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American half-century

If you are wondering why it took 50 years for American Century Investments to open its first offices outside the US, it is instructive to look at who owns the business. Among the partners, primary control is held by the cancer research group associated with the Stowers Institute for Medical Research in the firm's home town of Kansas City. About eight years ago American Century's founder, Jim Stowers, now an octagenarian cancer survivor, donated almost all of his wealth to establish the institute. Since 2000, 40% of the firm's profits have been paid as an annual dividend to the institute - a total of more than $750m.

"That's profound motivation that you can't find anywhere else," says Jonathan Thomas, president and CEO. "And it gives you a very long-term perspective. The Stowers Institute says to us, ‘It's going to take 50 years to find a cure for cancer - is this business you're building going to have that sort of lifetime?' That tends to align your portfolio managers with the long-term objectives of your clients."

Doing things in a hurry isn't American Century's style. The first 35 years were focused on US growth equity for individual retail clients, and the last 15 have been spent diversifying the client base - 90% or more now comes from institutions or intermediaries - and the strategies. US fixed income was added in 1980; quantitative US and ex-US core, growth, value, long/short and small-caps capability was launched in 1990; ex-US growth, emerging market and small-cap equity in 1991; US value in 1993; and asset allocation products in 1996. All of this culminated, at the end of 2008, in a series of new leadership appointments, team consolidations and fund reorganisations that Thomas describes as "a process of institutionalising the business".

"We'd reached the point we wanted to domestically, and the logical next step was to expand internationally," he says.

That process began with the hiring of Morgan Stanley's Michael Green as senior vice-president, international, in April 2008. In the past 18 months the firm has put together an international team, registered with the Financial Services Authority (FSA), set up a Luxembourg SICAV, opened a Hong Kong office, settled into the heart of London's West End at the beginning of October - and pulled in $1.9bn from non-US clients into segregated accounts before its SICAV was even up and running. That success has come from medium-to-large institutional investors, primarily in the UK, the Netherlands, Germany, Switzerland, and the Middle East, and these will continue to be the target for the UCITS III SICAV company, which will be devoted to the US Growth and Global Growth strategies, in both standard and concentrated versions.

"We think that will help secure brand identity," says Green. "The split between growth and value is not as prevalent here but, even so, those offering equities are most often doing so with a value style, so hopefully we offer something a little different as well as playing to our strengths."

The firm claims a different approach to growth investment, too, calling the turning-point in company earnings growth through traditional analysis and earnings screens. A classic growth investor would begin with an absolute hurdle rate for earnings growth, set at the point at which they would expect a return (perhaps as much as 20- 25%), ignoring companies not already exhibiting that level of growth.

"Because we are looking for the turn in earnings our opportunity set is always greater," argues client portfolio manager Shelia Hartnett-Devlin. "Even last year, someone was always improving on a relative basis. It also means that areas that are not considered classic growth, such as utilities or even energy, offer us opportunities at different points in the market cycle."

An example from US mid-cap companies might be airlines. These are certainly not showing growth characteristics at the moment: pricing pressure and rising costs have squeezed margins. But passenger numbers are edging back up and the canniest operators are tacking extra charges onto the basic ticket price. Revenue per seat is increasing and spare capacity is on its way down, but neither is reflected in price momentum.

"If you think of the earnings cycle as an ‘S', we try to invest in the belly of that ‘S'," says Hartnett-Devlin. "Then we have a very strict sell discipline at the top of the ‘S' as we see deceleration in earnings growth."

Hartnett-Devlin says that "we are very much bottom-up and don't take big top-down calls", but to what extent does timing that earnings-growth cycle ‘S' involve timing the macroeconomic or business cycle?

"A company's inflexion point will come because of new market share, new technology or a new product," Hartnett-Devlin insists. "That will have the wind at its back as we move into recovery, but that's just an added catalyst."

The proof of that statement lies in the performance of the firm's US Growth portfolio this year, she observes. It lagged its benchmark in Q2's ‘dash to trash', resulting in year-to-date underperformance of 45bps. While the macro environment shifted, American Century's bottom-up discipline held firm. "We are always focusing on a two to three-year time horizon, looking for more sustainable earnings and, therefore, generally stronger balance sheets," Hartnett-Devlin explains.

Take performance back three years, encompassing the whole of the credit crisis, and the benefit of that discipline becomes clear: the US Growth portfolio has outperformed its benchmark by 2.37% annualised.

"Our fixed-income performance has been absolutely outstanding through the crisis," notes Thomas. "That's all been down to proprietary credit and balance sheet analysis. There is a very close tie between fixed income and value, so the credit team's concern that risk and reward was out of sync flowed there first; then it flowed from value to growth within equities. There is no macro overlay, no CIO making calls, just independent teams making decisions and sharing information."

One call he is prepared to make: "This is a great time to be an active manager. Just being in the market is not going to be good enough over the next few months and years."

Expect tough going in a lower-growth environment, warns Hartnett-Devlin, but also opportunity as Q4 earnings improvements continue into the new year, thanks to ongoing cost-cutting and an incremental pick-up in demand. In this situation the outperformers will succeed in defending margins and picking up scraps of slowly growing market share. Some top-down positions make sense: the tech sector, for example, which survived the crisis well after realigning its business models during 2000-01; and emerging markets, both in themselves and as growing consumer markets for developed-world exporters.

"But stock selection within every sector will be important because there is going to be real differentiation between winners and losers," Hartnett-Devlin predicts. "In Global Growth we have TenCent Holdings, a Hong Kong-listed online advertiser that provides exposure to China, where online currently accounts for just 10% of the advertising market. In US Growth we have J-Crew, a great example of how to exploit consumer trends for greater value and more internet shopping. American Express is in both portfolios. It managed reserves very well and is well placed to exploit any pick-up in consumer spending."

If American Century were a public company, it might be in this kind of portfolio, too. With almost $2bn already committed, it comes to a huge new market with 50 years' experience at a time when disenchantment with the usual names is at an all-time high. That has ‘growth strategy' written all over it.

 

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