would enable you to enjoy an array of other services such as Member Rankings, User Groups, Own Posts & Profile, Exclusive Research, Live Chat Box etc.. 
Home
Avancka Herat is in his element in bear markets. He now has to contend with management challenges of operating a mutual fund too
Few fund managers can beat a rowdy equities bull run, the type which ensued when the war ended. However no fund manager will mind the wondrous impact an exuberant bull run has on long term returns which are about averages.
Fund manager Avancka Herat however hasn’t been so lucky. He missed the first bull run of the last decade – when a ceasefire with the Tamil Tigers boosted market sentiment in 2001 – because he took a job with a multinational petroleum company where he worked for three years till 2004. He returned to the industry after a chance meeting with tycoon Harry Jayawardena at an airport led to an offer to manage the portfolios of Distilleries group and Sri Lanka Insurance as Chief Investment Officer of Aegis Fund Management.
Over the next six years, as business grew Herat managed at its peak Rs100 billion in assets, the largest private portfolio in the county. However on the eve of the second bull market of the last decade, in 2009, the Supreme Court ruled the Sri Lanka Insurance privatization illegal and returned the firm to the government. With little else to manage Herat quit Aegis and missed the rowdiest of all bull runs which more than quadrupled the value of listed companies.
Herat is circumspect about the opportunity, “I know I will be very uncomfortable in a bull market because it’s not my market, it’s everybody’s market,” he says after less than a year in at his new job as Chief Investment Officer at National Asset Management or Namal, a manager of mutual funds, controlled by Union Bank. He bears no hopes of a repeat of the type of exuberance in stocks seen during the two years up to mid 2011. Bear markets are here to stay, for a while at least.
Bull runs are rare occurrences that take place in response to a watershed event like, the end of a war, change in government, market friendly reforms or sweeping structural changes in an economy, and last for a couple of years at most. “It’s the bear runs that last longer and that’s where professional fund managers, like us, come in to play. We are very comfortable in bear markets,” he says during an interview at Namal’s office at Harry Jayawardena controlled Aitken Spence. The firm will soon move to Union Bank’s new Galle Road headquarters.
Even without the benefit of an unprecedented equities bull run Herat can impress. Under Harry Jayawardena’s leadership Avancka Herat, who moved to Aegis from US multinational Caltex, started rapidly expanding SLI’s equity portfolio from Rs300 million in 2004. “With the life fund we were trying to match the long term liability,” says Herat. “How do you get the exposure, it’s just like a pension fund it has to be equities.” SLI went against the grain ramping up equity exposure to the maximum allowed 30% for its life fund while other insurance firms sought safe harbor in fixed income securities because the outlook for stocks were bleak due to the war escalating.
In a depressed market SLI’s Rs10 billion portfolio made it the 2nd largest shareholder of 15 of the top 20 market cap companies. Stakes included 10% of Caltex- Herat’s previous employer in Sri Lanka, 5% of Colombo Dockyard, 10% of banks HNB, DFCC & 5% of Sampath Bank and 10% of Central Finance. The portfolio also included a number of hospitals. SLI acquired thirty percent each of Asiri and Asiri Surgical Hospitals and Apollo (now Lanka Hospitals), where Jayawardena’s takeover bid succeeded while the management takeover of the other two failed.
In 2006 Harry Jayawardena acquired a controlling stake in Namal; Herat was advising on that purchase. Five years later Avancka Herat was advising a consortium led by Union Bank who were in a bidding war with Heraymila, a Middle Eastern backed stockbrokerage and fund management outfit to acquire a controlling stake of Namal. Winning the bid came at a cost of three times the firm’s net asset value at over Rs600 million. “It was a bit steep, no two words about it,” he admits but adds the Union Bank which purchased a 51% stake and Ennid Capital – the investment arm of family controlled B P De Silva group – which owns 19% had no choice. Founder shareholder DFCC Bank still owns a 30% stake.
