| FOCUS ON | OMIGSA | INVESTMENT RESEARCH | New edge on research Ivory Tower days are gone being an analyst was often seen as a steppingstone to fund management. It still can be. However, under Investment Research’s new approach analysts have more control over the outcome of their recommendations and ultimately over how much money they can earn. That’s the second big change. As with the other boutiques, analysts work on a profit-share basis. Remuneration and bonuses are determined by the conviction and accuracy of their recommendations and whether they can convince other fund managers to invest in their recommendations (see separate report). That aligns the goals of the analyst, the fund manager and the client. The first two mentioned do well financially when OMIGSA clients do well. The basis of that is probably the most revolutionary new development in Investment Research: Continual measurement of analysts’ calls measured against the market and on a share versus share basis. Finally, Investment Research has invested significantly in hardware and software “smart systems” to leverage research. Those systems don’t replace the emphasis on fundamental research but aid it, offering tools to rank companies and to establish a standardised framework where companies and industries, both in SA and overseas, can be compared on a meaningful basis (see separate report). “We encourage the analysts to ‘sell’ their recommendations to other boutique fund managers. They need conviction in their recommendations to do that. And if a fund manager doesn’t act on a good call, he’ll be financially compromised, as there’s a direct link between performance and the profits they share,” says Linley. He concedes it’s a system that can encourage analysts or make some feel threatened. “If there’s a proper framework, which I believe we have, it allows analysts to grow. The environment we try to cultivate is one where we critically evaluate our recommendations and then look to learn from our mistakes. That’s how we grow.” Essentially, research analysts are in the “knowledge” business. However, Investment Research has taken that beyond the old days, when analysts would often produce well-researched, comprehensive reports on companies that – despite all the insight provided – still ended in the innocuous “hold” recommendation. The original knowledge produced by analysts is now linked directly to the success it brings to OMIGSA’s clients. ¤ HOW IT FITS IN… boutique, with its team of 49 people, offers in-depth proprietary research to all the other boutiques in the OMIGSA structure. The other boutiques are Investment Research’s clients and they pay for the research provided. That isn’t limited to equity research, headed by Steve Minaar in charge of a team of 16 analysts. The boutique also provides economic research, quantitative research, credit risk analysis and risk research. Boutique head Peter Linley says Investment Research offers OMIGSA boutiques a critical advantage over other smaller boutiques in the industry, which don’t have the staff numbers or depth to cover the entire market. At Investment Research, specialist research analysts in various fields are given the freedom to do just that. The competitive advantage for OMIGSA’s boutiques is that while they’re independent of each other they all have access to top quality research not available to many smaller competitors. Another advantage is that buy and sell orders from the various boutiques are co-ordinated through Investment Research’s central equity dealing desk. The different boutiques don’t know what orders others are placing, but having those orders go through a central dealing desk increases the opportunity to achieve highly competitive prices in the market. In addition, consolidation of orders means lower trading costs can be negotiated for clients. Apart from research, Investment Research also has senior analysts managing a number of specialist portfolios where they can put their best ideas to work. Those funds are the Old Mutual Mining & Resources, Industrial, Small Caps, SA Quoted Property, Financial and Gold Funds. The aim of Investment Research is to help the other boutiques make money by providing solid research fundamental to good investment decisions. ¤ 29 NOVEMBER 2007 FINWEEK 51 THE INVESTMENT RESEARCH Focus on quality research. Peter Linley LARGE AND experienced team of research analysts providing a steady flow of proprietary research has always distinguished Old Mutual Investment Group SA (OMIGSA) and its predecessor, Old Mutual Asset Managers, from other investment houses. But since the implementation of the multi-boutique structure – which also makes Investment Research an independent boutique – there’s been a fundamental change in the research function, introducing new, sometimes radical, approaches to investment research and the way analysts work and their performance measured. “One of the big things for me is the separation of research from the portfolio construction function,” says Peter Linley, head of Investment Research. “The focus now is on quality research – ultimately, it gets measured by the success of our clients, who are the portfolio managers in the other OMIGSA boutiques.” There are probably at least four innovations that have made investment research a “hard discipline” at OMIGSA and which provide an edge to the boutiques in the group. First is that the new structure and measurement system