Avoiding the worst investment decisions

Who wants to invest today when there could be another major corporate scandal tomorrow.

The highest profile cases have been Enron, Worldcom, Elan and Xerox, unfortunately, these are not isolated cases. The worst excesses of the TMT boom are only now being uncovered. Five of the eight largest Chapter 11 cases in history have been filed since December 2001. Besides Enron, they include telecommunications company Global Crossing, with $25.5bn in assets, Adelphia with $24.4bn, and NTL, the UK's biggest cable-TV operator, with $16.8 billion

The published accounts of publicly quoted companies are a primary source of information in analysing companies. Investment managers and stock analysts study the accounts in great detail, scratching below the surface to glean as much information as possible. If, however, the directors and auditors of such companies deliberately set out to deceive the public through false accounting - investment managers can do little to counter such fraudulent activities. False accounting information can and does lead to investment managers making misinformed and therefore possibly bad decisions.

How does a fund manager reduce the risk of falling prey to company spin? Or the more sinister smoke and mirror tricks designed to deceive and mislead. Why haven't they followed the herd into investing in these eventual calamities? Not everyone has fallen into this trap.

The Bank of Ireland Asset Management group or BIAM ( not to be confused with compatriot financial services group, Allied Irish Bank, which has hit the headlines recently with financial scandals of its own.) has a track record of prudence combined with a long term investment track record. They are a significant pension fund manager in America, and also provide a range of offshore funds to expatriates.

The group is proud that none of its actively managed portfolios held investments in any of the companies mentioned above. I asked them how they had managed to stay clear of what had been attractive shares to many. Graham Cawley, head of client services at Bank of Ireland Asset Management (Jersey) Limited comments on recent accounting irregularities and explains the group's philosophy.

"We believe that a common sense investment philosophy has been and will continue to be paramount. At BIAM we judge companies on a number of basic and vital criteria. In formulating its judgement BIAM's asset managers look for key traits, the ability to generate income and visibility in the earnings streams, balance sheet strength - highly geared companies carry more risk and are more likely to suffer if earnings decline or interest rates rise"

The third item is equally important, he notes, "Transparency - if BIAM's asset managers don't understand a company's accounts, they won't invest, and Value - the price BIAM pays for a stock - is the key to deciding whether or not to invest."

BIAM believes commitment to its philosophy has enabled it to avoid the recent large bankruptcies. Its managers met the senior managers of many of the "problem" companies over the years. In the case of Enron, it was sceptical of the company's corporate strategy, and on analysing the numbers, felt the performance of the company did not stack up.

Again BIAM viewed Worldcom as high risk as the company has $27bn in debt due to its heavy acquisition program, which included investing in many Internet companies at excessive prices. In the case of Elan - BIAM felt that the product range was narrow and preferred investing in other pharmaceutical stocks - for instance GlaxoSmithkline, Aventis and Johnson & Johnson with a broader product range and stronger pipeline.

Not even the most cautious fund manager can avoid all problems, after all risk is an inherent element in investment and BIAM readily admits that not every investment they make turns out as planned. High profile disappointments in their own portfolio include Vivendi and Tyco. As the investigation into accounting practices proceeds it is possible that other problem cases in their portfolio may also surface, but they feel so far they have been successful in avoiding too many nasty surprises.

In the coming months BIAM believes the ability of companies to achieve top line earnings growth will be the key to their performance. Stocks that fail to deliver on earnings will suffer. BIAM's investment process has been tested in good and bad times and has stood the test of time. Good-quality blue-chip, companies with a strong franchise, a good track record of growing earnings, visibility of earnings and a clean balance sheet have continued to do well even in the current bear market. The bottom line is that while investment fads or fashions may come and go, quality will always
shine through in the end.

In these days risk management is a term which should be transferred from the corporate management field to personal investing, and it is re-assuring to see that there are fund managers who are still applying the fundamentals, and assessing risk as well as potential, and sometimes unrealistic future profit.