“If you look at the goodwill, the track record, it takes away at least one times from the three times book value paid. So it’s a matter of doubling the earnings, to do that you have to double the funds under management.” Leveraging by year end the planned 40 branch network of Union Bank to attract retail clients to its eight mutual funds, particularly ones investing in stocks, is at the core of its strategy to double the fund base under management. “I do agree we have paid next five years cash flow, so it is hard work, there are no two words about it,” Herat says.
For the price Union Bank acquired the management firm of the country’s oldest mutual funds, the first of which, the National Equity Fund (NEF), was launched in 1991: 20 years ago. That unparalleled franchise value, coupled with a loyal client base exceeding 25,000, assets under management of Rs7 billion more than half of which for retail clients, offers a solid platform for growth. The flagship National Equity Fund’s 20 year annual average return of 15.25% including dividends was the icing on the cake.
Doubling funds under management – which will also double fund management fees - will have more to do with retail investors’ confidence in the stock market option, than it does on effective distribution or awareness about mutual funds. Presenting a compelling argument for stocks is challenging even for a fund manager who achieved a 22% annual return on a life insurance portfolio with a 30% ceiling on equity investment.
Union Bank has been growing its credit at almost twice the market rate and that sort of aggressiveness is now expected of Namal too. “It’s a new bank and they want to make it work,” points out Herat who has his work cut out in a market forecast to be range bound. He forecast market earnings will grow at 13% or around five percent above GDP growth. “Market will underperform, it will be subdued,” forecast Herat regardless of his optimism about the economy. Foreigners however may continue to be net sellers for a couple more years according to Herat due to global economic uncertainty. Last year the foreign outflows topped Rs19 billion from the Colombo stock exchange where more than 20% of company ownership is controlled by foreign institutional funds. Fifteen years ago foreigners owned more than 40% of listed stocks.
Namal’s fund managers expected stocks to come off 25% off their peaks starting mid last year. Although delayed, the 25% correction from the peak did come by early January turning some of the more speculative portfolios to dust. “You are not going to see foreign funds coming to Sri Lanka hurriedly, they would compare and contrast markets like Vietnam, Indonesia and the Philippines which are trading at very attractive multiples, we are competing for the same pot of funds,” Herat points out.
The most compelling of Herat’s arguments on why this isn’t nadir for shares is based on their absolute values. “Some guys will look at absolute measures, they will look at weighted average capital cost or the discount factor used in valuing cash flow yields,” he explains. The weighted average capital cost is the rate that a company is expected to pay on average to all its security holders, like shareholders and debt holders. “Weighted average capital cost is about 14% so you are discounting at that. Depending on the risk profile some fund managers will increase your risk premium on equity, expecting more systemic risk, say increase to 15 or 16%,” he argues. A company must make this minimum return on its existing asset base to satisfy its creditors, owners, and other capital providers. Herat estimates cost of equity at 18% after adding an 8% risk premium to the risk free rate.
Free cash flow (FCF) represents cash a company is able to generate after setting aside money required to maintain and expand its asset base. Free cash flow allows a company to pursue opportunities that enhance shareholder value. “On that basis to find companies giving a cash flow yield above the 10 year bond yield will be challenging.”
Since share prices have fallen they look attractive relative to government bonds. But in absolute terms, they aren’t that cheap. Foreign institutional fund managers – the ones who have been here for 10 to 15 years – who are value investors tend to buy stock in half a dozen firms in this country “and I suppose they will look at those numbers not the relative measures,” says Herat, who started his career at Jardine Fleming’s local stock brokering unit 15 years ago. “They would be the most aggressive investors when markets come off. They will come, no two words about it, but that’s on a selective basis, bottom up stock picking”.
“You will definitely find stocks that will give you 30% return, so its bottom up as opposed to top down stock picking two years ago,” says Herat confidently. He also expects the four quarter trailing PE to fall below 10 times from the current 13 times as stock prices hold current levels while company profits edge up. Consensus among institutional stock brokers tracked by Namal is that market wide earnings will grow 16% next year.
