Angus Tulloch and the Herbaceous Portfolio
The lessons to be learned from one of the UK’s fund management greats.
The above fund has a personal edge for me. Its sister fund, Stewart Investors Asia Pacific Leaders, was one of the first I inherited when I began analysing funds for Premier in 2007. Its manager, Angus Tulloch, was generous enough to spend time humouring a rooky fund picker, and although my job was officially to check up on the fund and its management team, I spent more time in those sessions learning than I did judging.
Back then I was like the bartender from Bob’s Country Bunker in The Blues Brothers: Just as she played both types of music; Country and Western; I thought I ‘knew’ both ways of investing; Value and Growth. So getting to understand the nuances of the Stewart investment philosophy exposed shone a light of the many shades of grey that live in, around and between those two styles. It opened my eyes.
Angus retired in 2017. Unusually, for a manager of a popular “sector-killing” fund, he did so with his fund still outperforming, and with the complete respect of his peers, his fund holders, his staff and pretty much anyone else he worked with too.
He left a legacy of great investors too: Be that within Stewart Investors, David Gait’s Sustainability team, who grew up in the intellectual safe space forged by Tulloch, are perhaps the best and most genuine (i.e. greenwash-free) responsible investment teams in the business. Or outside of it, with many of his peers starting up Stewart Investor offshoots across the industry.
His original fund made a total return, after charges, of 4,777% over the course of his career (see chart, above). Which means £10k invested on day one would have grown to £488k by the time he stepped back. The average fund in his sector*, meanwhile, would have grown to just £178k (which is why I heed the passivists’ advice by not investing in ‘average’ funds).
That chart looks like an easy cruise to incredible returns, but it wasn’t: There were times when the process looked broken, tempting holders to abandon ship — most likely for an inferior fund.
Doing so would have proved costly.
The most notable temptation came, not coincidentally, in the late stages of bull markets. When investors are only interested in the few exciting sectors or stocks whose prices have recently risen, and have little concern for the valuation or fundamentals of the underlying businesses.
This is technically referred to as ‘momentum investing’ (and less technically known as ‘performance chasing’).
Perhaps the most challenging of these was the original tech bubble in the late nineties:
As this period began, the Stewart team had already sold much of their tech exposure, due to concerns about company valuations and underlying fundamentals. Angus then attended a standing-room-only tech conference, where he was shocked by his “more tech-savvy co-attendees” who were clearly swallowing everything the presenter said “hook, line and sinker”. His team sold the remainder upon his return.
This is a common experience among successful fund managers. They often miss out on the final, frothy extension of the bull market, as they simply can’t stomach what they’re having to pay for the most popular shares. The stocks that do look sound investments, meanwhile, get left behind in the rush for the glitz. But, as the chart below illustrates, such managers are usually proved right when the rose-tinted glasses slip away. The team’s performance over the next five years was nothing short of stellar:
There are many lessons to be learned from studying the methods of proven fund managers. For fund holders, the big one is that great managers do not always outperform. In fact, an occasional period of underperformance is actually a feature of a great fund, not a flaw. Yet we see reams of comment bemoaning a lack of funds that have outperformed for five calendar years in a row (or some other randomly-selected yardstick).
This drives fund investors to make their most common and costly mistake: Buying good active funds after they’ve outperformed, then selling them after they’ve lagged — usually in favour of a different fund that’s just outperformed. And so on and so on, until they’ve made the same mistake so many times that they give up on good managers altogether, settling instead for the guarantee of sub-par returns from a market tracker.
But there are plenty more lessons to be learned from Tulloch’s Stewart Investors experience. A long time back, he sent me an excerpt from a book called Asia’s Investment Prophets, by Claire Barnes, pointing me towards the Herbaceous Portfolio passage. It’s a fantastic way to think of running a portfolio. I use the same analogy all the time (my take on it introduces our quarterly reports at Downing).
I’ve pasted the Angus Tulloch chapter below. I’ve rearranged it slightly to suit the medium (books didn’t have to compete with 24–7 cat videos back in 1994), but I’ve changed none of the words. Be you fund buyer or fund manager, you could do a lot worse than heeding at least some of its lessons:
The herbaceous portfolio
Angus Tulloch of Stewart Ivory
One of the most dedicated stockpickers in Scotland is Angus Tulloch.
He heads the small team of four who run the Asian and emerging markets funds of Stewart Ivory, one of the fortunate companies still ensconced in the elegant houses of Edinburgh’s Charlotte Square.
There are limits to tradition, however: Tulloch is not dour.
