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A new breed

Philip Scott assesses the outsourcing move at Foreign & Colonial Investment Trust.

The decision to move the US large-cap and potentially the Japan portfolio of the Foreign & Colonial Investment Trust to external managers is being seen in the industry as a logical move.

Many commentators see the change as inevitable, given the turbulent period the trust has seen recently, with lacklustre performance, relegation from the FTSE 100 index and internal upheaval within the F&C stable following the merger with Isis to form F&C Asset Management.

In FCIT’s annual report, chairman Mark Loveday, summed up the relative net asset value total return performance in 2004 as “disappointing against the objective set, following a good performance in 2003”.

The reasons given for this include a continuation of disappointing stock selection in certain regions and for continuing to invest in falling emerging markets during the first half of the year.

Given that it has delivered reasonable performance over the longer term, Loveday notes that the Europe ex UK section was particularly disappointing relative to its index and the North American and Japanese portfolios again disappointed.

The upshot is the decision to switch the large-cap US portfolio (20 per cent of assets)to an external multi-manager and it is anticipated that the same switch awaits the Japanese section (5.5 per cent of assets).

Julian Cane will take over the running of the UK portfolio from Jeremy Tigue, who remains the overall fund manager but no longer has direct stockpicking responsibilities. The board has reduced the notice period for the management contract from 12 months to six months.

The move towards more of a best of breed approach has been broadly welcomed. Iimia head of investment trusts Nick Greenwood says: “There is more supply than demand and I believe the only thing defending them is their sheer size. There was a lot of activist investing throughout 2004 with investors looking to more specialist vehicles.”

Global investment trust giant Witan has been working as a multi-manager vehicle since last year. Initially, a decision was made to adopt a best of breed approach by Witan’s board in late 2003 to outsource some of its regional portfolios to various managers with the move chiefly as a result of poor performance. The board also appointed a chief executive, Jim Horsburgh.

Greenwood says: “Witan reinvented itself. Edinburgh Worldwide was also a generalist while it was under the management of Edinburgh Fund Managers but with Baillie Gifford it is run as quite a focused portfolio.”

As well as taking steps towards a best of breed approach, FCIT’s board is also keen to encourage greater conviction in stock selection and to be more active in the use of gearing.

Loveday says it has been strategically accepted that better performance requires a degree of increased risk although within carefully set parameters.

FCIT will increase risk in markets where it believes there are greater opportunities to add value and where the manager has greater conviction on the investment outlook.

Loveday says: “In terms of asset allocation, our exposure to private equity, including other direct unlisted investments, is increasing and likely to account for a material part of our total assets within four years or so.

“At the same time, our manager has adopted a higher-conviction approach and has been increasing our exposure to emerging markets and developed Asia towards 15 per cent, which is higher than most in the global growth investment trust sector.

Best Invest investment trust analyst Simon Moore says: “During 2002, 2003 and again into 2004, discounts of generalist investment trusts were widening and directors were asking themselves what needed to be done – the simple answer was perform. This is a good move for the industry though.”

Close Wins head of research Charles Cade notes that the decision comes at a time when many private client groups are moving away from global growth investment trusts, preferring to buy regional funds which enable them to determine their own asset allocation. At the same time, net retail flows into equity funds have been weak and F&C’s savings scheme has suffered from a high level of redemptions. Cade says: “Given this background, it is hardly surprising that the discount has remained wide.” At March 10, the trust stood at a discount of 15.1 per cent.

Loveday says the board do not believe it is possible to control tightly the absolute or relative level of the discount, given the cyclical nature of demand for investment trust shares. He says: “Ultimately, it is net asset value performance and income growth that influences the share price, which in turn affects the level of discount.”

However, this situation has raised some questions. Arbuthnot Securities investment trust analyst Tom Tuite-Dalton notes that the sector is moving towards discount control mechanisms. He says: “What I would like to see with FCIT is more action taken to tackle the discount. Witan has taken steps to keep it at around 10 per cent and Invesco Perpetual European is moving to hold it at around 5 per cent.”

Cade adds that outsourcing may mean a higher expense ratio, which is currently just 0.5 per cent, but it will be irrelevant if the alterations mean in the end a better performance. Both Tuite-Dalton and Cade believe the decision by the board is a positive move but they believe it falls slightly short of Witan’s example.

Cade says: “In our view, Witan’s move to a best of breed global fund was somewhat of a halfway house due to the decision to keep half the portfolio with Henderson through enhanced index trackers. However, FCIT has only gone a quarter of the way towards becoming a best of breed vehicle.

“Witan recognised this conflict and decided to hire an independent chief executive. We believe there is a similar argument for Foreign & Colonial IT and feel it would make sense for Jeremy Tigue to be employed directly by the investment trust rather than by F&C Management.”

Cade believes that the new structure has created potential conflicts of interest. “F&C Management is responsible for asset allocation and yet gains no revenue from assets invested in the US or Japan, providing a clear disincentive for them to allocate assets to these regions,” he says.

Loveday says the board meets every month with the manager who outlines his views on asset allocation and the policy and changes that are being considered.

He explains: “The board has set asset allocation ranges and it is not possible for the manager to move outside these ranges without board approval. The board have confidence in the manager and want the manager to take decisions and add value through asset allocation. Everyone is alive to conflicts of interest and, given the process outlined, we do not believe this will be a problem. Ultimately, the board has a duty to make sure shareholders’ interests are protected.”

Cade believes performance has improved in recent months and it is becoming increasingly differentiated from its peers with steps taken towards bolder asset allocation.

Loveday points out that FCIT has a solid brand and a reputation for delivering long-term results in a responsible, prudent and effective fashion. He says: “We are a little contrarian in our long-term view and, as such, differ from our peers with the investments that we have made into private equity and the plans to move around 15 per cent of the portfolio into emerging markets.”

Now the FCIT board is outsourcing some of the portfolio, there will be growing pressure to deliver performance. In Cade’s view, the board may well decide to outsource more of the portfolio over time and if this happens he says it would be necessary to redefine the overall management responsibilities of F&C.

The move to outsource some of the portfolio is not a new one and some time ago management of the private equity part of the portfolio was outsourced to HarbourVest and Pantheon.

Loveday says: “We review performance constantly and we will continue to do so. In this day and age, everyone is on the line to perform. FCIT takes a longer rather than shorter-term view but both the board and the manager are well aware that performance over time has to be delivered to shareholders.”

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