Namal seeks out companies that can compound wealth over the long term, a typical value investing model. The company only reveals the composition of its funds annually. However the close ended Namal Acuity Value Fund publishes quarterly accounts and at December 2011 held stakes in 21 companies of which 16 were sizable stakes. Since the management change Namal has dropped five stocks and picked up two according to Herat who says he seeks out “high quality companies which have a primary business model supported by dominant intangible assets (brands) which have the potential to consistently give above market returns.” This is underpinned by Herat’s golden rule that return of capital is more important than return on capital.
Fund managers have to beware of the risk of overpaying for companies in their pursuit of high quality businesses. “In our opinion, the most accurate manner to evaluate companies is using free cash flow.” But Namal fund managers are most excited about firms with franchises, which are difficult to find. They also haven’t invested in conglomerates, as is the case with many Sri Lankan portfolio investors. However towards the end of Herat’s tenure at SLI he did purchase a 7% JKH stake. “That’s because Rajaratnam was exiting and at 62 rupees you couldn’t go wrong.” Unlike local portfolio fund managers, foreign ones do buy proxies to a country; diversified conglomerates. “For a foreign fund, it’s easier to buy a well managed holding company than going one level down.”
Local portfolio managers are not snapping up bargains; yet. Many have a higher-than-normal weighting in cash because they expect stock prices to cool further and bond prices to rise. Twenty percent of the Namal Acuity Value Fund remained un-invested by December 2011, reflecting the manager’s view that stock prices could fall further due to the global financial crisis. “In times of crisis global markets work together and the outflow from emerging markets has been threefold in the last 6 months. Until that cycle reverses we have to be patient, collecting stocks that we think are fundamentally cheaper than the broader market,” opines Herat. The Namal Acuity fund’s net asset value fell 26% to Rs747 million in 2011 with the overall market decline.
On top of the fallout from the global crisis Herat expects interest rates to rise this year by two percent or so. “Auctions haven’t happened and there will be bond rollovers soon, therefore everybody is in the short end of the market,” he points out. Instead of gilt Namal is seeking out fixed income investment opportunities with corporate paper which are now offering yields of between 2% to 3% higher than one year T-bills. The same dynamics playing out in the equity market will also impact the sovereign debt market. “Central Bank is expecting a lot of funds in to the investment account, but that won’t be enough because the portfolio account is under pressure. When it comes to the bond rollover, the market, they will ask for a premium because of the heightened risk. That premium has to be priced in,” Herat points out.
Namal has to convince potential retail clients - who pay the equivalent of 1.5% of assets under management as a fee in addition to charges at entry - about the long term potential in stocks. Despite a war and seesawing economic policies, equity returns have far outstripped bonds in Sri Lanka, as they have done pretty much everywhere else too. In its strategy to double funds under management Namal has identified private wealth management, management of discretionary portfolios of companies and institutional asset management. Namal is also in the process of launching an off-shore country fund.
Even if the entire industry managed to double assets under management, unit trust penetration would still be 0.4% of GDP whereas in India it tops 4%. The average Sri Lankan’s retirement savings have very little exposure to stocks because the EPF, the island’s main private sector retirement fund which is managed by the government, has only 7% exposure to equity in its trillion rupee portfolio.
Mutual fund penetration in India took off when the government of India decided to benchmark the performance of state pension fund managers with those from the private sector who were allocated 10% of the funds to manage. “Try it out here,” challenges Herat, whose 22% annual return on the SLI life fund which only had a 30% equity allocation, beat the returns offered by the EPF twice over. “If the private sector is saying they can perform, then allow them to come and match government fund managers.”
