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Fund Manager Focus - March 2010

Nick Cowley, Henderson Global Investors - London

Established in 1934 to administer the estates of Alexander Henderson, the first Lord Faringdon, Henderson Global Investors is an independent global asset management firm. The company provides its institutional, retail and high net-worth clients with a broad range of asset classes. Following the acquisition of New Star in 2009, Henderson is one of Europe’s largest investment managers with $92.3 billion under management of which $43.7 billion is in equities.

Nick Cowley has been at Henderson Global Investors since September 2004. He began his investment management career at Chiswell Associates (now Sarasin Partners) in London in 1997. Nick and his colleague, Antony Gifford, run the US desk, managing $500 million in active North American strategies and contributing to the management of a further $2 billion in enhanced index money.

You’ve been in the investment management business 13 years – what’s changed?

“The S&P 500 is not much above where it was when I started my career! That highlights the long term potential from investing in equities…we are at such an attractive level and we’ve been in a holding pattern for a long time in equities.

Also, when I first started I was working for a much smaller company so we tended not to get the same access to management as I do now at Henderson. Companies tended not to come to London as often as they do now particularly the range of companies. A lot of companies from the mid cap area are now coming to London and that’s a real sweet spot for us.”

How do you interact with the Henderson technology team in Edinburgh? Are there two ports of call for a technology company such as IBM for example?

“The technology team is based in Edinburgh and they meet companies up there and sometimes they come to London and share meetings with us. It’s our decision which technology stocks we invest in but there’s a reasonable amount of overlap.”

How big is the technology fund?

“They were one of the beneficiaries of the New Star acquisition, last year was a great year for technology stocks and they’ve got an impressive track record. They are the biggest technology investor in the UK. They’ve got approximately $2 billion in assets under management.”

How would you describe your investment style?

“We are focused on quality companies with a competitive edge and attractive growth through the economic cycle, i.e., secular growth. We like companies that can beat earnings estimates not just in the next quarter but over a 4–6 quarter period so we are very focused on meeting management and getting a sense of where expectations are and understanding what management think they can deliver in the next 18 months. The mid cap area of the US market ($1 billion to $20 billion) is a particular area of focus as we believe it is a relatively inefficient segment of the market. Companies in the mid cap range might only be covered by 7– 10 analysts so if we meet management and do our homework we can come up with some attractive new investment ideas which are off the radar of the conventional investment manager.

We do invest in larger companies too, but it’s much harder to get an edge as they are covered extensively by Wall Street analysts. There might be as many as 30 analysts covering a particular stock – so it’s difficult for us to come up with something new. However, there are areas of the mega cap market that essentially get forgotten about for long periods of time. That happened with Microsoft in recent years owing to a number of disappointing product launches. It’s only been in the last six to 12 months that people have started looking at Microsoft again as it is now at the start of the Windows 7 product cycle as well as other product cycles. People who had dismissed Microsoft realize that it is actually very attractively valued with some great growth drivers in place for the next two to three years.”

What are the three key things you look for when picking stocks?

“Secular growth – i.e. the ability to grow from cycle to cycle. Competitive edge – a dominant market share position like a Microsoft or innovation like Apple has delivered over time. Valuation – this is obviously very important but we also want to see a catalyst roadmap for a company. It’s all very well to find a company that ticks a lot of boxes but if there’s no catalyst for the next 12 months to deliver against the expectations that we have then we are not going to invest in it – we need to see when we’re going to get paid not just how much.”

Do you initially screen stocks?

“We are keen to meet as many companies as we can. If Phoenix phones us up about a company we’ve never heard of we’d be keen to meet them as the implication is that it is under the radar screen and not well followed by the market. So we don’t run a lot of screens. We have strict valuation criteria but we are keen not to dismiss any ideas at first glance. We look for companies that can beat earnings expectations. Your original screen might have excluded that company at a very early stage. If you do the work and discover that the earnings power is greater than the consensus, then it’s a cheaply valued company based on the earnings that we think they can deliver.”

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

“It’s high – over 80% and that’s partly due to the fact we are overweight in the mid cap area and underweight the mega caps.”

Average holding period and number of positions in the US equity portfolio?

“It varies but 18 months to two years - that’s where we think we can realistically forecast the earnings power of a company.”

Average market cap of a US holding?

“$35 billion but that’s because holdings such as Microsoft, Apple and AT&T sway it. We certainly have a skew toward companies of $1-$20 billion.”

Do you have any market cap constraints?

“We can invest below $1 billion but we typically don’t.”

Any sector constraints?

