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Fund Manager Focus - September 2015



Legal & General - London

Legal & General is one of the largest life assurance companies in the UK. Its asset management subsidiary, Legal & General Investment Management (LGIM), has total assets under management of over £735 billion ($1.2 trillion). Historically, the large majority of LGIM's equity assets have been indexed, making it the second largest European institutional manager, after BlackRock Global Advisors. Legal & General recently took the decision to manage some of its equity portfolios more actively. There is now a team of 10 managing an outcome-oriented fund which aims to beat inflation by 4% and has a global remit.

Lance Phillips joined Legal & General as head of active equities in 2013. Prior to this he spent 12 years at Standard Life in Edinburgh and before that at UBS Asset Management. Lance began his career withBain & Co as a Strategy Consultant in 1986. He also worked at Grosvenor Ventures, MC-BBL Securities and Deutsche Bank. Lance is a graduate of St John's College, Oxford and Harvard Business School.


Legal & General has historically been known for its index investments, why the change?

"As the world shifts from defined benefit (DB) pensions towards a defined contribution (DC) model, the responsibility for pension investment decisions shifts from informed pension trustees to the individual. We believe this has created customer demand for more-intuitive outcome- oriented funds, with a direct pension related goal. For example, the outcome-oriented goal of our first fund, The Real Income Builder, is to produce an income that grows at inflation plus 4% - and that's a goal you can manage towards with active bottom-up investing, but you struggle to do it with passive."

Of $1.2 trillion of AUM - what percentage is in equities? What percentage in global, US, European (ex UK) equities respectively?

"Of our total AUM, approximately £200b ($310b) is in equity. Although the majority is passive, £8.2 billion ($12.5 billion) is actively managed. Our first outcome-oriented fund, the Real Income Builder, is currently at £400 million ($600 million), with approximately 60% in equities and 40% in fixed income. However, our ambition is to grow this fund substantially as we start to gather external funds."

Do the 10 FMs/analysts split sectors?

"Everyone has a sector allocation but we also look at drivers of substantial change in a company's prospects. For example, I - along with one of my colleagues - look at management change as a specialisation (we tend to do things in pairs, as we believe working collaboratively leads to stronger outcomes). Other drivers we look at include technological change, industry structural change, transformational acquisitions, balance sheet restructuring, and regulation and policy change. We also have specialists in high growth economies and emerging markets. We took the opportunity to analyse the world in non-traditional ways to identify early events that can change the direction of a company and its prospects."

Do you use screens?

"We don't screen mechanically. We are largely looking for companies where we believe the future is substantially different to how the market currently prices it. Currently, as our first product is an income growth product, if a company doesn't produce a dividend and is unlikely ever to, then it is of relatively little interest to us. However, later this year we will launch another product - the Real Capital Builder - where if we believe a company is an attractive investment opportunity but it doesn't pay a dividend it would be included in that fund. The Real Capital Builder will be launched in December."

I understand you don't use benchmarks - discuss?

"We are not benchmark constrained. There is no index benchmark for a target of inflation plus 4%. This allows us to spend a large amount of resource on a fewer number of companies. The fund has 30 - 50 equity holdings with an expected holding period of three years so amongst the 10 of us, we can afford to look at things carefully and extensively."

Do you have a target price when you buy a stock?

"We don't have a target price but we need to have a view that the value of the company is significantly different from the current share price - so 25% upside over a number of years. We continually review if we think there is still upside in the stock rather than having a trigger to sell at a certain level."

Do you look for a particular yield?

"We have a yield threshold for the portfolio overall but the holdings vary with some having less yield but more growth and some having more yield today and lesser growth. On average the portfolio has to have a yield above the market but we are not constrained that every stock has to have a yield above the market."

Average market cap?

"We would be considered a mega cap fund by most definitions, with the median market capitalisation of our current equity investments of $20 billion. We may have one or two holdings less than $10 billion but the majority are large cap stocks. It is meant to be a scalable fund so we need to invest in large, liquid companies."

Typically what size of positions do you take? Value of largest position?

