Snakebite In The Black

Martin Currie’s new TMT fund exploits communication failure

STUART FIELDHOUSE

Capital markets are still inefficient and these inefficiencies can be as banal as a lack of communication within individual financial institutions. When even analysts within an organisation, for example those tracking the TMT sector, don’t speak to each other on a regular basis, those inefficiencies compound themselves. For a hedge fund, of course, opportunities emerge when communications break down.

Take TMT as an example: when buy-side analysts within an investment bank who are covering the telecommunications equipment manufacturers (e.g. the telecoms services analyst and the component manufacturers analyst) are not talking to each other, then information advantages are not being exploited.

To take advantage of this for the benefit of its investors, Martin Currie has launched its latest global long/short fund, the Global TMT Fund. Portfolio manager Jamie Mariani, who leads a TMT team of three out of Martin Currie’s Edinburgh HQ, has been running the fund internally since January 2007, drawing on the firm’s existing infrastructure and research base as he does it. Since launch, the fund is up over 20% (see Fig 1). Mariani and his team have been able to capture the 2007 upside in the sector, and protected the portfolio against the current downturn, which has seen many of its peers sheer off into negative performance.

currie1

Mariani is arguing that of all the sectors out there, TMT is one of the most robust. Why? They’ve been here before. He calls it the ‘snakebite effect’. Following the collapse of the TMT bubble in 2000, many of the listed companies in this sector have retained more conservative balance sheets and have either been averse to borrowing too much or have been treated with a degree of scepticism by lenders following the antics of 2000-01. “TMT balance sheets are generally in good shape,” Mariani explains. His team looks at net debt to EBITDA multiple on a time series basis.

“There was a clear peak around 2000-01; a lot of lessons were learned,” he explains. “The businesses went bankrupt as mistakes were made in the way capital was being allocated. Now the IT sector is net cash: lack of access to capital has not proved to be a significant issue. Most of the companies we are looking at have not been heavily impacted by the credit crunch.”

Having said that, Mariani admits that the current economic slowdown is exerting huge cyclical pressure, with advertising revenues significantly down, but he feels the TMT sector is well-positioned to weather the crunch. He is still keeping a careful eye on some of the firms that have been struggling, like Virgin Media, but with an active short book is able to exploit those stocks that look set to underperform. Not everyone out there is a media (or technology) darling!

Boom time for emerging markets telecoms

In addition, while bad news cloaks emerging markets at the moment, the mobile telecoms story in the developing world, particularly in areas like Africa and India, remains huge. Mariani’s team, for example, was alive to the opportunities for growth in SIM cards within the mobile telecoms market in the emerging world. Operators were not interested in subsidising mobile handsets in these countries: they simply wanted more SIM cards.

It is a major macro theme and it is no surprise that the TMT team at Martin Currie has tapped into it. Some estimates now put the total number of mobile phones in use globally at more than 3.3 billion and the wireless industry is already focusing on signing up another billion handsets. New business models are being explored, like renting out handsets one call at a time, delivering agricultural data over phones to farmers and smallholders, and even selling extra-cheap individual text messages.

Other means of reducing costs in these markets include recruiting local entrepreneurs to run base stations, sharing network infrastructure costs, and even using biofuel to power base stations, as Nokia Siemens Networks has done.

“This is all about taking the bigger view: who is going to be impacted?” says Mariani. “We used to own Nokia through the long book, and we owned it because of positive changes, but that is no longer valid. There was obviously a disconnect between what the analysts were saying, and what the mobile phone operators were saying. We sold it in December; in retrospect we should have shorted it.”

On the other side of the book, these macro trends also translate into upside potential. Mariani likes digital security specialist Germalto, which manufactures security chips, and is well-placed to benefit from the drive-by operators in emerging markets to sell SIM cards, not handsets. “You have to exploit the potential inefficiencies across markets,” says Mariani. “We spend a lot of time looking at mobile phone operators at the moment.”

Another big theme is the ongoing growth in consumer products, which kicked off with the home computer boom in 1999-2000. This has now evolved into a range of sophisticated, memory-rich devices including smartphones, game consoles, notebooks and flat panel televisions. Just focusing on smartphones, alone, Mariani thinks the development of the touchscreen will help to catalyse the broad adoptions of 3G wireless services. Apple has set aside US$100 million to support developers working on applications for its iPhone. Using blended consumer forecasts, Mariani thinks that smartphones are looking at a 50% annual unit growth rate (they already comprise 12.5% of mobile phone shipments).

