Secrets of super fund managers

Secrets of super fund managers

M Shanmugam

IT is amazing what fund managers will do to pick out a good stock.

Tan Teng Boo, the managing director of Capital Dynamics Asset

Management, scans the annual reports of all 800-odd companies listed on

the Kuala Lumpur Stock Exchange (KLSE) to identify those with value.

Dr Tan Chong Koay, who helms Pheim Asset Management that manages RM1.2

billion of funds regionally, makes it a point to talk to the company’s top

management before deciding whether or not to invest.

Ivan Tham, the chief investment officer-cum-general manager of Hong

Leong Group (HLG) Asset Management, has gone to the extent of stationing

his research guys outside an `investor-unfriendly’ manufacturing company

to determine how well – or badly – the business was faring.

Walking the extra mile pays dividends, especially in falling markets. It

differentiates the winners from the losers. The aforementioned three are

among a select group of fund managers who have managed to outwit the bears

marauding on a market that has been in sluggish mode since February 2000,

when the technology-stock bubble burst.

Most of the funds, although outperforming the KLSE Composite Index (CI)

that at end-2000 slipped by 16.3 per cent from the previous year, still

ended up in negative territory.

According to a Watson Wyatt survey on the performance of 16 local and

regional asset-management companies during the period, nearly half failed

to outperform the index. (There are 75 licensed fund-management companies

in Malaysia.)

Capital Dynamics, which was not part of the Watson Wyatt survey, managed

to stay above water by registering a positive return of 0.95 per cent for

2000. `Last year (2001) was not as bad as 2000,’ recalls Teng Boo.

Although the stock market ended on a marginally brighter note last year

by inching 2.4 per cent higher compared with 2000, it was still a

generally difficult year for the investing community.

The CI was down 12.7 per cent in the first six months of 2001 and up

15.9 per cent for the period between July and August. The Sept 11

terrorist attacks in the United States sent the market into a tailspin,

causing the index to fall by 10.5 per cent in that month. It rose 13.1 per

cent in the last three months, thanks partly to the festive season rally.

`The stockmarket has been extremely volatile,’ says Yoon Mun Thim, chief

investment officer of Amanah SSCM Asset Management.

Amidst such a scenario, what was the secret of those fund managers who

managed to outperform the CI and rake in millions?

`It is actually not that difficult,’ says Teng Boo, who subscribes to a

simple principle: `You have to know what you know and what you don’t

know.’

What it essentially means is that an investor should not only find out

all he can about a company before he puts his money there, he should also

be aware of the gaps in his knowledge.

Last year, almost all fund managers had exposure to construction stocks

as they realised the sector would be a direct beneficiary of government

stimulus efforts. Predictably, Gamuda was a favourite. However, its price

rise has not been as phenomenal as the other construction stocks.

In such a scenario, the most successful fund managers would not put all

their money in known stocks (such as Gamuda) but instead endeavour to

identify the undervalued and unknown ones.

A common feature of successful fund managers is that they conduct

primary research on companies and sectors before making their picks. Top

on their list is the determination of intrinsic value to enable them to

gauge potential.

Primary Research

`Working out an intrinsic value to the stock of a company is the most

difficult part,’ says Teng Boo. `We have to look at its assets and ability

of its earnings to sustain and grow.’

For instance, one of Teng Boo’s top-performing stocks last year was OYL

Industries, a unit under the Hong Leong Group that manufacturers home air-

conditioners. He had been following the stock since the early 1990s.

`Studying OYL, I feel that in time to come, contributions from

operations outside Malaysia, for instance in China, will be bigger than

operations at home,’ he says. `Also, the management takes care of the

interests of minorities. A certain amount of profits is returned to

shareholders and the rest retained for further investment.’

OYL is a favourite among fund managers. Its 12-month high is RM16.50 and

its low RM11.10. And some fund managers like Teng Boo still consider it

cheap because of its growth potential.

Yoon of Amanah SSCM pays particular attention to value.

`I can never explain to my client (if I do not have a value) … I have

to have a value to all investments I make. Value to some extent will exist

irrespective of whether the market is up or down,’ says the Cambridge-

trained engineer who joined the investment industry in 1993 as a research

analyst after completing his MBA.

Tham of HLG Asset Management does not leave anything to chance when

valuing companies. His research team even travels overseas to determine

for itself how a company fares against its competitors.

`Always do your homework. Find out everything you need to know about the

company … the business it is in, the management team, the positioning of

the company, its relative valuation in relation to the domestic and

regional industry, its reputation and whether it has a history of looking

after minority shareholders,’ he says.

He recalls a particular manufacturing company that refused a request for

a company visit.

