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Fund Manager Focus - February 2011

Andy Headley, Veritas Asset Management - London

Veritas is an independent investment company formed in 2003 by Stewart Newton, the former chairman and founder of Newton Investment Management and its former CIO Charles Richardson. The firm has a mandate to invest on a global basis to achieve real returns and not relative returns against an index. Assets under management are in the region of £4.5 billion ($7.2 billion) with 80% in equities. Their approach is long term and involves concentrated portfolios expressing their conviction. Veritas has offices in London, Zurich and Hong Kong.

Andy Headley is ex Newton and co-runs the Veritas Global Equity Income Fund with Charles Richardson. He also runs the Veritas Global Focus Fund.

Am I correct in thinking that all fund managers and analysts are based in London rather than Zurich?

“The Zurich office is a servicing office. The majority of the investment analysis is done in London but we have an office in Hong Kong and there are two investment professionals there who look at Asian equities. We are split into three teams – the funds and institutional business is where I work and that’s split into two – the global team and the Asian team. I am in the global team and that team has two fund managers – me and Charles Richardson and we’ve got six analysts. Our Asian team has one fund manager and four analysts. Our private client business has 5 portfolio managers who utilise both the funds on the institutional side of the firm as well as using our research”.

You are thematic investors, can you elaborate on this?

“We use three ways to narrow down the universe – we look for mid to large cap companies – anything from $3 billion upwards. Worldwide there are roughly 5,000 companies that are $3 billion and above so we can’t analyse them all! We do some quant screening which is actually the least important screen for us. We also use networks for ideas – other fund managers or company management or other investors. However, the most important way for us to find ideas is using themes. We are really looking for strong drivers or tailwinds for companies that are beneficiaries of those themes.

We typically have four or five themes that we want to focus on. An example is structural growth which has a number of sub themes, so an area which we think can grow regardless of economic growth. Obesity has strong growth in the US particularly and it has certain related diseases such as cardio-vascular which is actually very difficult to invest in. Also diabetes is a related disease as the number of type 2 diabetics is growing at 4–5 % a year simply because of the growth in obese people and we have a couple of investments in this field. It’s a bit of a morbid subject but it gives us structural growth and it’s that kind of thing we look for.”

What’s your investment horizon?

“Three to five years”.

Is there anything you won’t invest in?

“There’s no area we won’t invest in as we don’t claim to be moral guardians for our investors. There are areas that we find it more difficult to invest in as we are always trying to find good quality companies, franchise type companies and buy them at attractive valuations. It’s difficult to find franchise type companies in metals and mining for example. What is gold or iron ore really worth? With iron ore for example, there’s millions of tons of the stuff in the earth so there’s not a supply deficit but there is a bottle neck in getting it out of the earth and at some stage that will change and it’s very difficult for us to play that timing. The only commodity we will invest in is where we think there’s a long term structural supply deficit. So the things we’ve looked at on that basis are in oil, where we have some investments and uranium where we don’t have any investments currently”.

How much money do you manage?

“We have about £4.5 billion ($7.2bn). We have £2.5 billion ($4bn) on the global desk, £1.5 billion ($2.4bn) on the Asian desk and about £500 million ($800m) in private clients”.

Typically how many positions do you hold, what’s your average position size?

“We don’t invest on a benchmark basis – we hunt around the world for good companies at attractive valuations. So our geographic weightings move around quite a lot. In the last year we’ve been buying quite a lot of US positions as we’ve been finding more and more things in the US that are attractively valued and are good quality. Today, we have 13 holdings in the focus portfolio out of 33 – so slightly more than a third of our holdings in the US. Things that we hold include Transdigm – it supplies parts to the aircraft manufacturers such as Airbus, Boeing and Lockheed Martin. It also supplies those same parts in the aftermarket, so if you’re British Airways and you own a 747 and your ignition unit needs changing you can’t buy it from anywhere else as no other company is certified to sell it. It’s a business that goes on for ever. 747s are already 40 years old.

