Back in 1986, when Downing began life as a two-man band in the attic room of a house near London’s Victoria station, ‘top down responsibility’ was perhaps more likely to refer to whose turn it was to go out to buy lunch. Talking to chief executive Tony McGing, who himself joined the investment manager back in 1992, it comes up in the context of the culture of the business he has helped grow from 10 to more than 150 people today.
“For us, from those first days right up to now, it has always come back to doing the right thing,” he says. “If you put your customers ahead of your own interests from the top of the business down, then your staff will follow that example. Alongside that, our culture has always been about being enterprising, and originally, when it was only a few of us, that meant being a thorn in the side of the big guys.”
Back in the late 1980s and early 1990s, when Downing ran Business Expansion Schemes – a forerunner of the Enterprise Investment Schemes (EIS) that are a key focus of its tax-efficient investing arm – it meant the likes of Close Brothers and Johnson Fry were its competitors. Two significant hires – and accompanying fund launches – this year signal the business’s intentions to poke the “big guys” of asset management too.
In quick succession over late March and early April, Downing launched the Unique Opportunities fund for manager Rosemary Banyard, who had built up a formidable reputation in smaller companies investing during two decades working at Schroders, and the Global Investors fund for Anthony Eaton, who oversaw the Global Opportunities portfolio at JM Finn for 15 years.
“The arrival of two such big names is probably giving us more publicity than we have been used to receiving, but steadily building the asset management division has actually been part of our strategy since Judith Mackenzie joined us in 2009 to head up that part of the business,” says McGing, before underlining the prudence of diversifying into non tax-based investments.
“Our specialisations in venture capital trusts, EIS and inheritance tax-planning means we are more at risk should the UK government feel short of cash and decide to remove some of the tax reliefs in those areas,” he points out. “Raising funds in non tax-based areas has become more important and that has increased the focus on our Downing Fund Managers arm.
“So now we are being enterprising by having in place the right infrastructure to provide us with a platform to launch new businesses and new products, and to bring in high-calibre fund managers. Furthermore, because we are a partnership and so in that sense do not have any investors, we don’t have to do anything we don’t want to do when it comes to running the business.
“If something is going to reduce our profits in the near term, it does not matter so long as we are investing for the company’s future – we can take a longer-term view, which is what we are doing on the asset management side.”
The partnership structure also provides a degree of insulation from the attentions of other groups – a trend that had been increasingly in evidence before the Covid-19 pandemic struck.
“We can still be acquired and we could acquire,” McGing acknowledges. “However, it is easier for a listed company to do, as it can give out shares in the business. To be honest, I do not follow that market so much and we are not looking to be involved in any M&A activity. We prefer to paddle our own canoe, bringing in individual people rather than buying businesses. We are more organic than acquisitive.”
Tax-efficient roots
Downing’s roots in tax-efficient investing appear to have influenced the business’s thinking on everything from service and value for money to asset allocation and ESG, not to mention regulation and liquidity (see boxes). “We have always had strong sales and sales support teams,” asserts McGing. “It is one of the reasons people come to us, and why we have two new fund managers coming in.
“Distribution and servicing advisers is so important. More than 90% of our business has always been through advisers and we have maintained the same-sized sales team over many years. It also stems from offering more complex products. If you are selling VCTs and EIS and you are dealing with top-end IFAs giving a lot of tax-based advice, then you need to be offering them a high level of sales support.”
The gap between the fee structures of tax-efficient investments and public equity funds has widened in recent years, with annual management fees of 2% not uncommon with the former, whereas asset managers tend no longer to charge half that. “We find it a bit odd when we are charging what seem to be higher fees on the venture capital side of the business and lower fees on the asset management side,” observes McGing.
“There is a lot more research and due diligence to be done with venture capital funds, which can justify the higher level of fees. It has been the same on our asset management side, where we have focused pretty much on microcap funds and, again, we will be investing quite small amounts and doing due diligence over maybe six months. That will be very different from a bigger group with bigger amounts under management.
“I believe we do provide something different. If you look at our income fund, for example, it is small and midcap-based, and so does not overlap with many other income funds, while Rosemary’s and Anthony’s funds will also be very different from their competitors. To justify your fees, you have to be doing something a bit different and then hopefully outperforming. If you are one of many doing the same thing, though, it is harder.”
Downing may be diversifying into asset management but, given its ongoing operations in the tax-efficient space, it is not surprising to learn McGing believes private investors – and, by implication, their advisers – themselves need to be diversifying beyond more traditional asset classes. “Venture capital is too small a part of most people’s portfolios in this country – especially compared with investors in the US,” he says.
“The UK government has put some great tax reliefs in place with VCTs and EIS so that really should be a consideration for any portfolio. We also see renewables, energy and infrastructure as very important, together that accounts for 25% or 30% of our funds under management. It is an area we are still looking at and where we may launch some public funds, though, at the moment, we are all in private funds.”
On purpose
It is a short step from talk of renewables to the key issue of ESG, so how does this figure in Downing’s strategic thinking?
“We actually set off on an exercise to think about Downing’s purpose last year, and initially we struggled a little because it has changed over the years,” says McGing. “After all, starting off as a two-man band is very different from when you grow to 150 people.
“As a starting point, we decided to look back at what we had been investing in, and, back in the BES days, we did a lot of work with House The Homeless and the Peabody Trust housing association. Now we are investing in lots of early-stage start-ups and SMEs, and, as I said, renewable energy. We also invest a lot in healthcare and care homes.
“While we have not necessarily set out to invest in businesses that have a positive impact on society, it just so happens that is what we have done, it has been more of an instinctive thing. So we have taken that on board, and, from last year, started to work on putting in place an ESG framework and focusing much more on the impacts of what we are doing and where we are investing.
