Profile: Simon Edwards & Alan Borrows, Midas Capital

When any fund suffers a period of poor performance, there is no surprise that what follows is a period of self-reflection and an autopsy of the investment approach.

This is the situation Midas Capital founders Simon Edwards and Alan Borrows found themselves in after what they describe as a "terrible" 12 months during the height of the financial crisis

The managers saw the strong performance they built up for more than five years in the £390m CF Midas Balanced Income and £350m Balanced Growth funds disappear through the market downturn.

Market bottom

However, the pair avoided the temptation of many investors - succumbing to selling at the bottom - with many deeply distressed positions now delivering from the March market rally.

"Last year was a bloody awful year for us. While we saw something similar before in 1997-98, this was new territory for us in our Midas life. After having five or six years of good performance, everything which could have gone wrong, went wrong," Edwards says.

"It does lead you to question your model and your fundamentals and the way you do things.

"Our funds performed very poorly last year and we are very conscious of that. Some of this was due to market factors but also to some bad decisions. Diversification also did not work for us.

"But we believe it was an extraordinary event, rather than the model is bust. One of the things that helped us was the fact we had worked together for nearly 15 years and we could work through the difficult period."

The managers' faith in their convictions has already begun to pay off, with the Balanced Income fund beating its sector in 2009 and Balanced Growth top quartile this year.

"Thankfully, we held our nerve and we added to those positions that had been very painful," Borrows says.

"It was the time when you could more or less name your price for these assets and the market price was not at all relevant. If somebody needed to sell it, you could bid 50% below the market price and it was yours.

"But the recovery has come pretty much across the board, throughout the portfolio. It has not been reliant on just equities, in fact we have been slightly cautious on the equity side."

While the funds have bounced back strongly, the duo are not naïve enough to believe fund managers cannot learn lessons from a period of underperformance.

"During the downturn we did not have enough cash in the portfolios and we did not have enough gilts. The true diversification across the portfolio, which normally cushions the portfolio from any major falls, did not really help last year," Edwards says.

"The level of contagion across asset classes was very painful. It was particularly painful for us because of several factors, but I think the key factor that led to our underperformance was we had too much in the closed-ended area. We got a triple whammy on the way down from both conventional investment trusts and the AIM-listed vehicles."

One mistake unlikely to be repeated by the pair can be found in the overuse of closed-ended funds.

"Price dislocation from NAV really opened up significantly to levels that I have not seen in 25 years of investing. And I think we underestimated that quite badly," Edwards says.

Borrows adds: "Quite a lot of those assets performed reasonably well in the circumstances. Unfortunately, the vehicles they were sitting in came under intense pressure from investors such as hedge funds and long-only investors were having to liquidate their portfolios.

"At every point you thought this could not possibly get any cheaper and you did a little bit of buying. Then you found that a week later, you were 10% on the wrong side, or even more."

Borrows says the vehicles had upwards of a quarter in closed-ended vehicles which he believes with hindsight was far too large an exposure.

"There are some assets it would actually be quite difficult for us to participate in unless we went through closed-ended products," he says.

"A lesson learnt is not to get caught with such large positions. I think between 5% and 10% is the right level. I think we would reserve the closed-ended element for those investments.

"While some positions fell sharply, there is still a lot of value left in some things we hold, although I do not think we can assume they are going to trade at net asset value. But they are trading on 40% or 50% discounts still."

Redemptions

One of the by-products of poor performance is redemptions, with the Midas funds experiencing consistent outflows. However, Edwards says the redemptions were considerably less than feared.

"There has been a steady period, probably eight months now, of redemptions, but we are starting to see towards the bottom," he says.

"This is because the year-to-date numbers are very strong on the funds, albeit the medium term numbers still need a lot of work.

"But interestingly, if you take the Growth fund, one of the strongest relative performances ever has been during the last six to nine months. This has been a period when we have had fairly heavy redemptions.

"The question of how have we been managing outflows is in there."

Another factor which must be considered during this period is Midas Capital's corporate situation. Midas was forced to enter discussions with its bank earlier in the year after breaching debt covenants. The distraction was particularly evident for former group CEO Edwards, who relinquished the role earlier in the year.

"Having gone through the New Star situation late last year, investors were rightly nervous," Edwards says.

"We worked with HBOS through the first quarter and came to a very satisfactory restructuring proposal and finalisation. The banking situation now is very stable.

"The group is highly profitable across its divisions and there is absolutely no issue with cash flow, interest cover or any of the covenants. The bank has been very supportive and so have the major shareholders.

"I was group chief executive for a while and there was a degree of distraction for me as a fund manager. I gave that up when we had finalised the restructuring. Now all I do now is manage money. My life expectancy has probably gone up a few years as a result of that."

With corporate issues resolved, the managers are focused on continuing the strong 2009 turnaround story. Both the Growth and Income vehicle have stayed almost fully invested, but there is a deliberate avoidance of gilts.

"We think there is a bubble in the gilt market," Edwards says. "We think the fiscal position looks pretty horrible in the UK and most other major developed countries.

"We think obviously the monetary authorities and the government have been very focused on reviving the patient and very focused on growth as opposed to perhaps long term inflation control. There is no real inflation impact at the moment but we think further out, it is going to start to rear its head again."

However, the managers are more bullish on the equity markets.

"There is still a lot of liquidity sitting on the sidelines, both through fund managers and private individuals that could be committed to the market and is being committed. Risk is being taken on board again by investors," Borrows says. "The risk free end of the spectrum looks pretty unattractive."

Borrows' Income fund has also recently seen its first property position in almost three years.

"We think the property market for the first time in a while looks interesting," Borrows says. "I have just put my first toe in the water in an open-ended fund, the SWIP Property fund. I would be very reluctant to go through the closed-ended route again."

Renewed optimisim

After negotiating one of the most tumultuous market periods in history and a degree of corporate uncertainty, there is no doubt Edwards and Borrows are looking to 2010 with a renewed optimism.

"We are very focused on continuing to build on this clawback in performance this year. We would like to think we are back on track now in terms of performance and building back the medium and long term track record," Edwards says.

"Most importantly, while we have performed well this year, we think there is still a lot of genuine value left in the funds."

Borrows adds: "All the team is still there, nobody has left, nobody has either wanted to leave or been forced to leave. It is very much the team that created the good long-term track record, which is still very much focused on getting back to where we know our investors want us to be."