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Investing needn’t be a big gamble

A monogamous relationship with a specialist mandate can force managers to bypass pot- entially lucrative opportunities.

This phenomenon is not restricted to funds based on singular themes or market capitalisations, as one might imagine. Several global funds limit themselves to a simple choice of being overweight or underweight in an individual country. But why dismiss a great stock because you have reached a target weighting?

Decisions cannot be made irrespective of the macro picture. We need to be mindful of geopolitical, legislative and economic drivers, to name but a few, and their implications for all potential investments. A mixture of skillful stockpicking and more top-down analysis is the most effective way to add value and mitigate risk. It forms a 360-degree view of the risk/reward profile.

Some traders adopt a shoot- first-and-ask-questions-later approach, often ditching high quality stocks for the next flavour of the month. It is in this space that we seek out opportunities that are misunderstood or simply have not been discovered by the market. This does not mean companies that exhibit high volatility from one quarter to the next but growth stories that fly under the radar of most investors yet demonstrate resilience against most economic conditions.

Typically, the strength and quality of the business model are my first port of call and valuations must be reasonable. One example is online auction site eBay. The company has a great business model that is scaleable and price-inelastic. However, the stock has been priced to perfection and there is no room for mano- euvre. A good business model is scaleable, defensible and exposed to as few operational risks as possible. If you can spot a good business model that operates in a growing market that everyone is not talking about at cocktail parties, you are on to a winner.

One theme I identified in early 2004 is online gambling. The internet allows the casino operator to reach every corner of the globe without increasing its costs substantially. Punters migrate to the sites with the most players, so the big sites force out the competition. We believe the poker model is attractive because the operator takes limited financial risk, meaning it is not dependent on the outcome of a hand and simply takes a rake for administering the event. PartyPoker operates the biggest poker site and continues to attract new customers.

Another way to play this theme is by following the com- panies that facilitate money transfers between players’ bank accounts and the poker sites. NETeller, the UK-listed company which services most of the casino and poker sites, takes a fee as money goes back and forth. While NETeller and PartyPoker have strong buiness models, they are also highly profitable, cash-generative and cheap relative to their growth prospects.

Finally, one only has to look at the headlines to see how security is gathering momentum . We began to research this theme post-September 11, 2001 and have focused on resilient businesses across areas as diverse as defence and surveillance. Our first investment was InVision, which develops, manufactures and markets explosives detection systems for screening airline baggage. InVision was later acquired by General Electric Company. Our latest holding is American Science and Engineering, which specialises in safe X-ray systems that can uncover hidden weapons and explosives. The com- pany has received a grant from the US Transportation Security Administration to develop technologies to scan airline passengers for contraband that may not set off a traditional metal detector.

Flexibility is key to allowing us to tap into growth areas across the world and extrapolate a theme to its fullest extent without adhering to a benchmark weighting.

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