Legal & General’s Lance Phillips talks greater active management

Legal & General is bucking the wider investment trend and becoming more active. One of the largest life assurance companies in the UK, the firm’s asset management subsidiary – Legal & General Investment Management (LGIM) – has total funds of more than £735 bn ($1.15 tn).

Historically, the majority of LGIM’s equity assets have been indexed, making it the second-largest institutional index manager in Europe after BlackRock.

Lance Phillips, Legal & General
Lance Phillips, Legal & General

Recently, however, it took the decision to manage some of its equity portfolios more actively. There is now a team of 10 managing an outcome-oriented fund, which aims to beat inflation by 4 percent and has been given a global remit.

Lance Phillips joined Legal & General as the company’s head of active equities in 2013. Prior to this he worked for Standard Life in Edinburgh and UBS Asset Management. He began his career with Bain & Co as a strategy consultant in 1986, and is a graduate of St John’s College, Oxford, and Harvard Business School.

Legal & General has historically been known for its index investments – why the change?
As the world shifts away from defined benefit pensions toward a defined contribution model, the responsibility for pension investment decisions shifts from informed pension trustees to the individual.

We believe this has created customer demand for more intuitive outcome-oriented funds, with a direct pension-related goal. For example, the outcome-oriented goal of our first fund, the Real Income Builder, is to produce an income that grows at inflation plus 4 percent – and that’s a goal you can manage with active bottom-up investing, but you would struggle to do it with passive.

Of the £735 bn you currently hold in assets under management, what percentage is in equities?
Approximately £200 bn is currently in equity. Although the majority is passive, £8.2 bn is actively managed. The Real Income Builder Fund is currently at £400 mn, with approximately 60 percent in equities and 40 percent in fixed income. But our ambition is to grow this fund substantially as we start to gather external funds.

Do your 10 fund managers/analysts split sectors?
Everyone has a sector allocation but we also look at drivers of substantial change in a company’s prospects. For example, one of my colleagues and I look at management change as a specialization. Other drivers we look at include technological change, industry structural change, transformational acquisitions, balance sheet restructuring, and regulation and policy change. We also have specialists in high-growth economies and emerging markets. We took the opportunity to analyze the world in non-traditional ways in order to identify early events that can change the direction of a company and its prospects.

Do you use screens?
We are largely looking for companies with a future substantially different from how the market prices it. Currently, as our first product is an income growth product, if a company doesn’t produce a dividend and is unlikely ever to, it is of relatively little interest to us. But later this year we will launch another product – the Real Capital Builder Fund – and we would include in that fund companies that are an attractive investment opportunity but don’t pay a dividend.

Why don’t you use benchmarks?
We are not benchmark-constrained. There is no index benchmark for a target of inflation plus 4 percent, which allows us to spend a large amount of resources on fewer companies. The fund has 30-50 equity holdings with an expected holding period of three years, so between the 10 of us, we can afford to look at things carefully and extensively.

Do you have a target price when you buy a stock?
No, though we need to have a view that the value of the company is significantly different from the current share price – so we’d look for a 25 percent upside over a number of years. We continually review if we think there is still upside in the stock rather than having a trigger to sell at a certain level.

Do you look for a particular yield?
We have a yield threshold for the portfolio overall but the holdings vary, with some having less yield and more growth and some having more yield today and less growth. On average, the portfolio has to have a yield above the market but we are not constrained to every stock having to have a yield above the market.

What’s your average market cap?
We would be considered a mega-cap fund by most definitions, with the median market cap of our current equity investments at $20 bn. We may have one or two holdings less than $10 bn, but most are large-cap stocks. It is meant to be a scalable fund, so we need to invest in large, liquid companies.

What size position do you take?
Our Real Income Builder fund is currently $600 mn, but we expect it to be substantially larger than this by the end of the year (around $1 bn). Ultimately, the potential scale is tens of billions. Today we have approximately 30 investment packages – equity positions individually matched bottom-up with one or more complementary fixed-income instruments – so the average size of each equity position is around $12 mn. This for us is small scale; in future we’ll be able to run it at a multiple of this size.

