Barclays seeks edge from b2

Rivals unlikely to match risk-free investment vehicle

SAN FRANCISCO is known for its chilly summers, and the summer of 1987 was certainly a frosty one in office of Wells Fargo Nikko Asset Management, which overlooks San Francisco Bay.

Its innovative method for managing institutional funds - the so-called quantitative approach - was removing clients' money from the stock market, and clients were furious because the market was soaring.

Then on 19 October the market crashed and Wells Fargo Nikko was a hero. The company's funds, which had under-performed the benchmark measure by 60 per cent in the first eight months of the year, ended the year with an outperformance of 73 per cent.

Eleven years later, Barclays is relying on this quantitative approach to fund management to support b2, the new product designed to reassure investors that their savings can be invested in the stock market with virtually no downside risk.

Barclays bought Wells Fargo Nikko in 1995 and merged it with its own asset managers to form Barclays Global Investors or BGI, now the world's largest institutional fund manager with $530bn (pounds 320bn) under management. It will manage funds for b2.

"What we're trying to do is use technology to make our job easier," said Lindsay Tomlinson, BGI's chief executive for Europe, in his London office overlooking the Thames. "For most of our competitors, there has been new technology but overall the way they do things is still the same."

The b2 scheme, whose Caribbean beach advertisements are already adorning televisions and billboards across the country, offers the ease of a bank savings account and exposure to the UK stock market - while guaranteeing that its depositors will receive at least 100 per cent of their deposit at the end of a fixed period.

Meanwhile, as BGI manages b2 funds, another arm of the bank, Barclays Capital, the fixed-income and derivatives unit, will undertake a series of hedges to ensure it is protected against a sudden market drop.

Whereas traditional asset management uses fund managers to pick stocks and assemble portfolios, the quantitative approach uses a model that resembles the main stock market index with extra strong weightings in certain sectors or companies.

"I've been over there and I've seen the system, and it really is very impressive," Peter Jeffreys, managing director of Standard & Poor's Fund Research, said of the San Francisco operation. "It's practised by people with tremendous academic qualifications, and they've worked closely with the universities to develop it."

The system is designed to outperform a tracker fund - which matches rises or falls in a given index - and Mr Tomlinson of Barclays said the aim is to exceed each index's returns by 1 percentage point a year.

In the UK, BGI has produced returns of 19.9 per cent annually over the last five years, compared with 16.6 per cent for the FT-SE 100 Share index and 16.3 per cent for the WM Company's average of all UK equity funds.

In the US, BGI has returned 20 per cent annually, compared with 17.8 per cent for a composite of the Dow Jones and the S&P 500, and 16.9 per cent for the WM Company's average.

Mr Tomlinson, who has been with Barclays for 11 years, said the human part of BGI's fund management comes in devising a model that works - and constantly testing and adapting it to make sure it is still valid. BGI employs 25 researchers to investigate the stocks and feed their data into the models to update them constantly. "The object is to find something that is theoretically sound and works in practice."

He added that care must be taken in analysing the findings, because "there's tremendous danger that you torture the data until it confesses." BGI begins by assembling a basket of stocks that resembles the index and then looks to increase the proportion of companies with strong potential.

First, it examines the companies' fundamentals, taking into consideration such ratios as price-to-book value, price-to-earnings and yield. It was the widening gap between equity and bond yields that signalled the danger for equities in the summer of 1987.

BGI then compiles recommendations from 4,500 analysts around the world, and uses computers to calculate whether they recommend, on balance, buying or selling a stock. Mr Tomlinson said the company places a lot of emphasis on this stage.

It finally examines the company's public disclosures that may indicate the directors' thinking, such as whether directors are buying the shares.

Mr Jeffreys at S&P said the one weakness of the system is that if the index itself is inherently risky - that is, if the shares are overpriced - the GPI system may take on some of that risk whereas a traditional fund manager would have more discretion in moving out of the market.

b2 takes depositors' money and invests 86.2 per cent of it - this percentage is adjusted every quarter, depending on market volatility. The investor gets to keep all the return on the portion given to BGI, minus a 1.5 per cent annual fee.

The remaining 13.8 per cent is used to invest in options to hedge against a loss. Barclays makes money placing these options. Eventually b2 will require thousands of options to be written to protect against a fall.

b2 executives believe it will be difficult for competitors to imitate the product, which will give Barclays an edge in the scramble for long- term investments.

"My hunch is that it means a lot to be first in this market," said Martin Taylor, Barclays chief executive. "People will find that this is not easy to copy."