A: We know that our clients are worried, above all, about losing principal. They can accept a small movement in their assets but they want a performance that is as smooth as possible.

Modified Value at Risk basically analyzes the extreme events. In a bell curve that provides a range of outcomes, there is a median point that represents the most likely return. Normally, we would be on the positive side of the curve and we try to avoid the extreme events on the negative side. To effectively take out the extreme downside risks, we also tend to give up the extreme upside and we compress the curve to give a range of outcomes that is a lot smoother.

Q:  Could you give us some specific examples of funds you invest in?

A: Within the Generation Fund, we have some segregated accounts which mirror an open-ended investment company, which are the U.K. version of mutual funds as well as some created specifically for us. For instance, we have an equity income product, whose manager has a top quartile long-term track record but remains fairly low profile. The investment style is simple – using yield as a proxy for value, but he manages to execute it very sensibly. In Edinburgh we have a segregated account run by a very highly regarded emerging markets manager (Angus Tulloch). He is a wise investor with a value bias, great track record, and is good at preserving capital. The special account that he runs for us is unique and provides our fund with access to the Asian emerging markets, as well as to Australia and New Zealand when it makes sense.

In the U.S., we have invested with Harris Associates based in Chicago in a very concentrated (roughly 18 stock) portfolio of U.S. equities. They probably run about $10 billion in those stocks and therefore differ from the traditional managers in their focus and deep involvement in the companies they invest in. In Chicago, we also have a reasonably standard U.S. equity portfolio (managed by Brinson) and a micro-cap portfolio run by Driehaus —an aggressive growth manager. We also have managers who specialize in European equity and in U.K. equity.

The common theme between these managers is that they invest in individual companies with an absolute return mindset. They buy the stock at a certain price, know their target, what will take the stock there, what’s going on in the company, and the trigger points they are looking for. This is a very different approach from those of managers who define their exposure based on the index weights.

Q:  What is your buy and sell discipline?

A: The ‘buy’ decisions depend very much on the needs of our clients at a particular time. We have different sources of information and the investment process is quite long-winded. There are managers that we have considered interesting three or four years ago, but we never had a reason to employ them. When we do have a reason, it gives us a chance to dust down the files and see if there’s something that we want to utilize.

We meet between 200 and 400 managers a year in various locations, either in their own offices or when they come to the U.K. We have a quantitative database that has been developed through our research effort in Yorkshire, and a qualitative database that refers to the observations from our meetings. We also use external databases on individual funds such as Lipper and MorningStar. The selection depends on what we’re looking for; if we need a manager, we will do a more detailed search.

In terms of our sell discipline, since we spend a lot of time picking the managers in the first place, we rarely sell because something has gone wrong. In the ten years of the existence of the Generation Fund, I believe that we have parted company with only five or six managers.

We’d part with them if they change the way they invest. However, we can ride some of the smaller cycles as long as the manager is passionate and experienced in investing in that direction. We regularly monitor their portfolios and with the expertise that we have in house, we can analyze the holdings and see if they match the investment philosophy. Provided that the portfolio is in line with the philosophy, we understand that in certain periods it won’t work perfectly, so we have a certain amount of patience.

Our turnover is usually less than 15% a year and we sell mainly if the changes contradict the goals of the client. If the strategic direction changes, then there’s a need to change. We may also have a tactical overlay of gaining or eradicating exposure to a certain area. In such cases we have no choice but to part with the manager. But overall, we try to create a portfolio that can stand the test of time.

Q:  Is the Generation Fund open to any investors?

A: All the funds are open to investors but some funds require higher initial investments. The Generation Fund has about 700 investors. Over the years many families in the U.K. began to like the idea of an open-architecture structure and the investment philosophy. Now the fund has a wide range of investors who may have invested a few hundred or a few million pounds.

We also run eight other open-ended investment companies (OEICs). Some of them have 50 to 100 investors, and some have fewer than that. The funds represent an attractive tax vehicle for U.K. investors but they are open to investors across Europe. I’m not sure whether the U.S. investors can invest directly into a U.K. registered OEIC. We don’t market the funds but when somebody wants to invest with us, we’ll try to facilitate it. Above all, these products are solutions for our clients needs but there are quite a few people who have come aboard.