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October 3, 2014

Fund Manager Briefing: FOUR Active Global Income & Growth Equity Fund

by Jake Moeller.

Lipper’s Jake Moeller reviews highlights of a presentation by Colin McQueen, Portfolio Manager, FOUR Global Active Income & Growth Equity Fund—September 15, 2014.

Reuters/ Nikola Solic

Reuters/ Nikola Solic

As with many funds that have a global mandate, the unique selling point of this one is what it doesn’t actually contain. Colin McQueen has a starting point of 14,000 global stocks from which to choose, and he whittles those down to a highly concentrated portfolio of 40 to 60 holdings. It’s no surprise that this portfolio has an active share of over 90% and is therefore aimed to please investors who exhibit a robust belief in inefficient markets. Furthermore, the name of the fund is slightly disingenuous, intimating perhaps that some sort of dividend discipline is involved in its construction process. That isn’t the case. The key element Mr. McQueen and his colleagues concentrate on is free cash flow (FCF) rather than dividend yield, and it is this metric that is firmly entrenched in their key concept of “intrinsic value”the present value of future FCF available to shareholders.

Mr. McQueen had 25 years of experience in global and U.S. equities, notably at UBS and Morgan Stanley, before joining FOUR in 2010. His global colleagues Gregg Bridger and Stephen Walker are both very experienced and form the FOUR global equity team, partaking in ongoing peer review and idea generation and challenging individual stock theses.

Table 1. Three Year Performance of FOUR Active Global Income & Growth Equity Fund within Quartiles of Lipper Global Equities Sector (Funds Registered for Sale in UK only) to 30 September 2014 (in GBP).

Source: Lipper for Investment Management. Past performance is no guarantee of future performance.

Source: Lipper for Investment Management. Past performance is no guarantee of future performance.

The FOUR proposition is based around finding strong businesses at attractive prices–not unique in itself, but there is a willingness by Mr. McQueen to look longer into the future than most of the market does generally. (He cites, for example, the number of published earnings forecasts for Apple for 2014 [51], compared to forecasts for 2017 [2] as evidence of the myopic nature of the market.) The fund’s proposition allows Mr. McQueen to identify stocks with robust business franchises (he considers barriers to entry, balance sheet strength, and use of cash among other metrics), model their “intrinsic value,” and thus create a reasonably reliable barometer of whether the market has a stock’s price right.

As with many boutique funds, FOUR’s proposition appears to benefit from the nimbleness of decision-making that comes with a lack of formal committee-based structure. Stocks are sold on a two-of-three majority of the senior portfolio managers, who determine a stock’s inclusion but also whether there is a case for its revision outside the intrinsic-value barometer. That’s not to imply there are no risk or governance structures in place. Factor biases are monitored and relayed back to the PMs, who aim to keep two-thirds of the portfolio active risk attributable to stock-specific factors.

A five-stage screening process performs the grunt work of making the investible universe manageable and looks at growth, quality, risk, and valuation criteria (this process forms about 60% of the assessment process). External research from some of Mr. McQueen’s trusted sell-side providers is drawn upon (to augment his qualitative knowledge of a business). Stocks that appear favourably at this level are placed on his “whiteboard” and are then subjected to deeper analysis to assess the intrinsic value. Consensus market expectations are examined and discounted cash flow valuations undertaken. Potential impacts on valuation are considered, and finally a detailed research note is prepared for debate and final inclusion.

Table 2. Three Year Risk/ Return of FOUR Active Global Income & Growth Equity Fund within Lipper Global Equities Sector (Funds Registered for Sale in UK only) to 30 September 2014 (in GBP).

 

Source: Lipper for Investment Management. Past performance is no guarantee of future performance.

Source: Lipper for Investment Management. Past performance is no guarantee of future performance.

The preference for stocks with a higher FCF yield and the quality metrics give the portfolio a value feel, but cyclicality is not ignored, since dividend yield doesn’t feature highly as a metric (there is another FOUR global equity fund that invests solely in “steady Eddies”). Indeed, it was exposure to cyclicals that resulted in a very poor year of performance for 2011. Mr. McQueen explains that the market was being frightened by the Eurozone, interpreting events then as a potential reversion to 2008. Therefore, while cyclicals appeared attractive for the intrinsic-value methodology, it was “safety first” stocks that became the market darlings as FCF yields were eschewed for high dividends. He found himself particularly overweighted in financials, with stocks such as BNP Paribas contributing significantly to the poor attribution that year. However, Mr. McQueen actually added to these positions as they fell (value traps are avoided under his methodology because, despite share price falls, FCF is still increasing) and has recovered well by holding his nerve.

Table 3. BNP Paribas Share Price Performance 2011.

Source: Thomson Reuters - Eikon.

Source: Eikon.

Mr. McQueen sees the current market priced at fair value, but he can still find undervalued stocks. He highlights that the current price-to-book ratio of his portfolio is where the market was two years ago. He still sees some opportunities in defensive stocks, but he is currently excited by financials, tech, select property companies in Asia, energy, and healthcare.

Boutique investing isn’t for everybody. There isn’t the reassurance of large research teams, seemingly endless investment infrastructure and there is often higher key person risk (although that is diffused here with Mr McQueen’s able support). Potential investors in this fund should see the recent announcement that the Sanlam Group has acquired a 90% stake in FOUR as an additional positive – the backing of a large institution is a desirable feature for any smaller house.

 


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Disclaimer: 
This material is provided for as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice. The author does not own shares in this investment.

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