`Finally, we stationed our research guys at the gates of the factory to

determine the viability of its operations … to determine the amount of

goods going in and going out,’ says Tham. As expected, they were not

impressed.

Fundamental retail investors and fund managers with small research teams

sometimes depend on secondary research, which is research from broking

houses or other sources, to get an idea of whether a stock is over or

undervalued. But the problem with such information is that it is known to

all. And what is known to all is no information at all!

Pheim Asset Management’s Chong Koay’s most successful performers last

year were picked after researching `right up to the horse’s mouth’.

`We do research and also speak to the people at the very top. We do not

depend on information from lower executives,’ he says. `We also go down to

the factory or worksite to ascertain for ourselves the progress of work.’

Construction stocks were the call of the day amongst fund managers last

year as it was a sector poised to gain from the country’s pump- priming

exercise. Though Gamuda was well-favoured, Pheim Asset chose to put their

stakes in WCT Engineering Bhd and YTL Cement. The reason boiled down to

basics – as the cut-throat construction business is known for thin

margins, Pheim Asset was looking at companies with fat margins.

`I liked WCT Engineering because it was a specialist within the

construction segment and did difficult jobs that earned it fat margins,’

Chong Koay says. (It is said that among WCT Engineering’s most difficult

jobs was the construction of the triple-decker bridge on the LDP- Federal

Highway interchange.)

WCT Engineering’s 12-month high is RM3.80 and its low RM1.50. Pheim is

still hanging onto the stock.

Knowing the business

Meeting the very top people of a company to ascertain the strength of a

company is one way of separating fact from fiction. But following a

particular company for a long period can also bring success.

Some of Capital Dynamics’ most successful investing stories concern its

perseverance with companies like Inti Universal Holdings Bhd and Malaysian

Pacific Industries Bhd (MPI).

Teng Boo had been following Inti even before it was listed. `I came

across Inti when I was doing research on Stamford College Bhd,’ he says.

Capital Dynamics bought into Inti at prices of between RM1.10 and RM1.20

per share. At time of writing, Inti was trading at RM4 and Teng Boo still

considers it a buy.

As for MPI, Capital Dynamics bought into the chip manufacturer during

the stockmarket meltdown of 1998, when institutional investors were

selling the stock down because the company had failed to hedge its

operations effectively.

`Institutional investors and local funds were really scared and were

throwing the stock. But we saw the hedging problem as only temporary.

Fundamentally, the operations were strong. The more investors threw, the

more we bought.’

It was a situation that Teng Boo describes as one that `even Warren

Buffett would have jumped into’. (Buffett is widely touted as the world’s

greatest investor.)

Capital Dynamics accumulated MPI shares in October 1998 at prices

ranging from RM5 to RM20. Its average exit price was RM47. It also

accumulated Globetronics Bhd, entering at an average of RM2 and exiting at

RM12.

Its success in electronics stocks vaulted Capital Dynamics to the

position of one of the best performing asset-management companies for 1999

and 2000 in a survey by William, Mercer, Zainal and Frazier.

Be sceptical

Most fund managers do not invest in businesses they are not familiar

with. Ahkter Abdul Manan, the chief executive officer-cum- executive

director of MIDF Aberdeen Asset Management, says the company to be

invested in should have a simple-to-understand business.

Tunku Afwida Malek, the executive director of Commerce Asset Fund

Managers (CAFM), expresses a similar sentiment. She does not believe in

investing in areas she is unfamiliar with.

`All our fund managers are analysts as well who look at their respective

sector specialisation. We have a top-down as well as a bottom-up approach.

We take the cue from the macro side and then come out with the sectors

that we want to be in,’ she says.

Being sceptical is a must for investors, though venturing into the

unknown can also pay off – if there is sufficient research.

`We have to be sceptical always. Just remember, there is no easy money

to be made,’ says Tham of HLG Asset. `Always investigate your leads. Go

the extra mile to verify the facts. Nothing is ever handed to you on a

silver platter.’

A case in point is Johor-based arowana fish-breeder Xian Leng Bhd, one

of the most successful stories unfolded last year.

The company was listed on the KLSE second board last December. Prior to

quotation, fund managers were presented with an opportunity to take up its

shares. The going price was RM1.65 per share. Many were sceptical – it was

post-Sept 11 and the global economy was teetering on the brink of

recession. Who would want to invest in a fish-breeding company?

Tham, although sceptical, decided to do research on Xian Leng. A few

trips were made down south to inspect its operations. As there was no

other local listed company to make comparisons with, the research team

went to Singapore to study a listed company operating in the same industry

there.

