‘This is a litigious culture,’ reflects Michael Lally ruefully, explaining the delicate balancing act that Thesis Asset Management attempts to strike between investing for optimal client outcomes and centralised oversight.
‘And if something went to zero then it would be right to contest why we were invested in it. But we are all human beings and there will be disagreements – we have to try and hard not to be caught up in spending all day looking over each other’s shoulders.’
Thesis’s head of its Chichester office, head of research and manager of the Thesis Optima Bond fund is not one of life’s natural enforcers. Mild mannered and avuncular, if Werther’s Originals ever decided to cast a slightly younger man as the grandfather in its TV ads, Lally would be in the running.
But from an investment management perspective (if not necessarily from that of a compliance department or regulator) a moderate is probably who you’d want in charge of deciding where your freedom to operate stops and where the company’s authority begins.
‘A compliance culture makes everyone more comfortable just doing the same thing that everyone else is doing. Being able to point at other people and say they were all doing it is an effective insurance policy – which is exactly what we want to avoid.
‘[On the other hand] some companies will allow their offices to do more or less what they want, so long as they are profitable,’ he says.
While admitting there is no way to perfectly square this circle, Lally is nonetheless proud of the relative elegance of his solution.
Managers have leeway to select stocks for their clients from the buy list, within the constraints of the company’s liquidity screening policies (as a generalisation, FTSE 350 stocks only).
The exception is a ban on either buying securities on the sell list, or selling securities on the buy list. Exceptions can be made but must be convincingly argued by managers in its investment meetings – for instance, capital gains tax (CGT) liabilities – hence the title of the system, Second Sight.
‘It comes back to making sure people don’t get distracted, but it also keeps people in line. If you don’t want to sell, let us know, and tell us why. We have been with Arc for two years and over that period we have been consistently first or second quartile, which is exactly what we want to be, to have that consistency.
‘Or to use another example, the Optima Bond fund is almost consistently second quartile – on the same principle, that shows it’s doing exactly what we want it to. It’s when you are going between first and third quartiles and back, that is when we would start worrying.’
Second Sight is just one of several innovations that somewhat belie Lally’s outwardly mild-mannered and unassuming demeanour.
Like most businesses in the sector, Thesis has invested heavily in compliance but Lally has sought to embed client suitability and risk controls within the company’s security selection via the adoption of a stock screening process, developed jointly with researchers at Cranfield University.
He draws a distinction between the Thesis Equity Stock Screen [Tess] and a quant box-based investment methodology, saying qualitative judgement remains the final arbiter. But referring back to his distrust of statistical extremes, he adds it has been ‘almost worryingly’ successful.
The weighted screen filters on the basis of dividend yield; earnings per share; Ebitda to sales; return on assets; and prior year’s total return. The internal investment policy emphasises its importance to the decision to sell as much as its guidance on potential buys.
‘When we look at some of the things that have done very well for us, such as Ladbrokes, Reckitt Benckiser and William Hill, the temptation is to sell into them just because they have done well. It is easy to not look at their history and what they are still capable of – just assuming there will be a mean reversion is a very dangerous thing.
‘I am suspicious when people look at graphs and say just because something happened 20 years ago, it must happen now. A lot of the technology we now take for granted didn’t exist then and is genuinely disruptive. That’s the danger of just relying on a model – you stop allocating.’
The stock selection process has helped bring discipline to portfolio turnover, which he says has gone from being a naturally occurring semi-annual process to being one that is almost continuously managed.
‘It’s partially a reflection of poor liquidity, and partially a reflection of poor sector rotation. It used to be a factor once or maybe twice a year, but now we find that it is much more evenly spread.
‘It would be nice to take a five year view and stay there, but that does not work anymore. The danger of high turnover is obviously high transaction costs,’ he says, though he adds these are now charged to the company’s balance sheet.’
Over the course of 2012, the company’s four risk-rated portfolio models consistently outperformed – beating the index by a greater margin at the lower end of the risk spectrum.
The Thesis Cautious portfolio returned 8.4% over the calendar year versus the Arc Sterling Cautious return of 5.8% and the FTSE Apcims Conservative’s 5.4%.
In contrast, the Thesis Equity Risk portfolio on 10.8% scraped out a much narrower margin above Arc Sterling Equity Risk’s 10.8% and the FTSE Apcims Growth’s 10%.
Lally has also shaken up the internal career path for investment managers to focus more on client relationship and business development, and doubling up some responsibilities between the dealing and research desks.
‘The dealing and research [idea] is fairly new. All the research in Thesis was previously done by the investment managers, across geographies and sectors. The problem was the quality could be variable, and it could put [time] pressures on managers.’
‘This way, recruits have experience of both and it is ultimately better for their careers because they can make the career choice about where their strengths lie and where they choose to go.’
The company currently employs 15 managers out of an 84-strong workforce, working out of five offices across the south and south east of England. They manage a 2,800 strong client list, 10% of which are Chichester-based ‘green welly money’, as Lally describes it.
The company runs a total of £5.3 billion, £1.6 billion of which is invested via the private client division.
This includes charity assets, generating £34.7 million in income in the year to April 2012, up from £26.9 million in the same period of the previous year. Private client assets have grown 16% over the last few years. However, this has been dwarfed by the substantial growth in the private office division of the business, which offers asset management and administration services for ultra high net worth clients and families.
His own portfolio, the Thesis Optima Bond fund, has a history of recording steady incremental gains above the market, returning 47.7% over the last five years versus the average IMA Sterling Corporate Bond sector manager return of 42%.
This has been achieved through some genuinely punchy calls, such as taking duration out to an average of nine years over the end of 2012 as most of his competitors were slashing their average maturity, but constraining risk by only expressing his conviction at the margins.
‘[These calls] are really a matter of guts. I was very tempted to go long on gilts within the bond trust when everyone else was shorting them, but I just lacked the conviction. I really have to see a very sound reason before I will put on a trade like that. We are now virtually out of gilts, but we took a very long time to come out, and we were very long duration. It’s obvious that eventually you will only lose money on gilts.’
Within client portfolios, the company has this year sold out of the biggest bond funds on liquidity concerns, and opted instead for smaller mandates such as the Kames Strategic Bond fund.
‘We have completely overhauled high yield over the last few months. We are moderately positive, but worried about how bullish everyone else is – we are perilously close to the equity yield,’ says Lally.
‘We are buying a lot of dollar [issues], very long-dated. We don’t think we will make much money on the bonds but we will on the currency.’