“We signed up to the UN’s Principles for Responsible Investment last year and, over all, this move has been really well received by staff. So ESG is a big part of who we are and what we do going forward. We have been working on it for quite a while behind the scenes but we really wanted to put our own house in order before we started preaching externally.”
If McGing was trying a spot of neuro-linguistic programming – or perhaps the Jedi mind trick – it has worked: so what has he concluded Downing’s purpose to be?
“It is to make investment more rewarding,” he replies. “Both in terms of profitability and impact. We need to focus on the impact we are making while ensuring that, by investing in sustainable businesses, returns are not compromised but, in fact, enhanced.
“That does not mean everything we do will have a positive impact, but nothing should have a negative impact. We have never invested in tobacco or fossil fuels, for example, and never will, that goes without saying. If ESG is going to become mainstream, which it is, investors will not compromise on returns, and I think that is the difference between ethical investing back in the day and how things are now.”
Pandemic ‘stress test’
Finally, how has the Covid-19 pandemic affected Downing’s short-term thinking and longer-run outlook?
“In the short term, we quickly shut down before the lockdown was imposed to protect our people,” McGing replies. “There now seem to be two camps, half our staff seem to enjoy working from home and the other half miss the office. So we are putting support mechanisms in place for them, external talks, buddy systems and so on.
“In terms of assets under management, as of late April, we had probably lost just under 10%, which I would say is reasonable compared with others. We are probably in quite a strong position since, because of the tax-based nature of a lot of our funds, people do not want to withdraw money, and so lose the tax relief. That has helped to shield the business to some extent.”
With due respect to all the human and economic suffering Covid-19 has caused, McGing is pragmatic enough to acknowledge this has not necessarily been a bad time to launch two new funds.
“Rosemary and Anthony have both been able to come in knowing they have no legacy holdings and with an awareness of the effects the virus has had on particular sectors,” he says.
“Also, if you take a longer-term view, starting with 100% cash has offered them the opportunity to phase all their money into the market. As for our other portfolios, the market falls have acted as a kind of stress test. For example, we have some capital preservation funds in our estate-planning range that have only fallen around 4% in the period, and we also have quite a lot of liquidity across them.
“So, in pure investment terms, this has been decent test for us. Longer term, however, this is really difficult to call. The business has a good level of recurring revenues and quite sticky money on the tax side, but prudence will be absolutely key. When we assess our underlying investments, it is all about ‘survivability’, and I think we have some great survivability credentials within Downing because of the type of business we are.”
A lesson from the EIS world
“Does everyone pause before answering that question?” asks Tony McGing a few seconds after I wonder if he believes there is too much or even too little regulation in the financial services sector. “Certainly I would not like to see any more regulation brought in, although, in general, I would say the FCA has done a reasonable job over the years and has grown more proactive over time.
“Still, we have probably now reached the point where I would like to see it being pushed back again, with the FCA focusing more on self-regulation while supporting firms to do the right thing.” To illustrate his point, McGing highlights the example of the EIS sector, where firms seeking funding can apply to HM Revenue & Customs for ‘advance assurance’ that the money being raised is eligible for tax relief.
“It would be sensible if the FCA did something similar,” he reasons. “So, an environment where there was more self-regulation, but, if they needed to, businesses could go to the regulator and receive more certainty on something in advance. At the moment, if you go to the FCA, you will not generally obtain any kind of opinion at all, and you end up having to rely on your own advisers.
“And then, when perhaps something that was common practice at the time may look a bit stupid a decade later, hindsight can end up coming into the equation. I would like a system of greater self-regulation alongside formal opinions that financial businesses could rely on, and, if the FCA chose to outsource that to law firms, I reckon we would all happily pay for it.”
Changes and catalysts
Given the business’s historic focus on small – often very small – companies, what work has Downing done in relation to the sort of liquidity and governance concerns that have reasserted themselves in investors’ thinking in recent years? “On the venture side, it all works pretty well,” says McGing. “VCTs, for example, have to be 80% qualifying, so there is always 20% of liquidity.
“What is more, investors lose their tax relief if they sell within five years and, as people are not really going be selling, liquidity tends to be less of an issue. EIS investors also have to adopt a longer timeframe, and it is similar with our inheritance tax funds. Once investors in those have lived two years, they will lose their tax relief if they sell out.”
When it comes to its public equity funds, Downing makes a point of stressing that investors need to be taking a longer-term view of five to seven years. “I believe we have done a reasonable job in getting investors on board who understand what we do,” says McGing. “In turn that should make it easier through this current period, as long as you are communicating with them. And it is all about that communication.”
As for governance, McGing notes Downing has helped bring about board changes in around half the holdings across the firm’s micro-cap strategies. “That shows you how engaged we are with the governance aspect of the underlying businesses we are investing in,” he says. “We are actually helping put in place changes and catalysts that will hopefully drive long-term returns while also reassuring investors we are not just along for the ride.”
QUICKFIRE Q&A
What is the best piece of advice you have ever been given?
Life is too short, so work with people you like and trust.
What is your ‘top tip’ for professional managers to help them run a better business?
Hire the best people, then empower them.
What single issue should most concern professional investors at present?
I am struggling to look past the economic and political impacts of the coronavirus.
Does anything about your job keep you awake at night?
Nothing keeps me awake at night, but, during daytime hours, my main concern is looking after our investors.
And what most excites you about your job?
Using our infrastructure to launch new products and new business areas.
If you were head of the FCA for a day, what’s the first thing you would do?
I would hunt out the best and most driven young talent in the organisation and set them the task of coming up with plans to change regulation for the better.
And what advice would you give to someone starting out in investment today?
You never stop learning, so aim to work for, and learn from, the best people in the industry.
