not commodity traders. Airlines are another example as they are almost entirely driven by the oil price. Small biotech companies where you have to take a bet on whether a drug will get approved in the future. Anything that requires crystal balling the future we tend to avoid.”

What are your favored holdings at current time?

“Affiliated Computer Services is our largest holding as it has been outperforming the market recently. We bought it late last year. The stock had held up until around September last year and as the market fell strongly in October and November, it sold off in spite of the fact the company has very high (80%+) recurring revenues under long term contract. And 40% of revenues come from government customers so it’s a company that is only slightly impacted by a weak economy yet when people sold off the market because of a weak economy, that stock was sold off quite heavily and became quite undervalued. People in the US are more worried about it being affected by the economy than we think they should be.”

Any other holdings you are keen on?

“Fidelity National Information Services. They do bank processing. They process checking account transactions and debit card transactions. 85% recurring revenues. It has cash flow conversion of about 120 – 130%. Very high generation of free cash flow. They hit every earnings forecast last year. It grew last year and will grow again this year and yet the stock is very cheap because people assume business must be bad if banks are your customers. The reality is the only way to not be paying Fidelity National would be to close your bank and close everybody’s account! As long as you have accounts in existence you pay them.”

So will you switch out of Affiliated Computer and Fidelity National when things pick up?

“No. We don’t own traditional defensive stocks in general because we actually think you pay a defensive premium and if we wanted something defensive we would have a bit of cash in the portfolio. Stocks like the two I mentioned are possibly more defensive than a traditional defensives like Procter & Gamble and yet they are cheaper. Because the market doesn’t perceive them as defensive, there is a good chance they would still go up in a rising market.”

Do you like unloved stocks then?

“Not unloved, misunderstood. These stocks aren’t wildly out of favor; they did relatively well last year. We look at three factors – the quality of the business, the fundamentals of the business and the valuation. If we can find a company which is higher quality than people realise then that’s a stock we can hold for a very long period of time. For example, we’ve held Oracle for six years. It’s a company with very high profit margins, very good cash flow and a very high base of recurring earnings and yet the market continues to trade the stock violently in the short term because it’s a tech stock and they look at short term new license sales which actually only have a modest impact on the earnings and cash flow of the company. That company has grown every single year but the stock price has been very volatile.”

How focused are you on quarterly results?

“We are focused because no matter how long term an investor we are; you have to be pragmatic, if companies disappoint people they will go down in price. If you expect a company to disappoint and go down, there’s no sense in holding on to it. So if we believe a company’s going to disappoint, we will sell it.”

How do you measure your performance?

“Most clients are global equity clients and we measure against the MSCI World. We’ve outperformed that index six consecutive years by an average 400 basis points a year. And we’re even further ahead of that already this year.”

How many US companies do you meet a year?

“Probably about 150 – 200.”

How important is it to meet management?

“The most important thing for us is to understand how the business works which management can explain to you. The most important job of management is the redeployment of capital. Management are totally in charge of that and it’s very important to speak to management to understand their plans for the redeployment of capital – do they buy back stock, do they make acquisitions, do they pay dividends or do they just put the money in the bank? They can add or subtract a lot of value to their business in how they do that.”

Who do you like to meet?

“The more senior the better.”

Best US companies at IR?

“Bank of New York’s IR, Steve Leahy is good. We like IR to have or have had operational responsibility within the company; they tend to understand the company better. We also like companies to have a consistent policy of coming to London at least once a year. We like consistency. What we don’t like are companies who have nothing to say to investors until there’s a problem and then it’s too late. A steady consistent IR effort is what we value.”

Who would you most like to see in London that you don’t currently?

“The senior management of Microsoft. For a company like that where it’s very important to understand the redeployment of capital – the stock buy back, the bid for Yahoo! and so on and their long term strategy – hearing from senior management is key.”

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