As he embarked on a recent trip to China, his son requested that he should bring back a panda. He returned with a panda suit, changed into it on the plane, and persuaded staff at Edinburgh airport to broadcast a request for William Tulloch to report to the meeting point to collect his panda. His family, unfortunately, were late. He therefore ended up sitting in the waiting room, in his panda suit, reading the Financial Times. A large crowd gathered. William was not impressed by his father’s antics: pandas, he thought, should be on all fours. Tulloch’s efforts were not entirely wasted: a prospective client was far more amused, and invested a million pounds in the fund.
THE HERBACEOUS PORTFOLIO
Tulloch is fond of a gardening analogy, a traditionalist’s version of modern portfolio theory. He learnt from Lord Faringdon at Cazenove to view his portfolio as a herbaceous border, and wrote the following explanation in early 1993:
‘Gardening is an art, not a science. A herbaceous border should be much more than a symmetrical expression of what flowers are currently in vogue. Variety — be it in or out of fashion — is the essence of success. Plant exploration has an important role to play, as newly discovered seedlings could be tomorrow’s Chelsea Show triumphs. These, in moderation, ought to have a place alongside sturdy shrubs, hardy perennials, and regular blooms. Whatever the weather, colour must always be found. Above all, gardening should be creative and fun.
“The New Pacific portfolio owes much to the influence of this approach. We too aim for balance and avoid taking excessive positions in individual markets, sectors, or stocks. No one market presently accounts for more than 30 per cent, or stock for more than 5 per cent of the fund’s value. Ten countries and fifty companies are currently represented. Over half the portfolio is invested in recognized regional “hardies” — Brambles in Australia, Fraser & Neave in Singapore, and Swire Pacific in Hong Kong are examples. Less well-known medium to smaller companies with proven track records — Cifra in Mexico, Crusader Oil in Australia, Shaw Brothers in Hong Kong, and Trans Island Bus Services in Singapore — are also strongly represented. Finally, we always make room for a selection of publicly untested “exotica”.
‘Many of the latter holdings result from subscription to new issues in the less mature and currently unfashionable markets of Indonesia (eg Dynaplast and Nipress) or Thailand (eg Bangkok Dusit Medical and Srithai Superware). Access to such issues in more buoyant times is rarely available. Such companies are chosen primarily on growth criteria — all are in the process of expanding capacity — but careful attention is also given to their balance sheets. As much as possible, we use our local contacts to check out management integrity prior to subscription and make a determined effort to visit the companies when in the relevant country. This investment category will never comprise more than 10 per cent of the fund (now a little over 5 per cent) and individual holdings, at cost anyway, will rarely exceed 1 per cent of the total portfolio. Here we hope to find tomorrow’s star blooms. Here also we might experience our greatest disappoint-ments. We operate a particularly vigorous weeding programme in this part of the herbaceous border, having no hesitation in discarding seedlings which disappoint on to the compost heap.
‘With a substantial premium being placed on liquidity, smaller companies in the region have tended to be ignored by international investors over the recent period. One of the advantages of a specialist fund is that by holding a relatively large number of stocks, it can afford to carry a limited spread of younger companies. Thus the New Pacific Fund is particularly well-placed to apply this green-fingered guru’s herbaceous border approach to portfolio management.
NAV PLUS DIVIDENDS: THE MEASURE OF ENTREPRENEURIAL SUCCESS
One of Tulloch’s long-standing arguments is that the markets focus too much on earnings, whereas an Asian entrepreneur will focus on appreciation in the net asset value of the company, plus dividends.
This is a fair observation, and a useful extension to the conventional ways of thinking about investment. Much investment theory of course has been developed in the United States, where real estate is much less important as a component of business and of the stock market than it is in Asia, and the true value of a business is a function of its future cash flows. The difficulty in Asia is that book values often lag far behind current market values of the assets, so how possible it is to evaluate the historic record of an individual company on this basis depends on whether the company is regularly realizing assets and booking its capital gains, or alternatively and less commonly revaluing its assets.
Asian entrepreneurs, he argues, have a philosophy which can be simultaneously very short term, and very long term. When choosing the site for a brewery, they will automatically pick a location with long-term potential for an extraordinary gain, recognizing the dramatic transformations which can occur over a period of decades in a particular economy or city. Accordingly, he looks for growth, not necessarily in earnings, but maybe in net asset value or cash flow.
He tries to take a three to five year view, rather than one or two years. While he looks for value, he considers it well worthwhile to pay up for quality and management integrity.
Tulloch’s largest holding for some years has been the Malaysian conglomerate Perlis Plantations, which in mid-1994 accounted for 6 per cent of the New Pacific Fund and 7 per cent of the Emerging Markets Fund; it is one of the few holdings common to both funds.
