Foresight Capital Partners

Over the past century there has been a rapid rise in government regulation of just about all commercial activities. Now one way or another if a company (or individual) has to spend more time and expense on regulatory requirements, less time can be invested in delivering the products and services which its customers require. Clear historical precedents have been set for regulatory effects on limiting economic expansion and development. For example, the greatest recent period for economic expansion in the US was during the period 1900-1920, when regulation at least by today’s standard was virtually non-existent. It is also important to point out that this period saw the greatest rise in living standards in the US.

Though all sides of the political spectrum have played there part over the years in the ever increasing regulatory burden on business. The present UK government in power is due to take it one step further with the proposed “Companies Act”, which is likely to go through parliament this year. For me alarm bells start ringing as soon as I hear that the bill runs to 500 pages and contains 900 clauses. Besides this document ushering in a steady diet of box-ticking activity for UK directors, it also “codifies” UK director’s responsibility to “the impact of the company’s operations on the community and the environment”. Now taken at face value this could mean a director facing legal action over the actions of a company employee who he did not even know about.

As always such policies will be sold in the name of “shareholder protection”, and/or “consumer protection”, but as even it will be the shareholder and customers who will ultimately pay the price. Moreover the end result is likely to be fewer people willing to expose themselves to such regulatory risk, companies more inclined to relocate offshore and the only growth which is likely to result in the UK will be in the governments own bureaucratic empire.

On occasions when I have been in France, in particularly in the late 90s, when I had the good fortune to visit various Paris academic institutions, I have always been rather impressed with the vibrant creative and technically able people I have met. Moreover, as I was led to believe by such French academics the nature of the French revolution was “to return the power to the people”. For these two reasons I am rather concerned at some of the political baggage which the left-wing candidate Ms Royal, brings to the French Presidential election which is to be held later this year.

I am not trying to impose my political views from the other side on the English Channel, but as a passive observer I feel that the introduction of some of the dogmatic socialist legislation being proposed by Ms Royal, would lead to further net emigration of Frances best and brightest minds which surely cannot be seen as in the French nation’s best interests. For example, at present there are an estimated 300,000 French nationals working in the City of London who have already voted with their feet. An even more capital repressive system in France would surely only result in this number swelling further. Significantly adding to the UK economy while having an equal and opposite effect of the French economy.

What seems most surprising to me, is that Socialist policies are not only weakening the French economy, but seem at odds with the spirit of the French republic, this is “liberty”. When ever the state gets bigger the freedoms of the individual are reduced. This lack of freedom usually is sold in the name of “worker protection”, or “consumer protection”, but all such `big state’ policies boil down to the following. Some (3rd Party) government bureaucrat forcing both the consumer and producer of a produce or service, to adhere to government legislation. Where as the free market (Anglo-Saxon model) allows each parties to decide for them selves what is and is not in best interest and transact accordingly.

Here we detail our Investment Process which roughly speaking consists of an ongoing investment research effort, with all known investment ideas working within a competitive flux for capital. The research process consists of the following three consecutive stages which form an investment complex:

Investment Research Process

• High Level Ideas: Select Top-down Investment Themes with a likely duration of ideally 2-5 years.
• Medium Level Research: Systematic research of all LSE listed assets which allow the expression of the ‘High Level’ Theme, and the selection of the assets (or basket of assets) which allow the most efficient expression of the ‘High Level’ Theme.
• Low Level Quantitative and Trading Techniques: Once the asset(s) have been selected suitable structures and trading approaches will be developed in order to gain exposure to the required assets.

Flux of Investment Complexes

The competitive flux for capital is created when there are more known investment complexes than sufficient capital to cover these complexes. By continuously under-taking fundamental research in order to select ‘High Level’ Investment ideas, construct asset(s) to represent these ideas and investigate the technical and trading aspects of entering such investments. At all times all such discovered investment complexes (invested and un-invested) are in a competitive flux and the fund will switch between investment complexes if and when a un-investment complex is deemed to provide a sufficiently strong argument over an invested complex.

We aim to be fully invested at all times.

Detailed description of the Investment Research Process

The investment process consists of the following three consecutive stages:

1) Generation of High Level Ideas: Macro, stylistic/sector specific or thematic Investment Ideas

The key driver of the out performance of the investment process is the identification of top-down, stylistic/sector specific or thematic investment ideas. The managers are seeking to identify investment ideas which will play themselves out within financial markets over a 2-5 year time frame. The mangers believe that through continuous systematic research and lateral thinking, they will be able to identify on average 2-4, such ‘High Level’ investment ideas per year. The managers also strongly support the view that it is not the number of such ideas which will determine the over-all performance of the fund but the quality of these ideas. For this reason the managers are highly selective in there acceptance of any such ‘High Level’ investment idea and numerous investment conjectures will be considered during any one year. Note that a ‘High Level’ investment idea will generally be formed from multiple underlying investment conjectures.

