Although Peter Walls has come to fund management relatively late in his career, he is well qualified to manage a portfolio of closed-end investment company shares. Having spent 18 years as an investment trust analyst and commentator, ultimately as head of the investment trust department at Credit Lyonnais Securities, he joined the newly formed Unicorn Asset Management in July 2001.

At the end of that year, Unicorn launched its Mastertrust, an open-ended fund concentrating on the investment company sector, and Walls has led its management team since then. The fund is currently ranked 11th out of 63 funds in the Active Managed sector over three years (to the end of July 2007) and eighth out of 48 over five years, showing a total return of 106.78 per cent over the five-year period compared to a sector average of 79.1 per cent.

A proven sector

These are interesting times for his chosen sector as the somewhat cosy traditional world of investment trusts expands into a broader universe of investment companies. Walls observes that closed-end investment companies, in the form of investment trusts, ‘have been around for more than 150 years. Indeed, some of the individual companies have been around that long and how many listed companies can you say that about? This indicates that it is a most attractive structure for long-term investments.’

He adds, ‘It is also quite a flexible and friendly structure in terms of how you manage money. Permanent capital is a significant attraction. Quite a lot of fund managers like to work in that sort of environment. And it is interesting that some of the newer entrants, for example the funds of hedge funds, are turning to a structure that has been around for a century and a half.’

As managing director of Unicorn Asset Management, Peter Walls has a range of responsibilities, but his focus as an investment manager is on the Unicorn Mastertrust portfolio. He explains, ‘The fund is almost exclusively invested in investment companies. We do have the flexibility to have open-ended funds, but we don’t have any at the moment.’

He adds, ‘This is primarily through investment trusts, although what is interesting about the sector has been the growth of opportunities in things like property-based funds and funds of hedge funds and, more recently, single-strategy funds and funds investing in particular parts of the world.’

Personal stake

In common with many “boutique” houses, Unicorn’s managers invest in the funds they run. ‘It is also important to have our own money in the fund,’ says Walls. ‘The thing about this structure is that capital gains can roll up in the fund, but it can be prohibitive to try to be too clever. I have no desire to set up a hedge fund to show that I am much cleverer than the market. In the end, the greatest returns come from long-only investing, over time, and you have to be patient for that to work.’

In terms of investment approach, the focus is on generating long-term growth from a balanced portfolio. Walls says, ‘The strategy is pretty straightforward. I start from the premise that I don’t believe there are very many talented fund managers out there. Many will have their particular moments but there are very few who can deliver returns consistently. However, I believe that quite a few of the ones that do exist are at large in the investment company universe and this is partly because of the attractiveness of the structure of closed-end investment companies to these individuals.’

He adds, ‘With this fund I try to have at least 55 to 60 per cent invested in those high-quality managers who will allow me to sleep at night. These are my core holdings, things like British Empire Securities or, if you are looking for a core small-cap fund, something like Aberforth Smaller Companies. In North America it would be Russell Cleveland’s Renaissance Capital and venture capital would be Candover, managed by a team that has done well through all market cycles.’

Putting it in context

However, successful stockpicking tends to take place within a framework and Walls accepts the importance of having a clear view of what the global economy is doing. ‘I have a top-down overlay, which is a view of global markets, where I am trying to get a view of what is happening in the world at large. Then on top of that I am trying to be more opportunistic. I suppose it is being contrarian, trying to identify out of favour stocks on big discounts and choosing the right time to go back into them. But what I am basically looking for is good management teams.’

Such an approach is not infallible. He confirms that ‘Over the past 12 months, I have basically moved back into growth funds and increased the weighting towards tech and biotech funds. Perhaps you could say that this was too early and certainly that strategy hasn’t done too well over the past couple of months, which means the performance has suffered compared to its peers. But there is good capital performance coming through from growth companies and we are confident we can get the growth back and make it six years of outperformance out of six.’

One of the drawbacks of investing in what is undoubtedly a specialist area is that it can be easily overlooked by investors. Walls admits that ‘The fund is around £15 million now, which is still probably too small, but it is growing. There is certainly sufficient capacity in the sector for a fund that is six or seven times this size. I see it as a very specialised adjunct to that market. You require specialist knowledge in a sector that is not always thoroughly researched, so there are more opportunities for pricing anomalies, which, of course, you don’t get with open-ended funds.’

Using the discount

The most obvious way in which these anomalies manifest themselves is in the movement of the discount – the difference between an investment company’s share price and the net value of its underlying assets. Discounts can be extremely volatile and, on occasion, a company’s shares can even move to a premium, where the value of its shares is greater than its net asset value.

These considerations can deter private investors from getting involved in the sector, but Walls stresses that they frequently highlight the most attractive investment opportunities. ‘Discounts have been widening and that creates opportunities. For example, if you look at the property funds at the moment, they are on discounts of more than 20 per cent, having been on ten per cent premiums a year ago.’

He adds, ‘But we have also seen discounts widening as the investment company sector generally has gone down.

You have seen a lot of the geographical specialist funds go down and, even more surprisingly, some of the venture capital funds amid worries about them having to finance over-inflated buyouts.’

Individual analysis

So investing in investment company shares is clearly a matter of careful stock selection. Walls’s key advice to investors looking at the sector is that ‘You have to look at each company on its own merits and even that doesn’t necessarily equate to finding a successful fund manager. In the old days, there were a lot of fund managers who had been running the same fund for more than ten years, but it is far less practical to take that sort of long view today.’

However, he adds, ‘It is a sector that offers the opportunity to add value on a consistent basis, providing that you get your asset allocation and fund selections right. It is helpful to know about the history of the fund manager, but it is easy to concentrate on performance measures that are too short term.’

Finally, Walls stresses the importance of taking a long-term view: ‘I don’t believe that momentum investing is the answer to all investment problems. Fundamentals will win out eventually. I suppose there is no time horizon for most of the core investments I make. I more or less expect them to be there for ever. Sometimes I will set a target price for particular investments, but that is not always the right thing to do.’

This article is from the September 2007 issue of What Investment.