Earnings have been relatively lacklustre in recent years, and the company is not viewed with much enthusiasm by brokerage analysts, but Tulloch reckons that annual EPS growth has been of the order of 12 per cent and NAV growth around 17 per cent; the dividend yield is about 2 per cent. His comment in a recent report was that:
‘Interests comprise a mixture of strong cash generators (principally flour-milling and sugar-refining) which have been used to finance the purchase of initially low-yielding but potentially very rewarding assets (hotels, plantations and property). Perlis is typical of many Chinese-controlled companies in focusing more on long-term net asset value appreciation than short-term earnings growth. Consequently, extraordinary gains (usually tax-free) are a regular feature of the company’s results.’
Another unusual name which has featured in the portfolio for many years is the Singaporean company Trans Island Bus Service (TIBS). Tulloch bought this company when it was on a PE about half that of the market, and its cash flow multiple one quarter; at one stage he owned 10 per cent of the company. The holding has been trimmed back to 7 per cent after a quadrupling of the share price in the last few years, but Tulloch remains an enthusiast. The buses are depreciated over eight years, he points out, compared to a fifteen year norm in the UK. Earnings growth fluctuates because of the timing of price increases, but the company’s very strong cash flow has allowed it to diversify into other businesses ranging from packaging and waste disposal to leasing, and most recently a bus manufacturing joint venture with Mercedes Benz in China. ‘The key to evaluating TIBS is its success in growing net asset value. We expect the historic compound NAV growth rate of 20 per cent per annum to be maintained through the disposal or listing of group assets over the next five years?
A SOUND ATTITUDE TO ACCOUNTANCY
The interest in transport goes back to a spell working for a bus company. Tulloch graduated from Cambridge with a degree in economics and history, and spent a few years in accountancy, which he treated with an appropriate and unconventional irreverence. (He spent most of his final examination paper composing ‘An Ode to Cheer up the Examiner’, composed to the tune of ‘Hark the Herald Angels Sing’.) The subsequent stint at a ‘nationalized, bureaucratic’ bus company taught him how an industry should not be run. He subsequently joined Cazenove in 1980, spending three years in Hong Kong researching Malaysia, Singapore and Thailand before moving to London to run the Australian desk in 1984, then into fund management in 1986, and back to Scotland in 1988 to join the independent firm of Stewart Ivory.
Another of Tulloch’s favourite stocks is Saha Pathana in Thailand, which is trading at a discount of over 50 per cent to estimated net asset value, based on the value of stakes in affiliates and industrial property. Stewart Ivory started accumulating the stock in 1993, on the basis that the various group businesses were of high quality and only temporarily troubled, and that the stock was cheap; a ruling that associates should be equity accounted came as a bonus, and is expected to double the reported earnings in 1994. With recovery under way, the stock is estimated to be on a current-year PE of around 10, with sustainable growth of the order of 15 per cent thereafter.
Tulloch says his principal mistakes have been made with recovery stocks, and he has now decided that distance is a disadvantage in this limited category, since local investors are better placed to pick up any deterioration or discrepancy in the story. (In general, he is a firm advocate of the argument that distance conveys detachment.)
In a dynamic region, the opportunity cost of waiting for recovery or takeover can in any case be high. Moreover, the prevalence of family-controlled companies limits the scope for release of value by predators.
He does not worry unduly about country weightings, which tend to arise from the stock selection and can differ dramatically from the indices, but does try to ensure reasonable geographical and sector diversification.
The team members generally visit their most important regional markets (Hong Kong, Singapore, Malaysia) three times a year; Thailand, Korea and India twice; Indonesia and the Philippines at least once. Tulloch makes a point of trying to visit new or potential emerging markets early; he went to Vietnam in 1990, and in late 1994 has just returned from Myanmar, now vastly changed from his last visit in 1983. Between them, the team have visited 70 per cent of the portfolio in the last twelve months; they emphasize visits to the small and medium-sized companies, which they find less researched and more informative.
An interesting checklist of ‘What to look for in a company, which he drew up at the request of his colleagues, is included as Appendix B. While there may be nothing there which is totally original, the list may be of interest both to new analysts and to more experienced investors who are new to Asian markets, since there is a clear emphasis on the issues which crop up most regularly in the region.
THE BEST, THE WORST, AND THE MOST INTERESTING
The internal quarterly review discipline at Stewart Ivory is unusually constructive. Tables are drawn up to show the ten top-performing stocks, the ten worst-performing stocks, and the impact of country weightings against the benchmark. A paragraph has to be written on the single best-performing stock, the single worst-performing stock, and one stock selected by the manager, with conclusions or lessons drawn. Each investment director makes a ten-minute presentation, and fields fifteen or twenty minutes of questions from his colleagues in different markets.
Tulloch says he pays more attention than most people to risk; and that he always tends to outperform significantly in flat or dull markets, but to underperform in bull markets, which make him very nervous. This makes sense: he does not chase the themes which can take popular companies to unsustainable valuation levels, and the less popular companies in which he is invested do tend to be much less volatile. Long-run returns, nevertheless, are respectable.