After ascertaining the business fundamentals, Tham looked at Xian Leng’s

growth prospects. Its existing operations of exporting to Japan were

steady. For growth, he saw potential for Xian Leng in the Taiwanese market

which up till then was closed. (At time of writing, Xian Leng had

announced that Taiwan had agreed to open up its arowana market.)

Its research done, HLG Asset subscribed to the placements. The decision

paid off handsomely as Xian Leng’s share price shot up to more than RM3

upon listing and, at time of writing, was still holding at a slightly

higher level.

Discipline and timing

Xian Leng is one of the new listings that made a handsome premium on

debut. Recently, new listings have become a hit with investors, just like

in 1995/96. But analysts question the reasons behind the euphoric rise in

some share prices. For instance, Lipo Bhd, a company dealing in precision

and metal stamping parts, has seen its share price rise to as high as

RM8.60, from its offer price (in October 2001) of RM1.40.

Hence, comes the question of speculation. Tham, like most other fund

managers, stresses the need for discipline.

`Do not ever let previous successes fool you. You may have made a lot of

money by punting on one speculative stock and you may think it is the

right strategy. You will soon be proven wrong,’ he warns. `Have a game

plan and stick to it. You must have an exit strategy … know what the

company is worth.’

Some fund managers turn down clients who do not believe in their

investment philosophy. Tunku Afwida of CAFM is one.

`We don’t take clients who want us to trade and speculate. We have an

investment process. We don’t trade but tend to move out of stocks whenthey

reach fair value. We have target buy and sell prices,’ she says.

Ahkter of MIDF Aberdeen says that from his experience, the secret of

successful investing is to keep to a strict discipline and not be swayed

by rumours. `That is why attaching a value to each stock is important.

Decisions are made based on valuations,’ he says.

The KLSE is an efficient market. Information flow is good except in

certain cases when the company itself fails to divulge timely information.

In such instances, it is reflected in the share price.

One of the most prominent cases was when United Engineers (M) Bhd (UEM)

failed to make timely disclosure of its acquisition of a 32 per cent block

in parent company Renong Bhd in 1997. The information seeped out and UEM

shares slipped. The UEM/Renong Group never recovered from the exercise.

On the whole, knowing about market-sensitive information is vital.

However, that alone is not enough.

`It is the ability to correctly interpret the information faster than

the average investor that is going to be the crucial factor,’ says Yoon of

Amanah SSCM.

For instance, in the post-Sept 11 period, the CI fell 10.5 per cent.

Many were expecting it to fall further. But that did not happen. Some fund

managers, who had sold out anticipating a major correction, were

disappointed.

But not all were so panicky. Teng Boo in his Sept 13 weekly investment

newsletter I-Capital wrote that the impact of plunging global stock

markets on the KLSE would be relatively limited. His analysis was based on

the economic fundamentals in Malaysia.

He said pressure on the ringgit had abated and that the supply/ demand

situation was different compared with June 1997 (before the Asian

financial crisis) and March 2000 (before the technology bubble burst).

Also, foreign funds were no longer a significant force.

At the end of the day, Teng Boo’s strategy of examining the fundamentals

proved to be the right move.

The secret of sizing up a situation and making sense of information lies

in primary research. The cases of WCT Engineering, Inti Universal, OYL

Industries, MPI and even Xian Leng are there for all to see – only those

who walk the extra mile get to enjoy the super profits.

Secondary research does help but as the information is available to

everybody, returns from price rises tend to be limited.

The 10 Tenets of Investing

1. Do your homework – know all there is to be known about the company.

Talk to suppliers, customers and you will be surprised at what you may

discover.

2. Determine intrinsic value – find out the true value of the stock. It is

the single most important thing to consider when entering and exiting a

stock, that is, to get in at undervalued prices and to get out when the

stock is over-priced.

3. Discipline – stick to the intrinsic value. Rarely does anybody get in

and out of a stock at the lowest and highest points. Most of the time, the

last 20 per cent or 30 per cent has to be given away.

4. Be sceptical – just remember, there is never easy money to be made.

Always investigate your leads. Nothing is ever handed on a silver platter.

5. Never invest on borrowed money – you may have to make a decision that

you may regret later, such as being forced to sell.

6. Be patient – as evidenced by the three-year and five-year returns of

fund managers, long-term investment pays. Much success can be achieved by

inactivity too.

7. Do not over-diversify – it is better to invest in a few companies that

you know a lot about than to invest in a lot of companies that you know

little about.

8. Do not average down on a money-losing proposition – remember, a bad

business is a bad business no matter how much you invest in it. An example

is timber stocks that have not recovered since the mid-1990s.

9. Watch others – be fearful when others are greedy and greedy when others

are fearful.

10.Be smart – you need to invest to become rich but you do not need to be

rich to invest.

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