Sticking to your last
David Testa sits square in his chair as chief investment officer at T Rowe Price in Baltimore. His chair may swivel, Testa doesn’t. He’s seen most of it before and he ain’t for turning.
That’s not surprising since he has been with the firm since he was hired as an equity research professional upon his graduation from Harvard Business School. Testa was the lead portfolio manager for the firm’s flagship mutual fund, the T Rowe Price Growth Fund, from 1984 to1994, later, becoming director of the entire equity division.
His focus is on one thing and one thing only – investment – successful investment – from true and tried principles.
So have we come through the worst? Testa ventures that we have. “After thinking the world was a very difficult place in which to invest, we have begun over the last 12 months to move in the other direction,” he says. “This was a perception that value was there in more growth oriented investments”.
This was done on the back of recognising that valuations had moved to a more reasonable level, he adds. “The economic environment if subdued was not likely to get worse and that the relative attractiveness of equities to other forms of investment given what was happening to interest rates was compelling.”
Where it makes the strategic choices in portfolios, the firm has also changed its asset allocation. “There we have been building up the growth oriented part, with an emphasis on small to medium sized companies, which do well as things turn for the better.” So an increase in equities over bonds has been one shift and in bond portfolios taking more credit risk, by emphasising high yield and corporate, has been another.
Testa does not see this stance as contradicting the firm’s avowed bottom-up focus. “From this approach, all things flow,” he maintains. “We look on the individual investments in each manager’s universe. We do not have a grand strategic point of view and expect everyone to fall in line with that. We find that does not work so well.”
T Rowe stayed out of the high tech bubble and acknowledges that it paid a price at the time for this. Back in March 2000, Testa rejected the notion that “we should be plunking down money for outrageously priced stock”. And his convictions have been vindicated by the outperformance of around 80% of their 34 equity strategies over the past five years.
“You need to know the companies you are investing in, so you really need to do good financial analysis.” Here, he laughs at finding himself restating the obvious. “Secondly, valuation always does matter a lot. What you pay for something is as important as anything you do.”
The third lesson relates to diversification: “Running pretty diversified portfolios is a good way to go. Too many in the late 1990s and early 2000s were taking the view that diversification was for mugs, that it was better to concentrate your portfolios and always ride the hottest horses in town. We did not go there, as we have always had a long list of names in our portfolios.” So at that level it has been back to basics.
But the world has changed, he acknowledges. “One fact emerges is the extent to which you should pay attention to top down issues. Big questions have emerged and need to be answered as to how we run money to some degree. While we have not changed our process, we are all the more cognisant of issues like inflation, deflation, the extent to which you can hope for growth to come along.” These are areas that are going to be important looking ahead, he says. “In our communications, we have more discussions about these areas, but we have not formally changed our process to move in that direction.”
During the bad markets the focus was on what the portfolios owned – “we did not want big cash positions”. “I suspect we will stay with that mode, so in the course of trying to figure out what we should own, some of those top down questions will flavour the portfolio managers’ thinking as they make those choices.”
Testa points to fixed income where the process has a much more top down structure with an explicit policy applying across portfolios and right across the credit spectrum.
The heavy specialist mandates that dominate the US world has meant that the bottom up focus is almost the norm and most investment firms moved away from having a big policy structure. The firm did experiment with this for a time, but “it was a really unsatisfactory experience and we bought into the bottom up approach”. “But you must not get blindsighted by doing that. Nowadays we are more alert to that risk.”
Internal contact is one way to avoid such tunnel vision, he says. “There is a lot of communication between the fixed income corporate specialist and equity research analyst at an analyst to analyst level and to some extent portfolio manager to analyst and portfolio manager to portfolio manager.”
That could amount to quite a number of conversations, as the firm has over 60 portfolio managers, plus another 17 acting in a portfolio manager/analyst role, and 70 analysts. Keeping this pool of experienced research and management professionals on whom the group’s strong longterm performance depends in the loop and focused is clearly a key objective. But he does not think a “policy umbrella” is going to be opened over this.
As to where the firm’s overall stance is in relation to the marketplace, he says: “The portfolio manager will decide the portfolio, on the basis of its being a growth or whatever. And the firm’s overall position is the aggregate of these stances.” He shrugs at his own impotence in this respect: “It is not as if I am positioning anything!”
But the firm does take stances necessarily as it did when avoiding the high tech craze, as it puts it. Testa says that’s not the history of the firm to shun opportunities by any means. “We did well in the 1990s in a good market environment. Now that the market is going up again, we are gratified that our portfolios are competitive.”
By choice the firm has not gone the alternatives investment route. While it has had some success through venture capital partnerships investing in bankrupt or distressed situations, it clearly is not something that sits comfortably with him. “That kind of investing does not fit with what we do in public markets. Not that it is a problem, but we do not see much benefit in doing them together.”
With hedge funds, Testa sees real difficulties. “We think there is tremendous potential for conflicts of interest, which could create significant stresses in the organisation.” He explains: “If the company was faced with choices between allocating investments in portfolios where you have a direct interest in the outcome, as against where you are acting purely as an agent, then it is a naturally conflicted situation.” Such conflicts he agrees could be managed. “But unless you are very careful, it is hard to see how the issue would not come to the floor, or appear to do so.”
In his view, the longer term growth of the investment business will be driven by the pressures to fund for retirement at an individual or corporate level, in the US, Europe and elsewhere. “This will release funds to purchase equities to some extent,” he says. While there has been a shift to bonds, but the need to obtain the returns that market related investments deliver means money will go to equities. “Where pension plans are assuming annual returns of 9%, there is little choice in bonds at just over 3%. Or else you have to be a very active tactical allocator, which most people do not want to be.”
T Rowe Price took the opportunity to recruit through bad markets, reckoning that this would be an opportunity to pick up good people. This in addition to its successful policy of keeping its professional teams in tact to provide stability means that it is well positioned to go ahead.
The firm has around $160bn (E143bn) in assets, of which $100bn are sourced from institutional investors. While most of the assets are US originated, an increasing proportion is coming from outside. In 1999, only $100m was managed for non US institutions, currently this is over $3.5bn.
Testa points to the success they have been having particularly in Europe, where the firm has been very active in building up its presence. “We now have a very good team and have built up a marketing process we are very comfortable with. It is very professionally run.”
Testa reckons that the firm has to keep pushing forward with its achievements in Europe and elsewhere. He won’t even hazard a guess as to what proportion of business the firm would like to see emanating from Europe. But he sees opportunities opening there with the advance of open architecture and the emergence of ‘best of breed’ criteria in selecting managers.
“We want to take this as far as we can, but with a number of provisos. The first is that people understand what they are getting when they hire us.” The aim is to grow longterm business and to avoid the ‘hot money’ flows. “The second is that we want to be sure we can do what we are being asked to do.” Disappointed customers are not on his agenda.
“There will all be areas that people are interested in that we cannot follow up on, but at the same time, we have a pretty broad capability,” Testa says, summing up the firm’s offering in characteristic no nonsense terms.