Back in 2012, investment bankers dreaming of a global recovery predicted markets would see a Great Rotation from bonds to equities. Martin Davis, chief executive Kames Capital, was not impressed with the argument then. And he is not impressed now.
Davis: Ã¢ÂÂMy philosophy is to get it right, and if we get it wrong, our oversight team needs to be in a position to reactÃ¢ÂÂ
He said: “We’ve not seen a Great Rotation. People are looking for income, rather than expecting growth, and that is going to be true for the next 10 years.”
Low growth is perpetuating attempts by central banks to stimulate economies. Returns from sovereign bonds and bank deposits are stuck near zero. But this is good news for Kames Capital, thanks to its early-mover advantage with strategies which generate income by other means.
It has driven its assets to £58 billion (€73 billion). This equivalent to only a fifth of the group total of €344 billion managed by its parent Aegon Asset Management. But Kames reckons it can lead the way in marketing, after its success in wooing third-party clients, which generate 60% of its revenues.
Third-party business boosted consolidated pre-tax profits at Kames to £18.6 million in calendar year 2015, according to a spokesman, compared with £15.9 million in 2014. This year, its parent raised funds by selling a £6.5 billion mature book of business to Rothesay Life. Davis is not perturbed: “It was fair enough to hand it over. We are not chasing assets – we are interested in revenues and profit.”
Even by chief executive standards, Davis is sensitive to client issues. He says: “We manage things really tightly, because people have become more worried about losing money than making money. The vast majority of our market comprises clients who want an income to supplement their pensions. If they expect £500, they should get £500.”
Davis served in the army as an officer in the Royal Irish Rangers and fought the first Gulf War. He went on to join Reuters as a strategy director before seeing service with Zurich Insurance Group and UK platform provider Cofunds.
He likes a clear plan of action and ways to deal with the unexpected: “I’m quite a fan of General Eisenhower, who said ‘planning is everything, but the plan is nothing’. His trick was to get everyone drilled to deal with unforeseen events. My philosophy is to get it right, and if we get it wrong, our oversight team needs to be in a position to react.”
As regards investment shocks, Davis doesn’t quite rule out a hike in interest rates to 5% or 8%, which would clobber bond prices. He said Kames, and its clients, needed to continue developing a cross-border diversified approach.
He is a big fan of a monthly diversified income strategy managed by Vincent McEntegart, formerly a senior consultant at Hymans Robertson, launched in February 2014. Its broad array of investments includes aircraft leasing, real estate, solar power, Paraguay bonds, equities and credit.
Davis said: “The fund seeks to pay an income to its clients, from a range of assets. It aims to reduce volatility without killing the upside and it has exceeded its 5% target with some growth.” He said investors often had monthly bills to meet, and McEntegart set out to provide them with the money on time.
Of late, the fund has been performing better than the Kames diversified growth fund, which has lagged its benchmark since its 2011 launch in a crowded market. Davis concedes: “We’d like the fund to do more.”
Investors who like a steady return from a cocktail of bonds are also keen on the £2 billion Kames absolute return bond strategy which has returned an annualised 1.9%, net of costs, since inception in 2011, compared with 0.6% from its benchmark. The fund is near capacity but Kames has added a constrained equivalent targeting a 0.5% return, to compete with bank deposits, plus a global fund.
Davis said: “We’ve also developed equity market neutral funds from matching long and short positions, which we can leverage twice. It’s all about achieving an absolute return, without exposing clients to market risk.”
He said investors should also think hard before buying expensive prime real estate at 4% or less. His active value funds sets out to achieve an internal rate of return of 6.25% by purchasing secondary real estate, with improvement potential.
“We seek to redevelop and upgrade, in line with new regulations relating to sustainability, including heating and lighting. You need to make buildings more efficient to extend tenant leases. And we have the expertise, and finance to achieve this.”
Davis reckons sustainability will drive equity returns, as well. “Once this was a specialist area. Now we are seeing 5%, or 10%, weightings.”