encourages analysts to become “career analysts”. Previously, A OMIGSA | INVESTMENT RESEARCH | Getting equity fundamentals right With help from other research units and systems EQUITY RESEARCH IS A major function at the Investment Research boutique and is based on fundamental research: A detailed analysis of the company, its financial statements, an evaluation of management, the industry the company operates in and the potential drivers or threats that could affect company performance. But other research units and tools are also pulled into that fundamental research process to check, challenge and fine-tune the recommendation an analyst makes. The final aim is to determine the intrinsic value of a company and to explain or understand if there’s a significant difference in a company’s intrinsic value and the market price of its share, says Steve Minnaar, head of equity research. “We don’t have a magic formula. It’s about hard work, deep research and clear analysis. That’s what gives OMIGSA a proprietary research advantage,” he says. “Obviously, it’s important to have the right people. My team has diverse academic qualifications, often including analysts with non-financial degrees who have worked in the industry they cover. That results in rigorous debate and produces original thinking, exactly what you want from research analysts.” But Minnaar adds that just thinking omigsa equity research process > differently isn’t good enough. “You have to be right” and have conviction in your call. The boutique encourages analysts to think Analyst TIM Industry Company Investment of the business they’re analysing “as if Portfoliio Analysis Analysis Ratings they are the owner of the business – then Investment Ideas compare that to what management of the Highest Monitored Conviction business is doing”. Stock List Ideas He says Investment Research can’t be Financial slotted into a particular style of investment Price Specialist Valuation Statement Potential Portfolio's Analysis research, such as value or growth. “We Analysis think value if the share price is very different to where it should be – when a comSource: Omigsa pany’s share price is below its long-term investment value.” The opposite also applies. If the intrinsic value of a company doesn’t support a high tion-adjusted asset growth and other business share price, warning lights start flashing and drivers. The team also uses the Holt database, the analyst would recommend a “sell”. with almost 20 000 international companies for There’s also what Minnaar calls the reverse comparison and valuation (see separate report). gear. “We want to understand what’s being Minaar also uses models from other teams, implied by the market price. such as quantitative research, to test and chalThe alarm bells can ring very quickly when lenge the equity team’s fundamental research. you look at it that way before getting into a The result is deeper research, with robust analymore detailed assessment.” sis and systems to provide the groundwork for Core to the research and company valuinformed investment decisions, because, as ation approach at OMIGSA is its focus on the Minnaar says, “investment decisions shouldn’t long-term cash flow return on investment, inflabe taken lightly”. ¤ ANOTHER TAkE ON EQUITY VALUATIONS THE QUANTITATIVE RESEARCH unit is almost used as a foil to challenge the fundamental research of the equity analysts. Quants models, constructed by unit head Chanel Rowan, provide dispassionate assessments and rankings of shares. If the quantitative research assessments differ significantly from the fundamental research valuations, the equity analyst is sent back to the drawing board to ensure nothing has been missed. “I have three models – large cap, small cap and value – where I back test a number of factors that could determine future performance of shares. The models are back tested continually,” Rowan says. The models also cover some shares, such as neglected small caps, that might not be analysed in equity research. Rowan also runs an extensive internal database and manages a quants hedge fund. ¤ ACTIVELY MANAGING RISk RISK RESEARCH MONITORS more than 80 portfolios throughout OMIGSA’s boutiques, assisting fund managers to assess risk – from portfolio construction through to post-trade monitoring of risk. “There’s compliance, specified in the mandate, that we ensure the mana-ger sticks to,” says risk team head Warren McLeod. “We ensure consistency across the mandates, making sure that funds with similar mandates mirror each other.” The team also looks at risk in current portfolios, determining where risk is coming from and what factors – for example, currencies – could affect risk in the portfolio. “When portfolio managers plan changes to portfolios we consult them to explore and explain the new risk they’ll be taking on,” McLeod says. “We monitor the risk daily and will bring any moves to the portfolio manager’s attention if they cause a significant change in the Monitors risk. portfolio’s risk.” ¤ Warren McLeod Testing models continuously. Chanel Rowan 52 FINWEEK 29 NOVEMBER 2007 OMIGSA | INVESTMENT RESEARCH | Stocks on the block Analysts can control their outcome “FOR AS LONG as I’ve been in this business there’s been an ongoing debate on how to appropriately measure analysts’ calls,” says Steve Minnaar, head of equity research. “When the analysts were intricately involved in the You can’t focus on performance