Ian Heslop has a keen interest in the healthcare market. For one thing, after years of playing squash, football and now running around after his two children, his knees are giving him problems.
His former career has also given him something of an affinity with the sector. He was once part of the medical world himself and holds a PhD in medicinal chemistry.
However, when it comes to stock picking, the Citywire AA-rated manager, who runs several global equity funds at Old Mutual Global Investors, has more pragmatic reasons for his enthusiasm for the space. Indeed, he says his background has given him no advantages when selecting healthcare-related businesses.
So what is it about the sector that has encouraged him to invest 18.1% of his Old Mutual World Equity fund there, where the likes of Gilead Sciences and Roche Holding, account for six of the portfolio’s top 10 stocks?
Heslop, who is head of global equities at the company, which has recently got a new CEO in former UK equity star Richard Buxton, has compelling arguments. He believes healthcare, which has outperformed for the last three-and-a-half years, sits well with investors’ currently risk-averse stance.
‘Some of that healthcare performance is down to the fact that interest rates are at zero and pharmaceutical companies have a ton of money that they are throwing at biotech firms.
‘However, I think it is more about the sector’s defensive nature. In an environment of quite significant instability in returns and one that is quite unpredictable in relation to investor risk capital, it has been the type of stock that investors have been buying and we have as well,’ he says.
Heslop’s reasoning looks good if his performance figures are anything to go by. Over five years he has left his average peer in the Global Equities sector way behind, returning 116% in US dollar terms versus 45%.
Nevertheless, He is keeping a watchful eye on prices at moment. ‘The worry that you have as an investor is when do biotechs start to look too expensive, given the amount of liquidity that the pharmaceuticals have?’
There has been increased M&A activity in the pharmaceutical sector this year and Heslop advises caution.
‘In the short term I don’t think biotechs are necessarily as bubbly as certain areas of the onshore Chinese stock market were, but I do think we have to be wary of valuations. I think these are probably a bit ahead of themselves in certain areas.
‘As we move through the cycle and debt becomes relatively more expensive, it may lead to a pause in M&A activity. I am not suggesting there is an imminent crash coming – I think there is more likely to be a readjustment towards a tightening environment, which means these deals are more expensive to finance.’
Heslop does not make these predictions alone and runs the fund with two other AA-rated managers, Amadeo Alentorn and Mike Servent. As well as the Old Mutual Global Equity fund, they run other strategies together focused on North America and Japan.
A common thread joining the trio is that they all swapped science for stocks. Alentorn is a robotics specialist and Servent studied chemistry. But maybe it’s not such a leap, the methods and thought processes involved in science and stock picking are similar, says Heslop.
‘When you try to understand a very complex organism you prod it and see what happens. We are doing the same thing now. The market is a very intricate system with lots of participants all doing different things. That is all we are doing, prodding it and seeing what happens.
‘It’s that thought process – how is it that all of these massively different things are going on in markets and we come to one price? And why is the price often wrong, how predictable is it that the price will be misjudged and how do we make money from the fact?’
The trio have been working together at Old Mutual for more than 11 years and have an equal say in how the fund is run along with the power of veto. Each manager has different areas of expertise, but none has responsibility for a specific area.
‘What sets us apart is there is no lead fund manager, no one decision maker on the individual funds. We run the portfolios as a team. We always discuss how a portfolio looks, which individual stocks we should be buying and selling, but there is no trigger-pulling exercise that only sits on one person’s desk.’
Heslop gets on very well with his co-managers and says while they have never fallen out, they do disagree about the products of the fund’s biggest holding.
‘Mike hates Apple, he’s a PC guy. I’m quite pro its products. We do like Apple, more for its valuation than its growth. It’s one of the most visible companies – everyone knows what it is and what it does.’
The tech major makes up 2.7% of the fund and Heslop does not share concerns with other investors over the company’s July sales figures, which were lower than expected and caused the share price to drop.
‘I don’t think there is anything inherently wrong with what Apple is doing, I didn’t think there was anything amiss with the quarterly update. There is always this worry that you have sold x billion iPhones, what is next?’