"Our Real Income Builder fund is currently $600 million but we expect it to be substantially larger than this by the end of the year (~$1 billion). Ultimately, the potential scale is tens of billions. Today we have approximately 30 "investment packages" - i.e. an equity position, individually matched bottom-up with one or more complementary fixed income instruments - so the average size of each equity position is currently ~$12 million. This for us is small scale - in the future we'll be able to run it at a multiple of this size."

Any sectors you won't invest in?

"No, but we do have strong governance representation within Legal & General. We engage with all the companies we invest in on a governance and SRI basis but more on a 'continual improvement' basis than a 'pass or fail' basis. We generally vote our proxy for overseas holdings."

How are ESG and corporate stewardship considerations incorporated into the investment process?

"Governance is important given our average holding period. We engage with our governance side about Board level issues. When you're holding a stock for 3 - 5 years it is very difficult to become comfortable with an investment if you are not comfortable on the governance side."

Recent purchases and why?

"TD Ameritrade we like for the strength of its asset gathering model. We believe that the asset gathering industry is evolving. Digital, direct-to-the- consumer distribution is a long term valuable capability and TD Ameritrade is well positioned in this space. Off that base, we believe there are a number of things they can extend their service into which we expect to see play out steadily over time. The fund has been running since January and we bought TD Ameritrade in November so we've been building up the position. As well as the long term strength of its asset gathering franchise, it's a company that is cash generative and committed to paying dividends. Finally, if interest rates rise, that's a positive so that's another reason for owning it.

Intuit is another holding. It has obviously gone through a substantial change in its pricing model as it moves to a subscription, cloud-based service, which we believe will result in rejuvenated growth prospects. The things you can do with their product when people interact real time should add a lot of value. The underlying economics of this transition have been a bit clouded but we think the underlying figures are strong and therefore its long term growth prospects are strong. It is not a big dividend payer but its growth is strong and it is very cash generative."

So the 10 analysts/FMs - will they also work on the Capital Builder Fund as well as the Real Income Builder Fund?

"Yes. Our analysts provide the analytical "engine" to which we can attach a full suite of inflation plus products."

In terms of the Real Income Builder Fund - are you value investors?

"There's a slight value bias but it is not a deep value fund. For a company to pay a sustainable dividend there has to be underlying cash flow. The fund is pitched at an income level that is a little bit more than the market but not dramatically more. If you pitched it with too high a yield target that would be too constraining and you might invest in things that wouldn't be for the long term capital good of the fund. As a pension investment, someone might invest at age 25 and hold the fund for the next 50 years, so good income today but no capital growth is not going to be sufficient. The fund has to be pitched at a level which has income and income growth but not at the expense of capital."

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

"Yes. The process we have wouldn't allow us to buy a company we haven't met. We wouldn't be able to investigate a company to the depth that we require without meeting management. We have extraordinarily good access in the UK and Europe. In the US we have to work harder but we can get it. Often we travel to meet US companies. Even when we are at scale we will only have 30 - 50 equities in the fund at any one time so we will take the time to get to know those companies very well.

One of the advantages we have from the passive side is because of our large and broad holdings, we tend to get very good access. Most companies know we take our responsibilities seriously as a large investor - and we are known as an active shareholder on the passive side as a result."

Explain being an "active shareholder on the passive side"?

"It means although it is a passive position we still engage with companies in terms of corporate governance."

Where do you prefer to meet management?

"A mixture - obviously it's very convenient for us to meet companies here in our London office but we like to get out to see companies. We also attend conferences. Generally we prefer one-on-one meetings as we have a long term investment horizon, so often what we want to talk about isn't what other people want to talk about. We focus on hypotheses or events that are going to play out over the next 3 - 5 years."

Why should corporates target L&G?

"The nature of our funds (and client demands) allow us to be long term, constructive investors. When you are running against an income goal, if you are not sure about short-term share price fluctuations but are sure about the income, you can still hold that stock. And that allows us to have this 3 - 5 year investment horizon and often longer than that. We are long only, and if you are there for the long term you want the firm to be run in the best possible way. As a result we tend to have constructive, supportive dialogue with companies. We don't focus on the next or last quarter. When companies come to see us they tend to say we ask different questions to other people.

We work closely with the passive and governance teams and the passive side is going to be a continual shareholder in the company for a long time. We are not going to be holders for just three weeks, we are going to be there next quarter, next year, next decade."

This interview also appeared in IR Magazine.

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