It probably wasn’t planned this way, but Four Capital Partners was set up by Derrick Dunne and ex-Schroders UK equities managers Tom Carroll, Ted Williams and Chris Rodgers on the precipice of the financial crisis. Established in 2006, its first UK equities fund was launched in April 2007, on the very day that New Century Financial went Chapter 11.
“I launched my multi-manager business, MM Asset Management, about a month before the peak of the dotcom bubble,” Dunne recalls. “If I ever start another venture you know it’s time to get into cash!”
Don’t sell just yet. Five years on, the London-based equity boutique is going strong, with more than £600m (€750m) in its UK equity strategy, and another £410m in Europe and global strategies launched in April 2011.
That is partly thanks to the fact that the partners, their friends and families capitalised Four with a worst-case scenario in mind. By the time the $8bn South African financial group Sanlam offered to buy a stake in late 2008, it was sitting on three times its required regulatory capital. Friends and family took the opportunity to cash out at excellent multiples while global markets were tanking, and Sanlam remains a 49.9% stakeholder today – as well as an important partner for distribution.
But it also helps when you start with a respected, experienced team. Dunne recognises a good portfolio management team when he sees it. As a former client of Carroll, Williams and Rodgers – and of Dino Fuschillo, who would later join to head European equities – he knew these were the people he wanted to partner with for his “multi-team boutique”. Moreover, other clients liked them enough to stay with them. Six months after inception, long-term Schroders client the News International Pension Scheme bought into Four’s UK equities fund. Less than a year later, the firm picked up a mandate from Russell.
“Institutional was always going to be a target for us, given our backgrounds, and Russell backing us early, in July 2008, was a key break,” says Dunne.
Still, recent years haven’t been easy for active UK equity managers – even those, like Four, that have annualised 4.4% gross over the past five years, versus 1.9% from the FTSE All-Share benchmark. Despite good performance, the News International mandate ended when the scheme moved to passive equities. De-risking and a move to globalise equities, especially by UK institutions, have accompanied that passive trend.
“We do find pension assets coming through multi-managers,” says Dunne. “But almost all the interest in our UK product last year was from Continental Europe, the Middle East and Africa. We’ve partnered with IMR Partners to represent us before the central banks and sovereign wealth funds in the Middle East, for example.”
Investors aren’t exactly falling over themselves to buy European equities, either – and indeed, unlike global equities, there was never any specific ambition to launch such a product. “We prioritise finding talented people before we think about products,” Dunne explains. “We knew Dino and wanted him onboard.”
Again, this is a serious team. Fuschillo was head of European equities at Martin Currie and one of his co-managers, Marco Ricci, was a founding director of the Hermes European Focus fund. This is reflected in plans for the product suite; alongside the Europe ex-UK fund there is live money in pan-European segregated accounts and a long/short paper portfolio awaiting seeding.
It was Fuschillo’s contact with Colin McQueen, head of global value equities at Morgan Stanley Investment Management, that fulfilled the ambition to move into global equities. McQueen – a pioneer in standalone global equities in his Phillips & Drew days – brought Stephen Walker with him from MSIM in October 2010, and the team leadership was rounded out by Justin Maloney, a founder of global-equity hedge fund Artefact Partners.
Now a genuine multi-team boutique, Four nonetheless pursues a coherent investment philosophy across its strategies, best described as sustainable growth bought at a discount to ‘intrinsic value’. “Forget that the market is going to value it every second of every day,” McQueen explains. “If it was your family business, would it make you money or not over the next 10 or 20 years?”
‘Intrinsic value’ leads to a research focus on assets and sales growth, but most importantly, on the ability to generate free cash flow. That enables sustainable growth without excess leverage, but also makes it easier to establish a long-term valuation that looks through short-term market noise. Each team can only buy a share if it feels it is trading at least 20% below intrinsic value.
“The UK team is more likely to be closer to that maximum entry point,” says McQueen. “But in global we fish in a very large pond and can be choosier about a greater degree of upside.”
Each business is put through scenario tests, with those presenting the most pronounced and asymmetric upside risk weighted higher, before quantitative screens are run to identify common factor risks. Most of the portfolios manage around 40-60 stocks.
The philosophy clearly favours staples-like, steady cash-flow growth over time, but this group can include IT and service companies, and even media names, with strong recurring revenues. Industrials and resource companies that grow cash flows with a little more volatility around the business cycle also play an important role. Right now, consumer staples are underweight in all the portfolios. Technology is overweight, unsurprisingly, but so are industrials and materials in the UK and Europe funds.
“What we don’t like are businesses that suck in cash over time, asking for more money even when they’re announcing rising profits,” says McQueen. “We’re also wary of static free-cash generation, and a lot of telecoms and utility companies would come under that rubric.”
The ability to diversify is important for the main Global Income & Growth strategy, as McQueen points out that the staples-like businesses only represent about 30% of the cash-flow generators that Four prefers. However, in a move designed to appeal to pension funds, Four’s partners have just put $50m (€39m) into a new ‘low-volatility’ global strategy that will invest exclusively in that especially stable 30%.
The aim is to deliver at least CPI inflation. Historically, this universe has returned well in excess of that, and the portfolio currently offers an initial 7% free-cash-flow yield. Even as a nominal return, that shapes up impressively next to corporate bonds, but McQueen expects earnings growth at least as fast as inflation, turning that yield into 7% real.
“Pension funds have most of their money in bonds with low or even negative nominal or real yields,” says McQueen. “The equity-risk premium might be 6-7%, but it comes with a lot of volatility. We’re trying to bridge that gap. The volatility of the universe for this fund has been as low as that of US Treasuries in the past.”
Four’s bottom-up fundamental solution to this problem joins the ranks of countless other low-volatility strategies offered by quantitative asset managers, which tend to rely on correlation-based optimisation to over exposure to defensive, high-quality companies. McQueen concedes that some valuations have been stretched in these areas, but he only needs 20-30 stocks for the portfolio and still finds plenty of pockets of value. In healthcare he picks out US medical devices firm Medtronics, with its 9% free-cash-flow yield and 10 times P/E ratio; the IT sector is also fruitful.
Tapping into stronger themes in institutional investor demand, Global Income & Growth and Global Stable Equity mark the next phase of Four’s evolution. The recent hire of Michael Pinggera from Insight to head a multi-strategy team that will combine directional and non-directional ideas from within Four’s existing strategies with other emerging market, equity alternative, commodity and high-alpha positions, can be seen in the same light.
“We are just getting started with the pension fund and consultant community, and we think Stable Global will enjoy significant interest,” says Dunne. Next to him, Angus Scrace, recruited from Macquarie in February 2012 for institutional business development, nods in agreement.
“So many boutiques struggle to break the £400-500m level you need to get the attention of institutions and consultants,” he says. “Well, we now have a terrific five-year track record and are knocking around the £1bn threshold.”