Heslop’s self-reliant stance is reflected in some of his other approaches to stock picking. He doesn’t meet management teams, does not take big country or sector bets and refuses to hold a macro view. In his view, there are more important considerations.
‘Instead of having this macro view we are much more interested in what the market is doing right now and how investors are behaving. Is the market very volatile? That will be beneficial to certain types of stocks.
‘More importantly, what are investors thinking? Are they prepared to buy cheap but risky stocks or are they paying up for expensive but higher quality investments? That is very much about how investors are perceiving the future, the risk they are prepared to take on.’
Throughout the interview Heslop keeps stressing that stock picking is not about choosing companies because of their profile but instead about spreading risk across many holdings.
‘In a very volatile market within a highly changeable environment, the most important thing is not to have all your eggs in one basket. It is not about stocks. It’s about what type of stock you have in your portfolio.
‘If you have the same type of stock, inherently you have unstable returns. If the one stock you get wrong is a big wrong, it is going to blow the whole portfolio up.’
Heslop finds stocks don’t always behave as he predicts, which is why he holds around 500 of them in the Old Mutual World Equity fund.
‘To be brutally honest, the reason we have a lot of stocks is because we get a lot wrong. Not many fund managers will say this, but our hit rate is very similar to that of many managers. In a good month we’ll have about 55% of positions going in the right direction, and 45% going the wrong way.
‘What is not worthwhile is stock-specific risk. We don’t get paid for taking on that and so we try and diversify as much as we can.’
Heslop covers around 3,500 stocks each day and holds a view on each of them. As the former head of quantitative strategies, he has a system to help him do this.
‘We have a systematic investment process. It’s quite automated, but we try and avoid the word “quant” because it has different connotations for different people. We use a lot of fundamental, company-level information on stocks and the automation is just there to speed things up so we can use the data more efficiently. The major positive for us is that we can cover far more names.’
Up to 40% of the stocks in the fund are non-indexed positions and he puts a lot of emphasis on the value that they add to the portfolio.
‘We are very aware of this idea of active share. A figure of 60% has become the bellwether for active funds, our portfolios run between 70%-80% active share, so they are very active.’
Heslop drives the point home by pointing out how the fund’s play on certain trends emphasises its active stance.
‘If you take the fund and, as it were, tilt it on its side, you can see that the themes running through the portfolio are quite concentrated.’
However, risk matters to Heslop as much as returns. ‘I often get asked “what’s your return target?” I don’t have one. We have a risk target and we manage the portfolio to a level of risk, but the return comes from the information ratio we are able to achieve in the absolute return space.
‘It’s a mind-set that risk management is integral to portfolio construction and it is also very important to understand the risk that you run through concentrations of style.’
Once again Heslop’s scientific background comes into play as he tries to find an explanation for the unknown. ‘Our information coefficient is 6%. It means that we can explain 6% of the returns that we can see at any point in time. We are not explaining 94% of the return. That’s the opportunity. Get more of the 94 into the 6 and you get a higher return.’
With so many stocks to look after, Heslop has a pragmatic view that is unsentimental.
‘We don’t buy companies – we are not private equity we are equity fund managers and we effectively buy and sell second-hand equity.
‘I always suggest when investors are looking at portfolios that we tend to rent stocks, we don’t buy them. Stocks are in a portfolio for as long as they do the job for us, when they stop doing that, they are removed.’
Heslop shrugs off his success and views his investment methods as an experimental work in progress.
‘It is very important to recognise that just because you have the best mouse trap now, it doesn’t mean that you will have it in 18 months’ time. You’ve got to continue to work at your investment process to ensure it evolves.
‘But I’d never assume outperformance. I think that is a very dangerous game to think that you somehow have the holy grail of investment, some kind of edge that is always going to work. As soon as you think you have some sort of magic formula, that’s when the market tends to take your trousers down and smack your arse.’
It’s this sort of thinking that keeps Heslop sharp and ensures he’s not a man to rest on his laurels: ‘It’s this idea that no matter what you do right now there is always the opportunity to do it a little bit better.’
This article originally appeared in the September edition of Citywire Global magazine.