“We do have some limits in terms of sector weights compared to the index, but we have plenty of flexibility. There are sectors that we typically dislike. We’ve always struggled in the semiconductor industry even though we’ve got a technology team in Edinburgh. We find it very difficult to pick stocks within the semiconductor industry. They tend to have their own unique cycles and their competitive edge doesn’t tend to last very long and it makes it difficult to really make a lot of money when you have an 18 month time horizon.”

Do you include Intel in your dislike of semi stocks?

“We haven’t invested in Intel for a long time. Because it’s a much bigger company, it’s more predictable and it’s got the competitive edge that we would look for. It’s a market share leader, it continually invests in innovation when other people don’t, so it tends to grow from cycle to cycle. So Intel is not one I would dismiss. Right now, there is a product cycle that is really working in their favour so this is a unique time when we actually would consider Intel.”

Favoured companies?

“Emerson Electric has some attractive secular growth drivers such as energy efficiency and exposure to emerging markets. However, the fact that they are not highly levered and they have more late cycle exposure means that the stock has lagged some of the higher beta more financially leveraged companies in its sector from when the market picked up in March last year. These lower quality companies have done very well from last March as they were companies that people thought might not survive. They have survived and come out with restructured balance sheets and better cost structures but they have been forced to slash R&D spend and therefore now lack the ability to drive revenue growth from new products. A company like Emerson which is high quality with a strong balance sheet and excellent management should be able to take advantage of this. They made an acquisition of a company called Avocent (equipment use in data centres) which is a good example of the strong getting stronger and that’s something that we’re very focused on.”

Which companies aren’t you favouring and why?

“Mega caps are an area where we are underweight but we recognise that stocks in this area come in and out of fashion over long periods of time. Currently, we’re not keen on the pharmaceutical industry and would include Pfizer and Amgen (a biotechnology company) in this. The stocks appear very cheap but in the long term they are under pressure in terms of their ability to come up with new products whilst their existing product portfolios begin to face generic competition. They are struggling to maintain their existing earnings power and it’s difficult to make a case for long term growth. However, we keep an open mind and if these companies can re-invent themselves in the coming years, then we’ll come back to them.”

Can you invest in Canadian companies?

“Yes we can. We have typically two or three Canadians in the list of 50 stocks we own. We’re bottom-up stock pickers so it doesn’t matter if a good idea comes from the US or Canada.”

How do you measure your performance?

“In our retail funds, the benchmark is the S&P 500. We’re top quartile over 3 and 5 years in the universe we’re measured against.”

How important is it to meet management?

“Very. Antony and I probably meet well over 200 companies a year. We do 5 or 6 trips to the US between us and in London we get great corporate access. It’s actually a positive sign when management has the confidence to come through London, but more importantly it’s a huge opportunity for us to get a better understanding of their business and develop our ideas.”

How do you prefer to meet management?

“A one-on-one meeting is preferred. Sometimes we’ll go to conferences but typically those are for more early stage idea generation.”

Who do you prefer to meet?

“Ideally CEO, CFO, COO – anyone in senior management. In terms of investor relations, the best ones are the ones who have access to the CEO or CFO on a daily basis. Some IROs might be a little cut off from senior management and you don’t get as much out of those as you do with someone who’s closely involved with strategy on a daily basis.”

Top US companies in terms of IR?

“A lot of people mention technology companies as being very good at IR and I think they are but you often only get to meet the IR person. There’s less ready access to senior management and that can be frustrating. McDonalds is an example of a big company that has got the balance right. They visit the UK and while not always bringing senior management to the UK, they make senior management from their overseas operations available to us. Then when we visit the US they make their senior management more accessible so we’ve been to their Chicago office and met their CFO on more than one occasion. That balance is useful.”

Tips for US companies visiting London

“UK investors have a longer term time horizon; they tend to be more focused on the long term strategy of the company. We’re not just trying to catch out the CFO to see what his earnings numbers are going to be next quarter; we’re focused on the long term strategy of the company and aligning interests with shareholders. Don’t ignore the UK – you can get some very credible investors that will take big positions and they’ll be there for a long time. So if you’re a management team that feels you’ve got a good strategy for the next three to five years and don’t feel the message is getting across in the US investor base; then come to the UK as we may be more open minded.”

How does Henderson differentiate itself from the competition – what’s your USP?

“We’re experienced investors. We’re focused on the strategic plans that the company has and we’re not going to be trading in and out of the stock. We’re not necessarily going to buy the stock after the first meeting as it’s a long process deciding if we want to invest but come to London; see us and be patient!”

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