Platinum international funds: secrets of success

Since their inception, the eight Platinum international funds have exceeded their respective indexes by a staggering 10 per cent per annum. Robert Keavney explores the culture behind the result.

In terms of consistent share of inflow, Platinum Asset Management must be the dominant international equity manager in Australia over the last decade.

These factors make Platinum an unusual business — and worth examining for what we can learn about creating a successful asset management business (disclosure: I am a Platinum unitholder).

Yet, to the best of my knowledge, it is also the only funds management business that has never employed any sales staff or remunerated an employee based on inflow.

It is hard to imagine a business becoming a market leader in any industry with no sales budget.

I thought hard about the merits of focusing on one organisation, which could draw criticism from competitors.

However, when a business produces results like those in Table 1 it is natural to enquire what led to them. Table 1 reports the performance of the eight Platinum funds from their inception to December 31, 2010, compared to their respective indices.

The figures in the column headed ‘Excess % pa’ reflect the extent to which the annual return of each fund beat its relevant index. On average the annual excess return of all funds was 10.1 per cent per annum.

The longest running fund in this table is the International Fund, which was launched in 1985.

Such performance over such a long period must rank Platinum among the best fund managers in the world. To put it in context, Warren Buffet’s Berkshire Hathaway has exceeded its index by 11 per cent per annum over its lifetime.

But this comparison should not be taken too far. Berkshire’s track record is over a longer period and carries the handicap of far greater funds to invest.

But it does give a sense of how rare it is to add value at 10 per cent per annum for a decade and a half. It is worthwhile to try to understand what is behind such results.

Most investors would be flattered at being compared to Warren Buffet. Kerr Neilson, the head of Platinum, will feel definitely uncomfortable.

When I told him I planned to write something about his funds, he urged me to “not overdress it” and pointed out how easy it is to make mistakes and how important it is not to create expectations to the contrary.

Putting it in context

A large proportion of purported active equity managers are, to some extent, closet indexers. This can be demonstrated by graphing the long-term returns of all equity trusts against their benchmark.

Many operate under controls that intentionally limit their index divergence. There can be sound business reasons for this.

Once a manager has become widely supported on dealers’ and platforms’ Approved Product Lists, its highest priority may be to stay there — making the avoidance of underperformance more important than striving for outperformance.

However, my view is that such a product ought to be priced more like an index fund. Why should an investor pay, for example, 1 per cent (wholesale) or 2 per cent (retail) for a fund that does not try to meaningfully beat an index, when you can buy an index fund for almost nothing?

Long history teaches that superior investment skill is almost always individual rather than corporate. But skill alone is not enough.

Star managers may be under pressure to take time to do marketing presentations, be impeded by a committee style decision-making process, or be constrained to manage risk in a way that hampers the full value of their skill.

For example, if the investment manager underperforms for a year or more by following its strategy, this can lead to complaints from advisers to business development managers (BDMs), flowing into pressure from the sales department on the investment team.

If the chief executive officer (CEO) is focused on the next quarter’s earnings result, stemming outflow may be more important that maintaining the purity of the investment process.

Thus, two things are necessary for a manager to sustain superior returns: skill, and a structure that allows it to flourish.

Team structure

Platinum has been structured to free fund managers from day-to-day business operations.

Neilson and Andrew Clifford (externally Kerr Neilson is seen as the main man in the company, but internally Clifford is seen as a co-founder) do not manage Platinum’s day-to-day business (running the systems, etc) — Malcolm Halstead does this. This leaves the investment team free to focus on the portfolios.

This is not common in boutiques where the chief information officer is frequently also the CEO in the conventional sense (ie, oversees all activities). Being freed of this removes a significant distraction. This clearly reflects great confidence in Halstead.

Platinum rarely offers its senior investment staff for adviser presentations. Many advisers prefer to hear directly from the people running the money than from sales staff to hear a technical rather than sales emphasis.

Marketing presentations can be a real drain on the time of the investment professionals but are seen by most businesses as essential. Platinum is generally prepared to sacrifice any such marketing benefits in favour of focusing on investment returns.

It is a truism about businesses that, if an organisation espouses one set of values but rewards another, the other always prevails. In this context Platinum is consistent. The analysts and fund managers are rewarded on performance and, as noted above, no one is rewarded for growing or retaining funds under management (FUM).

It is reasonable to attribute part of the success of the business to their unbridled focus on returns.

Investment style

It is common to refer to a manager’s style as either ‘value’ or ‘growth’. This is vague, inadequate and ignores the problem that there is not even a universally recognised definition of the two terms.