Herat is also concerned about systemic risks in the market including regulatory risk. However the bear won’t be a grinding one that can destroy faith in listed companies. Instead only investors who don’t carefully seek out companies will be driven to despair.
http://lbr.lk/fullstory.php?nid=20120226203647979
Few fund managers can beat a rowdy equities bull run, the type which ensued when the war ended. However no fund manager will mind the wondrous impact an exuberant bull run has on long term returns which are about averages.
Fund manager Avancka Herat however hasn’t been so lucky. He missed the first bull run of the last decade – when a ceasefire with the Tamil Tigers boosted market sentiment in 2001 – because he took a job with a multinational petroleum company where he worked for three years till 2004. He returned to the industry after a chance meeting with tycoon Harry Jayawardena at an airport led to an offer to manage the portfolios of Distilleries group and Sri Lanka Insurance as Chief Investment Officer of Aegis Fund Management.
Over the next six years, as business grew Herat managed at its peak Rs100 billion in assets, the largest private portfolio in the county. However on the eve of the second bull market of the last decade, in 2009, the Supreme Court ruled the Sri Lanka Insurance privatization illegal and returned the firm to the government. With little else to manage Herat quit Aegis and missed the rowdiest of all bull runs which more than quadrupled the value of listed companies.
Herat is circumspect about the opportunity, “I know I will be very uncomfortable in a bull market because it’s not my market, it’s everybody’s market,” he says after less than a year in at his new job as Chief Investment Officer at National Asset Management or Namal, a manager of mutual funds, controlled by Union Bank. He bears no hopes of a repeat of the type of exuberance in stocks seen during the two years up to mid 2011. Bear markets are here to stay, for a while at least.
Bull runs are rare occurrences that take place in response to a watershed event like, the end of a war, change in government, market friendly reforms or sweeping structural changes in an economy, and last for a couple of years at most. “It’s the bear runs that last longer and that’s where professional fund managers, like us, come in to play. We are very comfortable in bear markets,” he says during an interview at Namal’s office at Harry Jayawardena controlled Aitken Spence. The firm will soon move to Union Bank’s new Galle Road headquarters.
Even without the benefit of an unprecedented equities bull run Herat can impress. Under Harry Jayawardena’s leadership Avancka Herat, who moved to Aegis from US multinational Caltex, started rapidly expanding SLI’s equity portfolio from Rs300 million in 2004. “With the life fund we were trying to match the long term liability,” says Herat. “How do you get the exposure, it’s just like a pension fund it has to be equities.” SLI went against the grain ramping up equity exposure to the maximum allowed 30% for its life fund while other insurance firms sought safe harbor in fixed income securities because the outlook for stocks were bleak due to the war escalating.
In a depressed market SLI’s Rs10 billion portfolio made it the 2nd largest shareholder of 15 of the top 20 market cap companies. Stakes included 10% of Caltex- Herat’s previous employer in Sri Lanka, 5% of Colombo Dockyard, 10% of banks HNB, DFCC & 5% of Sampath Bank and 10% of Central Finance. The portfolio also included a number of hospitals. SLI acquired thirty percent each of Asiri and Asiri Surgical Hospitals and Apollo (now Lanka Hospitals), where Jayawardena’s takeover bid succeeded while the management takeover of the other two failed.
In 2006 Harry Jayawardena acquired a controlling stake in Namal; Herat was advising on that purchase. Five years later Avancka Herat was advising a consortium led by Union Bank who were in a bidding war with Heraymila, a Middle Eastern backed stockbrokerage and fund management outfit to acquire a controlling stake of Namal. Winning the bid came at a cost of three times the firm’s net asset value at over Rs600 million. “It was a bit steep, no two words about it,” he admits but adds the Union Bank which purchased a 51% stake and Ennid Capital – the investment arm of family controlled B P De Silva group – which owns 19% had no choice. Founder shareholder DFCC Bank still owns a 30% stake.