Over the five years to September 1994, the Stewart Ivory New Pacific Fund achieved compound growth of 23 per cent a year in US dollar terms, against 13 per cent for the MSCI Pacific Index. A couple of recent bull market years with growth in the 30–35 per cent range have dropped the fund down the league tables. It would be churlish to complain about these rates of growth, as risk levels rose with the markets. Like many of the more conservative fund managers who know Asia well, Tulloch was becoming cautious on Hong Kong well before Barton Biggs led the final surge of US investment into the territory in late 1993. On a risk adjusted basis, funds like this one and the Cazenove Pacific Fund, which have been uncharacteristically far down the league tables during the more exuberant periods, move sharply up the rankings.
Appendix B: What to look for in a company
Extracts from a checklist drafted by Angus Tulloch of Stewart Ivory
A. MANAGEMENT
Who controls the company?
How long has senior management been in place?
Depth of management? (One-man band, succession, etc.)
Has management a clear idea of goals and strategy?
Does management have a good grasp of sector trends?
Does senior management have a significant financial stake in the success of the company?
What is the track record for treatment of minority shareholders? (Asset injections, dividend policy, etc.)
What is the reputation for honesty and efficiency?
How is the company run? (Financial controls, targets for subsidiaries, etc.)
Has the company a conservative yet innovative culture? (Management aware of its limitations but willing to exploit new opportunities?)
How is management incentivised?
B. QUALITY OF BUSINESS
Does the company operate in a long-term growth sector?
Is the company well positioned in that sector?
Does the company have a competitive cost structure and sustainable pricing policy?
Does the company have an exclusive franchise and strong brand name?
Are there significant barriers to entry? (Capital cost, distribution networks, etc.)
How strong is existing and potential competition?
How vulnerable is the company’s business to exogenous factors?
(Changes in economic growth, domestic or international tariffs, currencies, government regulations, etc.)
How predictable and reliable is the company’s earnings stream?
C. TRACK RECORD
Does the company tend to disappoint or to exceed expectations?
Does the company tend to be accident prone?
What has the company’s growth rate been, in terms of profits (including extraordinaries), cash flow, earnings, and book net asset value, all in adjusted per share terms?
What have historical trends been for market share, sales, margins, tax rates and return on equity?
How has the company accounted for goodwill?
Has the company generated sufficient cash to finance growth in working capital?
What have historical trends been for working capital ratios? (Debtors to sales, stocks and work-in-progress to sales.)
What have historical trends been for debt-to-equity, interest cover, and net interest payments to operational cash flow.
D. OUTLOOK
What is the cyclical outlook for the sector?
Is growth momentum stable or increasing?
How do the company’s near-term growth prospects compare with the market and the sector?
Is the company sufficiently well financed to survive in the long term?
(Usual ratios but look at length of debt and currency exposure.)
Will future cash flow cover capital expenditure plans?
E. VALUATION
How do price to cash flow/earnings/book NAV ratios compare with
the sector, domestically and internationally?
How do these ratios compare with the company growth rate and historical parameters? (Adjusted for inflation.)
How do comparative ratios of intrinsic value measure up? (Market capitalisation to sales or to physical assets, current to peak earnings ratios, etc.)
Does the company have hidden assets? (Brand names, undervalued property, etc.)
Does the company have unrecognised future earnings potential? (Long-gestation projects, conservative accounting policies, etc.)
F. THINGS TO REMEMBER
Predictable and sustainable growth is the key.
A premium for quality management, business, and track record is always justified.
Brokers are paid to generate business, and to do this often sound knowledgable about companies they know little or nothing about.
If a company transaction is too complicated to be understood, avoid the company.
There is rarely only one cockroach in a cupboard.
The biggest mistakes are made by straying from your investment philosophy.
Never look at book cost of an investment.
Do not be afraid to cut losses.
Averaging down on quality growth companies usually pays.
Value without momentum (eg earnings growth) can remain unrecog-nised for a long time.
Market psychology should be respected, but reality will always win through eventually.
Patience will nearly always pay, so long as the ongoing business is matching expectations.
Do not become too attached to, or too prejudiced against, a company.
The instrument should always be secondary to the company.
The more immature a market, the more it is prone to excess.
No matter how good the company, if it operates in a very cyclical business, there will be a time not to own it.
Early timing is essential for both purchases and sales of illiquid stocks.
Analyse and learn from mistakes and successes.
Try to avoid instant decisions — especially after a good lunch!
Note: like all good proverbs, some of these final maxims may be contradictory, but they have the ring of experience and hard-won wisdom! CB
* As represented by the IA Asia Pacific Ex-Japan sector average. I’ve used this, rather than the market, because I don’t have access to relevant index data going back that far. The sector average, I think, provided a “close enough” proxy for the market (as you can judge from later charts where I do use an index).
