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The Hedgeweek Interview: Ian Lancaster, Fund Manager, Stockbridge Fund Ltd: Repeatable strategy that does not rely upon sector rotation or trading

Ian Lancaster unveils the strategies and ideas that go into the working of the Stockbridge Fund.

Ian Lancaster joined Progressive in 2004. From 1999 to 2003 he worked for MG Capital Plc managing a team specialising in smaller company investment research and as an investment advisor to smaller company funds. Prior to this, he was an Investment Manager with General Accident PLC specialising in Smaller Companies. In 1989 Ian graduated from the University of Wales with BA (Hons) in Economics, more recently in 1999 he was awarded a distinction at Imperial College, London for an MBA Dissertation on quantitative screening of UK smaller companies.

HW: What is the background to the fund?

IL: I am the Principal Fund Manager; the Assistant Fund Manager is James Follows, former associate director at Deutsche Securities. The investment team, who have worked together over the past 5 years, are the managers of the top performing Elite MoneyGuru Income & Growth Unit Trust (Rated AA by Citiwire, 5 Stars by S&P).  The Stockbridge Fund uses a derivative of the investment process developed for the Elite Fund. Using this process a notional long/short portfolio was tested between June 2003 and June 2004 with Stockbridge Fund Ltd launched on 30 September 2004. Current AUM is USD 3m.

HW: How and where do you distribute the fund? What is your current and targeted client base?

IL: To date the Fund has been marketed in-house. As a low volatility fund with target annualised returns of between 10-12 percent, we believe the client base to be Funds of Hedge Funds.

HW: What is the investment process of your fund?

IL: A core and satellite structure is adopted. We use a proprietary, multi-factor screen, to identify 'core' stocks - companies that demonstrate particular characteristics that we believe to be fundamentally attractive, or in the case of 'core' shorts, fundamentally unattractive. Inclusion in the fund is then determined by the conclusions drawn from subsequent qualitative investigations, and valuation assessments. Satellite stocks enable the fund to capitalise on situations that may not necessarily be picked up by the core screen. The satellite portfolio is designed to enhance the overall return of the fund without significantly increasing its volatility. Appropriate gross and net positions are determined by an assessment of the fund's expected return in conjunction with an appraisal of the equity market environment.

HW: How do you generate ideas for your fund?

IL: The shortlist of stocks for potential inclusion in the core portfolio, whether as long or short positions, is established by the screening of a multi-factor database of the stocks which comprise the FTSE 250 and FTSE Small Cap indices. This initial filtering screen uses a proprietary model that I have developed given my experiences of investing in the sector. This model systematically ranks the relative strengths and weaknesses of companies on the basis of thirteen criteria, resulting in a composite score for each company. This enables the screened companies to be ranked from strongest to weakest. The criteria include measures of momentum in earnings and price, incremental return on equity, an assessment of financial solidity and a calculation of potential earnings growth.

However the screens alone cannot be considered sufficient due diligence. A Qualitative assessment is undertaken that assesses potential positions using a structured form of analysis call DuPont Analysis. This methodology segments the return on equity into contribution from changes in margin, asset turn and leverage. Using this information combined with benchmarking, management contact and primary research we are able to make informed choices for fund positions. The valuation methodology assesses relative earnings growth rates.

HW: What is your approach to managing risk?

IL: As a low volatility fund with target annualised returns of between 10-12 percent we implement a risk adverse process. This leads to a fully diversified portfolio of, on average, 55 stocks. Position risk is managed using a combination of a stop loss policy and the monitoring of attribution across multiple time periods. Market risk is mitigated via short positions, which since inception have limited long market exposure to around 35 percent of NAV.

HW: How/against what do you benchmark the performance of your fund?

IL: We benchmark against a net exposure adjusted mix index comprising 50% the FTSE 250 Index and 50% the FTSE Small Cap Index.

HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?

IL: Performance during 2005 of 15% was above the target range due to higher than expected Alpha generation and a positive market performance. Standard Deviation of 3.8 per cent was in line with expectations. Given that the annualised Alpha generation of the fund since inception has been just over 8 percent and that the returns for the area in which we take positions should be positive for the year I would expect to achieve a return within our target range for 2006. There will be no change in style for the year.

HW: What opportunities are you looking at right now?

IL: Uncertainty over the level of Christmas retail sales and the inflationary outlook has increased the risk premium on financials, media companies and retailers. However if we experience a soft landing, as we predict, then the market should re-rate these sectors as the risk premiums unwind

HW: What events do you expect to see in your sector in the year ahead?

IL: Bids for Virgin Mobile, Pilkington and BPB and a number of other high profile names serve as a reminder that the market is well supported on valuation grounds. We expect bid activity to continue to be strong. The scenario of a hard landing induced by accelerating inflation still remains a possibility (if remote). As such, interest rate sensitive stocks will continue to demonstrate volatility and will provide attractive returns.

HW: How will these changes/future events impact on your own portfolio?

IL: The valuation process tends to do well in highlighting potential take over candidates. The portfolio is designed to be responsive and to perform well in a variety of market conditions.

HW: What differentiates you from other managers in your sector?

IL: There are many good managers in the sector. However we aim to achieve low volatility returns and therefore our net position tends to be low. Given our process driven approach we have a repeatable strategy that does not rely heavily upon sector rotation or trading.

HW: Do you have any plans for similar/other product launches in the near future?

IL: There are no plans for further product launches until we reach capacity.

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