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EXCLUSIVE INTERVIEW: Schroders Private Banking Drills Deep To Find Value

Tom Burroughes

3 September 2012

It is tough to find a positive regional economic “good news” story right now and any gems resting in the rubble are most likely to be unearthed at the company level, argues Schroders Private Banking.

The US economic position, while showing some improvements, could still spring nasty surprises; China’s once red-hot economy is looking far less perky and the eurozone’s travails just won’t go away. So making money requires investors to drill a lot deeper to discover value, argues Robert Farago, head of asset allocation at the firm, part of UK-listed Schroders.

“In terms of how we approach equities, we have not taken big regional bets; it is more stock-specific. We are favouring high-quality companies; companies that are able to generate dividends. The quality and dividend theme has been very successful. The concern is that have valuations gone up too far?” Farago told this publication in a recent interview at the firm’s offices in Wood Street, London.

“In terms of pure sustainability . It is still possible to get some firms for decent value, though,” Farago said.

In such an environment where there is no “easy” macro-economic theme to play on as in the past. The graft of searching for overlooked corporate gems becomes ever more significant, a fact that arguably highlights the positive case for active fund management as opposed to adopting a more purely “passive” stance.

The argument between the “passive versus active” schools of fund management is, probably never going to be resolved, and is arguably a falsely stark choice in the first place. But it is certainly the case that an outfit such as Schroders Private Banking believes it can prove its worth to clients when it is so hard to read the economic signs, as now.

The private banking arm of Schroders may not be the largest in terms of assets under management (£16 billion (around $25.4 billion0 at the end of June), but Schroders is one of the more voluble houses on economic affairs. (In total, Schroders has around £194 billion of client assets under management.) The end-June AuM figure of £16 million was unchanged from the end of December last year, suggesting that the bank has, in a difficult market environment, at least managed to hold client money at a steady level, although it will want to do better than that for client wealth to withstand inflation.

Farago, who has been at the blue-blooded firm since 1994, is also fund manager of the Schroder Managed Wealth Portfolio, a multi-asset unit trust. His investment career started in the post-Big Bang financial era, joining Bankers Trust in 1987. At Schroders, Farago has worked as a senior Pacific Basin fund manager, a member of the global equity team, and alternatives analyst for the multi-asset team.

Not so keen on China

China has been the investor’s darling for so long that it still almost comes as a shock to hear a more cautious approach. Farago explains

“I am not positive on China, so the positive points… are simply illustrative that we will probably avoid a hard landing, not that I am hugely bullish. For now, the economic data is pointing down (as is the stock market),” he said.

“Data has clearly showed that the economy has slowed and the economy, so concerns remain on the table. You are still seeing inconsistencies in data that makes people think that things might be worse than is suggested in the official figures,” he said.

But some of the signs point against a sharp crunch, he said: “China is one place where we have had some evidence that things look like they are turning and not getting worse. M2 money supply growth is picking up. Property sales volumes have picked up as well.”

It is easy to see why China’s markets make some experienced investors queasy. Farago explained that China’s massive construction boom has triggered fears about heavy mal-investments that, sooner or later, will have to be unwound. For example, construction makes up 12 per cent of Chinese GDP. In Japan, just prior to its property bust of early 90s, it accounted for 10 per cent of GDP.

Schroders’ Asia-Pacific managers are taking a cautious approach to China exposure, he said.

Uncle Sam 

The recent second-quarter earning season in the US has been a mixed bag, with some less-than-stellar results to remind investors that the world’s largest economy has a long road to travel before regaining its old lustre.

“There were some revenue disappointments that were a concern to us. We think there is room for earnings disappointment there,” said Farago.

Macro-economic data in the US remains a concern – and highly relevant as the US Presidential elections approach. For example, just over a week ago, figures showed an unexpected rise in initial jobless claims in the week that ended on 18 August, for example.

On the corporate side, while there are still strong firms with robust earnings to choose from, valuations are getting stretched somewhat, said Farago.  

“The concern is that have valuations for high quality, dividend-paying companies gone up too far? In terms of pure sustainability, things look a bit expensive. However, it is still possible to find companies with strong balance sheets and generating strong profits at attractive valuations.”

Gold and inflation

Along with some other wealth management firms, such as the UK’s Kleinwort Benson, or the private bank of HSBC, Schroders Private Banking has been a fan of gold, although in the case of the latter firm, it has decided to retreat slightly for the moment.  

“Gold is something we have invested in for some time. We took some profits earlier this year. It had become too expensive to be a reliable hedge for inflation,” he said. (Gold traded around $1,690 per ounce today, as of the time of writing; it is some way from its record high above $1,917 an ounce.)

Any talk about gold raises the issue of inflation, an issue that, despite concerns about sluggish economic growth and even a protracted recession in some countries, is a worry for anyone protecting real wealth.

In fact, even the debate about whether passive investing is the way forward touches on inflation, because Farago argues that in passive investments, it is not always clear to a manager what the relevant benchmark should be.

“For an individual, the real benchmark is but that is not something you can buy a passive product to replicate,” he said.

Eurozone

Farago is concerned, like his peers, about the risks of a eurozone crack-up.

“Whereas two years ago the odds of a currency breakup were zero, now they are quite real. That would trigger a global recession and be disastrous for European companies,” e said.

In peripheral European markets, Schroders is cautious, taking the view that if the euro remains, it will come at the expense of years of low-growth and austerity. Banks, meanwhile, “look like bad bets” with their opaque balance sheets and exposures to European bad debts. There are good quality European firms earning revenues from around the world; compared with global peers, they look relatively cheap, he said.  

And finally, there is Schroders’ home turf: the UK. Farago said there is little point discussing the national economic story when considering investing in UK-registered firms, since the UK and its companies were so influenced by global factors that a national perspective made little sense.