2) Medium Level Research: Value Oriented Fundamentally based, contrarian Research approach to select particular securities which efficiently express the ‘High Level’ investment ideas.

Once the ‘High level’ investment ideas have been identified by the managers, the managers will systematically undertake a search for securities which first allow these ideas to be expressed, and secondly offer the best risk/reward profile within the context of how the managers believe the high level idea will play out within financial markets. Though the fund managers would broadly agree and apply much of the traditional value investment methodology as detailed within the writings of Benjamin Graham and Warren Buffet, in particular the works:

• The Intelligent Investor, by Benjamin Graham.
• The Essays of Warren Buffett, edited by Lawrence A Cunningham, 2000.

The managers have developed a certain variant of this approach which is compatible with their own mental frameworks which they have applied within the various investment activities and markets in which they operate.

The managers have often found that the most efficient means in which to express a given ‘High Level’ investment ideas is by taking positions within under researched small cap (or even fledging) securities. The managers believe that the rationale for such findings is that these sectors are often the least covered by the research community, and in many cases are just to illiquid to be considered by institutional investors, and as a result the greatest inefficiencies often occur in such sectors. It is anticipated by the managers that investment companies and associated assets (many of which are fledging) will form a significant portion of the investment portfolio. Though such securities themselves are often small-cap the underlying securities which they hold are generally a well diversified collection of blue chip securities, and hence such investment companies do not pose a high level of risk to the investor. It should also be noted that due to the fact that over the past 10 years the managers have often found the greatest opportunities within this sector the managers have build up an expertise within the investment company and associated sectors.

Note: The investment process is not in any way either a small-cap or fund-of-funds approach. Any selection of either small-cap or investment company investments is taken purely because it is believed to be the most efficient means (i.e. best risk/reward profile) in which the express a given ‘High Level’ investment idea.

3) Low Level Techniques: Scalping/market making/technical trading, relative value quantitative techniques and the leveraging of the technology foundation of the fund managers.

This portion of the investment process will generally supplement and run in conjunction within the fundamental research (item 2 detailed above) which is undertaken. The portion of the investment process results from the particular technical skill set which the fund managers bring to the investment process. The technical skills can be divided into two sections: trading (scalping, MM strategies, TA), and quantitative/software. Below we provide further details:

• Trading: Overlay the application of short term trading techniques such as scalping, various market making strategies and acting as a provider of liquidity. In addition, analysis of market internals and trading considerations from a technical analysis stand-point will be considered. The aim of this process is to provide more opportune entry and exit points within our fundamentally selected investment opportunities. In should also be noted that these techniques may also be applied during the period when a given investment idea is being expressed within financial markets. Where we envisage taking a general stance with appropriate holdings over an extended period, however within this period we either switch between associated assets on a relative value or market internals motivated based, and/or scale in/out of the position in order to increase the risk adjusted return profile.
• Quantitative Techniques and Software Platform: Since 1999, we have undertaken firstly the research of quantitative finance, and secondly the development of financial and mathematical software components (see http://www.webcabcomponents.com). These components offer a wealth of financial and mathematical functionality which is leveraged within our internal research systems. In addition, we have developed a proprietary data archive and quantitative financial research platform. This system can apply a variety traditional and state-of-the-art statistical and quantitative finance techniques including regression and time series analysis; pricing and risk (Greeks/global VaR methodology) analysis (for virtually all equity and equity derivative contracts in accordance with a number of price/volatility/interest rate model assumptions).

According to the Adam Smith Institute (see http://www.adamsmith.org), Tax freedom day is now 3rd June, which means that we now spend more days each year working just to pay tax than at any time during the 1970s where income tax level where as high as 80%. In 1997, 2M people where higher rate income tax payers and now the figure is 3.5M, with inheritance tax the situation is even worse….

Two Yale academics have formally justified what I expected all along. That is, on average real stock pickers who have high conviction (most likely concentrate) index independent portfolios who ideally have smaller sums under management, not only outperform the “cookie cutter” closet index trackers and the sector/theme rotator funds but also the index before and after expenses. The degree of this out performance after expenses is a highly significant 3%, and this out performance is persistent. In particular, the authors show that the funds with the highest Active Share (see below) continue to outperform there indexes (after expenses) by 2.29%-3.69%.

The key introduced notion (known as the Active Share) within the research is to view the level of active management by the level to which the managed portfolio weighting deviates for the underlying indexes stock weightings. Rather than the portfolio’s deviation in term of performance.

For further details, we refer the reader to the following web page of one of the authors:

http://www.som.yale.edu/Faculty/petajisto/research.html

where you will find the main article “How Active Is Your Fund Manager? A New Measure That Predicts Performance”, but also a number of other interesting related articles included some popular summaries of the research.