“If you look at the goodwill, the track record, it takes away at least one times from the three times book value paid. So it’s a matter of doubling the earnings, to do that you have to double the funds under management.” Leveraging by year end the planned 40 branch network of Union Bank to attract retail clients to its eight mutual funds, particularly ones investing in stocks, is at the core of its strategy to double the fund base under management. “I do agree we have paid next five years cash flow, so it is hard work, there are no two words about it,” Herat says.
For the price Union Bank acquired the management firm of the country’s oldest mutual funds, the first of which, the National Equity Fund (NEF), was launched in 1991: 20 years ago. That unparalleled franchise value, coupled with a loyal client base exceeding 25,000, assets under management of Rs7 billion more than half of which for retail clients, offers a solid platform for growth. The flagship National Equity Fund’s 20 year annual average return of 15.25% including dividends was the icing on the cake.
Doubling funds under management – which will also double fund management fees - will have more to do with retail investors’ confidence in the stock market option, than it does on effective distribution or awareness about mutual funds. Presenting a compelling argument for stocks is challenging even for a fund manager who achieved a 22% annual return on a life insurance portfolio with a 30% ceiling on equity investment.
Union Bank has been growing its credit at almost twice the market rate and that sort of aggressiveness is now expected of Namal too. “It’s a new bank and they want to make it work,” points out Herat who has his work cut out in a market forecast to be range bound. He forecast market earnings will grow at 13% or around five percent above GDP growth. “Market will underperform, it will be subdued,” forecast Herat regardless of his optimism about the economy. Foreigners however may continue to be net sellers for a couple more years according to Herat due to global economic uncertainty. Last year the foreign outflows topped Rs19 billion from the Colombo stock exchange where more than 20% of company ownership is controlled by foreign institutional funds. Fifteen years ago foreigners owned more than 40% of listed stocks.
Namal’s fund managers expected stocks to come off 25% off their peaks starting mid last year. Although delayed, the 25% correction from the peak did come by early January turning some of the more speculative portfolios to dust. “You are not going to see foreign funds coming to Sri Lanka hurriedly, they would compare and contrast markets like Vietnam, Indonesia and the Philippines which are trading at very attractive multiples, we are competing for the same pot of funds,” Herat points out.
The most compelling of Herat’s arguments on why this isn’t nadir for shares is based on their absolute values. “Some guys will look at absolute measures, they will look at weighted average capital cost or the discount factor used in valuing cash flow yields,” he explains. The weighted average capital cost is the rate that a company is expected to pay on average to all its security holders, like shareholders and debt holders. “Weighted average capital cost is about 14% so you are discounting at that. Depending on the risk profile some fund managers will increase your risk premium on equity, expecting more systemic risk, say increase to 15 or 16%,” he argues. A company must make this minimum return on its existing asset base to satisfy its creditors, owners, and other capital providers. Herat estimates cost of equity at 18% after adding an 8% risk premium to the risk free rate.
Free cash flow (FCF) represents cash a company is able to generate after setting aside money required to maintain and expand its asset base. Free cash flow allows a company to pursue opportunities that enhance shareholder value. “On that basis to find companies giving a cash flow yield above the 10 year bond yield will be challenging.”
Since share prices have fallen they look attractive relative to government bonds. But in absolute terms, they aren’t that cheap. Foreign institutional fund managers – the ones who have been here for 10 to 15 years – who are value investors tend to buy stock in half a dozen firms in this country “and I suppose they will look at those numbers not the relative measures,” says Herat, who started his career at Jardine Fleming’s local stock brokering unit 15 years ago. “They would be the most aggressive investors when markets come off. They will come, no two words about it, but that’s on a selective basis, bottom up stock picking”.
“You will definitely find stocks that will give you 30% return, so its bottom up as opposed to top down stock picking two years ago,” says Herat confidently. He also expects the four quarter trailing PE to fall below 10 times from the current 13 times as stock prices hold current levels while company profits edge up. Consensus among institutional stock brokers tracked by Namal is that market wide earnings will grow 16% next year.
