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Fund Manager Focus - July 2016



LPP - London

The UK is consolidating the pension funds of its local authorities, creating larger pots of capital. One example is LPP, formed in April by pooling the assets of the London Pensions Fund Authority (LPFA) and Lancashire County Pension Fund (LCPF). LPP will continue to implement the long-term, large-cap focused approach of its predecessor funds, though it will have more money to play with.

Richard Savage joined the LPFA in 2013. Prior to this he worked in investment banking at Singer Capital Markets, Kaupthing Singer & Friedlander, Oriel Securities and Goldman Sachs. He has a master's in mathematical trading and finance from Cass Business School.


Can you provide a brief overview of the UK's local authority pension funds?

"There are 89 local government pension schemes but very few of them have internal public equity management, principally because most lack the economies of scale that would make internal management worthwhile.
The LPFA established its first internally managed equity portfolio in 2014 after the disappointing returns achieved by some active managers. The mind-set of some portfolio managers meant they were too benchmark-aware so portfolios were being run on a tracking-error basis, rather than taking a true long-term ownership perspective, which we believe has the greatest probability of meeting our long-term pension liabilities.
So we looked at the portfolios run by investors that shared our philosophy, and they tended to be concentrated funds with a limited number of high-conviction positions in companies with stable business models and good long-term structural growth prospects.
After doing a lot of homework, we reached the conclusion that this was something that could be done internally. Our approach draws its influence from noted focused investors such as John Maynard Keynes, Warren Buffett, and so on - we think it is better to know 25-30 companies intimately than 150 companies in passing. So we are aware of the benchmark for risk purposes but we are not constrained by it - for example, we don't hold any utilities, banks or energy stocks."

The UK government recently launched a consultation called 'Local government pension scheme: opportunities for collaboration, cost savings and efficiencies'. What do you expect to happen from that?

"Last year, the UK chancellor set out his plans for the consolidation of local authority pension schemes. He wants to see six pools of £25 bn ($36.6 bn) each. We are in the process of pooling our assets with LCPF and we received Financial Conduct Authority (FCA) authorization for the new investment company in April this year. This new partnership, LPP, will have assets of £10 bn. Eventually, we'll look to work with other partners to get to the £25 bn. figure."

The LPFA has assets under management of £4.8 bn. What percentage of this is managed in-house?

"The internal equity portfolio is currently £850 mn., so around 18 percent."

How many stocks do you hold, and which are your largest?

"We currently have 24 holdings but can have a maximum of 30. The biggest European ones are WPP, Reckitt Benckiser, London Stock Exchange, Experian, Nestlé, BAT, Richemont, Roche, Diageo, Anheuser-Busch and Assa Abloy. We are agnostic about where companies are listed but find the majority of the stocks that meet our investment criteria are concentrated in the US, the UK and a few other western European countries."

Why did you buy Nestlé?

"Nestlé has a demonstrable track record of high cash flow returns on invested capital, stable or growing market share and an attractive margin profile - all hallmarks of a company with a sustainable competitive advantage. Our job is to determine whether a company has a competitive advantage, which aspects of the industry and company contribute to the competitive advantage, and how sustainable that competitive advantage is - in other words: what could go wrong?
There's no denying that Nestlé has certain barriers to entry: intangible assets such as its portfolio of brands, know-how and economies of scale in sourcing, production and distribution. As Buffett would say, Nestlé has a moat and it is our job to determine how powerful the walls around that moat are to sustain those cash flow returns in the future. Nestlé ticks a lot of boxes."

And what are your largest US holdings?

"Accenture, Google, Aon, Medtronic, Honeywell, Colgate, Johnson & Johnson and AutoZone."

Why do you hold Honeywell?

"We like its end-markets and the long-term growth opportunities they provide. It has shown itself to be a well-run company with high and sustainable returns on invested capital. We like what it has done in the past but are even more excited by what it's going to do in the future. As we want to buy only the very best companies, we look for high-quality companies at a reasonable price. We have to work out whether a company has a good chance of meeting our targeted returns."

Does a company need to pay a dividend for you to invest?

"We are very cash flow-focused in our analysis so we look for the ability to pay a dividend. We look for a strong cash-generative business that is sensibly geared or not geared at all. We are completely agnostic about whether that cash flow is reinvested in high incremental return on capital projects or returned to shareholders."

What's your view on buybacks?

"We like to see a disciplined approach. We prefer share buybacks to be ramped up in times of market distress and pulled back whenever shares are trading at high levels. We tend to look at buybacks on a case- by-case basis."

What are your investment style and time horizon?

"We are patient, focused, quality investors. When we buy a stock we are looking at a holding period of at least five years, preferably forever. Since we established the fund we've sold only one stock due to a deterioration of the investment thesis and one stock was removed through M&A activity."

Do you have a target price or market cap cut-off when you buy a stock?

"Because we are a pension fund we have inflation-linked liabilities so we seek investments that can match inflation plus a margin. That puts our target return for the portfolio at around 8 percent. But we don't set target prices for stocks; instead, we look for businesses that can compound returns at levels that at least meet our target return and that have low fundamental business risk.
With regard to market caps, there is nothing set in stone but [our cut- off is] generally anything above $10 bn for liquidity reasons."

Are there any sectors or themes that you don't favor?

"We don't like utilities because they are highly regulated so there tends to be a cap on their profitability and their ability to generate excess returns on capital. Most utilities struggle to make any incremental returns above their cost of capital and when they are too profitable, regulators tend to step in, so we like industries that can enjoy the unfettered benefits of capitalism. Industries with a demonstrable competitive advantage tend to be found in consumer-facing sectors, with some in technology, specialized industries and media.

We don't usually favor energy stocks, either, because we struggle to find companies of a high-enough quality. The product is a commodity, after all; as an end-user, I don't necessarily care whether my oil comes from Shell or BP so it's very hard to create a competitive advantage, other than being a low-cost producer. A consumer company such as Colgate, on the other hand, has tremendous power over the buyer."

Do you have to meet management before you buy a stock?

"We appreciate any opportunity to meet management teams but we realize their time is limited, and we don't always get the opportunity. We recognize we are still a relatively small entity but if we get to £25 bn then we would expect to have more corporate access (as we would then have internally managed equity assets of perhaps £6 bn or more).
Companies have generally been very receptive to our long-term approach - and relieved that our focus is looking to understand how they will achieve excess returns on the cost of capital for the next five or 10 years. Companies are more receptive to talking about that strategic view than what the price of oil is doing to end-markets for the next quarter."

Tell me why corporates should target your fund.

We believe we are good stewards of our pensioners' money and our liabilities are exceptionally long term. Company management teams should be long-term focused in their approach and we are prepared to be patient, so we think our interests are aligned.
We believe markets are far too focused on the short term these days - some studies show many holding periods of less than a year.

This article also appeared in IR Magazine.

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