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Shares: How to profit from directors and shrewd investors

Created:
29 September 2006
Written by:
Dominic Connolly

Global equity markets are changing and the way you research stocks needs to change, too. The rise of hedge funds and activist shareholders, combined with the financial firepower available to the private equity community, have all revolutionised the investment industry. The typical shareholder is no longer content with traditional passive funds and is impatient to see a return on their investments.

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Now, the emphasis is on releasing perceived hidden value and on optimising balance-sheet efficiency through financial leverage (borrowing to invest), which has been fuelled by low interest rates.

So I am surprised by the resources that are still dedicated to technical and fundamental analysis of shares, and the relatively little attention that is paid to the structure of the shareholder register - and not just in a static sense but also a dynamic one. Any potential investor in a company should be examining a company's shareholder register. Is a large percentage held by management? Have the directors - who should be best-placed to know - been recent buyers or sellers of the company's shares? Has the company attracted the attentions of any well-known 'shrewd' investors whose investment style and track record have impressed?

'Following the smart money', in this way, is an investment strategy that I have used for a number of years with some rewarding results. As an active but lazy investor with limited time, I have found it profitable to ride on the coat-tails of those far better qualified to assess a company than I am.

But how can you keep track of the movements of 'shrewdies' and who are they?

The Companies Act requires prompt disclosure of substantial holdings to the company itself within two business days if a shareholding reaches 3 per cent, falls below 3 per cent or changes by one percentage point or more above 3 per cent. The company then releases this information to the marketplace. Note that the Companies Act does not currently stipulate that contract-for-difference (CFD) positions above 3 per cent have to be declared. This is because CFDs do not generally confer beneficial rights as the shareholder vote resides with the stock, which is usually held by the CFD provider or investment bank as a hedge to the CFD.

That is why traders follow with interest large holdings in companies by CFD providers and investment banks as it is often the 'shadow' holding to a large CFD position or spread-bet. For example there has been recent speculation that Man Financial's 9.96 per cent stake in JJB Sports is held as a hedge against a CFD position held by Mike Ashley, the billionaire owner of Lillywhites.

If a company commences takeover talks, however, and enters an 'offer period', the disclosure requirements for CFDs become more onerous.

To make sense of this, over the past four years, I have built up a spreadsheet of companies with an interesting share register.

My list can be divided into the following broad types of shareholder:

• Shrewd investors

• Hedge funds with a strong UK track record

• Activists

• Large equity holders

• Stake-builders.

Shrewd investors, in my book, are those with an established track record of investing in undervalued situations, often with an uncanny knack of spotting future takeover candidates. Jack Petchey, for example, who usually invests through his investment vehicle, Trefick, has time and again taken sizeable stakes in companies that have later been subject to a takeover. Some of his major successes include DeVere Group, Aston Villa Football Group, Reg Vardy, Somerfield and Estates & General.

Other 'shrewds' whom I like to keep an eye on are:

• Sir Tom Hunter and his investment vehicle West Coast Capital.

• Bob Morton (who often invests through his vehicle Southwind). Vislink (3.67 per cent) and Vitesse Media (14.4 per cent).

• Nigel Wray.

• Guy Naggar & Peter Klimt of Dawnay Day.

• Leonard Licht, formerly of Jupiter and Mercury Asset Management and currently chairman of Hg Capital.

Others worth watching include Luke Johnson of PizzaExpress fame, Jon de Mol, creator of Big Brother, who is a large shareholder in several UK media companies and Richard Farleigh, star of the BBC's Dragons' Den television series.

My favourite funds that have a strong UK record include Lansdowne Partners, whose UK fund is run by ex-Mercury fund managers Stuart Roden and Peter Davies. Lansdowne has an excellent recent track record and although its notifiable holdings are too numerous to mention here they can be reviewed in my spreadsheet.

Laxey Partners has traditionally sought to accumulate stakes in closed-end funds trading at a discount to net asset value.

But my favourite fund manager remains Chris Mills of JO Hambro Capital Management, whose philosophy is to recruit the best fund managers in each asset class and give them the freedom to outperform. Mills and his team also manage a number of closed-end funds, which take an active value approach and trade under the North Atlantic Value brand.

Activists

Shareholder activism is on the increase and I am always on the lookout for funds that act as agents of change. In July 2003, I noticed Edward Bramson of Hanover Investors Partners (HIP), a turnaround specialist, had taken a stake of 14.8 per cent in 4Imprint, the promotional printing group. Shortly afterwards, in August, HIP declared a 10.6 per cent holding to give a combined holding of 25.4 per cent, established between 40p and 60p. The combined declared stake increased to 26.6 per cent during August and in September an extra-ordinary meeting was requisitioned by Hanover to effect board changes.

Despite initial resistance from the incumbents, Mr Bramson and Matthew Peacock of Hanover joined the board in October. Final results were published on 29 March 2004, confirming the turnaround in the performance of the company - the share price had risen in the meantime to 165p at one point. Hanover reduced its stake shortly after wards at around 140p, selling out completely by July of that year.

Hanover popped up again in January 2005, with a 10 per cent holding in Elementis, the chrome and specialist chemicals company, buying its stake at around 30p. After final results were released on 15 February, it increased its stake to over 15 per cent. By June, the company's existing chief executive officer had gone, with Mr Bramson and Mr Peacock joining the board, and by August, the chairman had left with Mr Bramson moving up to executive chairman. Final results in February 2006 confirmed that the company had turned the corner. Hanover reduced its stake shortly afterwards and, by August, of this year had sold out completely at around 80p, making a very healthy return on its investment.

Tracking shareholdings by activists and 'shrewds' can be time-consuming, but some websites take the sweat out of it. Citywire regularly reports on buying and selling by activists and 'shrewds'. In addition, a feature on Sharecrazy (www.sharecrazy.com) allows you to plug in a name and to scan the whole market for declarations by that individual or fund. I rely on being alerted by other traders and active investors and try to keep my spreadsheet updated quarterly. It contains most stake-building situations in the UK, which in itself can lead to future corporate activity.

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