After starting his investment career as an equity analyst with Kleinwort Benson in 1987, Stephen Edwards moved to the buy-side in 1990 when he joined Enskilda Asset Management as European Portfolio Manager. At the beginning of 1993, he became one of the founding employees of London-based Barran & Partners, one of several European hedge fund start-ups of the early 90s, which was being set up by Diana Barran, formerly CEO of Enskilda Asset Management and Gerard De Geer, former Chairman of the Enskilda Group. The Magus European Fund was launched in March 1993 with initial investments from two Swedish corporate investors which also had an equity interest in the management company. In early 1997, the firm went through a transition when the core investors left the fund. Diana Barran withdrew from the day to day running of the company and handed over sole responsibility for The Magus Fund to Steve. The company was renamed Magus Capital Management, Steve became Chief Executive and equity interest in the firm was redistributed. In the six years since inception, the Magus Fund has compounded at an annual rate of 19% with an asset base of $100 to $150 million. The firm currently manages $125 million, mostly in its Euro denominated fund. Stephen Edwards spoke with HFN publisher, Antoine Bernheim, in late April 1999.
Profile of Stephen Edwards
Born: September 11, 1963
Education: MA in Modern Languages, Oxford University
Family: Married to Anna
Last vacation: Koh Samui in Thailand
Last book read: Underworld by Don Delillo
Hobbies: Field hockey, running and reading
Favorite quote: We confide in our strength without boasting of it; we respect that of others without fearing it,Thomas Jefferson
How he best describes himself: Patient, calm, realistic with a tendency towards perfectionism offset by the fact that I have chosen to work in the stock market.
Q. Could you describe your investment philosophy?
A. There are hundreds of ways of making and losing money each day in the markets. The key is to focus on your strengths, on what you understand, on areas where you will feel comfortable taking decisions. My colleagues and I have many years of experience sifting through and analyzing companies in Europe. Our aim is to be good stock pickers and to make good consistent absolute returns with relatively low volatility. We do this by focusing on a concentrated universe of stocks and from that we select a concentrated portfolio of 10 to 20 longs and a slightly more diversified short side. We take large stock-specific risks but we do not use much leverage.
Q. Could you describe your research process and the resources you use?
A. We first reduce the total of several thousand quoted companies in Europe to a "manageable" universe of approximately 200 by trying to identify those industries which have organic growth, attractive characteristics such as low capital intensity and high cash flow generation, or industries or companies where there is significant change underway, such as consolidation or management change. In this process of whittling down this universe of stocks to those where we feel we can add value, we want to make sure that we are or can become well informed so that we can make decisions with reasonable confidence. We spend a lot of time thinking about which sectors we are going to follow and we review that four or five times a year by spending a whole day brainstorming on these subjects. We divide the sectors among ourselves and we are then all responsible for visiting our allocated companies, visiting their peer groups and doing our own projections. We then establish a one year view of what the upside and downside potential is from each stock. That sets up the framework from which we can select our favored stocks. Resources are primarily internal with selective use of broking analysts.
Q. Could you describe the criteria that may cause you to buy a stock or sell it short?
A. We focus on the risk-reward profile that we see at any point in time for any given stock which comes from our valuation analysis, normally cash flow based. I am a great believer in patience but also in discipline so as not to turn a good investment idea into a bad one by getting carried away and buying or shorting at the wrong price. We try to do an objective analysis with a one year view. On the short side, however, I think it is important to identify catalysts that will force other investors to appreciate a stock's overvaluation and mostly this means that the market numbers are too high. Occasionally a macro catalyst such as rising bond yields undermining growth stock valuations may come into play but we rarely rely on the macro world for help.
Q. What is the mix between trading and investing?
A. We hardly do any trading. We hold stocks over a long period of time, continuously updating our one year view. Typically we turn over our shorts more than our longs. Very occasionally, we may use futures as a market hedge.
Q. Could you describe how you manage your exposure?
A. We divide our portfolio between consumer, industrial, financial and service. We have no prejudices in owning small, medium or large cap companies. Once our bottom up process is completed, we make sure that we do not have more exposure than we want to a sector, a country, a currency or interest rates. Historically, we have always had quite a high exposure to the service sector on the long side and a high percentage of industrial shorts. At a certain level, we may decide to cut back sector exposure by reducing the long position or shorting against it. The key is to be aware of the risks inherent in our portfolio as a result of our stock picks.
Q. Could you give an example of a couple of stocks you find attractive and why?
A. Bodycote is a company that is not untypical of our holdings, even though it is an industrial company. It is involved in heat treatment and is a major beneficiary of outsourcing. It is by far the world leader but with still a very modest market share (10% of the outsourced heat treatment market and 1% of the overall heat treatment market). Because more and more heat treatment is being outsourced, they have very good organic growth. They are the consolidator of a fragmented industry. The business is somewhat cyclical but there are underlying dynamics which should provide for long term growth. We think the management is excellent, they have an ownership position and the stock is relatively modestly valued. It is approximately 4% of our fund.
Another stock we like is Premier-Farnell, an electronic components distributor. They encountered some problems following a US acquisition. They made significant pricing changes in the US which ended up causing a market share loss. We were attracted to it when there was a management change. The new CEO has brought in new people and invested in information technology. Historically, the business has grown at 1.5 to 2 times the growth rate of industrial production so it is cyclical but with a kicker. Margins are good with decent return on capital. This industry is also a candidate for being shifted to the web. Both of these companies are also in the Magus Global Values Fund, a much more concentrated fund which we recently started and which is run by Diana Barran.
Q. What are your risk management tools?
A. The best guide to the risk in our portfolio is the upside potential versus the downside of all our stock selections. If stocks hit our price targets, we normally sell them unless we can see continued potential on a one year view. We constantly monitor the different types of exposure risk which I have addressed. We automatically review positions when they go down 10%, often bringing in a new member of the team in order to retain objectivity. We do not have a rigid stop loss discipline which I think is somewhat inconsistent with stock picking. However, I recognize that we can make mistakes and when something goes against you, it is often better psychologically to get rid of it and move on to the next opportunity.
Q. Could you describe how your organization functions?
A. I have three analysts working with me. When we are about to make an investment, I would always discuss the idea with the analyst who has done the work but I am the one who makes the decision. In my absence, two of the three team members are allowed to trade from a policy point of view as well as a regulatory point of view.
Q. What are the factors behind the growth of European hedge funds?
A. Most important trends in the financial markets tend to be established in the US and then find their way to London. It took a surprisingly long time for European hedge funds to become a factor. I think there was a mixture of an old fashioned attitude in London, regulatory barriers/hurdles and not as much indigenous entrepreneurial spirit. Many traditional money managers in London are frustrated by bureaucratic procedures and obviously, there are many talented managers in the traditional business who can see the financial rewards available to successful hedge funds.
Q. Where would you like to take your firm in the future?
A. We do not want to change our way of investing. Our gut feeling is that we should close The Magus Fund once we get to the $200-$250 million range. The Magus Fund is a concept in which I believe and where I have any money that I have invested in the financial markets. I think we should just continue to focus on the way in which we believe it is best to make money. u