In his much heralded, but likely never implemented, report into financial market short-termism this year, professor John Kay neatly encapsulated the structural problems of investment intermediation.
‘It is hard to see how trust can be sustained in an environment characterised by increasingly hyperactive trading, and it has not been,’ he wrote in the 112-page indictment of the financial services industry.
In an outstanding year for financial sector scandals this point was nicely demonstrated by Libor, the exemplar criminal conspiracy among a crowded field of criminal conspiracies. The manipulation of the offered rate would never have happened if banks did not have derivative desks that stood to profit by gaming it.
At root, Kay called for a world of financial businesses small enough and localised enough that they would be incentivised by the level of trust that clients and counterparties placed in them, rather than however many basis points they were able to squeeze out of a given transaction.
Politely put, this is not a foreseeable outcome. The government’s detailed response was reducible to the statement: ‘Many of professor Kay’s recommendations, principles and directions are not for government but for market participants’.
The British Bankers Association essentially ignored the report, while the Association of British Insurers has spurned one of the few ideas in it to receive active government backing – a forum for long-term equity investor engagement.
For such a high value piece of research, which created almost unanimous agreement among market observers, the response has approached a pat on the head, and it is hard not to conclude that the vested interests opposed to it are aligned closely enough and are powerful enough that it is destined to gather dust on a very long shelf of ‘good’ but ‘inconvenient’ ideas.
There is an alternative to top-down imposition of course, and at least a handful of smaller banks have cashed in on their reputational dividend over the past few years, actively marketing themselves as the City equivalent of a cottage industry, selling banking as it was in more innocent times.
Most high profile of these has been Arbuthnot Latham, which has near doubled its share price over the last year on its deposit-financed programme of lending expansion and the listing of 25% of its retail banking division.
Less high profile and privately owned, but similarly successful, has been Duncan Lawrie. Both appear to offer banking as it might be if designed by Kay.
‘Or possibly Captain Mainwaring,’ adds chief executive Matthew Parden wryly. While the business’s expansionary phase pre-dates the credit crisis, having bought Bristol financial planner Hill Martin in 2006, it has geared into the widespread disaffection with the broader banking industry since.
‘It is a market opportunity,’ says Parden. ‘The financial crisis has created a peer group crisis.’ The company has some experience of financial contractions, having been launched into the secondary banking crisis in 1974, as the banking division of a trading conglomerate. This has evolved into the Camellia group, a diversified trading business, which remains the sole shareholder in the company.
Slightly built, sharp and engaging, Parden was one of the initiators of a major internal strategic review two years ago, which resolved to build out the company’s infrastructure to exploit the opportunities available to it.
The company has invested heavily in internal systems to future-proof its investment management controls. It also got its chequebook out to expand payroll and office space, with the regional Bristol team built around the core of Hill Martin moving into upmarket offices in Queen’s Square this year.
The business has also recruited Jeff Durant, previously regional head of Clydesdale Bank, to lead expansion in the South West.
While profitability in recent years has fluctuated as the company has seen its cash interest rate on deposits evaporate and it has sunk capital into the business, the balance sheet has remained iron-cast. Tier one capital stands at 37% – compared to a UK bank average scarcely out of single digits.
The business has also generated margin by moving into bridging finance for its client base, acting as a stop gap while borrowers search for harder to come by mortgage financing. By design, lending is constrained to a maximum one-to-one ratio with its deposit base.
Long-running Indian tea plantation interests held by its parent group mean the business has a representative office in Kolkata, and is pursuing opportunities in the growing middle classes of the subcontinent’s underserved ‘tier two’ cities, says Parden. It also has an offshore division in the Isle of Man.
Mainland UK remains the focus of activity however, he adds. ‘Places where we already have a foothold. We have a focus on regional expansion and investment and there is potential to do more with existing clients.’
Assets under management have grown from around £500 million at the time of the Hill Martin purchase to £700 million today. The strategic review targets a growth figure of doubling assets by 2017, with an accompanying 25% increase in staff numbers, from a current figure of 130, 20 of whom are based in its Belgravia headquarters.
Across the business, it services around 4,500 account holders. As many as a third of its clients were historically reputed to be drawn from the literary world, thanks to the friendship struck up between former chair Nick Grant and late poet laureate Ted Hughes over their shared love of fly fishing, but Parden says this has widened out in recent years.
Parden says the company would be open to further acquisition opportunities in the next few years as the retail distribution review disrupts client facing businesses, but has ruled out marketing the business as a third party asset manager.
Investment performance over three years to the end of September was strong across all but the upper end of the company’s four risk rated portfolios. The Duncan Lawrie Low/Medium risk portfolio returned 18.7% over that period versus 12.6% on the equivalent Asset Risk Consultants index, while the Medium/High risk model returned 21.6% versus 17.8%. High Risk was the only laggard, at 18.2% versus 19.3% by the index.
The principal asset allocation calls of the last few years were the ditching of gilts and a long-standing holding in inflation-linked gilts, says head of investment management Seth Cowburn, who leads a team of 12 dedicated investment professionals, three of whom work from the Isle of Man.
‘We have exited conventional gilts completely,’ said Cowburn. ‘Yields are so low that gilts now offer a negative real return and, as long-term investors, we are cognisant of the corrosive impact of inflation on investment returns. Most of this cash has been invested into corporate bonds.
‘Developing markets have performed well in the past 10 years and we expect them to continue to outperform developed markets in the future. We therefore have an overweight position in this area.
‘In the past we have tended to have a low weighting in US equities, partly because of the downtrend of the dollar versus sterling in the years preceding the financial crisis. We now recognise that the fundamentals of the US economy are on an improving medium-term trend and have increased our weighting accordingly.’