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Fund Manager Focus - May 2012


Fund Manager Focus - Stephen Docherty, Aberdeen Asset Management - Edinburgh


Stephen Docherty

Aberdeen Asset Management (AAM) is one of the world's largest investment management groups running money on behalf of both institutional and retail clients. Total assets under management are $295 billion, including $148 billion in equities managed across its different offices globally. Although it has offices in 23 countries, fund management is primarily conducted from Edinburgh (global equities, European equities and multiasset), London (European equities, fixed interest, multi-asset and property), Philadelphia (US equities, fixed income and property) and Singapore (Asia Pacific equities, fixed income and property). The Edinburgh-based global equity desk manages around $40 billion in various strategies with approximately $32 billion in global equity funds of which about $8 billion is invested in US equities. AAM global equity funds run portfolios which are quite concentrated with a range of between 40 and 60 stocks. The model portfolio will establish a new position with a 1% weight and this can rise to a maximum of 5% in a single holding, (meaning that positions vary from $400 million to around $2 billion).

Stephen Docherty is head of global equities managing a team of 16, including 6 senior global equity investment managers. Stephen joined Aberdeen in 1994 from Scottish Mutual Assurance PLC. He graduated with a BSc (Joint- Hons) in Mathematics and Statistics from the University of Aberdeen.

How does the global desk in Edinburgh interact with the team in Philadelphia?

"We interact with the Philadelphia based US equity team in the same way as we do with Aberdeen's other regional equity teams. Each team manages a range of regional or single country funds based on a common bottom-up process. This begins with a few basic rules: never invest in companies we have not met; never feel obliged to buy a stock because it appears we should (for reasons of size or perceived value as a market proxy say). Regional team members conduct hundreds of company visits per year then duly document these meetings and undertake rigorous analysis of the business model. We avoid businesses we don't understand or ones with discriminatory shareholder structures. Working from these precepts, stocks become almost self-selecting (provided we have done the essential investigative work). The more difficult decision is how much to pay. Here we place little value in ephemeral events or market 'noise' and more on factors that will ensure we can add value in a demonstrable and consistent way over time. Our focus therefore is on long-term returns rather than short-term gains.

From the regional portfolios constructed by our regional teams there is in effect a ready made universe of stocks which we refer to as the global equity buy list which is the starting point for the construction of a global equity portfolio. Arguably we are in a fortunate position of being able to access existing Aberdeen analysis of companies, undertake further due diligence and select from a truly global opportunity set. However, if a company is not held within a regional portfolio then we are unable to invest in it."

Do you share meetings with the US team in Philadelphia for example?

"Every two weeks we have a formal meeting with each regional team focusing on companies in their respective regions. We can and we do see companies but the prime responsibility of that aspect of the process lies with a regional team. For example, we saw the CEO of Schlumberger last week and someone from the team will have written a summary of that meeting so that our US team can see what was discussed. There are certain rules we have within our equity division – if anyone sees a company then you have to write either a short summary or a full note on the company and that information is disseminated around all our 90 or so fund managers worldwide. We have the same templates for filling in notes globally and the same process so in effect we speak a common language." (Editor's note: the US team in Philadelphia manages approximately $3 billion in US equities).

Who makes the asset allocation decisions? What percentage do you currently have in US equities?

"We currently have just under 25% in US equities in our global model portfolios but this is a result of the bottom-up stock picking process and not in itself an asset allocation decision to have 25% in the US. We look at businesses rather than take a view on a country. Is the company a good business and does it have a good track record for example? Is it well run; does it look after shareholders; how does it stack up against its competitors and are we paying up for it or not i.e. is the valuation reflecting all the good things or is there an opportunity? We don't want 50 companies all doing the same thing as we look to diversify the portfolio. We want to have a portfolio of businesses doing different things in different countries and sectors and at different stages of their life cycle to diversify our risk so that if something happens to one business and it goes wrong it does not destroy all the other companies we have in the portfolio."

Which are your largest US holdings – discuss why and when you bought them?