if you don’t measure it.” So how does the new system work? At the outset analysts have to understand exactly how they’re being measured. “Together, we agree a performance contract, setting out clearly the scope of the work and how it will be measured. Once agreed they then get on with it. It sounds bureaucratic but in reality it empowers.” The system must also work for all OMIGSA’s boutiques, so Minnaar says half the performance rating of an analyst comes through feedback from their “clients” – other boutiques – based on how good and convincing their research and recommendations have been. Analysts must demonstrate due diligence, conviction and a high degree of “let me help you make better investment decisions” to the boutique portfolio managers. “A further 25% of analysts’ ratings come from comparing their calls against the market. The long-term measure is over 24 months, though we regularly evaluate calls. That sounds like it could be a short-term focus, but it isn’t. The analyst digs deep in working out the right intrinsic value of each share. There’s nothing short term about that. When an idea pays off our clients and the analyst benefit. It’s as simple as that.” The remaining 25% of the performance ranking comes from analysts constructing a theoretical portfolio of the shares they specialise in, indicating which shares they consider to have the highest investment potential and measuring that against the market. Ultimately, analysts are being measured on three criteria: calling a share against the market, ranking the shares they cover in order of attractiveness and being able to demonstrate their conviction to the investment boutiques. If an analyst gets all three right, the OMIGSA client wins and the analyst will maximise his bonus potential. ¤ A WRONG CALL ANd YOU HOLT RIGHT THERE THE PRIMARY TASK of analysts at OMIGSA is to determine the intrinsic value of a business. The difference between that and the market price then provides investment opportunities to be exploited by the various investment boutiques on behalf of their clients. Their challenge is to improve the consistency and accuracy of determining that intrinsic value – something that’s notoriously difficult, given the vagaries of forecasting many years into the future. OMIGSA meets that challenge by choosing a valuation framework with a proven track record and then standardising it. The framework focuses on the cash flow return on investment (CFROI) that a company will deliver on an inflation-adjusted asset base. Quite a mouthful yet powerful in its simplicity and applicability. Steve Minnaar, head of equity research, says: “Firms need to deliver a CFROI that exceeds their cost of capital – otherwise they destroy value. “If they’re creating value you want them to grow their asset base and improve asset utilisation to create even more value for shareholders. Inflation adjustments are also critical; ask any management team having to replace or upgrade assets.” That analysis therefore goes far deeper than mere earnings per share forecasts and goes to the heart of value creation in firms. Modelling consistency is achieved across the analyst team by using the Holt system, a database that also contains almost 20 000 international firms for comparison purposes. ¤ It’s an ongoing debate. Steve Minnaar portfolio construction aspect of the previous house view, it muddied the waters: was the share in the fund for risk reasons or because the analyst called it a ‘buy’?” Measuring analysts’ individual performances is one of the most far-reaching new developments at Investment Research and its effect is felt throughout the new multi-boutique structure at OMIGSA. After much soul-searching, as well as exploring some international precedents, the boutique has set up a process to objectively measure analysts’ recommendations. On the basis that solid research is fundamental to sound investment decisions, a symbiotic relationship is established between analysts and fund managers. If the manager acts on a good call and invests in the share both parties share in the financial reward. And, of course, the client is the primary winner. Boutique head Peter Linley says he has to be confident research adds value. “At the end of the day the only way to know that, is to have an objective measure in place. That also allows analysts to manage the outcome of their research. Credit – only where it’s due BASHIER OMAR heads the credit research function within Investment Research, analysing all credit exposures in relevant portfolios and ensuring they comply with the set of credit policies and procedures guidelines. “We seek to ensure all aspects relating to credit risk are effectively managed so as to minimise both the probability and extent of loss in the event of default,” says Omar. “Exposure limits are set with regard to, among other factors, compliance with fund mandates, the fundamental credit quality of the counterparty and a risk versus return assessment.” Investments by client boutiques assessed by credit research include listed corporate paper, such as bonds, notes and commercial paper, structured finance investments, credit derivatives and unlisted debt. ¤ 29 NOVEMBER 2007 FINWEEK 53 OMIGSA | INVESTMENT RESEARCH | The art of managing ‘Putting their money where their mouths are’ RESEARCH ANALYSTS DON’T only provide investment recommendations to OMIGSA’s boutiques but also manage sector specialist equity