Platinum is usually classed a value manager, because its focus is to never over-pay. On one occasion a research house reduced Platinum’s ranking because it did not exclusively buy value stocks.

Neilson’s comment was “I never said we’d only buy value stocks — there’s a time to buy growth stocks.”

The following describes Platinum against a set of criteria I have developed over the years to classify managed funds.

Quality filters — Some funds use quality filters as their first sort criteria, wishing only to hold high quality businesses. Platinum departs from this, as was illustrated by a foray into a US airline some years ago. Neilson then described it as “A dog of a company in a dog of an industry, but not nearly as much of a dog as the price suggests.”

Portfolio concentration — the flagship International Fund’s portfolios is not highly concentrated, with the largest stock holding of 2.3 per cent

Large/small cap bias — no inherent bias though the large portfolio size tends to force the fund into larger stocks.

Geographic dispersion — will to depart widely from the index make up.

Cash — willing to move heavily into cash if stock value can’t be found. Shorting — prepared to short stocks and indices.

Currency management — actively managed ie not just for hedging back into the $A but to take positions for profit.

The last three focus on absolute return.

It is revealing to analyse when the International Fund achieved its excess return.

The bulk of outperformance was obtained during the two recent bear markets: the bursting of the dot-com bubble and the global financial crisis. If those periods were ignored, this fund would have beaten the MSCI index by roughly 2 per cent per annum — creditable and top quartile, but not remarkable.

It could be tempting to conclude that conditions over the last decade have played into Platinum’s hands, since the last 11 years have had more than a fair share of downturns and their skill is mainly downside protection.

However this is not true across all funds. The Unhedged, European and International Brands funds have achieved the bulk of their excess return during the recovery of the last couple of years.

Incidentally the absolute return focus leads some to believe Platinum should be classified as a hedge fund. Actually, the same funds that are priced as equity trusts in Australia are described and priced as hedge funds overseas.

This shows the absurdity of people paying large management fees, just because a product is labelled as a hedge fund.

I have always been amazed that people are willing to pay two, three or four times as much for a fund that shorts as for one that doesn’t — as if shorting is an obscure tool known only to the cognoscenti.

There are those who feel equity funds should be ‘true to label’ (ie, always be 100 per cent invested in stocks). Certainly any dealer’s Approved Product List of equity funds would include some fully invested managers.

However, I have always sought some funds with potential for downside protection by being willing to at least cash up when appropriate.

Preservation of the culture

As noted, key person risk is usually essential to generating superior returns, so I was interested to explore to what extent Platinum’s performance was due to the skills of two people.

Surprisingly, Platinum rarely hires analysts from the ranks of those with funds management experience. Neilson says they need to “train people to think, think in our perverse way” after hiring them. Those who have already acquired habitual ways of thinking at other organisations appear harder to train.

There is a culture of giving responsibility. After analysts have proven themselves, say over three years, they are given a small amount of money to manage — perhaps $25 million of the $9 billion flagship fund.

Not enough to affect the return of the fund, but enough to give the individual real management experience.

Analysts call a meeting of relevant people to discuss a stock.

However, even at this level, there are no committee decisions. After all views are put analysts and fund managers are empowered to make their own decisions.

This suggests that the strong results achieved over all eight funds are not purely the result of the skill of a couple of individuals — though no doubt their influence has contributed. I have to say this surprised me.

There is something else in the culture to foster emerging talent. Each analyst is given a cyclical and a defensive industry to cover so that, at each point in the cycle, each individual has something meaningful to contribute to the process.

There is one element of the Platinum culture that I have always appreciated: frankness about its mistakes. I have heard Neilson openly volunteer to an audience that large funds under management can affect performance.

He freely declared: “We fell in a hole last year”. He can explain the thinking that led to it, but seems delightfully free of the spin which most managers apply when explaining their performance.

However, to me the strongest impression is of the confidence that Neilson has always had in his process.

Conclusion

Unfortunately it is not possible to identify some simple, replicable secret behind the Platinum team’s performance. They are talented, self-questioning, patient and have built a business unreservedly focused on returns.

Of course, they make mistakes. Over the year to November 11, 2010, the MSCI pulled away from the International Fund by 3.4 per cent.

Over the 20 months to October 10, 1998, this fund underperformed by a staggering 29 per cent.

This was regained over the next 15 months but it was still a substantial underperformance at the time and was the price for being willing to diverge from an index. It could happen again.

They do not walk on water!

Any managed fund should only ever be part of a diversified portfolio featuring different management styles. No one should invest (or recommend) solely on the basis of this article.

Nonetheless, Platinum has built a quite extraordinary, and rarely matched, track record.

Robert Keavney is an industry commentator.