Johnson & Johnson: 3.5% model weight
"This is a company we have held for over 5 years now. It's a well-run business and has exposure to both healthcare products and pharmaceuticals. It generates lots of cash and has products that most people would recognise and has a very strong track record of growing its dividend (almost 50 years) thus rewarding its shareholders. The business is fairly stable and predictable and you sort of know what to expect. However, like all businesses it will have issues at some point but it is a question of can you fix the problem and how do management deal with the issues that gives you the confidence to go against the short term market view and buy more shares. Being a less cyclically sensitive company, we like the defensive characteristic it brings to the portfolio in times of market stress and we have been cautious for some time on markets given the debt woes of many developed market countries so it is a bigger position in the portfolio right now".

Philip Morris International: 3.5% model weight
"Another staple name and very stable business and one we have held a position in for a number of years. Tobacco companies are amongst the simplest businesses to understand. They make fantastic margins and they generate a lot of excess cash for shareholders, providing a platform to grow the dividend and returns to shareholders. Philip Morris International was spun out of Philip Morris a number of years ago and we kept the shareholding and added to it as it is effectively all the international businesses which give you exposure to faster growing emerging markets. It is worth noting that every time governments tax the industry more, then the companies raise prices as a result to compensate."

Oracle: 2% model weight
"Tech companies tend to specialise in one area of expertise but Oracle can provide a broad range of technologies for business from software to hardware or from Database management to business applications and servers. It's kind of a one stop shop if you want it to be in terms of providing tech applications for a company. They have grown through acquisition and within the portfolio it provides different characteristics to a J&J or a Philip Morris and is one of our more recent holdings."

United Technologies: 2% model weight
"This is another long term holding within our funds. A very well run diversified conglomerate industrial company. From Pratt & Whitney engines for airplanes and Sikorsky helicopters to Otis elevators and UTC Fire & Security they have good products and brands in the fields where they operate. Otis has been benefitting from the rapid construction boom around the world (think emerging markets)".

How many names on the buy list are from the US?

"About 65 large cap names. We regard small cap as <$5 billion and there is a separate list for that. We currently own 11 US large cap names."

Average holding period?

"We are very low turnover (last year about 12%). We usually hold stocks in excess of 3 years and some companies we have held for at least 8 years such as Quest Diagnostics."

Average market cap of US holdings?

"We tend to be more in the big cap space in our core global funds but of course for small cap then market caps will be a lot lower."

Which benchmarks do you use?

"Different clients have different benchmarks so it depends on both the client and the product. Typically a core global client will use MSCI World or MSCI AC World but it does not really affect how we manage money."

What's your active share ratio?

"I would guess it would be quite high given how the formula is calculated. We own 50 stocks and the benchmark has around 1800 and our minimum position is 1% which means almost as soon as we own a stock we are overweight to it relative to the index and we can go up to a maximum of 5% in any one stock".

How do you describe your investment style?

"Bottom-up definitely. Growth or value? We consider those terms consultant speak. If I invest in equities, surely I believe in growth, otherwise there is little point buying equities. Also, because I'm Scottish we like to buy things as cheap as we can, why would I want to pay more than a company is worth just because it is growing? I'd wait for a good opportunity to buy and if I don't get the opportunity then so be it, we buy another good company. We joke that we are GASP manager's which is "growth at a Scottish price"! If you said to me here's a company that is guaranteed to grow its earnings by at least 100% p.a. for 3 years I would quite happily pay 100x p/e for it as the earnings will come through faster and the multiple will drop. If you took the same company and changed the word guarantee to expected, then I would not touch it as at those valuation levels as if it failed to deliver on those earnings then the multiple would fall and the share price would come tumbling down as expectations had not been met. We try to think about making money long term by preserving capital short term, after all the best way to make money is not to lose it in the first place so I have more capital working to benefit from the upside when it comes – I think this is why some people quite often put us in the value box but I don't see myself as a traditional value fund manager as we are not looking to buy something just because it is cheap or has "intrinsic value". We are looking to buy good companies where for whatever reason the multiple does not reflect the quality of the business and wait a number of years for that to be realised."

What about Canadian stocks? Can you own them and do you?

