Colonial First State’s philosophy is a winner

Colonial First State says its recent gong as Money Management Fund Manager of the Year is no flash in the pan. Zilla Efrat looks behind the group's impressive numbers and finds out what makes the investment process tick.

Last year was one of the biggest years yet in Colonial First State's history. The group not only tripled the size of its funds under management, but it also turned in a strong investment performance that made it Money Management's Fund Manager of the Year.

Chief executive officer Chris Cuffe is quick to point out that this is no flash in pan.

First State won the award in 1996 and was ranked second two years in succession before that. The group has also picked up a host of the specific category awards over the years, making it, according to Cuffe, the most highly awarded fund manager in the 1990s.

He attributes this success to Colonial First State's (CFS) low staff turnover, and to a three-pronged investment philosophy which has not changed over the past 10 years and which is a constant starting point for every asset class the group manages.

This philosophy is deeply shared by all. In fact, Cuffe says CFS will not hire anyone who does not think the same way, and even has ways of testing whether these values are in the blood of potential employees. Before Cuffe even talks to potential employees, they can be subjected to an essay-style test from a head-hunting firm to ascertain their true investment beliefs.

The starting point is a belief in active funds management, one that continually makes assessments rather than passively follows market indices.

Indeed, indices are viewed as mathematical figures which do not reflect good investments but, rather, average out both good and bad ones.

"Some times the world gets so caught up with indices that people forget what shares are all about," Cuffe says.

The second leg of CFS's philosophy is a focus on earnings - or on choosing quality investments.

"We believe in buying good assets at sensible prices rather than mediocre assets at what are perceived to be bargain prices," says Cuffe, adding that the approach echoes that of Warren Buffet.

CFS bases its decisions on solid research and is definitely not swayed by market sentiment, which it believes can lead to irrational investment decisions and only affects prices in the short-term.

All this is backed up by the third prong, a "disciplined methodology" for managing money which involves continuously monitoring and controlling various investment risks.

The aim is to manage risk appropriately, not avoid it, and the focus is always on the medium-to-long term.

Cuffe says CFS's success is not only based on what is done. "A lot of our success over the years has been due to the securities we have avoided as much as the securities that we have bought," he says.

Research house Morningstar considers CFS well resourced, with clear strategic plans for organic growth.

Morningstar managing director Graham Rich says: "The brand has previously focused on one investment sector - Australian equities - but CFS is now becoming a mainstream investment manager."

For his part, Cuff says CFS's equity focus is primarily on individual companies.

The size of a company does not matter and, while an industry's economic outlook is never ignored, CFS believes that, over time, an individual company's characteristic will have the most impact on its share price.

The company characteristics that will be most closely scrutinised under CFS's microscope are earnings prospects, debt levels as well as management experience and competence. In each case, CFS must also understand the business it is investing in.

These factors, and not where a company is located, also dominate offshore equity purchases. Indeed, CFS views weightings for specific regions or countries as an outcome of its investment process, rather than a starting point.

Cuffe says CFS's approach to Australian equities saw it overweight in infrastructure, selected services and telecommunication shares in 1998 and underweight in resources.

Among the specific stocks it bought were Hills Motorway, Transurban, Infrastructure Trust, Harvey Norman, Sonic Healthcare, Flight Centre, Telstra and Cable & Wireless Optus.

Internationally, CFS was underweight in Asian equities last year. A leaning towards technology-based stocks in the US helped bolster its performance, as did investments in financial services and telecommunication sector stocks.

Among the its stock holdings were Nokia, Cisco Systems, Sun Microsystems, Irish Life Assurance, Bank of Ireland and Bank Nationale de Paris.

When it comes to resources, CFS believes the sector is at the forefront of the globalisation of international economies and share markets.

Cuffe says the starting point is, as always, the company or project. "Geological deposits, mining and processing methods are not influenced by country borders.

Hence, all mining projects can be assessed on the same basis in search of the best operations anywhere in the world."

In 1998, CFS scored from its purchase of South African gold and broader

resource stocks, especially in the second half of the year, with investments in Ingwe Coal, Amcoal and Goldfields of South Africa.

An overweight position in Rio Tinto worked well for CFS, as did its underweight position in BHP. Investments in Delta Gold and Acacia Resources also paid off.

CFS property investments tend to be listed securities, including property trusts and property related companies. It actively manages these investments by looking for sectors of the property market, as well as those shares, which are likely to outperform the market.

Morningstar's Rich says CFS is more quantitatively driven in property than it is in other sectors, describing its approach to property as "strongly fundamental and bottom up, overlaid with a macro economic and industry sectorial backdrop".

In 1998, CFS was overweight in retail and diversified mid cap property stocks, including the likes of AMP Shopping Centre Trust, Westfield America and National Mutual Property Trust. It was underweight in hotels and avoided a lot of the poorly performing floats.

The quality of the security again rules - and the focus is always on fair value - when CFS makes cash investments.

While the possibility of interest rate fluctuations are taken into account, the company never tries to forecast any short-term changes. This is because it does not believe that accurate short-term forecasts can be consistently made.

Cuffe adds that a belief in setting the sector allocations and then sticking to these has paid off when its comes to managing multi-sector funds. CFS was awarded the gong for multi-sector trusts in the recent Money Management awards.

"We stay exactly on predetermined values and this has taken out the subjectiveness which often comes with managing funds," Cuffe says.

CFS manages 30 retail funds and has a total of $27 billion of funds under its management. Of this, $8 billion is retail and the balance is largely internal from Colonial's life companies.

The acquisitions last year of Legal & General and Prudential added about $15 billion to the funds managed by the entire Colonial group, but they have in no way effected CFS's low turnover rate, a rate which Cuffe views as reason for its strong investment track record.

While the vast majority of funds management staff at Legal & General and Prudential were retrenched, he says there were no hard decisions to be made at CFS, "because it was the strongest company of the lot".

"Our team knew that it was in place, but we benefited because we got more money to manage," he says.

And, he does not view CFS larger size - the result of both acquisitions and organic growth - as a hurdle to its future investment performance.

"The Australian share market is rapidly expanding and it is good to grow into a growing market. Besides, if one believes in being active, the size of the portfolio does not matter," he says.