Morningstar Analysis: Newton American

Chetan Modi, fund analyst at Morningstar, writes: We believe the Newton American fund benefits from the backing of Newton's strong career analyst bench. Their analysts have usually worked in their respective industries before analysing stocks and we think this gives Newton's research output an edge, by giving greater insight and perspective on the sectors and stocks they are analysing. The research team combines macro themes with bottom-up analysis and their work leads to a recommended list of global stocks. The analysts' remuneration is based on their ability to convince portfolio managers to buy their picks and we think this promotes conviction in the ideas that feed into this fund.

Simon Laing has eight years experience in managing US equities and is able to add value beyond the analysts' research. After working as an equity analyst for three years, he co-managed US equity mandates at Newton from February 2000 until October 2002, when he took sole charge. Laing is backed up by an experienced alternate manager in Alex Stanic who has thirteen years' investment experience and has been managing a number of global equity mandates since joining the firm in 1999. Laing can also glean ideas from his colleagues on the global equity desk, a department we regard highly at Newton.

Laing looks for stocks that are trading cheaply by assessing the company's value in relation to its earnings, using EV/EBITDA ratios as a guide. That said, Laing is willing to buy a stock if its EV/EBITDA ratio is artificially high because the company is posting depressed earnings in the short-term but he still sees some growth potential or scope for improving profit margins. Indeed, the fund's exposure to growth stocks has, on average, been higher than its Morningstar US Large Cap Blend equity peers during his tenure. Millicom International Cellular exemplifies Laing's growth tilt relative to his peers, the stock was trading at high multiples before the downturn but is set to benefit from a growing customer base in emerging markets and widening profit margins over the longer term.

Laing's strategy has led the fund to beat its average peer in the Morningstar US Large Cap Blend equity category by 1.31 percent, on an annualised basis, from the beginning of October 2002 to 31 October 2008. this performance ranks the fund in the top quartile of its peer group. However, the fund has lagged its FTSE North America benchmark and the S&P 500 Index since Laing took over. It is worth pointing out that only a handful of funds have managed to beat these indices over the same period. The fund's compact portfolio of 45-55 stocks and its added exposure to growth stocks has meant the fund's outperformance versus its peers has been achieved with a higher level of volatility and we expect this to continue going forward.

Taking all into account, Newton American has the ingredients of a sound fund for those who prefer active management, although we believe one can make a strong case for simply going with an index fund when it comes to US equity exposure. We think Laing's experience, coupled with the backing of a strong global equity desk and deep analyst bench, gives this fund a strong chance of outperforming its peers over the long term.

Strategy

Macroeconomic themes lie at the heart of Newton's firm-wide process. The research analysts have currently identified 15 themes that they feel will act as catalysts for change in the world over the next five years. However, Newton's thematic process is not flawless - their sector or country bets could turn out of favour at market inflexion points. The analysts, who are organised by sector, are charged with looking for companies that are well placed to benefit from those themes. Within each theme, they try to identify companies that are fundamentally strong, but which trade at attractive valuations. Once stocks are sorted by theme, those that exhibit the most compelling combination of value and quality will qualify for the analysts' recommended list--each analyst will generally have 8 to 10 recommended ideas. It is from this list that the managers can add value.

Around 10% of the stock ideas in the portfolio will be generated by Laing as he looks to broaden the US names beyond the recommended list for this portfolio. Although Laing likes to buy cheap stocks based on valuations metrics such as EV/EBITDA, he will look at stocks with artificially high valuations if the stock is posting depressed earnings in the short-term but is still showing signs of growth or is improving its profit margins. Laing's willingness to buy higher-valued growth stocks is notable, leading the portfolio to straddle the line between the Morningstar US Large-Cap Growth Equity and US Large-Cap Blend Equity categories during his tenure.

Management

Simon Laing has been managing US equities for over 6 years and has shown himself to be more than capable by beating most of his peers while at the helm of this fund. Laing joined Newton in 1997 as a graduate trainee;,initially he was a food retail analyst before this broadened to retail stocks globally. Whilst Newton is supportive of the career analyst path, Laing felt his future lied elsewhere and moved into a portfolio management role in 2001 as co-manager alongside Trish Bridson on this fund and the Lux-domiciled clone, MGF North American. Bridson retired as head of the US equity desk in March 2002 but continued to work alongside Laing as co-manager until October 2002. Laing then became the sole manager and also head of the US equity desk.

We like the strong resources backing Laing. This fund s alternate manager, Alex Stanic, has over 13 years' investment experience and is a highly respected global equities fund manager at Newton. Moreover, Laing sits on the global equity desk at Newton and can glean stock ideas from the global equities team, he also contributes to the team's US equity ideas (he specialises in the education sector) to complement the stocks on the analysts' recommended list.

We think Newton has a strong line up of managers. There have been some notable departures, but they have been infrequent and most managers have spent their entire careers at Newton which results in reasonably low staff turnover among its investment professionals.