Last year we bought Citigroup and Northern Trust. Something else we bought last year, which was opportunistic as we are quite value disciplined, and managed to get quite a reasonable position in, is Google when it fell to $450. At that point we thought they were quite attractively valued. (Editor’s note – as of 14.1.11 – Google was valued at $624). So they had fallen a long way. There are eight of us doing analysis on the global team and the first question we ask ourselves is “is this a good quality company?” and if it is, it goes on our universe list and we do all the analysis on that company. We look at their business model, quality of the company, speak to management, speak to competitors, model the company, read the last five or six 10Ks – we will do all the analysis. We’ve done about 240 now and so they are the companies that we want to own but we will only own them at the price we want to buy so when they hit that, we buy.

We own Lockheed Martin which we bought in the last three or four months. It is a good quality business. We often invest in companies when other people don’t like them. Usually when a company is facing a hurdle. If you are trying to buy good quality companies, it’s so rare that they are priced cheaply. Why would they be? So the only opportunity to buy these good quality companies is when people are questioning whether they are still good quality companies. That’s how we managed to invest in Google as people were questioning their growth rate. That’s how we managed to invest in Lockheed Martin as people were questioning defence spending and if the F-35 program will be successful). In our analysis, we think Lockheed Martin will be quite successful. It is a good business and we can buy it at an exceptionally cheap valuation. So we quite often find that we are investing when others are turning their nose up at these companies”.

Which benchmark do you use? How do you measure performance?

“We don’t use a benchmark because we have a three to five year investment horizon. We tell our investors that we are not going to construct the portfolio like a benchmark. But obviously over a period of time, which isn’t necessarily a year, we would generally expect to beat a benchmark or otherwise why would we be doing our job? So on a rolling four to five year period, we will have an absolute return target and we will have a target to beat the MSCI.”

What’s your active share? (how much will you bet against the index?)

“It’s high because we are benchmark agnostic and because we only have 30–35 positions, we will look dramatically different to the benchmark. We don’t hold a stock just because it’s part of the index. We will only hold something if we think we’re going to make at least 15% per year so we will only invest in Microsoft for example if we thought we could get at least 15% per year.”

Average market cap of your holdings?

“Probably $7–8 billion as we have the likes of Google and we do own Microsoft but then we have Transdigm ($3 billion) and Varian Medical Systems ($8 billion).

European names we own include PPR. We bought a year or so ago. We bought for a couple of reasons - they are undergoing a restructuring and we think they are being penalised for what they hold today and we like the Gucci group which dominates the valuation.”

What do you think about markets at the moment?

“We think markets today are in a fair value range – not cheap and not expensive so it’s getting more difficult to find ideas which we think will generate 15% return per year but we are not negative. As I said before, the area that we’ve been adding most to over the last year has generally been the US as we’re finding more opportunity there. We’ve sold a lot of our Asian positions simply because of valuations. It’s also getting more difficult to find ideas in Europe.”

Recent sales?

“I’ve not sold very much recently (apart from Asian names) as we had a bit of cash that we’ve put to work. We sold the Chinese oil company CNOOC on valuation grounds. We held a number of Asian REITs – primarily Singaporean REITs – which we sold on valuation grounds. Where we’ve been selling is largely Asia. Our universe is 240 companies and we like to see a nice (geographic) balance and when markets fell in 2009 we felt that the area we were getting the best bang for our buck and getting good growth and good quality companies was Asia. So we bought a lot of them in 2009 and their share price performance since then has been good so we’ve sold into that strength. Now it is skewed the other way – we have very little in Asia and much more in the US and Europe.”

What’s the split between US holdings and European?

“About half and half. The UK and Switzerland dominate our European holdings. Having more holdings in Switzerland isn’t a currency call – it’s just we’ve found better quality companies there at sensible valuations.”

What about Canadian companies?

“We own a few in our income strategy, mostly income trusts on the oil side.”

Do you vote your proxy?

“Yes and we have a proxy service that we use as well. We look at all the resolutions.”

Are SRI considerations important to you?

“Yes but mainly from an investor perspective. We look at SRI in so far as we think it will affect the value of a company. So for example if we look at a company and it is polluting and we think that will be detrimental to the value of the company as a shareholder, then we look to do something either through voting or by not owning the stock. We have been activist one or two times when we’ve bought a position and something we didn’t expect has happened so we’ve got involved but generally we’re not activist investors.”

How do you manage your currency exposure?

