Quality works its way from the bottom up for Perpetual

Most traditional value managers have been languishing at the bottom of the performance charts over the past year, but not Perpetual In-vestments.

The group grabbed third place in the equities category of Money Man-agement's 1998 Fund Manager of the Year awards, having won the same category the previous year.

Its Industrial Share Fund returned an average of 16 per cent a year over the past decade and 17.1 per cent in the year to the end of April.

However, chief executive and chief investment o

Most traditional value managers have been languishing at the bottom of the performance charts over the past year, but not Perpetual In-vestments.

The group grabbed third place in the equities category of Money Man-agement's 1998 Fund Manager of the Year awards, having won the same category the previous year.

Its Industrial Share Fund returned an average of 16 per cent a year over the past decade and 17.1 per cent in the year to the end of April.

However, chief executive and chief investment officer Rodney Green says: "It's been a tough year. It has rewarded those taking risks as well as those who bought growth stocks rather than value stocks."

He believes it is Perpetual's focus on quality that has set it apart from other value managers.

"Most value managers will buy any stock as long as it is at a dis-counted price. They look at price first while we look at quality first and then price," he says.

"Quality is the only thing that really guards against unforseen prob-lems, particularly when there is a fall in the market or a recession. Even if they fall in the short-term, quality shares always survive and rebound in the longer term."

Green adds that thanks to this philosophy, Perpetual, with more than $6 billion under management, has never invested in a company that has gone into receivership, even in the recession days of the early 1990s. Likewise, its mortgage fund has never had a bad debt in its 33 years of existence.

Perpetual uses what it calls the four point quality test to narrow its potential investments down from the 1,200 companies listed on the Australian Stock Exchange to about 200.

This test measures whether a company has conservative debt levels, strong management, quality of business and, in the case of industrial companies, recurring earnings.

The test is impartial to company size. Indeed, Perpetual is currently heavily overweight in companies outside the 50 biggest companies.

The quality test also ensures that the group will never invest in high-flying Internet stocks or mining exploration companies because these cannot show evidence of recurring earnings.

"We are happy not to own these because they tend to be volatile and, more often than not, they don't deliver the goods," Green says.

According to research house Morningstar, Perpetual's internally gen-erated, fundamental company research is a key factor in the past out-performance of its equity funds.

Perpetual does not rely on any single methodology - like price-earnings ratios or dividend yields - to value companies. It has sev-eral in its toolbox and will choose each to suit the company and in-dustry being analysed.

It is also always on the lookout for wasted assets or unlocked value. For example, the group began to focus on franking credits long before this was fashionable.

Indeed, Green says that some years ago, it identified and bought into about 23 companies with high franking credits. It then wrote away to management, attended shareholders' meetings and was generally rather vocal in its call on management to dish these credits out.

"In the end, close to 20 of these companies paid out. Their share prices rose and we made a lot of money," he says.

Perpetual's 10 equity analysts visit about 600 companies each year. And, often the focus is not solely on the company being visited.

"We often learn more about a company from its competitors," Green says.

"We try to avoid the public relations people on our visits as they are trained to say all the right things. Instead, we will stop and chat to someone on the factory floor, like the foreman, to get the real story."

Perpetual portfolio manager John Sevior adds: "We like to go into companies in pairs so that while one analyst is reflecting on one is-sue, the other can pursue a different train of thought. We believe that it helps us get a more balanced perspective."

Perpetual's team also travels offshore to learn more about the compa-nies it invests in - a tactic it says has paid off. For example, in-stead of panicking at the start of the Asian crisis, it sent two of its analysts on a lightening trip to talk to Australian companies based in the region.

"There was a lot of fear and misinformation around at the time and the trip gave us a first hand view from the people managing busi-nesses in that part of the world," Sevior says.

On another occasion a few years back, its international watch helped it spot a gap at malt producer Joe White Maltings after a similar company in Canada was taken over at a price far higher than that the Australian company was valued at.

"We bought into Joe White Maltings. Eventually, there was a takeover bid here which paid off for us," Green says.

Perpetual has a formalised internal mail system where analysts re-ceive all their colleagues' reports. After that, the emphasis is on quick decision making.

"We do not select stocks by committee. We do all the work up front and if we see something we like, we buy it after a short, but consid-ered discussion. We certainly don't wait for the monthly or quarterly meeting," Sevior says.

Perpetual's offshore equity investments are handled by Fidelity, one of the world's largest fund managers, with which it formed a strate-gic alliance in May last year.

Green says Fidelity has a similar investment approach to Perpetual.

"We are both value managers who are focused on bottom up research and the common thread between us is an emphasis on quality."

"Fidelity has a slightly stronger growth bias than we do. It is more willing to accommodate companies with a strong growth profile. While some may appear expensive today, the investment is always justified by fundamentals."

According to Morningstar, Fidelity's major underlying strength is its global network of experienced analysts. Fidelity has 167 analysts following 6,450 companies around the world, covering about 90 per cent of the stocks in each market.

On Perpetual's investments in other asset classes, Green says: "We do not pretend we can do everything. We know we can add value through local and international equity investments, but we believe there is little opportunity for outperformance when it comes to fixed interest and property investments. Because of this, we manage these on an in-dex basis."

Perpetual is careful to hire people who share its investment philoso-phy, but, at the same time, encourages diversity. Indeed, it boasts a team with backgrounds as different as journalism, accountancy, ad-ministration, geology and mining.

One way Perpetual tests whether prospective employees are like-minded is by getting them to make a company presentation to the equities team before they are hired.

"From this, and the responses to our questions, we will know if they believe in what they are saying," Green says.

"The people we hire need to be hungry, cynical and independent think-ers. We are definitely not looking for 'yes' personalities, but for people who will speak their mind.

"We need analysts who can make quick decisions and can make them even when, say, only 80 per cent of the information available. In this business, you can never have all the information you need."

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