funds and invest a large part of their bonuses in OMIGSA funds. Equity research head Steve Minnaar says they’re encouraged “to put their money where their mouths are”. Minnaar runs two funds: the in-house Shareholders’ Fund (Old Mutual money invested and managed for the life company) and the retail Industrial unit trust fund. Boutique head Peter Linley would probably like to be managing a fund or two himself. He built his reputation over a number of years at the former Old Mutual Asset Managers as a fund manager. “The break has been nice and there’s no time at the moment for fund management as well as heading the boutique. But fund management is where my heart lies – maybe sometime in the future.” Minnaar’s Old Mutual Industrial Fund is rated as “aggressive,” a five on Old Mutual’s rating scale of one to five. It aims at superior returns for investors over the medium to longer term by investing in selected industrial companies. It’s been affected recently by the sell-off in interest rate sensitive shares, but Minnaar’s confident the fund is positioned for inflation to come back within the targeted range soon. He therefore holds undervalued counters such as Ellerine, Lewis and Jd Group. The fund is fully invested in MTN, Remgro, Richemont, Naspers and Sappi. Performance over recent years has been below the benchmark, but it’s above the benchmark over five and seven years. ¤ > Best growth opportunities: Where OMIGSA's view vs. consensus is most differentiated Non-consensus View Company's Forward Earnings Growth OMIGSA's View } Investment Opportunity Consensus View Source: Omigsa Analysts also manage funds financials are the hot sector. And though financials have underperformed for longer than expected due to rising interest rates, it’s encouraging to see that Tracy Brodziak’s Old Mutual Financial Services Fund has been comfortably outperforming its benchmark for more than three years. It’s a specialist fund that will come through on clearer views on inflation and interest rates. Brodziak maintains an overweight position on banks. Her fund has a proud reputation, winning a Raging Bull certificate and Standard & Poor’s sector award for one and three years in 2006. Gold shares are the really volatile specialist fund and here again Investment Research’s Mandla Mapondera’s Old Mutual Gold Fund has strongly outperformed the gold index over the past three years. With top holdings in gold majors such as AngloGold Ashanti and Gold Fields, this fund is well positioned to benefit from the current rampant gold price. On the broader mining front, 54 FINWEEK 29 NOVEMBER 2007 FOR VALUE INVESTORS Anwaar Wagner’s Old Mutual Mining and Resources Fund has also outperformed its benchmark since 2004. Wagner remains bullish on demand for commodities from China, offsetting views on slower global growth in other countries. He’s also confident that infrastructure spending in emerging markets will support demand for other non-gold commodities. Listed property has been a solid performer for the past four years, especially for retired investors who need steady and growing income. Len van Niekerk, who manages the specialist Old Mutual SA Quoted Property Fund, says despite a possible de-rating over the short term he remains positive on listed property returns over the next three to five years. Surprises could come from inflation (which Van Niekerk has concerns about), interest rates and bond yields. That, according to best and worst scenarios, could push returns in a range between 5% and 25% per year. But his view remains that quoted property could offer attractive returns COPY: Shaun Harris relative to other asset classes over the next three years. Small capitalisation shares are currently out of favour with many asset managers, possibly influenced by the perception that the good times can’t continue forever. Returns from small caps over the past five years have been phenomenal: 66,7% for the past year (as measured by the index), 52,5%/year over the past three years and 42%/year over five years. Compound that return and investors in small cap funds more than quadrupled their money. Brian Pyle’s Old Mutual Small Companies Fund has kept pace with that outstanding rate of return and he expects the momentum to be retained until year-end. Much of the growth has come from new listings on the JSE – Pyle says he’s been selective about those and remains underweight in retailers and overweight in manufacturing companies. All of the above funds are available to retail investors as unit trust funds. ¤ THE BIG PICTURE unit is where the big macro factors that so often affect financial markets are researched and analysed. Headed by Rian le Roux and assisted by senior economist Johann Els, this part of Investment Research provides OMIGSA’s boutiques with an immediate perspective on key issues in the South African and global economies, including research regarding currencies, inflation rates, interest rates and industry trends. That’s information that all boutiques – from niche specialist equity boutiques to fixed interest and property – need to inform investment decisions. Macroeconomic research also feeds into asset allocation decisions. Boutique head Peter Linley says that helps give the independent boutiques a decision-making edge and frees the fund managers to do what they’re best at – investing. ¤ THE ECONOMIC RESEARCH ADVERTISING: Stephané du Toit
"A LARGE ANDexperienced team of research"