He is emphasising what he calls “multiple change drivers” in the global TMT industry at the moment, including a process of structural and technological change that looks set to change the boundaries between sectors radically. There are also opportunities within the economic cycle, with technology stocks doing well late in the cycle, media performing better earlier on and telecoms with largely non-cyclical characteristics.

There is also now a major structural shift happening, from traditional forms of advertising to more spending online. This has been a process many TMT analysts have been saying would happen for almost a decade and indeed recent reports by consultancies like Deloitte have started to recognise that this time it looks like it really is happening. This will prove to be a significant boost for the sector, as broadband penetration in the retail market correlates positively with online advertising. As Mariani points out, the Internet currently accounts for 27% of current media time, but has only 14% of the advertising share. That gap has got to close in the next few years. As Mariani says, “media companies have the choice: go online or go bust.”

Like many larger fund managers, Martin Currie also has the benefit of expertise across a range of geographic and sectoral areas and investment teams are encouraged to confer with each other. Mariani and his team are able to interface with the firm’s Asia, global emerging markets, Japan and China teams. Given his particular emphasis on emerging markets TMT themes at the moment, this is a particularly valuable resource.

In practical terms, the fund has gross exposure of +60% to +200% and net exposure in the range of -20% to +50%. The long portfolio will hold between 10 and 40 stocks, with a typical position size of between 2% and 4% and a maximum limit set at 8%. The short portfolio will hold between 5 and 35 stocks, with slightly smaller position sizes than the long side of the book, and a 5% maximum. Risk management focuses on fortnightly VaR with a 95% confidence level, multiple stress testing and maximum illiquidity set at 25%.

The portfolio managers receive a daily risk report from the risk management team and, on a monthly basis, will review all factors, including the ‘soft’factors like VaR and other sensitivities. As Mariani points out, the fund management team has invested a significant proportion of its own wealth in the fund and is not interested in having a high volatility, high risk portfolio under its aegis. Consequently, the fund does not employ leverage and has not done so when being run internally.

“As volatility has increased, we have reduced our net and gross exposure, particularly where visibility has contracted,” Mariani says. “We think it is an appropriate stance to be taking, and we’re currently broadly neutral. The need to be taking a small number of large positions has decreased, and we’re now upping the number of positions. This has helped to dampen the volatility within the portfolio.”

Omnium
The fund is also being made available via the Martin Currie Omnium Fund, launched in March 2008. This is a diversified fund product which provides access to the entire Martin Currie fund range. It has a portfolio that is optimised to generate the best risk/return reward from the underlying funds. Omnium is being managed by David Sheasby, a 23 year veteran of equity markets, and is being overseen by Paul Hughes, Head of Risk Management at Martin Currie.

Omnium invests across the entire Martin Currie hedge fund range, using qualitative and quantitative analysis of the underlying funds to ensure that risk is being correctly balanced across the entire product set. Capital is invested in a fixed proportion and the risk bandings are reviewed annually. Although at the time of writing, the allocation to the TMT fund within Omnium had not been finalised, Martin Currie says it will have a moderate risk banking within the fund. Its addition takes the total number of hedge funds in the Omnium portfolio to nine, along with a 2% cash weighting.

Mariani emphasises that his team sits next to each other and shares the same destiny when it comes to remuneration. He is keen that the mistakes the sell-side analysts make when covering this sector are not repeated by his own team. “We try to focus on bottom-up drivers of change,” he says. “We feel we have the information advantage. Making the top-down calls, the big picture calls, doesn’t necessarily give us that.”

THE MARTIN CURRIE GLOBAL TMT TEAM

Jamie Mariani is a Director and Sector Manager with Martin Currie, focusing on the technology, media and telecoms industries. He has over 10 years of experience, having been a director of the telecoms equities research team at ABN Amro. He was ranked in the top five in the Extel survey of telecom sell-side analysts in 2003 and rated number two amongst rising star analysts on a cross-sector basis in 2002. He joined Martin Currie in 2005.

Mariani is assisted by Jane Coull, a Sector Manager for TMT stocks with a 15 year track record who has been with Martin Currie for four years. She previously managed money in Asia, Japan and the UK. Also on the team is Luca Fasan, who joined in July 2007. He was previously the manager of the San Paolo Technology Fund.