"Yes if they are on the buy-list. We have positions in Potash Corp and Canadian National Railway. It is a railroad company that to an extent benefits from the high oil price as it becomes commercially more viable for companies to use railroad than trucking when the oil price is higher. They are unique in that they have a North-South, East-West railroad network in North America. They can move imported goods from Asia from the West coast ports around the US and export goods back the same way and then can take commodities from Canada down into the USA."

What are your favorite sectors?

"As stock-pickers we don' have any but we tend (given our style) to lean slightly towards consumer staples. We tend not to get too excited about material companies as they are very cyclical in nature and not so in control of their own destiny as commodity prices tend to go up and down reflecting expectations for economic growth, though we do hold some and would hold more at the right price. In technology we tend to invest in big tech with a good track record. We are unlikely to invest in a company with no track record and no earnings and we tend to avoid highly leveraged companies."

Do you have a buy trigger? Does a stock have to have 20% upside for example?

"The complete opposite. It sounds strange, but when we buy a stock we want it to fall so that we can buy more. When a stock starts to go up we want more than a 1% position in it so we get more capital working on the up-side. Don't get me wrong we don't want it falling 50% after we buy it but we want time to build the position as we think it's impossible to predict market or stock bottoms or tops. If I put 5% into a new stock on the first purchase and it falls 20% then I lose 100 bps and it hurts my clients' capital but if I only put 1% in it falls 20% then I only lose 20 bps and then I've got room to buy more. We will then raise the model weighting to 1.5% then 2% etc up to a max of 5%. Once the share price starts to improve we move in the opposite direction, reducing the model weight and selling down the position."

What about ESG screening?

"All of the companies of the buy list are researched across a number of screens but we don't necessarily use negative screens unless a client asks us to incorporate something for them. However, good corporate governance is endemic to our core process and we look to avoid companies with bad corporate behaviour. We do this by looking at who is running the companies and how they have run it in the past and by scrutinising the small print in the report and accounts amongst other things."

Does a stock have to be profitable?

"Lots of companies go through periods where they may not have a profitable year so we need to be careful in definition here. We like to invest in companies that have a demonstrated track record of making profits over time, so it is unlikely we would invest in a start-up biotechnology company for example. At the end of the day it is very difficult to know what a company is worth if they don't deliver any profits and what we would say is the difference between investing and speculating. We prefer the more tried and tested route, more "boring" companies if you like."

Do you vote your proxy?

"Yes."

On your website, you mention disliking a discriminatory shareholder structure. Can you explain this stance?

"Where there was evidence that minority shareholders were being abused or a history of being treated unfairly then we would look to incorporate that negatively into our quality rating. We are willing to own preference shares that trade at a discount to the ordinary shares if we think the company passes our quality tests. It is things like poison pills, cross-shareholdings and sometimes family ownership structures that can cause issues for us."

If a company is on your buy-list, do you want to meet it?

"We are more than happy to see companies that are on our buy-list or that we hold in our global funds, but the prime responsibility of our regular meetings with companies lies with the regional teams located in or close to the regions where we invest. We are interested in asking the questions that we feel are important and not necessarily what Wall Street may think. We are looking to invest our clients' capital and safeguard and grow it over a five year + period, so we want to ensure its put into proper companies run by people who are going to look after our clients' money as owners."

Do you therefore not pay too much attention to Wall Street research?

"Wall Street research can be useful for background research on companies in certain areas but we are not that interested whether it's a buy or a sell as quite often the timeframe we look at (3 to 5 years) is not really aligned with what they look at which tends to be shorter term driven. If for example you get an analyst that covers Pepsico and Coca-Cola they can tell you in great detail about the companies and which one you should own, but they can't tell you whether you should own a bank or an oil company rather than Pepsi or Coke – I guess that's our job in trying to safeguard our clients assets and grow them over time."

What's your outlook for stock markets for the remainder of 2012?

"We expect a sustained period of volatility as fundamentally there remains a lot of sick economies in the developed world through the unsustainable excess debt accumulation that occurred in the boom times. Governments seem to be trying to push the problems down the line. People talk about risk-on or risk-off and I can guarantee that equity markets will go up and down as that is what they always do. However, I worry about the companies my clients are invested in and not how ultimately markets will perform."

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