The top UK equity strategy at Kames is an ethical fund, run by Audrey Ryan, who achieved a top quartile annualised return of 9.9% over five years, against 5.3% from the FTSE All Share index, despite falling back over the last 12 months.
Over the last five years, the strategy has been helped by a lack of exposure to commodities and lenders to emerging markets. Davis said: “We pick stocks from a narrow universe, and tend to favour small and mid-cap stocks.” Kames has just launched a global ethical fund to seek further opportunities.
Despite recent performance issues in the Kames strategic bond and high-yield strategies, and some lacklustre equity strategies, 44% of Kames funds are rated four or five star by data provider Morningstar. A further 19.4% have two or three stars. Davis said investors look closely at league tables: “We’re sixth in terms of wholesale sales in the UK.”
Morningstar says the Kames management team is relatively stable. It is paid for its long-term performance and contribution to overall revenue. It is deferred over three years or more and invested in Kames funds for the duration. Davis sais: “I’m not a fan of phantom equity, because it is not always determined by performance.”
Kames is named after Scottish philosopher Lord Kames, a devout believer in the importance of property ownership to economic development. Its origins go back to 1998, when life assurer Scottish Equitable launched a self-standing asset management business. Dutch insurer Aegon bought 100% control of Scottish Equitable shortly afterwards and Kames became a division of Aegon Asset Management, led by Sarah Russell.
Despite short-term performance issues in strategic bond and high-yield strategies at Kames – and room for improvement in equities – an impressive 44% of Kames funds are rated four or five star by data provider Morningstar.
Kames has poached David Ennett from Standard Life Investments to boost high yield. Its former co-manager Claire McGuckin has left the group. A spokesman declined to elaborate. Sector specialist Phil Milburn should return from sick leave in the third quarter to take strategic bonds forward. The spokesman said performance for some strategies has fallen behind this year, following record returns in 2015 but said prospects were robust.
Davis said wholesale clients tended be leery about performance when times are hard. He said: “When you are managing volatility, investors are much more analytical.” To prevent client surprises, he has tightened scrutiny over third-party data and managed capacity by stopping marketing funds, when necessary. He believes institutional opportunities are set to grow. In a survey published on June 13, consultant Mercer said a growing number of cashflow-driven pension schemes are switching from sovereign to risk-averse income strategies.
In 2015, Davis hired Peter Ball as director of institutional business, to diversify out of wholesale and forge links with Aegon Asset Management’s US and Dutch asset management arms. Ball previously led UK marketing at JP Morgan Asset Management and, more recently, JLT’s investment consulting arm.
Ball said 60% of Kames revenues are derived from third-party investors, rather than in-house clients who would pay Kames rather less. The proportion of third-party revenues from Aegon’s overseas businesses is much lower. He said: “Having seen the success of Kames in capturing external clients, the aim is for other units to follow suit and further increase their revenues from other clients.”
Ball points out Aegon’s Dutch mortgage strategies, yielding 2.6% over Libor and guaranteed by the local government, are a great marketing opportunity, together with US high-yield strategies.
Aegon also runs Dutch-based TKP Investments, whose skill lies in multi-manager products. Aegon also has a Chinese affiliate. Davis believes Kames’ ethical products should achieve traction across the group. He said: “Our parent applies a sustainable approach across our operations, as well as our funds. It’s a great discipline for us.”
Last year, Ball was involved in Aegon’s purchase of a quarter of La Banque Postale Asset Management in France for €112 million. LBPAM is the fifth largest asset manager in France, with €150 billion under management, and Kames has negotiated a niche on its platform. When marketing in France, Davis said local distributors have a clear marketing edge.
In May, Aegon bought BlackRock’s £12 billion defined contribution platform. According to investment bankers, Aegon has also considered buying Cofunds from Legal & General. “Who hasn’t talked to them?” asked Davis, with a shrug. “The platform space is in turmoil.” Ball said the Banque Postale deal was time-consuming and he doesn’t expect another big deal, for now. Davis points out there is no shortage of existing synergies to exploit.