“The focus fund’s base currency is dollars so when we invest outside the dollar we take a view as to whether that currency will depreciate against the dollar and if we think it will, we hedge it back into dollars. If we don’t think it will depreciate, we run the currency exposure. The other thing we will do, is if we have a large cash position (it can be as high as 25% and we had 20% at the end of 2007), it would normally be held in the base currency, i.e., the dollar, but if we were worried the dollar was going to depreciate, then we would put that cash position in other currencies.”

Outlook for currencies?

“We have no strong view currently between the big 4 (USD, GBP, EUR, JPY). But over the longer term we do think that some of the emerging market currencies will do well. Particularly emerging markets where they’ve got surpluses, they will do well against the dollar as we will see a continued debasement of the dollar. But equally we will see a debasement in the Euro, in Sterling and in the Yen. So the big four – it’s an ugly competition - difficult to chose between them.”

How do you know if you want to meet a company?

“We would look at some metrics but generally we try to identify a competitive advantage – that’s the first question we ask ourselves – ‘do they have a competitive advantage or not?’ Regarding market cap, we would look at a $2.8 billion company if liquidity was enough but we have £2.5 billion and an average position is 3% so we need to get £75 million invested ($115 million) so if it’s only a couple of billion we are going to struggle with liquidity.” Editor’s note: a theoretical maximum position could be 8% so £200 million ($300m) but the largest current position is 5% (£125m / $190m).”

How important is it to meet management?

“It’s particularly important when we expect management to do something different to what they’ve done in the past. Or where there’s a new management team or where there is restructuring. So in those circumstances it is exceptionally important. If it’s a management team that’s been there for a long time we actually prefer to analyse what they’ve done and we’re not so fussed about meeting them before investing. We do like to meet them still but it’s not a pre-requisite. If you take Transdigm, the guy that runs it has been at the company for around 20 years and he’s got a very long-standing team around him so we don’t need to meet him to understand how he runs the business. We’ve got this whole history of how he’s built the business and we can see what he does so we can invest before seeing him even if it’s nice to meet him afterwards.”

Who do you prefer to meet (eg CEO, CFO, IR)?

“Generally we prefer to meet the CEO.”

Which companies stand out in terms of IR?

“I think the quality of IR has massively improved in the 16 years I’ve been investing. It is now taken much more seriously and because it’s taken more seriously by the corporates, the quality of people doing it has increased substantially. So it’s taken more seriously by investors too. It has generally improved across the board. We are happy to meet IR particularly if a company wants us to meet IR first and say ‘you can see the CEO later’. And when we are trying to understand a company, generally talking to IR is best. One company to stand out in terms of IR recently is Verisk – their IR lady is exceptional.”

How do European vs Asians vs US companies compare in terms of IR?

“The US is best, Asia is worst and Europe is somewhere in the middle.”

How many companies do you see a year?

“A lot – on the team we see 600 or so.”

How do you manage your corporate access?

“We don’t often see companies through brokers. Many times we’ll contact a company directly. We only do it through brokers for Asia as it is more difficult to get hold of them. We haven’t used brokers much for organising access.”

How big can Veritas get?

“For my side (i.e. the global assets) – we are looking at £6 billion (we are currently £2.5 billion) – so we are nearly halfway. We may close before then as we limit the time that we spend marketing and client servicing to 10% of our total time. The most important thing is that 90% of our time is spent on investment. We’ve seen it before, if you let the marketing take over, performance dies, as you spend 30% of time talking to people and only 70% of your time on investment.”

Outlook for 2011

“Another volatile year. We expect a flip flopping between markets of risk on/risk off trade because there are very powerful tailwinds for markets such as quantitative easing and very low interest rates. These are massive stimulatory measures which will push markets up but there are some massive headwinds – consumers are under pressure, inflation is coming back, wage growth is very low. We think that margins are likely to decline a bit over the next couple of years given where they are and pressures such as raw material prices. So there are quite a lot of headwinds as well and it’s just a question of which of these in investors’ minds will win the battle for supremacy and that will change from time to time. The problem next week may be European peripheral debt and suddenly it will become a big issue and the risk off trade is the one that everyone will worry about and markets could fall. Then all of a sudden people will be talking about Bernanke doing QE3 when QE2 is finished and all of a sudden markets will be off again, so it will be this flip flopping risk on/risk off – so we expect volatility.”

To access the latest fact sheet on this fund, please click below:

Veritas Global Focus Fund - Q4 2010

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