For decades, active managers have tried to bend markets to their will by paying dear for tools, talent and client relations teams which strive to persuade clients to stay loyal when their funds fall below benchmark.
Andrew McNally, chief executive of Equitile Investments, is not impressed with the fees they charge to achieve this, noting that disillusioned investors, including family offices, have switched trillions into cheap, passive, funds.
Clients don’t trust the industry. Fees are a big issue. Passive management was a great innovation
McNally and George Cooper, his investment chief, are out to challenge the active status quo by investing in relatively liquid stocks on a record low fee. Family offices, who have a nose for a bargain, have been their earliest backers.
Equitile co-founder Thor Johan Furuholmen, principal of family investment company AS Vidsjå in Norway backs the firm, out of conviction it can deliver returns of 9% a year, net of fees, over the long term.
McNally says several other family offices based in Europe and China have invested, taking Equitile’s 40-stock Resilience fund to $170 million in value. UK wealth managers are starting to nibble.
Equitile counters the common view among managers that stock markets are efficient and continually offer a way for active managers to make money, when prices drift from the norm.
Instead it compares stock market investors to a flock of starlings. McNally says: “They fly in one direction, then another, following the example of their leader. You don’t know where they are headed. You don’t know if they’ll continue to follow the same bird. All you know is they will continue to crowd together.”
Equitile’s portfolios are steadily adjusted to take account of these changes in market style, as starlings swoop and dive. The firm does not rebalance against a benchmark. In fact, it does not see the relevance of a benchmark. Instead, McNally says: “We have a strong trend-following function, and a good stop-loss discipline, which helps us deal with mistakes quickly.”
Equitile has evolved a programme called Darwin which shows when stock positions should be reduced, as they start to lose market support. It goes on to pivot towards new styles, as they suggest that stocks on a reserve list take their place, as they pick up momentum.
Stocks are rated according to their characteristics which perform better in some markets than others, as opposed to their ability to hit an overall target. McNally adds that ‘buy and hold’ is not a good active strategy, given the fickle nature of markets.
McNally says: “George (CIO) has a background in fixed income, so his instinct is to protect the portfolio against loss. But we are tolerant of volatility because we are happy with our portfolio. We also know we are protected because our stocks are lowly leveraged.”
The Equitile universe currently covers 2,000 liquid stocks with an individual market value of $7.5 billion. Resilience’s top three investments comprise Microsoft, Intuitive Surgical and Visa.
Although Equitile’s approach is systematic, McNally says human judgement, even gut instinct, can play a role: “We don’t neglect our experience, and we can express a personal view. One of our current suspicions, for example, is that big tech stocks may become more challenged over competition or tax issues. That may count against them.”
Between 2003 and 2014, McNally was chairman of Berenberg Bank in the UK, competing against large investment banks, putting the interests of their proprietary traders ahead of their private clients. Berenberg seized its chance to win business after the credit crisis when the big banks were found wanting.
He went on to focus on disruption in asset management: “Clients don’t trust the industry. Fees are a big issue. Passive management was a great innovation.”
In 2015 he joined forces with George Cooper, a former bond manager at JP Morgan and hedge fund BlueCrest. Cooper, like McNally, took a pronounced view that economics and financial services were poised for a revolution.
McNally and Cooper are optimists. McNally says: “Companies are increasingly capital light, resulting in higher returns from less investment. The average cost of labour has also been falling. Taxes, thanks to Donald Trump, have been coming down.”
Equitile believes interest rates will remain low because central banks have been backed into a corner: “They keep pushing the debt burden uphill. Every now and again it slips, then they try again. This means rates will stay low.”
McNally says central banks saw the impact of higher interest rates in the fourth quarter of last year, when markets became highly volatile. Equitile now believes that Jerome Powell, chair of the US Federal Reserve, is aligned with US president Donald Trump on the importance of low interest rates amid political uncertainty.
Growth and cash flow are key factors that drive Equitile stock picks. Returns on capital matter far less. McNally says: “We don’t care whether companies pay high dividends or buy back their shares. What interests us is their ability to pay cash. Our tolerance for leverage is very low.”
The Equitile portfolio is 78% balanced towards the US, but currency positions are hedged. Equitile invests in capital-heavy sectors like oil, banks and healthcare, but can back disrupters in each.
Performance to satisfactory, setting aside its first eleven months, when sterling returns were 3.3% , against 16.1% for a roaring sterling-hedged MSCI World comparison index.
In 2017, returns were 25.8%, against 17.1% from the comparitor; in 2018 returns fell -8%, against -9.8%.; in the year to May, they have been 21.4%, against 16.2%.
Net returns are bolstered by low fees, which comprises an ad-valorem fee of 70 basis points for its first £350 million of assets. Beyond £350 million Equitile charges a 10% performance fee, with the ad valorem fee diluted further as spreads across more clients.
McNally is unimpressed by unlimited ad valorem fees, arguing this incentivises managers to take on too much money: “We are out to minimise our costs. We are highly automated. We only pay for research when we need it. And we don’t pay licencing fees for our indices.”