Namal seeks out companies that can compound wealth over the long term, a typical value investing model. The company only reveals the composition of its funds annually. However the close ended Namal Acuity Value Fund publishes quarterly accounts and at December 2011 held stakes in 21 companies of which 16 were sizable stakes. Since the management change Namal has dropped five stocks and picked up two according to Herat who says he seeks out “high quality companies which have a primary business model supported by dominant intangible assets (brands) which have the potential to consistently give above market returns.” This is underpinned by Herat’s golden rule that return of capital is more important than return on capital.
Fund managers have to beware of the risk of overpaying for companies in their pursuit of high quality businesses. “In our opinion, the most accurate manner to evaluate companies is using free cash flow.” But Namal fund managers are most excited about firms with franchises, which are difficult to find. They also haven’t invested in conglomerates, as is the case with many Sri Lankan portfolio investors. However towards the end of Herat’s tenure at SLI he did purchase a 7% JKH stake. “That’s because Rajaratnam was exiting and at 62 rupees you couldn’t go wrong.” Unlike local portfolio fund managers, foreign ones do buy proxies to a country; diversified conglomerates. “For a foreign fund, it’s easier to buy a well managed holding company than going one level down.”
Local portfolio managers are not snapping up bargains; yet. Many have a higher-than-normal weighting in cash because they expect stock prices to cool further and bond prices to rise. Twenty percent of the Namal Acuity Value Fund remained un-invested by December 2011, reflecting the manager’s view that stock prices could fall further due to the global financial crisis. “In times of crisis global markets work together and the outflow from emerging markets has been threefold in the last 6 months. Until that cycle reverses we have to be patient, collecting stocks that we think are fundamentally cheaper than the broader market,” opines Herat. The Namal Acuity fund’s net asset value fell 26% to Rs747 million in 2011 with the overall market decline.
On top of the fallout from the global crisis Herat expects interest rates to rise this year by two percent or so. “Auctions haven’t happened and there will be bond rollovers soon, therefore everybody is in the short end of the market,” he points out. Instead of gilt Namal is seeking out fixed income investment opportunities with corporate paper which are now offering yields of between 2% to 3% higher than one year T-bills. The same dynamics playing out in the equity market will also impact the sovereign debt market. “Central Bank is expecting a lot of funds in to the investment account, but that won’t be enough because the portfolio account is under pressure. When it comes to the bond rollover, the market, they will ask for a premium because of the heightened risk. That premium has to be priced in,” Herat points out.
Namal has to convince potential retail clients - who pay the equivalent of 1.5% of assets under management as a fee in addition to charges at entry - about the long term potential in stocks. Despite a war and seesawing economic policies, equity returns have far outstripped bonds in Sri Lanka, as they have done pretty much everywhere else too. In its strategy to double funds under management Namal has identified private wealth management, management of discretionary portfolios of companies and institutional asset management. Namal is also in the process of launching an off-shore country fund.
Even if the entire industry managed to double assets under management, unit trust penetration would still be 0.4% of GDP whereas in India it tops 4%. The average Sri Lankan’s retirement savings have very little exposure to stocks because the EPF, the island’s main private sector retirement fund which is managed by the government, has only 7% exposure to equity in its trillion rupee portfolio.
Mutual fund penetration in India took off when the government of India decided to benchmark the performance of state pension fund managers with those from the private sector who were allocated 10% of the funds to manage. “Try it out here,” challenges Herat, whose 22% annual return on the SLI life fund which only had a 30% equity allocation, beat the returns offered by the EPF twice over. “If the private sector is saying they can perform, then allow them to come and match government fund managers.”
Herat is also concerned about systemic risks in the market including regulatory risk. However the bear won’t be a grinding one that can destroy faith in listed companies. Instead only investors who don’t carefully seek out companies will be driven to despair.
http://lbr.lk/fullstory.php?nid=20120226203647979
