Pick 'n' mix

By Rebecca Macfie

Sunday 1st February 2004

Ever wondered what arcane formulas determine the make-up of managed funds? Do portfolio managers follow some rigid algorithm, or is hunch and intuition more important? Is it art or science? We asked Franklin Templeton, manager of the BNZ's International Equity Trust ($120 million under management as at September 2003), how they do it.

Franklin Templeton's (FT) portfolio-building process revolves around two lists: a bargain list and a sell list, explains Bahamas-based Jeffrey Everett, chief investment officer of the Templeton Global Equity Group and portfolio manager for the BNZ's International Equity trust. It's the job of FT's team of 33 analysts worldwide - each of whom covers particular industries and countries - to scout for underpriced companies to bring to the bargain list, and conversely to put up recommendations to bump stocks already held onto the sell list. Analysts can use whatever sources they like - talking to company management, following industry trends, sussing out the target company's competitors, and so on.

Based on this array of intelligence, analysts produce a research report that includes five-year forecasts of target company earnings, cash flows, asset values and projected price:earnings ratios. The research is put in front of the entire team of 33, which subjects it to critique and challenge. "Anyone can ask anything," says FT software sector analyst and portfolio manager, Melbourne-based Peter Wilmshurst. And therein lies the art: the group is an eclectic line-up, including lawyers, finance wonks, actuaries and biotechnologists - so, as well as bringing a range of geographical and industry perspectives to the process, an array of intellectual disciplines comes into play.

The final decision as to whether a stock goes on the list rests with the director of research, who checks whether the analysis includes robust investigation of things like industry growth rates, competitors, and how well the analyst's forecasts line up against historical results.

Portfolio managers choose their stock purchases from the bargain list. Everett: "You basically choose the best bargains. If there's something that's outstandingly cheap, you bring that into your portfolio. And you may have to sell the most expensive stocks to buy the bargain."

So does the FT method produce results? Wilmshurst says FT has outperformed the main global share indices by 2-3% over the last half-century. And although returns from the BNZ International Equity Trust, which FT has managed since 1994, have been negative for the past three years, it has ranked in the top quartile of comparable funds.

And what of the future - have we seen the worst of the downturn in equities?
Probably, says Wilmshurst: while there are plenty of large stocks that are still overvalued, there are plenty that are undervalued too. The trick is in finding them and in seeing the long-term trends. Everett points out that US stocks, for instance, account for a "crazy" 60% of world stock market capitalisation, but FT has the BNZ's international fund pegged back to a 26% US weighting. Conversely, it's overweight in European equities, as well as emerging markets like China, Brazil and Mexico.

"If you look at the BRIC [Brazil, Russia, India and China] economies over the next 10-20 years, one bet I would make with you is that when my kids and grandkids are grown, the US will not be 60% of the world stock market cap."

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