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‘There’s nothing to buy’: behind AAA-rated manager’s cash call

‘There’s nothing to buy’: behind AAA-rated manager’s cash call

Tom Naughton likes to push himself: ‘I like running in the mountains. A few weekends ago I ran in the Ultra Tour Monte Rosa, which goes from Grächen and all the way round. It is 116km with about 9,000m of climbing. It took almost 23 hours and was great fun,’ he says.

Having set up home in London, the Prusik Investment manager is finding it hard to replicate such lung-busting runs.

‘I live in Richmond, South London, so the closest I can do is do 1,000 reps up and down the same hill from Petersham Gate.’

Describing himself as ‘naturally competitive’, Naughton’s resilience and stamina also pervade his professional life, as shown by the table-topping performance of his Prusik Asian Equity Income fund and his rock-steady Citywire ratings history, see graphs, right.

Having first become eligible in February 2014, Naughton has been Citywire AAA-rated in every one of the 45 months since. On top of that, his fund sits second out of a 384-strong peer group for his three year returns, while he leads the pack over five years.

But competitive spirit aside, what else has powered Naughton to the top of the rankings? ‘The key appeal of this fund was that our aims matched those of our clients.

‘Nobody needs to be exposed to the soaring stories in China to pay for their school fees or retire. What they need is to grow their income and meet their liabilities, I would invest my own money in the same way.

‘The defining question was how do we get a portfolio which is as near as possible to what almost everybody wants? It produces an income of 5-6%, that grows after inflation by 5-10% per year and we also make some money on the valuation side and we compound over time,’ he says.

Vying for value

Naughton, who adopts an opportunistic, value-focused style in his high-conviction approach, believes his $960 million fund challenges the common perception of how Asian equity funds invest, which again gives him an edge.

‘Everyone else is seeking high growth and excitement but we are looking for boring, stable investment. We were able to achieve that cheaply because most people are looking for that growth.

‘Asia grows at a faster rate than the rest of the world and you can often make more money when you get things right in this market. That approach wouldn’t work in the UK or the US, because those markets are too efficient, but Asia isn’t,’ he says.

The fund has proven hugely popular and was closed to new money in late 2012. However, this did not stem the tide and it was fully closed a year later. Naughton now follows a ‘traffic light’ system which needs to hit four green beacons before the fund is reopened and this is monitored closely.

‘Most of our investors have been with us a minimum of five years and many have clocked up six or seven. We have the benefit of a long history,’ he says. This, Naughton adds, puts the company at odds with the Asian market, which is increasingly home to stocks with shorter lifespans.

‘In Asia, many companies have short track records and operate in volatile markets. Therefore, it is unwise to follow a buy and hold strategy.

‘For example, a company which was successful in China 15 years ago may be in a very different position today. Consumer brands are changing rapidly, for instance, some are doing well and some are being destroyed.

‘But what makes us different from the other “quality” managers in this space is that we tend to be much more opportunistic and value-sensitive. We do focus on quality but we are more valued-biased. I am not one of these people who thinks that if you find a great company you should hold onto it regardless of where the valuation goes. Sometimes you can do that but in most cases you can’t.’

Despite admitting to impatience, Naughton says a longer-term view of the market is at the heart of his approach. But this view goes hand in hand with a healthy dose of pragmatism. In Asian markets investors should be ready to have their views challenged, and adapt accordingly, rather than being too rigid.

Keeping capital ready

At present Naughton has around 40% of the fund exposed to Hong Kong and China, while nearly 15% is invested in Korea. At a sector level, transport stocks are narrowly the largest area of investment at 15.4%. However, the most notable part of Naughton’s investment strategy at the moment is his reluctance to buy.

The fund is running near all-time high cash levels of 14.6% as at the end of August, an increase from 13.4% one month previously. Is this an opportunistic play? Naughton booms with laughter as he responds.

‘There’s nothing to buy. We are selling a lot of things. We try to keep the selling and buying situations separate as much as possible, so I don’t think I have to sell something if I find something I want to buy.

‘We sold five or six positions this year as they had reached our targets and we have only effectively bought two new positions. Our cash level has gone up. I am generally positive on Asia, but we can’t find enough stocks that meet our criteria, which are very strict.

‘We don’t want to take on any risk but we do want to make a lot of money. This is arguably too demanding an approach but I want to keep that discipline and we are at the limits right now.’

Naughton may have outperformed consistently since launch but he is wary of growing complacent. ‘You have to include core strategies that don’t change, but you also need to be flexible enough to adapt to changing markets.’

One market development that is testing him at the moment is the rise and rise of Chinese tech companies. The problem being that, while they may eat up headlines, neither Alibaba nor Tencent Holdings meet Naughton’s investable criteria.

‘This is the first time I have been nervous. Because, in the past, the big stocks in Asia have been things like the Chinese banks or BHP – I can own them or not and I am relaxed either way.

‘Alibaba and Tencent are both extremely attractive but they don’t fit with the way I think about investing. That is because they are very highly valued, very difficult to predict and I think they will do very well.

‘But the models I use don’t work with those stocks. They are very big, so our decision to exclude them will have a knock-on effect for our relative performance. That is a new issue and I don’t have a particularly good answer.

‘Like most managers I have an ego and I am concerned when things go badly, but one of my strengths, I think, is that I find it very easy to admit mistakes and adapt accordingly. For some people that can be a big problem. People get stuck on certain themes or ideas and when things start to deteriorate they find it very hard to change tack. That isn’t a problem for me.

‘It is not that I don’t feel bad that I have made mistakes, but I am willing to change. Having run a hedge fund for years with leverage, you can’t afford to be inflexible and compound losses.’

Performance pick-up

Naughton says his fund has underperformed in only three of its 26 quarters since inception so he is not desperate to overhaul the strategy just yet, but that doesn’t mean he is sitting on his hands.

‘Even though I don’t focus on relative performance I am not particularly patient with stocks that are not performing well. We are trying to make sure our capital is working as effectively and efficiently as it can all the time. Our philosophy is to try and outperform constantly.

‘The difficulty at the moment is our cash levels have gone up, and things that are driving the market are cyclicals, as well as Alibaba and Tencent, which we don’t own. We don’t want to buy stocks that are cheaper and underperforming but we don’t want to own the expensive outperformers either. It’s hard to figure out where we go from here.’

Nevertheless, Naughton is confident investment ideas will emerge and adds this is one of the benefits of being closed to new money, as it is allows his small team to dedicate more time to both idea generation and client communication.

‘As a boutique, any investor can call me up and talk. We are an expensive fund and in return you get my undivided attention because I only run this fund, we don’t raise money and, while it sounds clichéd, it is a partnership between us and our investors.

‘We don’t suit investors comparing monthly and quarterly returns with competitors. Our fund is the only Asia exposure most of our investors have, alongside bonds or global equities, and they are not worried about short-term performance.

‘Some people might wonder when our outperformance will stop and mean revert. But I hope the same strategy that helped me outperform is hopefully the one that stops me underperforming.

‘It’s all about not overpaying and having discipline. If a fund manager does a bad job then the priority is to protect capital, but we have that strategy built into our approach any way.’

This article originally appeared in the November edition of Citywire Selector magazine.

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