WHEB Commentary

How much is enough? WHEB’s approach to capacity


WHEB is a partnership and a B Corporation and determined to build value for clients through positive impact investments over the long term. In our view, the investment funds industry, and specifically consultants and intermediaries don’t always spend enough time analysing and discussing fund managers’ capacity when analysing and selecting investment funds. Much time and energy is spent on analysing fees, whereas the mismanagement of capacity can represent a greater risk to client outcomes. 

Fund Managers in general are not incentivised to manage capacity, as they are often more focused on asset gathering to maximise overall fees. The drive for lower cost has increased this incentive as managers aim to grow assets under management (“AuM”) to even a larger scale to compensate for lower headline fees.

Yet we have seen high profile examples of significant losses to clients where capacity has been mismanaged. Since then, liquidity risk management has become a greater focus for regulators and investors demanding more due diligence from fund managers.

Hence, we think it is important that we are clear and transparent about what we believe the right level of capacity is for our strategy, how we have arrived at that figure, and monitor it consistently to ensure the best outcomes for our clients.

What we have said before

At WHEB, we have always been very conservative and transparent with our approach to capacity for our investment strategy. Since 2012, we have held to a figure of $3bn capacity.

The $3bn calculation was based on the assumption that our smallest stock in the portfolio might be $500m.  If we managed $3bn and our smallest position size was 1% of the portfolio, our resulting $30m investment would represent 6% of the share capital of that investment.  The UCITS fund rules limit us to owning 10% of the share capital of a listed company in a single fund.  So in context WHEB’s effective limit at 6% as a house across multiple accounts felt like a conservative number.

We last wrote about this publicly in a blog in response to the collapse of Neil Woodford’s funds.   https://www.whebgroup.com/lessons-from-woodford/

Time to review

WHEB’s $3bn capacity number has not been reviewed or changed over the last 10 years and the calculation above is not a very sophisticated analysis. We don’t currently hold anything anywhere near $500m market-cap, so our capacity analysis is out of date and overdue a review.

Our portfolio and universe have both evolved over time, and the investment strategy, along with the market has migrated steadily up the size spectrum.  We have also reduced the number of holdings in the portfolio, so the smallest position size is now typically 1.5%.

Many of the Small-Cap companies that we owned have organically moved up the market-cap scale, but our opportunity set continues to be in the Mid-Cap space as this is the area where we find the most impactful companies with strong growth and quality characteristics. We have therefore revised our universe to not include any companies with a market- cap below $2bn which is in line with how we have been managing the strategy for several years.

We have added extra resource in the form of a specialist Risk and Performance analyst in 2021 and  subscribed to more sophisticated analytical tools to analyse portfolio liquidity. We have also expanded our Investment Team with the addition of two new experienced members so that we can manage, monitor and review a wider range of investment opportunities. With these additional resources and tools in place, we are better placed to understand at what capacity level we can manage effectively the strategy.

The analysis & results of review

If we apply the same basic maths as we have used before, with the smallest position in the portfolio with a market-cap of $2bn and the smallest position size of 1.5%, the same 6% position would yield a capacity of $8bn.

However, today this feels like a very simplistic calculation.  So, we have spent the past 6 months carrying out a thorough review to test the liquidity characteristics of our current portfolio should we scale the strategy to this size.

To do this, we have sourced ICE data through FactSet which provides projected trade volumes to give us a true indication of what level of capacity would be suitable for our strategy. The data allows us to project trade volumes, days to liquidate different amounts at a security and portfolio level and market price impact projections. The system also allows us to run historical and custom stress scenarios consistent with regulatory guidelines and to assess daily changes in liquidity based on changing market conditions.

With this tool, complemented by analysis on real world conditions conducted by the dealing desk at Northern Trust, we have been able to quantify the liquidity impact on the portfolio and the overall strategy, if we gradually increase capacity to $3bn, $6bn and $8bn.

The boutique nature of WHEB has meant we have not had access to this information before but now with more sophisticated risk systems on board and extra resources, we feel we can be robust when assessing capacity. From a governance perspective, this liquidity analysis will be conducted and scrutinised quarterly in our Investment & Risk Committee.

Impact on our investment process

What is more subjective is the impact on the investment process. We are fundamental long-term investors, so our approach has never been dependent on getting in and out of positions quickly. We also have a rigorous investment process and are disciplined with how many stocks we hold in the portfolio and at what weighting these stocks should be held at. So, whilst AuM may grow, we are still cognisant of the potential that it could have an impact on the way that we manage the portfolio.

Therefore, whilst we believe that $8bn is the potential capacity for our strategy at this stage, we will still carry out a more formal review of capacity and any potential impact on the investment process once we reach $4bn and $6bn AuM. As impact investors, it is important that we do not let the amount of money we manage encroach on either our ability to deliver attractive investment returns or to seek out positive impact, on top of having the requisite liquidity to meet our investors’ needs.

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