Any sectors you won’t invest in?
No, but we do have strong governance representation within Legal & General. We engage with all the companies we invest in on a governance and SRI basis, but more on a ‘continual improvement’ footing than a ‘pass or fail’ basis. We generally vote our proxy for overseas holdings. Governance is important given our average holding period. When you’re holding a stock for three to five years it is very difficult to become comfortable with an investment if you are not comfortable on the governance side.

Any recent purchases?
TD Ameritrade we like for the strength of its asset-gathering model. We believe the asset-gathering industry is evolving. Digital, direct-to-the-consumer distribution is a long-term valuable capability and TD Ameritrade is well positioned in this space. From there we believe there are a number of things it can extend its service into, which we expect to see play out steadily over time. The fund has been running since January and we bought in November so we’ve been building up our position. As well as the long-term strength of its asset-gathering franchise, it’s a company that is cash-generative and committed to paying dividends. Finally, if interest rates rise, that’s a positive, which is another reason for owning it.

Intuit is another recent holding. It has obviously gone through a substantial change in its pricing model as it moves to a subscription, cloud-based service, which we believe will result in rejuvenated growth prospects. The things you can do with Intuit’s product when people interact in real time should add a lot of value. The underlying economics of this transition have been a bit clouded and it is not a big dividend payer, but we think the underlying figures are strong and therefore its long-term growth prospects are strong.

In terms of the Real Income Builder Fund, are you value investors?
There’s a slight value bias but it is not a deep-value fund. For a company to pay a sustainable dividend, there has to be underlying cash flow. The fund is pitched at an income level that is a little bit more than the market but not dramatically more. If you pitched it with too high a yield target, it would be too constraining and you might invest in things that wouldn’t be for the long-term capital good of the fund.

As a pension investment, someone might invest at age 25 and hold the fund for the next 50 years, so good income today but no capital growth is not going to be sufficient. The fund has to be pitched at a level that has both income and income growth – but not at the expense of capital.

Do you have to meet management?
Yes. The process we have wouldn’t allow us to buy a company we haven’t met. We wouldn’t be able to investigate a company to the depth we require without meeting management. We have extraordinarily good access in the UK and Europe. In the US we have to work harder but we can still get it. Even when we are at scale we have only 30-50 equities in the fund at any one time, so we will take the time to get to know those companies very well.

One of the advantages we have from the passive side is our large and broad holdings, which tend to get us very good access. Most companies know we take our responsibilities seriously as a large investor, and we are known as an active shareholder on the passive side as a result – by which I mean that although ours is a passive position, we still engage with companies in terms of corporate governance.

Where do you like to meet management?
A mixture: obviously it’s very convenient for us to meet companies here in our London office but we like to get out to see companies, too. We also attend conferences. Generally we prefer one-on-one meetings as we have a long-term investment horizon, so often what we want to talk about isn’t what other people want to talk about.

Why should corporates target L&G?
The nature of our funds allows us to be long-term, constructive investors. When you are running against an income goal, if you are not sure about short-term share price fluctuations but are sure about the income, you can still hold that stock. And that allows us to have this three-to-five-year investment horizon, often longer than that. We are long-only, and if you are there for the long term you want the firm to be run in the best possible way. As a result we tend to have constructive, supportive dialogue with companies. We don’t focus on the next or last quarter. When companies come to see us, they tend to say we ask different questions from other people.

Gill Newton is a partner at Phoenix-IR, an investor relations consultancy

Snapshot: Legal & General Investment Management

LGIM is the asset management arm of UK insurer Legal & General

Established in 1970 as Legal & General Investments

Assets under management: £735 bn+

Equity assets: £200 bn

Active equity assets: £8.2 bn, with plans to grow significantly

Plays active role at companies through voting and board-level engagement

Last year acquired US-based Global Index Advisors as part of international expansion drive

Source: LGIM

This article appeared in the fall 2015 print issue of IR Magazine

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