The moves flowed from what we consider a sensibl
e strategy. Murphy focuses on valuation but looks for growth-oriented companies that are generating returns above their cost of capital, i.e. that are creating shareholder value, and he looks for cash flow recovery stories. Looking for low valuations helped lead to his move up the market-cap ladder in 2007. He will sell a stock once it reaches its price target, assuming that subsequent research doesn't suggest the target be amended, or if the fundamentals begin to erode. To help ensure the fund avoids weaker companies, he views any erosion in a company's return over its cost of capital as a potential trigger for a sale.
Murphy usually purchases a stock with a three year view, but will sell if he finds a more attractive investment. The portfolio turnover rate thus far suggests a fairly high level of trading: Even excluding Murphy's initial restructuring of the fund, it has run around 90% per year. That concerns us a bit given his stated preference for a three-year horizon, and the incremental costs involved with trading so much. It should be noted, however, that market volatility in 2007 may have contributed to an elevated turnover rate, so we'll keep an eye on this going forward.
That said, Murphy cannot be accused of general impatience with his picks: For example, he has stuck with BBA Aviation - a company which specialises in support services for business and commercial flights. Murphy suggests it could benefit from growth in air travel, particularly fractional ownership. The stock has fallen by around 40% since he bought it in December 2006, but Murphy has been adding to his holding--he feels that the markets have underestimated BBA Aviation’s ability to withstand weakness in the US economy, despite the fact that three-quarters of the company’s revenues are derived from the US.
Murphy’s strategy has served him well thus far. At his previous fund, AXA Framlington UK Growth, Murphy returned an annualized 6.5% from the beginning of 1999 through January 2006, beating the typical fund in the Morningstar UK Large-Cap Growth Equity category by two percentage points. The fund drifted into the Morningstar UK Large-Cap Blend Equity category while Murphy was at the helm but he still managed to beat that peer group average by three percentage points over the same period. The AXA fund had also ranked in the top quartile of the IMA UK All Companies sector during Murphy’s tenure at the fund.
Morley, this fund’s investment manager, had previously been suffering from a high rate of turnover among its investment personnel, which had clearly affected the quality of its offerings. However, the Head of UK Equities, David Lis (who has been at Morley since 1997), had identified the problem as a cultural one. Morley simply weren’t paying their staff enough and had thus had difficulty attracting and retaining top talent. This manifested itself in a culture where achieving the best wasn’t a priority. To his credit, Lis clearly recognised the issue, and moved to correct it by making pay packages more competitive, restructuring the bonus scheme so around a third of the bonus is paid out after three years. Such incentives can attract and retain quality managers. While it is still too early to gauge the success of the new remuneration package, we feel it is certainly a step in the right direction and there have been no major departures since it was put in place in early 2007.
Much of this fund's success does depend on Murphy staying here and the firm's ability to retract and retain talent to build its research bench. The new incentive should help address both issues, and we think Murphy has proven his worth as a manager over a long enough period to make this fund a sound choice from a pure investment management perspective. Given all the other strong options in the category, however, the firm needs to maintain its recent stability over a longer period for this to be a truly compelling option.
