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Profiting from a rounded view

INTERVIEW: Julian Fosh tells Leonora Walters why it is important to get a rounded picture of a company and why he believes banks are value destroyers.
July 1, 2011

Metrics and company fundamentals play a key part in helping Julian Fosh and co-manager Anthony Cross determine the right stocks for the funds they run. But these investment tools are only a part of getting a rounded picture, which has helped them turn around the performance of the Liontrust UK Growth Fund, after taking over management in March 2009.

Over the past year Liontrust UK Growth has returned 30.5 per cent against 20.4 per cent for the FTSE All-Share Index, placing it in the top quartile of its fund sector, UK All Companies. But over three years it lagged the index and its fund sector, coming in the third quartile for performance.

Mr Fosh and Mr Cross's three stage investment process kicks off with finding companies which have at least one of the following three attributes:

•strength in intellectual property or intangible assets;

•strong distribution; and

•significant recurring business.

But none of this is of any use unless it translates into superior returns on a consistent basis, the second part of the screening process, while the stock’s valuation is also key. "If all the attributes we look for are already reflected in the share price we will not get a return," says Mr Fosh. "We look at the price-earnings ratio (PE) but this is static. Other important measures include return on capital (ROC) and market to value sales. Our aim is to get a rounded picture of the value the market ascribes to a company."

As an example, Domino's Pizza and Rightmove deliver a high ROC so that Mr Fosh feels their high PE is justified.

This investment process combines the input of both Mr Fosh and his colleague. "I brought the ROC angle to the process, and whether an economic advantage translates into profit," says Mr Fosh. "It goes back to when I was a fund manager in the 1980s and 1990s at Scottish Amicable, an investment house was focused on value investing. Value investing was not working so I was given charge of a range of high performance funds for retail investors and told to devise something different. I and a committee looked at various approaches and came across this one. By using this method of investing these unit linked life and pension funds did very well – this is a very valuable way to think of companies."

However this was not the final step. "I then took the process to Scottish Friendly Assurance where I refined the process, before I deployed it at Saracen," explains Mr Fosh. "It now fits very well with the economic advantage criteria at Liontrust because it focuses on the fundamental strengths of the company. It is the most specific investment style I have run."

Julian Fosh CV

Julian Fosh is co-manager on the Liontrust Special Situations, UK Growth and UK Smaller Companies funds. He joined Liontrust in 2008 from Saracen Fund Managers where since 2004 he was co-manager of Saracen Growth Fund.

Before this, Mr Fosh headed the investment department at Scottish Friendly Assurance Society where he worked for eight years and has also worked at Britannia Investment Managers and Scottish Amicable.

Homing in

Looking for companies with strength in areas such as intellectual property and distribution inevitably leads to certain sectors and types of companies. These include technology, drugs and engineering companies. "Britain is genuinely a source of many world class engineering businesses," says Mr Fosh. "Good examples are Spirax-Sarco, which pays recurring dividends, Rotork, and Halma which manufactures in an area where there are high barriers to entry and offers almost unrivalled dividend growth."

"That said, we don't target dividends, these are a by-product you tend to find in a well run 'growth' company, as they don't necessarily reinvest every last penny. Some businesses can be high growth like Rightmove but generate dividend growth. We start by considering whether it is a strong company. Often if it is strong in one area it is strong in another."

For example, drug companies had a strong intellectual property advantage during the last decade. "But now GlaxoSmithKline has strong distribution," says Mr Fosh.

Wrong shape

Resources and Land are the main sectors where they struggle to find companies that conform to requirements such as strength in intellectual property, so the funds have little or no exposure to mining companies, house builders or retailers.

However, there are always exceptions such as newsagent WH Smith. "This has good distribution," he says. "It has a presence in airports, where sales should pick up, and it is moving into hospitals. It is a great growth business, has a surprisingly good ROC and has surprised with big dividend increases."

Another sector which fails to meet the criteria is banks, to which the funds have no exposure. "Branch networks are not what drives their profitability so they do not meet our distribution criteria," he says. "I also do not consider that they have intellectual property."

"Although old-style banking had an element of recurring revenues, the emphasis has switched to one-off sources of revenue, such as origination and trading. It is a basic requirement for us that a company is able to demonstrate its superiority by consistently earning a return on equity which exceeds its cost of equity, and since the downturn the banks have been unable to do so. They are value destroyers rather than value creators."

No investment process is flawless and Mr Fosh says the commonest mistake he has made is to sell too early on valuation grounds, an example being online clothes retailer ASOS. "When this company internationalised there was a risk they would get their distribution wrong, but they got it very right and the shares became a lot more expensive," he says. "If your style is predicated on finding small business models they will consistently produce better results and look expensive. So we have learned to be less trigger happy – we will take the weighting down to control risk but not necessarily sell when a stock looks too expensive."

Indicators include profit warnings and relative highs and lows in the share price. "We note new lows but it does not necessarily trigger a sale," says Mr Fosh. "For example Renishaw (a machine tool producer) has fabulous intellectual property and a low staff turnover but issued some profit warnings. We kept it which was a good call and as it has been performing well since China picked up."